Lessons from the UK housing crash

It’s time for another trip down memory lane. It’s September 2007 and home prices in London have just started to fall, but are still holding up nationally (see below chart).

UK households are growing increasingly nervous. After embarking on an almighty borrowing binge over the 2000s, as evident by household debt to disposable incomes rising from around 100% in 2000 to nearly 160% (see below chart), finances are stretched, leaving households vulnerable to a deteriorating economy and rising unemployment.

Opinions are divided on the future trajectory of home prices. Industry spokespeople are publicly maintaining the faith, arguing that the underlying strength of the UK economy will ensure that prices, at worst, stagnate as incomes catch-up. By contrast, some analysts are predicting falls of 15% to 40% and a deep recession.

An article published on 12 September 2007 by Money Week’s James Ferguson, entitled Has the house price crash finally begun?, sums up the mood nicely:

If it looks like a duck, walks like a duck, swims like a duck and quacks like a duck, as the old saying goes, it most probably is a duck. The same principle applies to the present house price crash in London. In the last two months, the average house price in London has fallen 5%. In the context of the massive rises in house prices over the last few years this doesn’t sound like much, but consider this: if prices in the capital keep falling at this rate, they will have fallen 30% from their peak by this time next year. And that would look rather like a house price crash. There aren’t many who think this will happen (there are still armies of industry spokesmen out there assuring us that residential property is still a good long-term investment, and that prices will, at worst, just level off and stay flat), but I do think it is time to take the risk seriously…

Unlike last summer, this summer has seen a significant excess of properties coming onto the market compared to those coming off. Not only that, but the number coming off the market is way down on a year ago too…

The question to ask ourselves now is, “What does a property crash look like?” The answer first of all is that it doesn’t look like a stockmarket crash, at least not at first. Property is illiquid, so everything happens in slow motion. Take Rightmove’s price data. This records sellers’ asking prices, not the prices they actually sell at. Indeed, Mira Bar-Hillel, writing in the Evening Standard, quotes Russell Jervis of estate agent Haart as saying, “We have been advising asking-price reductions of 7% to 10%… due to there being fewer buyers.” There are a lot of sellers out there who won’t have been able to bring themselves to do that yet…

Another sign (and this is my favourite) is non-stop industry denial. Property insiders are predicting a gentle slowdown in the UK’s housing market, just as they did in 1989. The Royal Institution of Chartered Surveyors asserts that low rates and low unemployment mean a crash “is not on the horizon”. This, despite the fact that unemployment was also at a decade low in 1990. It didn’t prevent a crash then. In fact, the crash in property and consequent recession were what then sent the unemployment rate up from a ten-year low of 6.8% in 1990 to more than 10% by 1994. To me, the extent of the denial is as good as confirmation…

Most commentators who were bullish earlier in the year are now content to predict flat prices for several years as wages play catch-up…

Analysts who do accept that a crash is likely (those with no vested interest in property) predict price falls of anywhere from 15% to 40%, probably kicked off by the wholesale selling of properties by the buy-to-let investors. But how long will it take? Even some bears such as Roger Bootle of Capital Economics expect the fall in property prices to only last a year or so, since they expect recession to lead to interest rate falls by 2005.

However, once property crashes start they are hard to stop, even with rate cuts. The first half of the 1990s saw rates halved, the cuts starting almost as soon as the property crash got under way, yet prices continued to fall. If it takes the rest of this year for sellers to adjust to the new rules and all of next for them to adjust their asking prices down to the clearing level, it will take at least all of 2007-8 to rally enough buyers to sort things out. If a crash really gets under way, don’t expect it to end before 2008 – at the earliest.

The rest is history:

We all know what happened next. UK home prices fell by 21% over an 18 month period before recovering slightly, and are now 18% lower than at their peak (see below chart). Of course, with inflation having risen 12% since September 2007, the fall in real terms is far greater.

With the fall in home prices, the UK’s highly indebted households felt poorer, eroding consumer confidence and their willingness to spend (the ‘wealth effect’). And with many households moving into negative equity, they had little choice but to tighten their belts and begin the process of debt repayment (‘deleveraging’).

This process, whereby UK households shifted from borrowing/consuming to saving/debt repayment, is illustrated clearly by the below Bank of England chart, which shows home equity withdrawal (HEW) moving from positive to negative in Q2 2008. According to the Bank of England, households have injected £49.7bn into housing equity since the HEW measure turned negative.

The deleveraging process is also evident by the ratio of household debt to disposable income falling from a peak of 161% in Q1 2008 to 149% as at Q1 2010 (see below chart).

With UK households tightening their belts, sectors reliant on consumer spending began to contract and unemployment rose. Consumer confidence continued to fall, leading to ongoing frugality, house price weakness and job losses (see below chart).

Relevance to Australia:

Whilst each housing market is different, there are clear similarities between the UK situation in late 2007 and Australia currently, including:

  • low unemployment (5.2% in the UK; 4.9% in Australia);
  • high levels of household debt (nearly 160% of household disposable income in both countries);
  • low rates of mortgage arrears (click to view chart);
  • substantial supply-side constraints;
  • a significant increase in the number of homes coming onto market;
  • a significant reduction in the volume of sales;
  • discounting by vendors; and
  • constant denial by industry vested interests that the housing market is in trouble.

There were some differences too. The UK housing crash in part developed momentum because its banks were caught in the contagion of the global shadow bank freeze that started in the US. The subsequent credit rationing made everything worse.

As we know, Australia escaped the same fate only through massive government intervention, especially in the shape of the wholesale guarantee.

The point is, however, that it’s never certain what the trigger will be. The only certainty is that so long as valuations and debt levels are so overstretched then a trigger is all it takes.

The most important lesson from the UK experience for prospective housing buyers is that unemployment did not surge until mid-2008 – around a year after house prices began falling. This is similar to what happened in the United States, where house prices fell for a year before unemployment began to rise (click to view chart).

Think about the UK experience the next time a housing industry representative claims that Australia’s housing market is underpinned by sound fundamentals like low unemployment and, as a result, house prices won’t fall.

Then ask yourself: is Australia really that different?

Cheers Leith

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Leith van Onselen

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.

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Comments

  1. You know Leith I just have been emailing a friend of mine in Brisbane who keeps bragging about how great the Aussie housing and economy are going. Australia is going to kick everyones a$$. The sad thing is this is the mindset of almost all Australians. To many people either dont understand the writing on the wall or just choose to ignore it. The Aussie govt on the other hand just chooses to ignore it. I believe Australia as a whole country has gotten way to arrogant. Everyone tells me that ha we avoid the GFC and the US, UK, Europe is all doom and gloom. China is the greatest. I just cant understand why would anyone in their right mind want China to be the world power and control the world currency. I mean look at how they treat their people and look at what they are doing to the currency by devaluing it. I just shake my head at majority of Austrlaians out there as they just dont have a clue or really want to acknowlege the writing on the wall. I am figuring in a year or two majority of Australians will be looking back and thinking how wrong they got it.
    Cheers,
    LBS

    • Australia has enjoyed 20 years of unbroken economic growth. Everytime it looked like the economy was about to crack (2003 & 2008) we’ve been rescued by a resources boom. Our productivity growth (the real driver of improving living standards) has been in the toilet for a decade. Our strong currency rewards the lazy and punishes the hard-working.

      All of this has built up distortions and inefficiencies in our economy, so when the tide turns, it will be savage.

      BTW, I agree with you entirely about anyone wanting China to be a world power. Not just for political reasons, but environmental as well. The have pursued growth at all costs with disastrous consequences for the Chinese environment, but globally as well through a huge increase in coal consumption.

      And guess who wants to sell them a whole lot more coal? Yep, good old Australia.

      • “Our strong currency rewards the lazy and punishes the hard-working”

        What are you smoking? Since when has devaluation of the $ benefited those hard working people who save $?

      • “And guess who wants to sell them a whole lot more coal? Yep, good old Australia”

        We have one of the most environmentally conscious, carbon concerned governments in the world…and a government desperately chasing the bucks
        http://news.smh.com.au/breaking-news-national/good-future-for-coal-under-labor-20110305-1bidi.html

        But more generally, the tide had already begun to turn. Some time ago. We never did move on from being a resource based economy. Not really. We had a few attempts here and there – educator of choice for the expanding affluent Asian market; the MacQ model of M&As, infrastructure development and finance; the Big 4 thinking they were global players – but no, not really. So here we stand, enthusiastic supporters of economic globalization…watching the chickens come home to roost.

        Specialise, specialise has been the economic guru’s mantra – we have and we do – extraction and distribution!

        And what if, just maybe, China pulls it off. Averts a severe contraction in it’s economy – then, as it does right now, our resources sector will continue to be a sector that supports this country whilst we attempt to become a player in another piece of the global pie – just what that would be, I don’t know.

        I’ve linked to this before but still worth a look – Martin Jacques Understanding the Rise of China – maybe it really is different?
        http://www.youtube.com/watch?v=imhUmLtlZpw

        • Oops.

          “We have one of the most environmentally conscious, carbon concerned governments in the world” – sounds like I mean it. I don’t.

      • How does a strong currency punish the hard working? Say the $ was .75, petrol and food would be cheaper?? Am I missing something here????

  2. but the thing is the US, UK people did the same thing a few years back. Now look at their attitudes.

  3. Endrortsonhousing

    You obviously have not considered our marvellous water views; dual income households; low interest rates; the unique qualities of Aussie houses (world’s best housing stock), oh and kangaroos – you completely failed to mention the kangaroos.

  4. Very good points Leith. I was forced to read the Courier Mail (need something to read over brekkie) when I got back to Brisvegas yesterday and like others have said, its definitely a property magazine with a newspaper attached.

    The Matusik article listing 7 reasons why house prices can’t fall (the Usual Suspects) was head shaking reading: the excuses were delusional at best.

    I’ve saved the article for prosperity, like many other quotes ‘acute housing shortages’ from May 2010 rings a bell too.

    • Prince, I refute your assertion that the Courier Mail has a “newspaper” attached. It’s more like a dust cover with print! A collection of poorly researched and loosely tied together facts, opinions and human interest stories. Although that would describe most MSM these days I guess.

    • Prince: save storage space, no need to keep the paper …

      http://matusikmissive.wordpress.com/2011/03/30/basket-case

      1,2,3 are pure “this time is different”

      4, he may have a point if he means “unresponsive supply”. We know how hard it is to measure “undersupply” in times of euphoria. Anyway, Louis Christopher is more realistic about the current Qld oversupply. It shows up, in, say, OESR figures about “number of agents indicating increased demand”.

      5 – he’s just wrong about the timing of unemployment / house price declines, as we’ve seen here often — unemployment lags

      6,7 are not leading indicators of a correction/crash.

      I hear this guy on 612 ABC in Brisbane here sometimes — he’s just mouthing platitudes.

      “Financial crises are things that happen to other people in other countries at other times; crises do not happen to us, here and now.” — Reinhart and Rogoff

  5. In my view we haven’t seen the main meal served … GDP in the western world has peaked for at least 10 years, which will result in a deflationary period for the next 10 years, year on year in a very unfortunate depressing time for all western countries – IMHO.

    Even Obama can’t stop that with his spending frenzy. The US and Fed are desperately trying to inflate their way out of it, but the hole is too big. A simple overlay of births adjusted for immigration overlaid by predictable spending patterns gives you the forecasted GDP. All western countries had birth reductions in the early 1960’s when the pill was introduced, so 47/48 years later we pay as that medical breakthrough sent the birth rates backwards (1962-1975) until it started increasing again in 1976, Y Gen.

    Make no mistake, everything will be re rated – except cash.

    Housing will not escape as unemployment increases steadily – leading to a rush to the exits (housing). Then the ageing population will sell up to support their retirements, adding to the problem.

    Those households that have used their houses as an ATM are in for a serious shock, finding they have little equity in their house when 200K is taken off the top (of a 600K house).

    Look out below, just a question of when Australia is sucked into this enormous deflationary period – “the lost decade” is upon us. The lessons from Japan 1990 – need to be better understood, Japan fell for the same reason (no, not the pill), a massive fall off in births post WW2, with a 44 year lag to peak spending, it was the home market that caused it – GDP sunk and with it – all asset prices.

    Be prepared …

    Phil

  6. The rising cost of household expenses, especially fuel, has stopped dead any growth in the property market.Banks will batten down the hatches and squeeze those with existing debt and make difficult future borrowings. Take banks and mining stocks out of the asx and this gives a clear indication of where we are at.

    • Waz, even without taking the banks and mining stocks out, the asx200 still hasn’t gone up in nominal terms in 5 years.

      Read Steve Keen’s latest piece on the likelihood of future bank prices: I would not want to be holding bank executive options at the moment….(or for the foreseeable future)

      OTM puts on the other hand……

  7. The ‘establishment’ will do everything they can to stop a fall in house prices. In the UK, they reduced the mortgage rate to a bit over 1%, and then the banks relaxed the loan/asset ratio to 125%. This postpones the day of reckoning beyond the next election.

    If the ‘uptick rule’ applies to banking stocks \(i.e. can only sell if the price goes up), it can be adopted for housing as well. As the NSW ALP has shown, never underestimate the stupidity of a desperate government facing electorate defeat.

  8. A real wake-up call for the property bulls. But whatever happens they will find a way to put a positive spin on it.

    • Haha, yeah… I may have lost my investment properties, my house, my wife and im living in a gutter, but im still better than you saver scum! bahahahaha!

      Suck it up spruikers, your day of reckoning in nigh.

  9. It is worth bearing in mind when comparing Australian prices with UK prices on a world stage that the value of the Pound has HALVED!!! compared to $Au since 1999.

    • and to think that the Great British Pound used to be redeemable as 1 troy pound (12 troy ounces) of fine silver i.e. 1 (ancient) GBP would be worth about 480 AUD today. Let’s hope that silver is in a bubble and that the true value of the ancient pound is only about $120 :).

      • In the long run, silver (and gold, and any other commodity) can only really be “worth” what it costs to dig it up out of the ground, plus a reasonable return on the capital invested by miners, plus a risk margin. Anything beyond that is speculation.

        • The GBP is waaaaaay overvalued…what have they got to offer the world besides warm beer and shit food.

          Us Scots should have moved onto a Gaelic dollar… Its all about the peat and kelp farming…. the next boooom!!!

  10. Thanks Leith

    Would be interested to know what the UK Government did when it became apparent that the housing market was starting to slide.

    Given the size of the fall I’m assuming very little – which is kind of surprising given how much pressure would have been coming from vested interests and how it seems a fait accompli that Swanny will probably pull out some housing stimulus as part of the forthcoming budget (while cutting medical research etc…)

    • one thing they’ve done is bring interest rates down to 0.5%. Although I hear that mortgagees are still paying over 4%. The margin for bank profits has widened significantly though. Fun fun. Expect that here too.

      British property is still enormously overpriced even though the house prices have come down a bit and the GBP has plummeted.

      http://rightmove.co.uk/

      UK property prices do appear to have had a small reprieve last year but are heading down again this year.

      http://news.bbc.co.uk/2/shared/spl/hi/in_depth/uk_house_prices/html/houses.stm

      It’s hard to believe that this is still ongoing after almost 4 years since the cracks were starting to show. I wonder when the self-funded retirees hit the streets in protest too?

  11. Having lived through the UK housing crash, and all the media hype beforehand that house prices will never fall because the economy is so strong, it is remarkably similar to Australia today. However the real estate industry here seems to have a higher profile and the vested interests have more power. The culture in the UK is more geared towards saving business (industry and finance), and when prices did start falling, I can’t remember the government doing anything to prop up the housing market (apart from dropping interest rates as a general response to the GFC) – it was too busy sorting out financial crises with Northern Rock, Iceland banks etc. Also the UK media love a crisis, so the housing crash was widely reported once it started happening with typical schadenfraude, whereas here they hate reporting anything bad (unless it is happening overseas).

    • From the few I know in the hack industry here, if you don’t toe the party line, and churn the bank and EA releases, you are likely to find it impact very negatively on your career.

      Hence the opportunity for quality sites like this.

      The UK has a diverse and competitive media, some high quality some not so.

      I have to say,(having lived in both countries for at least a decade) that from my experience, Australia has a much more bully boy/gangsterish/primitive/vested interest approach within many of its institutions.

      Sorry.

      • “”I have to say,(having lived in both countries for at least a decade) that from my experience, Australia has a much more bully boy/gangsterish/primitive/vested interest approach within many of its institutions.
        Sorry.””

        Dont apologise, I am inclined to agree with you – and they should be treated as such, locked up or better yet, lined up against the wall.

      • Yes, it seems we are more American than Pom, much to the chagrin of the average Joe/Bazza.

        A clear sign of this – I literally threw up in my mouth – was the advertisement I saw on TV tonight for the new “Race Around the World:Australia” version.

        This is the end….

  12. Since I moved to Aus, I was struck with the similarity of the housing market here recently to that of the UK in the late 80s. Fortunately being a schoolboy at that time I was able to watch the train wreck from the outside. The previous house price crash in the UK ran from 1989 to around 1996 before prices began to generally improve nationwide. The tax relief on mortgage repayments was reduced in about September 1988 (2 unmarried mortgagees were no longer able to claim twice the relief of a married couple or a single mortgagee). This tax relif was phased out altogether by 1996 or so. There was a huge slow down in construction on top of this when the taxation rules applying to new building work were changed (I believe Oct 1989 or thereabouts). The government appeared to me do little to directly stimulate construction or stabilise house prices in this period. The press tended to focus tended on people, predominantly young first time buyers with negative equity. This probably helped a bearish mania and pushed prices down further.

  13. It’s worth bearing in mind that the UK housing market has not corrected anywhere near as much as the US market. Some think the UK market remains over valued, even at prices 18% off their (nominal) peak.

    Also worth noting that housing was the primary catalyst for the GFC, so it follows that recession and peak unemployment followed the house price falls. Chinese hard landing is unlikely to induce systemic melt down. With any luck, the resources boom will continue to pay the bills while the Aus housing market undergoes its much needed correction. For mine, that’s a best case scenario…and it would mean that the resources boom comes to and end just after the Aus economy has come out of a sharp house price correction. Worst case scenario is it all happens at once!

    I’m also interested in people’s comments about Australian attitudes and business environments. I’m moving back Down Under in the next months, having spent nine years in London. Needless to say, I won’t be buying any AUD just at the moment…!

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