A large part of the world’s economic ills are squarely the result of falling house prices. Or more specifically, falling house prices in a market where the borrowers were highly geared and the banks, as a result, heavily exposed to under-collateralised loans.
From the peak to trough level over the past four or so years, house prices have fallen by about 35% in the US, 30% in Spain, almost 50% in Ireland, 20% in the UK and a little more than 10% in the Netherlands.
Even though those falls in most instances followed years of eye-watering price increases, the bursting of these house price bubbles not only destroyed the wealth of a huge proportion of the population in those countries, but it smashed the banking sector. The banking sector ills, in this instance, showed up in guaranteed losses when houses with negative equity were sold as out-of-the-money mortgage holders defaulted. The other effect on the economy was through rock-bottom levels of consumer confidence, which translated to weaker spending and then rising unemployment.
This is where the downward vortex continued. In these circumstances it is not surprising that the banks then imposed their own form of a credit squeeze. With huge losses in the mortgage market and falling prices, which bank in its right mind would lend more for housing? The downward spiral therefore continued.
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Such is the poison the flows from the bursting of asset prices bubbles in general, but for housing more specifically.
There are some mildly encouraging signs on house prices coming through in the US. The US Case-Schiller house price series was released last night. It is showing that at long last there is a turn higher in prices. The national composite index of house prices rose an impressive 6.9% in the June quarter but that was from what looks to be the cyclical low point in the prior quarter. Aside from the short-term volatility, house prices have now been little changed — near these lows — since 2009 .
While policymakers would not want to reflate the housing bubble (note that house prices rose about 130% over the 10 years to 2007), a little bit of house price inflation in the US would be no bad thing. It would boost consumer sentiment and allay at least some of the obvious fears of those who held onto their house during the slump despite entrenched negative equity. Rising prices would also reduce the ongoing mortgage risk of the banks and would support the outstanding residential mortgage-backed securities market.
It is to be hoped that the uptick in house prices in the June quarter in the US is the start of something positive, at least for the next year or two.
In Australia, the debate over house prices, the housing bubble, affordability and debt continues to roll on.
Since the start of 2011, house prices have been falling, but the declines have been very orderly, mortgage arrears remain well contained and there are very few signs of a serious level of mortgage distress.
The peak-to-trough fall in Australian house prices was only 7%, with the low point reached in May 2012. In the past few months, prices have actually picked up by about 2%, suggesting stability rather than anything else in the housing market since the start of year.
Not only does there seem to be little to worry about, the softness in house prices over the past 18 months is highly desirable.
Australia again is a global exception in terms of how its economy and markets have adjusted to what may have been a housing bubble up until early 2011. There is no doubt that however they were measured, house prices were high. This presented a distortion for saving and investment patterns from consumers as well as creating a substantial inter-generational problem as young people were largely priced out of buying and owning houses while their parents and other long-time home owners basked in their fortuitously acquired tax-free wealth.
The moderate fall in house prices is not truly hurting any part of the economy, consumers or banks. At a time when annual wages growth is running at a 3.5% to 4% pace and interest rates have been trimmed, housing affordability is steadily improving.
The HIA-CBA Affordability Index continued to rise in the June quarter and outside the temporary lift during the GFC when interest rates were slashed, affordability is at its most favourable since 2003.
This is a welcome trend. As affordability improves, demand from those potential purchasers currently on the edges of the housing market will increasingly be able to be satisfied. They will now be able to enter the market, while those with houses will only have to deal with the uninteresting reality of little capital growth.
Again, Australia is avoiding the disasters seen in so many other countries, this time in terms of house prices. Good management, good regulation and favourable demographics are all helping to deflate the housing bubble without any serious side effects. It is a great that pity this didn’t happen in other bubble countries.
*This article was first published at Business Spectator