Vericool Finance

On the principle that even a broken watch tells the right time twice a day, those who predict a house price crash will one day be proved right. Has that time now arrived?

Property data is notoriously contradictory, but the majority of signals are pointing downward, and nervous eyes are being cast across the Atlantic where prices in some areas are in freefall. Notwithstanding the grim forecasts of www.housepricecrash.co.uk (no prizes for guessing its views), such an apocalyptic scenario remains unlikely in Britain, though the market is certainly slowing.

A good thing, too. Falling affordability is a social problem for millions. Ultimately, the economic fallout from a continuation of that scenario would be far more damaging than any nasty short-term shock. So far, so much like 2005, when property growth slowed only to accelerate again. But with interest rates substantially higher and prices even more stretched relative to incomes, the outcome may be very different.

The argument routinely used to justify Britain’s high property values is the shortage of supply. But because prices are now so inflated, a change in the psycology of marginal buyers – investors and new homeowners – could cause a large swing in the market.

We may not have yet reached a tipping point, but when it comes, the results are likely to be dramatic. Over the past decade, there has been a profound motivational shift in Britain: partly because of lost confidence in pensions, real estate has become the ultimate reserve currency. Buyers are not just seeking accommodation, but an investment.

It follows that if property begins to appear a sluggish investment… there will be an accelerating exit.

There are already some pretty horrible stories coming out of the buy-to-let market, particularly in former hotspots such as Manchester, where rent yields on new developments are less than monthly mortgage obligations, and property prices are falling.

The Council of Mortgage Lenders is lobbying for greater state support. There may be little sympathy for buyers in this predicament; but time will show that many have been ripped off by unscrupulous developers and banks.

No one accuses the victims of share mis-selling scandals of being greedy and foolish. Perhaps it’s time we took the same view of the ever-growing number of ruined lives that the buy-to-let collapse will leave in its wake.

Osama bin Laden has never been thought of as much of a market guy, yet there he was on TV issuing dire pronouncements about the state of the US economy. If the US sub prime mortgage crisis has reached the inner sanctums of the al-Qa’eda leadership bunker, you know it must be pretty serious.

Bin Laden’s timing was impeccable. On the day he released his video, the US government released a set of employment statistics that were a bigger horror show than even the terrorist leader’s ramblings. The number of non-farm jobs was expected to rise by 120,000 in August; instead they fell by 4,000: the first such fall in four years.

The figures are consistent with a sharp slowdown and while recession is not inevitable, perhaps not even probable, it just got significantly more possible.

The normally tight-lipped governors of the US Federal Reserve have embarked on an unprecedented information exercise, criss-crossing America to convince businesses and consumers that the mortgage meltdown is under control. An interest rate cut is seen as inevitable and some expect the Fed to shave off half a point – a clear sign of the seriousness of the situation.

Forget the talk of moral hazard – that cutting rates rewards the risky behaviour that caused the crisis. Inaction on those grounds would be like a doctor refusing to treat a heart-attack patient because of his bad diet. The worry now, given that it takes 18 months for a rate cut to have an effect, is that the move comes too late: the OECD has already reduced its forecast for US growth this year to 1.9%.

It is to the US consumer that central banks will be looking. If consumers feel poorer, it will weigh heavily on the US economy – and perhaps the world. But so far there’s little evidence that weakness in the housing market is dragging down the rest of the economy, and given the size of the US workforce, it’s a mystery why the loss of 4,000 jobs should presage a recession; the clear danger is that America ends up talking itself into one.

It’s certainly true that many more recessions have been predicted than have occurred. Yet house prices are falling at an annual rate of 4% – an event not seen since the Great Depression – and the downward trend is accelerating. Ultimately, one fact stands out on its own: Over the past half century, every US housing downturn as sharp as the current one has translated into recession.

The Government’s humiliating climb-down on Home Information Packs, which were due to come into effect on 1 June, has left the housing market in chaos. The packs – comprising title deeds, details of recent planning decisions, local searches and an Energy Performance Certificate issued by an authorised assessor – are the result of ten years’ work by Labour policy-makers.

Designed to streamline the house-selling process and encourage lower domestic carbon emissions, they could cost the seller between £300 and £600, depending on the size of the home and location.

But the scheme has already been watered down once in a panic decision to remove one significant item, the Home Condition Report, from the bundle. Now a court ruling that the Royal Institution of Chartered Surveyors has an apparently arguable claim not to have been properly consulted has forced the minister in charge, Ruth Kelly, to defer the start to 1 August, and then only for houses with four bedrooms or more.

Kelly’s allies have let it be known that her junior, Yvette Cooper was the prime engine behind the packs, while Cooper’s friends point the finger at Kelly – who claims the packs should be operating for all house sales by the end of the year. But, the policy is widely said to be dead in the water, and likely to be dropped by Gordon Brown.

That certainly won’t hurt house sales, but it’s bad news for the 5,700 people who have spent nearly £60m of their own money in training courses to become energy assessors under the scheme, and are now thinking of suing the Government for their losses.

But, the real sadness of the story is that the way people buy homes in England and Wales would clearly benefit from the introduction of certainty early on in the transaction – which is just what HIPs were intended to achieve.

It matters that the home-buying process improves. It’s a good idea to encourage homeowners to make their houses more energy efficient. Neither of these worthwhile aims can now be achieved with the existing policy. It’s time to knock it down and start again.

Who says London no longer jumps when the bell on Wall Street rings? The time-honoured tradition of looking to the US for direction was seldom more evident recently, than when London markets rocked and rolled on escalating worries about the US sub-prime mortgage crisis.

Sub-prime is an ugly euphemism for often extortionately priced loans taken out by poorer homeowners with low credit ratings. These accounted for 58% of mortgages taken out in the US last year, and many are proving toxic.

A combination of falling house prices and rising interest rates, have seen mortgage foreclosures hit a 37-year high, triggering what some claim as the worst economic crisis to hit the US in years. Whether or not this contagion spreads to the UK property market, we’ll all feel the consequences if the doom-mongers are right that a US slump is just around the corner.

Property prices in America might be slumping, but there’s little sign of a repeat performance in the UK where the resilience of the market – still rising at an annual rate of around 8% – continues to defy the sceptics.

Indeed, a crisis of an entirely different sort seems to be in train. Demand remains so high, and supply so tight, that experts claim the market is grid locked. In parts of London, 80-100 buyers are chasing every property.

Plainly, this situation cannot continue. There comes a point when prices are so high they have no way to go but down, but when will this happen? Nobody knows, but in the absence of a major economic shock, the consensus is still that a mild slowdown is the most likely outcome.

The attitude in Britain is to view the carnage in the States as a foreign story, yet the differences between the two countries aren’t so great. There are sub-prime sales teams at work here too and higher interest rates and rising bills have hit homeowners hard: repossessions jumped 66% last year.

Debtors increasingly have no financial slack to draw upon – particularly the young, who are either priced out of the market, or funding a vast redistribution of wealth between the generations by paying older homeowners extortionate prices for some hutch.

From this perspective, a crash is exactly what we need, but given the vast numbers whose financial security depends on staying out of negative equity, it would clearly be a disaster.

We have allowed ourselves to become far too dependent on the property market and now face a lose-lose situation. Whether prices go up, or down, the consequences are likely to be about as sub-prime as you can imagine.

Nobody wants to be the bearer of bad news – that may be why it’s almost impossible to find a housing market expert who predicts a crash or even a slowdown this year after a 10% rise in 2006. But don’t be misled: there’s increasing nervousness out there, focussed on the likelihood of further interest rate rises and the fact that “affordability” – house prices relative to average incomes – is at an all-time low.

In a Financial Times poll, for example, 11 out of 41 economists described the housing market as suffering from irrational exuberance: that’s not quite the same as predicting doom, but their concern is, at the very least, food for thought.

Then there’s David Miles, chief UK economist at Morgan Stanley, who warned in November that only half the recent growth in house prices could be explained by genuine issues of supply and demand; the rest was due to a “speculative bubble that could be about to burst”.

But those who do predict a crash are wrong – because they’re making two big mistakes. First, they use the wrong measure of affordability: if you look at the ratio of average prices or mortgages to income, houses have indeed become less and less affordable since the mid-Nineties. But if you measure mortgage interest payments against income, houses remain perfectly affordable, especially for first-time buyers. Secondly, doomsters have ignored the laws of supply and demand.

Family breakdown, immigration and the desire of young people to leave home mean that the number of British households is officially predicted to grow by 209,000 a year. But in the past year we built only 164,000 new houses, and until house building catches up with household formation, prices are bound to rise. This may sound blindingly obvious, but apparently it isn’t to a large number of otherwise quite distinguished economists.

So how should we interpret the latest Halifax survey showing an unexpected 1% drop in house prices in December, combined with a prediction by Lombard Street Research that interest rates could rise from 5% to 5.75% this year?

Some people have lost sight of the painful reality that house prices can actually fall. December’s outcome is a useful reminder: with interest rates on the up, the risk is now definitely moving towards the downside.