Title: The UK Housing Market: Measured Decline or Total Collapse
1The UK Housing MarketMeasured Decline or Total
Collapse?
- John Muellbauer and Stephen Nickell
- Stated Meeting Seminar
- Nuffield College
- 7th March, 2009
2- What has been happening?
- House prices, house-building, households,
incomes. - Do all the recent changes matter?
- Prospects
- House prices, house-building plans, households.
- The bigger picture.
- Impact on the overall economy.
3What determines house prices?
Basically, the price of houses is fixed at the
level at which the demand for houses today is
equal to the fixed stock available today.
Price
Pt
Demandt
Stockt
Houses
In the recent past, demand has been shifting to
the right more rapidly than the stock (which
moves to the right by around 3/4 per annum).
4So house price inflation depends on how fast
demand rises relative to the available stock.
Price
Pt1
Demandt1
Pt
Demandt
Stockt
Houses
Stockt1
5- Over the short term, house price inflation is
dominated by the speed of the demand shift. Over
twenty years, however, the rise in the stock is
big enough to make a significant difference to
the overall rise in house prices over this
period, and hence to the average rate of house
price inflation. - What are the implications of all this?
6- Typically, the price of houses exceeds, often
substantially, their replacement costs (ie. the
costs of rebuilding). The difference is the
value of the land. - This means that house prices and house price
inflation are, currently, more or less unaffected
by construction costs. Note, current
construction costs impact neither on the demand
for houses nor on the existing stock. - If construction costs go up while house prices
remain unchanged, land prices (ie. the price of
land with planning permission) will fall. - The same argument applies to tariffs or an
infrastructure levy.
7House Price Inflation in the Medium-Term
- Over the medium term, the key to house price
inflation is the rate at which demand (the demand
side) increases relative to the rate at which the
stock increases (the supply side). - The Supply Side
- The rate at which the stock increases is
determined essentially by the planning regime and
the capacity of the house building sector. - The more restrictive and directive is the
planning regime, the lower the rate at which the
housing stock rises and the higher will be the
rate of house price inflation. - Example.
8- What about the policy of cutting stamp duty to
first time buyers (FTBs)? - The key point to recognise is that this can only
help FTBs if the supply of FTB type houses is
higher than it otherwise would be. - Initially the demand for FTB type houses rises
and with constant supply, their price rises by
the amount of the tax cut. So the tax cut goes
straight to the existing owners of FTB houses. - This price will bring forth increased supply only
if keen landowners/house builders can persuade
planners to release more building land.
Unlikely. So aside from some, probably tiny,
composition effects, no other changes will ensue.
9What Determines Demand and Prices?
- Real incomes and the number of households
relative to the number of houses determines the
trend. - Note income elasticity of demand gt price
elasticity. So cet. par., as incomes rise,
prices tend to rise faster than incomes. - Other factors include ease of borrowing,
long-term real interest rates. Ease of borrowing
has been crucial in the last 18 months.
101997 - 2007
- From 1997 to 2006, real house prices more than
doubled. Real earnings increased by around 15. - The ratio of (lower quartile) house prices to
(lower quartile) earnings rose from around 4 in
2000 to over 7 in 2007. - From 1996 to 2001, housebuilding was at a rate of
around 135K per annum, households increased at
around 159K per annum. - From 2001 to 2006, housebuilding was at a rate of
146K per annum, households increased at around
199K per annum. Incidentally, this rate of
housebuilding adds around 1 of England to urban
areas every 20-50 years depending on use of
brownfield/density. - Households are now rising at over 210K. Net
migration represents around one third.
Increasing life expectancy and behavioural
changes continue to lower household size.
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15The Credit Crunch
- The inability of UK mortgage lenders to tap the
still buoyant supply of world savings has
generated severe mortgage rationing to first time
buyers. - So, rapid decline in house prices.
- Squeeze on housebuilders, collapse in housing
investment. - Private rental sector cannot take over.
16Does it Matter?
- As affordability and housing shortage worsens,
more people are pushed into private renting,
forcing up rents. - More people are driven into the already
hard-pressed social renting sector and queues
lengthen. - Deprivation increases and the situation worsens
in already deprived areas. - This affects us all. The economy suffers from
the consequent impediments to labour mobility. - Key workers are unable to find somewhere to live
near where they work. - Increasing quantities of taxpayers money are
required to address these problems. - Housing wealth has risen enormously. Can the
country really be wealthier because we
collectively restrict the supply of building
land?
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20What do Affordability Prospects Look Like? ?
- Household projections suggest that the number of
households in England will grow by an average of
around 223K per annum over the next 20 years.
This rate is significantly higher than in the
recent past. Furthermore, projected growth up to
2020 is even faster at an average of around 230K
per annum. - 168K new homes were completed in 2006-7, fewer
subsequently. - The fact that the rate of completion of new homes
has been well below the rate of formation of new
households means there is a large build-up of
unsatisfied demand. - The evidence suggests that over the long-term, a
1 per cent rise in real incomes raises house
prices by 2 per cent if the housing stock remains
unchanged.
21What do Affordability Prospects Look Like? ?
- Suppose credit conditions return to normality.
- If the housebuilding plans currently embodied in
the draft RSS plans (around 200K p.a.) are
fulfilled, house price to earnings ratios are
likely to rise from around 7 to around 10 over
the next twenty years. - If Green Paper plans (reaching 240K p.a. by 2016,
3m. new homes by 2020) are fulfilled, house price
to earnings ratios are likely to rise to around
9.5 over the next twenty years. This may be
reduced significantly by biasing new homes
towards more expensive regions and even further
by some bias towards larger family homes which
are in shortest supply. - NHPAU projections indicate that a plan to reach
270K new homes p.a. by 2016 would come close to
stabilising affordability in the long run.
22What do Affordability Prospects Look Like? III
- These are long-run scenarios. So does the
current slowdown make any difference? - Not much in the long-term unless elements of
mortgage rationing become permanent. There will
be a temporary slowdown because of severe
mortgage rationing. But as this eases, the
forces of rising incomes and growth in the number
of households will start driving up house prices
again, especially if housebuilding remains
modest.
23Overall Prospects
- Housing will be more affordable if there is
permanent mortgage rationing. - People will not, however, be better housed.
- Instead of high prices locking people out of the
housing market, the mortgage lenders do it
instead. No real improvement.
24Mortgage rationing would reduce prices, but the
level of supply will still impact on
affordability outcomes
For illustrative purposes only
LQ Affordability Ratio
25UK house prices in the global context
- Cameron, Muellbauer, Murphy (2006) basis for
CLGs housing affordability model? - if goldilocks economy of 2006-2007H1 had
continued, UK house prices were only approx 10
overvalued at mid-2007. - But goldilocks economy has collapsed, both at
global and national levels. - What are global prospects?
26Origins of Global Financial Crisis (1)
- Failure of prudential regulation by Fed, BOE/FSA
and pro-cyclicality of Basel II. - Over-leveraged shadow banking system arose partly
to by-pass regulation. - E.g. in 2004 SEC (Securities and Exchange
Commission) caved in to investment bank lobbying
(e.g. GS, Lehman) to reduce capital requirements
on investment banks.
27Why?(2)
- Competitive advantage e.g. in securitization put
pressure on retail banks (e.g. Citi, Bank of
America, Wachovia) to use off-balance sheet
vehicles to by-pass capital adequacy rules. - Distorted reward structure of originators of
financial products and of rating agencies. - Herd behaviour of bankers.
- Poor modelling of risk, espy macro risk short
history based on the Great Moderation period. - E.g. SP decided in 2000 piggy-back mortgages
were no more risky!
28(3) Examples SIVs and CDS
- ?Special investment vehicles were supposedly
off-balance sheet investments by banks, often
very risky and not transparent. - As crisis unfolded, had to be largely brought
back onto bank balance sheets. - Credit default swaps traded between banks and
other financial institutions not on open
markets and not transparent. - Original insurance purpose - but in practice
financial instruments of mass destruction since
they amplified counter-party risk.
29We structured the deal so it wont make any
sense to you.
Source The New Yorker
30Why? (4)
- Globalisation made it possible to spread bad
risks round the globe. - After the Asian Crisis of 1997-8, the Asian
economies built up huge foreign exchange
reserves. Their excess saving kept interest rates
low for Western economies, fuelling credit and
asset bubbles. - Bush administration keen to extend home ownership
- via private debt - to the poor.
31Why? (5)
- US tax regime stimulates desire for debt
unlimited tax relief for mortgages. - Fannie Mae, Freddie Mac, Fed Home Loans system
with implicit govt. backing created illusion of
low risk options for US borrowers. - Walk away option from negative equity in US
encouraged risk-taking by households. - Monetary policy errors in 2002-5 low rates led
to desperate search for yield risky assets!
32Why ?(6)
- Oil and commodity price spikes driven by high
resource-use Asian and other emerging market
growth spurt in 2006-7. - Exacerbated by hedge fund and other speculation.
- Raised inflation and eventually cut real income
growth in industrial economies.
33Why? (7)
- Recent policy errors compounded crisis
- Lehman Bros default.
- Failure by central banks in Europe to respond to
crisis in October and support well co-ordinated
treasuries. See The folly of the central banks
of Europe - http//www.voxeu.org/index.php?qnode/2488
- Initially wrong US bank rescue plan (TARP).
34Household credit channel
- Central to understanding prospects in
Anglo-Saxon economies and how other economies
differ. - Shift in credit supply function e.g. credit
crunch has profound effects not just on level of
house prices and consumption but on how monetary
policy works. - One channel in following chart
35Mortgage and Housing Crisis
Lower Demand for Housing
Lower Capital of Financial Firms
?Home Prices Wealth, Slower Consumption
Less Home Construction
? Counter-Party Risk, Money Bond Mkts Hit
Credit Standards Tightened on All Loans
Slower GDP Growth
36Global Prospects
- All parts of global economy are now in
Keynesian-style demand-deficient recession. - Fiscal and monetary policy solutions are
well-known when inflation is dead. - Belated ECB interest rate and fiscal loosening to
come. - Stuttering recapitalisation of the banking system
is in train, plus son of TARP.
37Prospects contd
- Eurozone policy failures have continued.
- In Nov-Dec. ECB cut interest rates less than fall
in expected inflation. In Feb. kept rate
unchanged, so raising real rate. - German fiscal policy late to grasp coming tidal
wave on Germany hoped to free-ride on
overstretched US fiscal stimulus.
38Blockages to sane policy
- 1. Endemic conceptual/model failure was to omit
household credit channel/financial accelerator
from CB models. - Blockages to unorthodox monetary policy
- or quantitative easing
- 2. Old monetarist fear that printing money is
inflationary even after huge wealth destruction
and excess capacity. - 3. QE is only possible once the policy rate is
close to zero. - 4. Fiscal-monetary co-ordination need for QE.
39Prospects contd
- Current problem is fear as in 1933 in FDR
inaugural. - Great Depression and Japan-style lost decade
could be prevented by sane policy. - One big difference fall in oil and commodity
prices is very good for Western households. - Indebted US and espy UK households helped by
lower interest rates unlike liquid Japanese.
40Long term
- China and other emergers will need new, lower,
domestically oriented growth strategy. - Partial de-globalisation with reduced financial
imbalances. - Smaller financial services industry, lower levels
of leverage, tighter regulation. - Suggests house price/income ratio will revert to
lower trend.
41UK in longer term
- Reduction in size of financial services industry
is negative supply shock. - Saving rate has to be higher than in last decade.
- Government debt will constrain PDI growth.
- Lower value of is helping rebalance economy but
takes time. - Also helps top end of housing market hurt by
collapse of City jobs and bonuses.
42Evidence from Cameron-Muellbauer-Murphy CEPR DP
2006
- Regional hp model based on inverse, solved out
housing demand function. - Given housing stock, long-run income elasticity
of real hp is 1.6, but income growth important in
short run, shifts with Credit Conditions Index. - CCI level effect on long-run real hp.
- Interaction with nominal and real interest rate
credit crunch makes nominal rate matter more,
real less.
43Hp evidence contd
- Strong momentum and downside risk effect last
years appreciation translates into 0.4 for this
years, but negative return in last 3 years is
negative for prices. Explains over-shooting. - Ripple effect from London, and London and SE
sensitive to stock market. Hence UK hp sensitive
to health of financial services.
44- Model attributed most of rise in real hp since
1997 to income and pop growth relative to
stagnant housing stock some to shift in credit
availability and low interest rates. - Speed of adjustment has fallen because of Stamp
Duty rise from 0.35 to 0.2 p.a. - Slow and volatile adj. to long-run equilibrium
all factors except supply side and interest rate
now more negative than last year real income
down credit supply down momentum effect
reversed down-side risk net migration stock
market.
45- Back of the envelope calculations-
- Overvaluation in mid-2007, say -10
- Lower income growth, -6 or worse.
- Reduction in long run credit, -5.
- Lower interest rates, say 2 but could be
better. - Short run dynamics (credit, momentum, downside
risk, income etc.), say -7 or worse.
46- Slow speed of adjustment means that hp could be
away from long-run equilibrium for long periods. - Net effect -26 but could well be worse.
- Much depends on global outcomes.