Panicology
Page 13
The Housing Bubble
‘House price explosion’ Daily Express
Panic about the housing market is widespread and comes in two particular forms – first, there is the worry that prices are so high that people who are not already home-owners will be permanently excluded from the market; second, there is the worry of the economic consequences of a material fall in prices should the so-called ‘bubble’ burst. Either way the large increase in prices over the last decade or more will leave us with a nasty hangover – the only uncertainty being which problem we have to live with and the nature of the social and economic crisis coming our way.
There is little doubt that the hefty house price inflation of recent years, baring a major fall, will lead to greater social division as the rich get richer and it becomes harder for first-time buyers to enter the market. ‘House price explosion’ and ‘Property ladder too high for 17 million’ are typical of the large-print, panic-inducing headlines that regularly appear on our front pages. There are particular concerns for key workers and young people – how can teachers or nurses be expected to buy property in the highly priced urban areas in which they work? Commuting is often not an option for those on low pay or working anti-social hours. Labour mobility is also curtailed as people find it impossible to move from areas of low house prices to areas of higher house prices. Alternatively a price correction – shall we call it a crash? – could leave the economy in tatters, given the debt mountain and speculation that has supported the rise in house prices.
House prices have been rising faster than general inflation and earnings in most countries for some years. With the exception of Germany and Japan, advanced countries have been in the grip of a housing boom since the mid-1990s. The Organization for Economic Cooperation and Development, the Paris-based think tank, has described this boom as unprecedented in its steepness, durability and geographical breadth.1 The Economist magazine described the worldwide rise in house prices as ‘the biggest bubble in history’.
The most notable growth has been in Ireland, where house prices have more than trebled after allowing for inflation since 1992. Prices doubled in the US in the last decade. It is daft money. In 2006, Donald Trump’s Palm Beach mansion and Tommy Hilfiger’s mountain home in Nevada were each put on the market for around $120 million, a figure surpassed only weeks later when a Saudi Arabian prince’s ranch near Aspen, Colorado, was on offer for $135 million. Trailers on the Californian coast sold for more than $1 million.
2007 saw several markets pause for thought and even show early signs of decline, but where are they heading? The positive housing market factors are common to most of those areas that have experienced above-inflation increases: growing demand for property (from families, immigrants and speculative investors), building land becoming increasingly hard to find especially in the more desirable areas, and interest rates and unemployment at historically low levels. The increase in immigration to the UK – three times higher in the late 1990s and early-to-mid-2000s than in the mid-1990s – has contributed to the price rise in the UK, especially in London. The government never adjusted the housing programme to take account of the extra 100,000 people a year the country is currently receiving, a consequence of the world’s increasingly open borders.
The rise in property prices has given home-owners considerable equity with which to buy additional properties, often on a buy-to-let basis, inflating prices further. And there has been no shortage of imaginative, alluring and generous financing deals from the mortgage lenders – zero down payments, low starter rates, loans higher than the valuation of the property, flexible payments, and even ‘stated income’ or ‘self-certification’ applications, in which the borrower is left to use his own imagination to describe his financial circumstances. In the UK, housing market turnover is currently only half what it was at the peak seen in the late 1980s – people then moved at a rate of once every eight years, now it is once every eighteen years. One explanation for this is the large increase in stamp duty (payable by the seller) imposed in recent years, which has reduced the number of properties on the market and helped push up prices further.
This is fantastic news for home-owners. As they see the value of their assets rise it makes them feel more financially secure about the future. There are many people who for some years have ‘earned’ more money from the rise in the value of their property than they do from their work. One article explained how the boom had seen the price of an average house ‘shoot up’ by £45 a day during 2006, a figure that rises to £80 a day for the typical London property.2 The newspapers, and presumably most of their readers, love stories telling us about the ‘massive’ increase – up by one-third in Britain in 2006 – in the number of people living in properties valued at over £1 million.
On the down side, housing unaffordability – measured in many different ways but essentially the cost of property relative to people’s incomes – is now at an all-time high, in Britain and many other countries, reducing the supply of buyers. Average property prices in Britain are now approaching six times average earnings, much higher than the most recent peak of five times in 1988 and the long-run average of about 3½. The plight is particularly desperate for first-time buyers. The average price paid by a first-time buyer pushed through the £150,000 barrier in 2006, according to Halifax, the lender, compared to the average full-time earnings of 22–29-year-olds across the country of just under £22,000. The number of first-time buyers was at a 26-year low in 2006, 37 per cent down on the half million plus seen in 1997. The last peak in the price earnings ratio in 1988 was followed by hefty nominal falls in prices, taking the price-to-earnings ratio back to its long-run average, landing thousands of people in negative equity (holding a mortgage debt higher than the value of the property) for years after.
There are pockets of unaffordable housing around the world. One study calculated the median house price to median household income ratio for a number of cities and regions in a handful of Anglo-Saxon countries. It described anywhere with a median multiple of over 5 as being ‘severely unaffordable’; a score of 3 was described as ‘affordable’. Three locations, Los Angeles, San Diego and Honolulu, had a median multiple score of over 10. Another twenty locations, about half of which were American, achieved a score of over 6. These included San Francisco, Miami, Sydney, New York and London.3 Roughly one-quarter of the locations studied were deemed as affordable and another quarter as ‘moderately unaffordable’, leaving the other half to be severely or seriously unaffordable. None of the British locations qualified as affordable, but those in the US and Canada so defined included Houston, Atlanta, Dallas and Quebec City.
The study described the last decade’s price escalation as ‘unprecedented’ and said that it was ‘a matter for concern’. The locations studied in Australia, the UK, New Zealand and Ireland (Dublin) had an average score of around 6, compared to 4½ in the US and just under 4 in Canada. The high scores were all the more surprising as most of the locations had ratios of around 3 as recently as a decade ago. The ratio for London, for example, had more than doubled to just under 7 since 1996. The report warned that less housing affordability is likely to lead to lower levels of home ownership, as is already evident in New Zealand.
Affordability is not the only problem. Interest rates and unemployment have risen from record lows with a commensurate impact on sentiment. Banks’ lending criteria have tightened, especially following the mid-2007 credit crisis. In Britain, increases in utility bills and taxes along with increasing interest rates on record levels of unsecured debts are also starting to bite. There are also concerns that the equity and rental returns on second homes, often bought speculatively in novel locations such as Croatia, Bulgaria and Dubai, will disappoint, leading to a glut of properties and forced sellers. As mortgage arrears and repossessions rise, albeit from a low level, lenders further restrict the flow of cheap money.
The boom in prices was spurred in good part by consumer borrowing, as discussed in the previous section.
During 2006 borrowing by homebuyers in Britain reached a staggering £1 billion a day. As one paper pointed out, the value of loans made in the latest year to British homebuyers was broadly equivalent to the annual economic output of an economy such as India.4 The median advance is now over £120,000, having trebled in just over a decade. The income multiple was over 3 by the end of 2006 compared to 2¼ a decade before and under 2 as recently as 1985. 2006 was the tenth year in which over one million loans were made, lifting activity to the levels seen in the five years up to 1988, even though the value of loans made now is roughly four times that of the mid-1980s.
There is no shortage of debate about the prospects for the housing market. Many analysts say that property is overvalued by anything from 10 to 40 per cent, and that a correction should be expected. This could be a fall in house prices, or, less painfully, many years of no increases. Material nominal falls in house prices would be expected to bring on an economic recession as people grappled with negative equity, and the appetite for credit disappeared.
Others, notably some researchers from Oxford University, say that the higher levels can easily be justified by taking into account housing supply, the changing age structure of the population, shifts in credit conditions and the level of nominal interest rates.5 Based on their modelling, nominal house prices will only fall in the years ahead under ‘quite dismal’ economic scenarios. A housing crash would bring widespread economic misery, while continuing high prices will consign the significant minority of the population that does not own property to a life of relative poverty.
John Kay, the British academic and columnist, says that the level of house prices ‘depends not just on levels of income but on social mores and the distribution of wealth’ and believes that modelling house prices requires a range of skills that few people have. That said, he has little difficulty with the concept of property hotspots. He explains that:
A house provides space and shelter and, in the American mid-west, these are the principal attributes of a house. There is more land there than anyone could build on and usually not much to choose between the prestige or convenience of different areas of the spacious cities. House prices are low, stable and tend to move in line with incomes.
In contrast, in New York, California and London, most of the price of a property reflects the location rather than the accommodation – he points out that you cannot make more houses on East 69th Street or in Belgravia. With increased mobility, the high prices in the hotspots reflect ‘the self-defeating character of the search for the symbols of status and affluence’.6 House prices are, then, what economists call a positional good.
In the short term, policy makers have got their fingers crossed hoping for a ‘soft landing’, typified by a period of stable prices, allowing the price-to-income ratios to return closer to the long-run average. Longer-run solutions to reduce the inequality brought about by the house price inflation are harder to find.
One possible solution would be to introduce a land value tax, a tax on any house price gains. In essence the burden of taxation needs to be shifted off income and profits and on to the currently untaxed gains in property values. Economists argue that such a tax – say, an annual charge of 1 per cent on a property’s value – would encourage far more efficient use of space. It would (probably) lower prices, discourage speculation and make second homes far less attractive than they are currently. But such innovative and sensible solutions are most unlikely to be introduced as governments would be afraid of the shifts in price and the redistributive effects of changed tax bills caused by the transition to the new structure. The building of more homes would help, but land is limited in areas of high demand.
Meanwhile, expect house price bubble stories to continue to appear in the papers and expect them to be written in a smug tone as most of the authors, and the experts quoted, will be sitting happily on property that had risen in value since they bought it.
Migrant Invasion
‘Immigrants to flood in’ Daily Star
‘Halt the tide of EU migrants’, screamed the front page of one newspaper, demanding that Britain’s borders be closed, while another warned that Britain’s population would hit 70 million ‘unless we get a grip on immigration’. One story quoted a ‘top military expert’ warning that ‘migrant vandals will bring havoc to Britain’, adding that mass population movements could lead Europe into a ‘Rome scenario’, in other words the collapse of an empire. These may be headlines from tabloids, but the story of immigration, and its impact on social structures and the economy, is a favourite for all newspapers, whatever their hue.
Some of these stories are reporting sound research that merits careful examination. For example, the warning about Britain’s population reaching 70 million came from Lord Turner, who studied population growth as part of his respected Pensions Commission report. He said that he was ‘amazed’ by the ‘piecemeal discussion’ on immigration and the ‘incoherence about the debate’. He warned that high levels of unskilled workers entering the country might have a short-term benefit but would ultimately damage the economy, saying that ‘to deny that is nonsense – it just flies in the face of all economic theory’.
Other stories lack substance, but there is no doubting that international migration has jumped up most countries’ policy agenda in the last decade in response to the rapid growth in immigration flows. Globalization, budget flights and more open borders, not least following the collapse of the Iron Curtain in eastern Europe and the broadening of the European Union, have increased travel opportunities and legitimate migration. Illegal immigration, via irregular or unconventional channels such as asylum seeking, fake documentation or overstaying legitimate trips as a student or a tourist, and humanitarian migration, in response to civil and ethnic conflict, have also increased.
The numbers are large. Around 3 million long-term immigrants are recorded as entering developed countries legally every year. This is giving rise to strains as some ethnic communities are having difficulty integrating into the host society. Fear and prejudice freely breed in the absence of accurate and reliable data – it is easy to fear the worst – and a lack of coherent policy from governments. In most countries there are serious gaps in available data with a too heavy reliance on imperfect administrative information and poor-quality surveys. This affects policy makers too. Mervyn King, the Bank of England governor, has said that the lack of accurate immigration figures makes understanding economic developments hard and is one of his biggest concerns when setting interest rates.
There are definitional differences between countries – how long does someone have to stay to be counted as an immigrant? – making the compilation of international comparisons a tricky task. Surveys are notoriously weak as people are often reluctant to respond, let alone give the true reasons for travelling. But the size of the flows in the future is potentially enormous. One study, admittedly from a lobby group advocating lower population for the UK, raised the prospect of some 60 million people moving from desertified areas in sub-Saharan Africa towards northern Africa and Europe in the next twenty years.1
The lack of decent data, in this area at least, goes hand-in-hand with generally unclear government policy. Balancing an openness to international migration with a firmness in managing inflows is a difficult task for governments to achieve. Most do not even try – they dodge the issue. This in part reflects the sensitivities surrounding the topic – one incautious remark can lead rapidly to accusations of racism.
The OECD has been developing harmonized figures for ‘permanent-type’ legal international migration that now cover nearly twenty countries and shed some light on the issue. Inflows were up by 11 per cent in 2005, following a rise of 16 per cent in 2004. The US had by far the largest long-term inflow of foreign nationals in 2005, the latest year for which figures are available, of over 1 million. The UK followed with over 360,000 new immigrants, and Canada with 260,000. Germany, France, Australia and Italy all received over 150,000 in the year. This repres
ented an increase on the previous year for all these countries except Germany and France, which recorded small declines. When that year’s inflows are presented as a proportion of the total population, it is the UK, Italy and New Zealand that come top of the pile.2
These figures do not include short-term migration, which is probably high in some countries such as the UK, and illegal immigration, which in common with any other covert activity is hard to measure with any degree of accuracy. Where estimates do exist, they put the illegal proportion of the population at between 1 and 4 per cent in many developed countries.3 The measure is highest for the US and Greece, both of which are characterized by an extensive land border with a country of much lower per capita income – and nationals from the neighbouring countries account for a large majority of the unauthorized immigrants. Such percentage figures might not seem very high, but it is striking that illegals represent a large proportion of the overseas-born population in many countries.
Feelings about illegal immigration run high, with most newspapers being firmly entrenched on one side or the other. One US editorial, titled ‘11 million reasons’, referring to the estimate of 11 million illegal immigrants in the US, said, ‘The problem is not just getting worse, but way worse, and very fast.’ Another article, ‘False facts tar immigrants’, said that some people in the immigration debate ‘regurgitate factoids ad nauseam, all with the purpose of blaming Mexicans for just about everything wrong with America’.
Whatever the tone of the newspapers, the flows are large enough to merit attention. Net unauthorized immigration to the US is estimated to be around half a million persons per year, equivalent to the population of a decent-sized city and one half of the current annual levels of legal immigration, as measured by the issue of green cards. In Italy, a regularization programme – essentially an amnesty for illegal immigrants – in 2002 elicited 700,000 applications. If all of these entered in the years since the previous regularization, it would imply unauthorized entries of about 175,000 a year, higher than the recorded levels of legal long-term migration over the same period.