That’s the question The Economist is asking this week. “House prices have been growing at a breakneck pace in many developed countries. This has encouraged householders to keep spending even during the global slowdown. But now that housing markets are looking soft, consumers may be forced to retrench,” Bagehot’s bible says here .

The Economist’s article starts by looking at the US, but soon declares that risky housing investment is “not just an American folly… while America’s ratio of house prices to rents is 32% higher than its average value from 1975 to 2000, by that metric houses are even more overvalued elsewhere: by at least 60% in Britain, Australia and Spain.”

It’s got a warning: “An IMF study on asset bubbles estimates that 40% of housing booms are followed by housing busts”. That IMF report is here – and it’s chokka with good analyses of booms and busts, like this.

“Housing price crashes differ from equity price busts also in three other important dimensions. First, the price corrections during housing price busts averaged 30%, reflecting the lower volatility of housing prices and the lower liquidity in housing markets. Second, housing price crashes lasted about four years, about 1 1/2 years longer than equity price busts. Third, the association between booms and busts was stronger for housing than for equity prices. The implied probability of a housing price boom being followed by a bust in the sample is about 40%. Housing and equity price busts have, however, one important feature in common. During the 1970s to the 1990s, they generally coincided or overlapped with recessions.”

More to think about over the long weekend and in the lead-up to Budget.

Peter Fray

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