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The global housing boom - The biggest bubble in history - The Economist - Jun 16th 2005
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This Link is located in the Public Channel Housing Bubble and Bear Links.
Posted by ian 1 year 212 days ago (economist.com). Views: 899
Tags: housing bubble |
| Related Tags: credit crisis wall street gold economics banks peter schiff recession |
June 16, 2005
The global housing boom
In come the waves
The worldwide rise in house prices is the biggest bubble in history.
Prepare for the economic pain when it pops
NEVER before have real house prices risen so fast, for so long,
in so many countries. Property markets have been frothing from
America, Britain and Australia to France, Spain and China.
Rising property prices helped to prop up the world economy
after the stockmarket bubble burst in 2000. What if the housing
boom now turns to bust?
According to estimates by The Economist, the total value of
residential property in developed economies rose by more
than $30 trillion over the past five years, to over $70 trillion,
an increase equivalent to 100% of those countries' combined GDPs.
Not only does this dwarf any previous house-price boom, it is
larger than the global stockmarket bubble in the late 1990s
(an increase over five years of 80% of GDP) or America's
stockmarket bubble in the late 1920s (55% of GDP).
In other words, it looks like the biggest bubble in history.
The global boom in house prices has been driven by two common
factors: historically low interest rates have encouraged home
buyers to borrow more money; and households have lost faith
in equities after stockmarkets plunged, making property look
attractive. Will prices now fall, or simply flatten off? And in either
case, what will be the consequences for economies around the
globe? The likely answers to all these questions are not comforting.
The increasing importance of house prices in the world economy
prompted The Economist to start publishing a set of global house-price
indices in 2002 (see article). These now cover 20 countries, using
data from lending institutions, estate agents and national statistics.
Our latest quarterly update shows that home prices continue to
rise by 10% or more in half of the countries America has seen one
of the biggest increases in house-price inflation over the past year,
with the average price of homes jumping by 12.5% in the year to
the first quarter. In California, Florida, Nevada. Hawaii, Maryland
and Washington, DC, they soared by more than 20%.
In Europe, prices have long been at dizzy heights in Ireland and Spain,
but over the past year have also spurted at rates of 9% or more in
France, Italy, Belgium, Denmark and Sweden. Both France (15%)
and Spain (15.5%) have faster house-price inflation than the
United States.
By contrast, some housing booms have now fizzled out. In Australia,
according to official figures, the 12-month rate of increase in house
prices slowed sharply to only 0.4% in the first quarter of this year,
down from almost 20% in late 2003. Wishful thinkers call this a soft
landing, but another index, calculated by the Commonwealth Bank
of Australia, which is based on prices when contracts are agreed
rather than at settlement, shows that average house prices have
actually fallen by 7% since 2003; prices in once-hot Sydney have
plunged by 16%.
Britain's housing market has also cooled rapidly. The Nationwide
index, which we use, rose by 5.5% in the year to May, down from
20% growth in July 2004. But once again, other surveys offer a
gloomier picture. The Royal Institution of Chartered Surveyors
(RICS) reports that prices have fallen for ten consecutive months,
with a net balance of 49% of surveyors reporting falling prices
in May, the weakest number since 1992 during Britain's previous
house-price bust. The volume of sales has slumped by one-third
compared with a year ago as both sellers and buyers have lost
confidence in house valuations. House-price inflation has also
slowed significantly in Ireland, the Netherlands and
New Zealand over the past year.
Since 1997, home prices in most countries have risen by much
more in real terms (ie, after adjusting for inflation) than during
any previous boom. (The glaring exceptions are Germany and
Japan, where prices have been falling.) American prices have
risen by less than those in Britain, yet this is still by far the
biggest boom in American history, with real gains more than
three times bigger than in previous housing booms in the
1970s or the 1980s.
The most compelling evidence that home prices are over-valued
in many countries is the diverging relationship between
house prices and rents. The ratio of prices to rents is a sort
of price/earnings ratio for the housing market. Just as the
price of a share should equal the discounted present value
of future dividends, so the price of a house should reflect the
future benefits of ownership, either as rental income for an
investor or the rent saved by an owner-occupier.
Calculations by The Economist show that house prices have
hit record levels in relation to rents in America, Britain, Australia,
New Zealand, France, Spain, the Netherlands, Ireland and Belgium.
This suggests that homes are even more over-valued than at
previous peaks, from which prices typically fell in real terms.
House prices are also at record levels in relation to incomes
in these nine countries.
America's ratio of prices to rents is 35% above its average
level during 1975-2000 By the same gauge, property is
“overvalued” by 50% or more in Britain, Australia and Spain.
Rental yields have fallen to well below current mortgage rates,
making it impossible for many landlords to make money.
To bring the ratio of prices to rents back to some sort of fair value,
either rents must rise sharply or prices must fall. After many
previous house-price booms most of the adjustment came through
inflation pushing up rents and incomes, while home prices stayed
broadly flat. But today, with inflation much lower, a similar process
would take years. For example, if rents rise by an annual 2.5%,
house prices would need to remain flat for 12 years to bring America's
ratio of house prices to rents back to its long-term norm.
Elsewhere it would take even longer. It seems more likely,
then, that prices will fall.
A common objection to this analysis is that low interest rates make
buying a home cheaper and so justify higher prices in relation to rents.
But this argument is incorrectly based on nominal, not real, interest
rates and so ignores the impact of inflation in eroding the real burden
of mortgage debt. If real interest rates are permanently lower,
this could indeed justify higher prices in relation to rents or income.
For example, real rates in Ireland and Spain were reduced significantly
by these countries' membership of Europe's single currency—though
not by enough to explain all of the surge in house prices. But in America
and Britain, real after-tax interest rates are not especially low by
historical standards.
Betting the house
America's housing market heated up later than those in other countries,
such as Britain and Australia, but it is now looking more and more
similar. Even the Federal Reserve is at last starting to fret about
what is happening. Prices are being driven by speculative demand.
A study by the National Association of Realtors (NAR) found that
23% of all American houses bought in 2004 were for investment,
not owner-occupation. Another 13% were bought as second homes.
Investors are prepared to buy houses they will rent out at a loss,
just because they think prices will keep rising—the very definition
of a financial bubble. “Flippers” buy and sell new properties even
before they are built in the hope of a large gain. In Miami, as
many as half of the original buyers resell new apartments in
this way. Many properties change hands two or three times
before somebody finally moves in.
New, riskier forms of mortgage finance also allow buyers to
borrow more. According to the NAR, 42% of all first-time buyers
and 25% of all buyers made no down-payment on their home
purchase last year. Indeed, homebuyers can get 105% loans
to cover buying costs. And, increasingly, little or no documentation
of a borrower's assets, employment and income is required for
a loan.
Interest-only mortgages are all the rage, along with so-called
“negative amortisation loans” (the buyer pays less than the
interest due and the unpaid principal and interest is added on
to the loan). After an initial period, payments surge as principal
repayment kicks in. In California, over 60% of all new mortgages
this year are interest-only or negative-amortisation, up from 8%
in 2002. The national figure is one-third. The new loans are essentially
a gamble that prices will continue to rise rapidly, allowing the
borrower to sell the home at a profit or refinance before any
principal has to be repaid. Such loans are usually adjustable-rate
mortgages (ARMs), which leave the borrower additionally exposed
to higher interest rates. This year, ARMs have risen to 50% of all
mortgages in those states with the biggest price rises.
The rapid house-price inflation of recent years is clearly unsustainable,
yet most economists in most countries (even in Britain and Australia,
where prices are already falling) still cling to the hope that house prices
will flatten rather than collapse. It is true that, unlike share prices,
house prices tend to be somewhat “sticky” downwards. People have
to live somewhere and owners are loth to accept a capital loss.
As long as they can afford their mortgage payments, they will stay
put until conditions improve. The snag is that eventually some
owners have to sell—because of relocation, or job loss—and they
will be forced to accept lower prices.
Indeed, a drop in nominal prices is today more likely than after
previous booms for three reasons: homes are more overvalued;
inflation is much lower; and many more people have been buying
houses as an investment. If house prices stop rising or start to fall,
owner-occupiers will largely stay put, but over-exposed investors
are more likely to sell, especially if rents do not cover their interest
payments. House prices will not collapse overnight like
stockmarkets—a slow puncture is more likely. But over the next
five years, several countries are likely to experience price falls
of 20% or more.
While America's housing market is still red hot, others—in Britain,
Australia and the Netherlands—have already cooled
What lessons might they offer the United States?
The first is that, contrary to conventional wisdom, it does not
require a trigger, such as a big rise in interest rates or
unemployment, for house prices to decline. British home prices
started to fall in the summer of 2004 after the Bank of England
raised rates by a modest one and a quarter percentage points.
Since 2002, the Reserve Bank of Australia has raised rates by
exactly the same amount and unemployment is at a 30-year low,
yet home prices have fallen. The Federal Reserve's gradual
increase in rates by two percentage-points over the past year
has done little to scare away buyers, because most still have
fixed-rate mortgages and long-term bond yields have remained
unusually low. But as more Americans have been resorting to ARMs,
so the housing market is becoming more vulnerable to rising rates.
Rung at the bottom
British and Australian prices have stalled mainly because first-time
buyers have been priced out of the market and demand from
buy-to-let investors has slumped. British first-timers now account
for only 29% of buyers, down from 50% in 1999. And, according
to the National Association of Estate Agents, buy-to-let purchases
are running 50% lower than a year ago. As prices become more
and more heady in America, the same will happen there.
British experience also undermines a popular argument in America
that house prices must keeping rising because there is a limited
supply of land and a growing number of households. As recently
as a year ago, it was similarly argued that the supply of houses
in Britain could not keep up with demand. But as the expectation
of rising prices has faded, demand has slumped. According to RICS,
the stock of houses for sale has increased by one-third over the
past year. America has faster population growth than Britain, but
its supply of housing has also been rising rapidly. Economists at
Goldman Sachs point out that residential investment is at a
40-year high in America, yet the number of households is growing
at its slowest pace for 40 years. This will create excess supply.
Another mantra of housing bulls in America is that national average
house prices have never fallen for a full year since modern statistics
began. Yet outside America, many countries have at some time
experienced a drop in average house prices, such as Britain and
Sweden in the early 1990s and Japan over the past decade.
So why should America be immune? Alan Greenspan, chairman
of America's Federal Reserve, accepts that there are some local
bubbles, but dismisses the idea of a national housing bubble
that could harm the whole economy if it bursts. America has in
the past seen sharp regional price declines, for example in Boston,
Manhattan and San Francisco in the early 1990s. This time, with
prices looking overvalued in more states than ever in the past,
average American prices may well fall for the first time since
the Great Depression.
But even if prices in America do dip, insist the optimists, they will
quickly resume their rising trend, because real house prices always
rise strongly in the long term. Robert Shiller, a Yale economist,
who has just updated his book “Irrational Exuberance”
(first published on the eve of the stockmarket collapse in 2000),
disagrees. He estimates that house prices in America rose by an
annual average of only 0.4% in real terms between 1890 and 2004.
And if the current boom is stripped out of the figures, along with
the period after the second world war when the government offered
subsidies for returning soldiers, artificially inflating prices, real house
prices have been flat or falling most of the time. Another sobering
warning is that after British house prices fell in the early 1990s,
it took at least a decade before they returned to their previous
peak, after adjusting for inflation.
Another worrying lesson from abroad for America is that even a
mere levelling-off of house prices can trigger a sharp slowdown in
consumer spending. Take the Netherlands. In the late 1990s, the
booming Dutch economy was heralded as a model of success.
At the time, both house prices and household credit were rising
at double-digit rates. The rate of Dutch house-price inflation then
slowed from 20% in 2000 to nearly zero by 2003. This appeared
to be the perfect soft landing: prices did not drop. Yet consumer
spending declined in 2003, pushing the economy into recession,
from which it has still not recovered. When house prices had been
rising, borrowing against capital gains on homes to finance other
spending had surged. Although house prices did not fall, this
housing-equity withdrawal plunged after 2001, removing a
powerful stimulus to spending.
Housing-equity withdrawal has also fallen sharply over the past
year in Britain and Australia, denting household spending.
In Australia, the 12-month rate of growth in retail sales has
slowed from 8% to only 1.8% over the past year; GDP growth
has halved to 1.9%. In Britain, too, a cooling of the housing
market has been accompanied by an abrupt slowdown in consumer
spending. If, as seems likely, home prices continue to fall in
both countries, spending will be further squeezed.
Even a modest weakening of house prices in America would hurt
consumer spending, because homeowners have been cashing out
their capital gains at a record pace. Goldman Sachs estimates that
total housing-equity withdrawal rose to 7.4% of personal disposable
income in 2004. If prices stop rising, this “income” from capital gains
will vanish.
And after the gold rush?
The housing market has played such a big role in propping up
America's economy that a sharp slowdown in house prices is
likely to have severe consequences. Over the past four years,
consumer spending and residential construction have together
accounted for 90% of the total growth in GDP. And over two-fifths
of all private-sector jobs created since 2001 have been in
housing-related sectors, such as construction, real estate and
mortgage broking.
One of the best international studies of how house-price busts
can hurt economies has been done by the International Monetary
Fund. Analysing house prices in 14 countries during 1970-2001,
it identified 20 examples of “busts”, when real prices fell by almost
30% on average (the fall in nominal prices was smaller).
All but one of those housing busts led to a recession, with GDP
after three years falling to an average of 8% below its previous
growth trend. America was the only country to avoid a boom
and bust during that period. This time it looks likely to join
the club.
Japan provides a nasty warning of what can happen when boom
turns to bust. Japanese property prices have dropped for 14 years
in a row, by 40% from their peak in 1991. Yet the rise in prices in
Japan during the decade before 1991 was less than the increase
over the past ten years in most of the countries that have
experienced housing booms. And it is surely no coincidence that
Japan and Germany, the two countries where house prices have
fallen for most of the past decade, have had the weakest growth
in consumer spending of all developed economies over that period.
Americans who believe that house prices can only go up and pose
no risk to their economy would be well advised to look overseas.
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ian said |
| 1 year 211 days ago |
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ian said |
| 1 year 211 days ago |
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important paragraph
One of the best international studies of how house-price busts
can hurt economies has been done by the International Monetary
Fund. Analysing house prices in 14 countries during 1970-2001,
it identified 20 examples of “busts”, when real prices fell by almost
30% on average (the fall in nominal prices was smaller).
All but one of those housing busts led to a recession, with GDP
after three years falling to an average of 8% below its previous
growth trend.
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