Every time I write about house prices, people ask why it matters if prices fall. After all, they’re far too high. So the lower they go and the faster they hit bottom the better – right? Yes and no.
There is no fighting with mean reversion and, bar a few speculators, we all want housing to be affordable. The problem is not with the end result of house price falls – it’s in what happens along the way.
In no other country are house prices so closely linked to economic performance. An OECD study a few years ago showed that, between 1971 and 2002, every 1% change in the value of British housing stock led to a 0.7% change in consumer spending. A strong economy creates higher house prices via rising incomes and falling unemployment. But in Britain, higher house prices themselves make the economy look even stronger.
In 2003, we felt so confident in our housing wealth that we took equity out of our homes to the tune of around 9% of our total disposable income. Even in 2007 we were still taking out 6% or so. Then we spent it.
Mortgage equity withdrawal (MEW) was a key driver of economic growth during the Blair years. Rising house prices also fed the wealth effect. If you thought you’d just made £50,000 on your house, you’d happily run up more credit-card debt than you could repay from income alone.
But all this works the other way around too. MEW is now running at the equivalent of -2% of disposable income. People aren’t borrowing money to spend. Instead, they’re saving money and repaying what they can off their mortgages. And as the economy deteriorates and prospects for house prices worsen, the wealth effect is turning negative too.
Much of the stimulus that caused our feeble 0.3% rise in GDP in the last quarter of 2009 has been withdrawn. The stamp duty holiday is over, VAT is back up, hiring freezes are in place – and everyone knows there is more to come. Taxes will rise in April and again when our new government arrives. Public-sector cuts will have to be savage so unemployment will rise. All this will make us feel miserable and less keen to borrow and spend. It’s as nasty a cycle on the way down as it was exciting on the way up.
When the financial crisis first began, pundits (myself included) avoided answering the question of what we would do if we were in charge by telling the old joke about how we “wouldn’t start from here”, and desperately hoping our time was up before the polite laughter ended. The joke is more apt than ever when it comes to housing. We all want to end up in the right place – somewhere where property is correctly priced relative to the past – but we really wish we weren’t starting from here. Affordable houses are good. Falling house prices are bad.