Friday 2 August 2013

UK Residential House Prices - Blowing Another Bubble?

The business secretary Vince Cable warned that the government's Help to Buy scheme may trigger a new house price bubble when he appeared on the Andrew Marr show last Sunday. The man may have a point.

It is easy to understand why the government are meddling: they're trying to provide liquidity to a mortgage market that is being choked off while lenders struggle with new capitalization targets.

Their attempts to stimulate the demand side are typical of an incumbent government trying to curry favour with voters. Rising house prices can inject a feel good factor into the economy. Homeowners feel wealthier and are more likely to spend, hopefully boosting GDP numbers along the way, thus enabling George Osborne to set his face to extremely smug.

Hopefully Mr Osborne won't have forgotten that it was an unbridled housing market that helped get us into this mess in the first place. Whilst some amount of government intervention might be productive, the last thing we need is for house prices to start increasing at rates above wage inflation.

The graph below shows how house prices have fallen in relation to earnings in the years following the financial crisis. This pullback has been healthy; ideally we need this graph to fall further until house prices reach their long run average of 4X earnings. This would set the economy in good stead for interest rate normalization. Arguably the government should be doing more to help increase housing supply, thus easing the chronic housing shortage that we have in the UK, whilst putting more downward pressure on prices relative to earnings. I think the ideal scenario is probably for house prices to remain constant nominally but continue to fall in real terms against wages and inflation.

As an aside I found an interesting graph on  showing the life cycle of a bubble (see below). What stage do you think our housing market is at now? I think maybe we are at the Return to ''normal'' stage, with interest rate normalization eventually pushing us into the fear and capitulation stages. Just a guess.

Lifecycle of a bubble

Source: Jean-Paul Rodrigue - Hofstra University

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