Sunday, 18 October 2009
Understanding housing property crashes
May 02, 2008
Are house prices heading for a 1990s-style crash?
At moments of crisis we turn to history to provide guidance to what lies ahead. With the housing market taking a turn for the worst, it is unsurprising that parallels are being drawn between the darkening conditions now and the last time price falls blighted the land in the early 1990s. We have taken a look at some of the key crash triggers then and now to assess what lies ahead for homeowners.
How bad was it in the early nineties?
House prices fell by 20 per cent between 1990 and 1993, according to the Nationwide building society, and 12 - 13 per cent on the Halifax and government measures. By 1995, they had dropped 30 per cent to 40 per cent in "real" or inflation adjusted terms.
Over the 1990-95 period 345,000 homes were repossessed and at least 2m households fell into negative equity, where the value of the property was worth less than their mortgage. It took until the late 1990s before the housing crisis came to an end.
How do conditions compare now?
Then: In the late 1980s the ratio of house prices relative to income leapt from about 3.5 times to nearly five times in a number of years making it difficult for first time buyers to enter the market.
Now: House prices are at even higher levels relative to incomes. The average home now costs 5.66 times average earnings, according to Halifax, and in the south-east of England the ratio is as high as seven times.
Verdict: A high price-to-earnings ratio is one of the principal reasons why a growing number of economists believe house prices have much further to fall. David Blanchflower, a member of the Monetary Policy Committee(MPC), which sets interest rates, says that house prices may have to drop by as much as one third for house prices-to-earnings ratios to be restored to sustainable levels.
Then: Interest rates were close to 10 per cent for most of the 1980s and at the end of 1989 they jumped to a terrifying 14.875 per cent. Even though the economy went into recession in the early 1990s high inflation means that rates couldn't be cut dramatically. Inflation, as measured by the Retail Prices Index (RPI) reached a high of 10.9 per cent towards the end of 1990.
These high interest rates proved crippling for homeowners.Confidence only began to return after the RPI fell back to less than four per cent and interest rates were cut to just over six per cent in 1995.
Now: Even though inflation is a problem - the RPI is 3.8 per cent, which is higher than the Bank of England would like - prices are rising at a much slower pace giving the authorities much more room for manoeuvre. The MPC has cut rates three times since last December - from 5.75 per cent to five per cent.
Verdict: Interest rates are nowhere near the problem they were at the end of the 1980s which is why some commentators, such as Martin Ellis, chief economist at Halifax, thinks a 1990s-style crash is unlikely.
Then: A leap in mortgage rates at the end of the 1980s was one of the principal triggers for the house prices slump. In 1987 the average building society offered homeloans charging a rate of 10.3 per cent. By 1989 the typical rate had jumped to 14.4 per cent, adding about £200 to the monthly bill on a typical £70,000 home. That's the equivalent of about £360 a month, or £4,320 a year, in today's money.
Now: Mortgage rates for new borrowers have jumped significantly over the past year as the credit crisis has struck, creating a payment shock for more than a million people. Homeowners who took out a typical two-year fix of about 4.5 per cent in 2006 face a repayment shock of about £200 a month - £2,400 a year - on a £200,000 loan, assuming they take the average two-year fix of six per cent.
Although this is a smaller jump than in the 1990s many households are hurting, especially as higher mortgage repayments have been coupled with a jump in energy and food bills. People have more debt on credit cards and loans than in the 1990s.
Banks and building socieities have also made it more difficult for borrowers by tightening their lending criteria: for example, reserving their best deals for people with a 25 per cent deposit or the same amount of equity in their home.
Verdict: It's bad, but not for everyone. More than 5m borrowers with mortgages that follow the Bank of England base rate have benefited from a drop in payments since December.
The mortgage hikes have been sparked by the crisis that has hit the financial markets worldwide. The Bank of England, in its latest Financial Stability Review, suggests that the worst of the financial crisis, may be over. If so, homeloan rates could start to fall in the next few months. Borrowers will be praying it is right.
Then: As the UK's economy plunged into recession the unemployment rate leapt to nearly 3m, shattering confidence and meaning hundreds of thousands were suddenly unable to meet their mortgage bills.
Now: Unemployment is at its lowest since the 1970s. Latest figures put the number out of work at 843,000, although there have been some worrying signs that it is beginning to pick up.
Verdict: Fears of an economic downturn, and even a recession, mean that even though the unemployment rate is low there are concerns that the jobs market will deteriorate. A sudden jump in redundancies could shatter already frayed nerves. However, unless there is a big leap in jobless numbers the impact is likely to be only short term.
Then: The seeds of the downturn were sown when Nigel Lawson, chancellor of the exchequer, cut the amount of tax relief allowed on mortgages in his 1988 budget. He made a fatal mistake by announcing a five-month delay before the tax relief cut came into effect. People rushed to take advantage of the relief while it lasted, creating a borrowing frenzy and a house price bubble: prices nationally rose 34 per cent over the course of 1988 and in some parts of the south east they jumped by 50 per cent. When interest rates started to rise the bubble burst.
Now: Stamp duty remains a turnoff for buyers who are nervous about moving up the property ladder but there hasn't been a comparable tax trigger this time round.
Verdict: Chancellors have learnt from Lawson's mistake. Nowadays controversial decisions are introduced immediately
So what is in store?
A lot depends on whether the Bank of England is right and the worst of the credit crisis is over. If it is, mortgage rates start to fall and an economic downturn isn't severe price falls should be in single digits.
It it is wrong, and the crisis continues, confidence will continue to deteriorate and prices could continue to fall for years. Yolanda Barnes, residential research director at Savills, an estate agent, forecasts a 25 per cent decrease by the end of 2009 if the credit crunch continues.