Transcript The UK Housing Market: Measured Decline or

The UK Housing Market:
Measured Decline or Total Collapse?
John Muellbauer and Stephen Nickell
Stated Meeting Seminar
Nuffield College
7th March, 2009
• What has been happening?
House prices, house-building, households, incomes.
• Do all the recent changes matter?
• Prospects:
House prices, house-building plans, households.
• The bigger picture.
• Impact on the overall economy.
What determines house prices?
Basically, the “price” of houses is fixed at the level at which the
demand for houses today is equal to the fixed stock available
today.
Price
Pt
Demandt
Stockt
Houses
In the recent past, demand has been shifting to the right
more rapidly than the stock (which moves to the right by
around 3/4% per annum).
So house price inflation depends on how fast demand
rises relative to the available stock.
Price
Pt+1
Demandt+1
Pt
Demandt
Stockt
Stockt+1
Houses
• Over the short term, house price inflation is dominated by the
speed of the demand shift. Over twenty years, however, the
rise in the stock is “big enough” to make a significant
difference to the overall rise in house prices over this period,
and hence to the average rate of house price inflation.
• What are the implications of all this?
• Typically, the price of houses exceeds, often substantially, their
replacement costs (ie. the costs of rebuilding). The difference
is the value of the land.
• This means that house prices and house price inflation are,
currently, more or less unaffected by construction costs. Note,
current construction costs impact neither on the demand for
houses nor on the existing stock.
• If construction costs go up while house prices remain
unchanged, land prices (ie. the price of land with planning
permission) will fall.
• The same argument applies to tariffs or an infrastructure levy.
House Price Inflation in the Medium-Term
• Over the medium term, the key to house price inflation is the
rate at which demand (the demand side) increases relative to the
rate at which the stock increases (the supply side).
The Supply Side
• The rate at which the stock increases is determined essentially
by the planning regime and the capacity of the house building
sector.
• The more restrictive and directive is the planning regime, the
lower the rate at which the housing stock rises and the higher
will be the rate of house price inflation.
• Example.
• What about the policy of cutting stamp duty to first time
buyers (FTBs)?
• The key point to recognise is that this can only help FTBs if
the supply of FTB type houses is higher than it otherwise
would be.
• Initially the demand for FTB type houses rises and with
constant supply, their price rises by the amount of the tax cut.
So the tax cut goes straight to the existing owners of FTB
houses.
• This price will bring forth increased supply only if keen
landowners/house builders can persuade planners to release
more building land. Unlikely. So aside from some, probably
tiny, composition effects, no other changes will ensue.
What Determines Demand and Prices?
• Real incomes and the number of households relative to the
number of houses determines the trend.
• Note income elasticity of demand > price elasticity. So cet.
par., as incomes rise, prices tend to rise faster than incomes.
• Other factors include ease of borrowing, long-term real interest
rates. Ease of borrowing has been crucial in the last 18
months.
1997 - 2007
• From 1997 to 2006, real house prices more than doubled. Real earnings
increased by around 15%.
• The ratio of (lower quartile) house prices to (lower quartile) earnings rose
from around 4 in 2000 to over 7 in 2007.
• From 1996 to 2001, housebuilding was at a rate of around 135K per annum,
households increased at around 159K per annum.
• From 2001 to 2006, housebuilding was at a rate of 146K per annum,
households increased at around 199K per annum. Incidentally, this rate of
housebuilding adds around 1% of England to urban areas every 20-50 years
depending on use of brownfield/density.
• Households are now rising at over 210K. Net migration represents around
one third. Increasing life expectancy and behavioural changes continue to
lower household size.
Indexes of real house prices, earnings and GDP, United Kingdom (1997 to 2006)
250
Real GDP
Real House prices
Real Earnings
Index (1997=100)
200
150
100
50
0
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Housing affordability: ratio of lower quartile house prices to earnings
10
LONDON
9
SOUTH EAST
SOUTH WEST
8
EAST
ENGLAND
7
WEST MIDLANDS
EAST MIDLANDS
Ratio
6
YORKSHIRE AND THE HUMBER
NORTH WEST
NORTH EAST
5
4
3
2
1
0
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
Number of completed dwellings
Housebuilding: permanent dwellings completed, by tenure, England
400000
350000
300000
250000
200000
150000
100000
50000
0
1946 1952 1958 1964 1970 1976 1982 1988 1994 2000 2006
Private enterprise
RSLs
Local Authorities
All dwellings
Household estimates and household projections, by household type, England only
30000
Number of households (000s)
25000
20000
one person
other multi-person
lone parent
15000
cohabiting couple
married couple
10000
5000
0
1981
1986
1991
1996
2001
2006
2011
2016
2021
2026
The Credit Crunch
• The inability of UK mortgage lenders to tap the still buoyant
supply of world savings has generated severe mortgage
rationing to first time buyers.
• So, rapid decline in house prices.
• Squeeze on housebuilders, collapse in housing investment.
• Private rental sector cannot take over.
Does it Matter?
• As affordability and housing shortage worsens, more people are pushed into
private renting, forcing up rents.
• More people are driven into the already hard-pressed social renting sector and
queues lengthen.
• Deprivation increases and the situation worsens in already deprived areas.
• This affects us all. The economy suffers from the consequent impediments to
labour mobility.
• Key workers are unable to find somewhere to live near where they work.
• Increasing quantities of taxpayers money are required to address these
problems.
• Housing wealth has risen enormously. Can the country really be wealthier
because we collectively restrict the supply of building land?
Number on housing register
2000000
1500000
1000000
500000
0
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007
Number on housing register
What do Affordability Prospects
Look Like? І
• Household projections suggest that the number of households in England
will grow by an average of around 223K per annum over the next 20 years.
This rate is significantly higher than in the recent past. Furthermore,
projected growth up to 2020 is even faster at an average of around 230K
per annum.
• 168K new homes were completed in 2006-7, fewer subsequently.
• The fact that the rate of completion of new homes has been well below the
rate of formation of new households means there is a large build-up of
unsatisfied demand.
• The evidence suggests that over the long-term, a 1 per cent rise in real
incomes raises house prices by 2 per cent if the housing stock remains
unchanged.
What do Affordability Prospects
Look Like? П
• Suppose credit conditions return to normality.
• If the housebuilding plans currently embodied in the draft RSS plans
(around 200K p.a.) are fulfilled, house price to earnings ratios are likely to
rise from around 7 to around 10 over the next twenty years.
• If Green Paper plans (reaching 240K p.a. by 2016, 3m. new homes by
2020) are fulfilled, house price to earnings ratios are likely to rise to around
9.5 over the next twenty years. This may be reduced significantly by
biasing new homes towards more expensive regions and even further by
some bias towards larger family homes which are in shortest supply.
• NHPAU projections indicate that a plan to reach 270K new homes p.a. by
2016 would come close to stabilising affordability in the long run.
What do Affordability Prospects Look
Like? III
• These are long-run scenarios. So does the current slowdown
make any difference?
• Not much in the long-term unless elements of mortgage rationing
become permanent. There will be a temporary slowdown
because of severe mortgage rationing. But as this eases, the
forces of rising incomes and growth in the number of households
will start driving up house prices again, especially if
housebuilding remains modest.
Overall Prospects
• Housing will be more “affordable” if there is permanent
mortgage rationing.
• People will not, however, be better housed.
• Instead of high prices locking people out of the housing
market, the mortgage lenders do it instead. No real
improvement.
Mortgage rationing would reduce prices, but the level
of supply will still impact on affordability outcomes…
RSS supply, rationing to 2012
RSS supply, rationing to 2031
NHPAU top end, rationing to 2012
NHPAU top end, rationing to 2031
2031
2030
2029
2028
2027
2026
2025
2024
2023
2022
2021
2020
2019
2018
2017
2016
2015
2014
2013
2012
2011
2010
2009
2008
2007
2006
2005
2004
2003
2002
2001
LQ Affordability Ratio
For illustrative purposes only
UK house prices in the global context
• Cameron, Muellbauer, Murphy (2006) – basis for CLG’s
housing affordability model→
•
if goldilocks economy of 2006-2007H1 had continued, UK
house prices were only approx 10% overvalued at mid-2007.
• But goldilocks economy has collapsed, both at global and
national levels.
• What are global prospects?
Origins of Global Financial Crisis
(1)
• Failure of prudential regulation by Fed, BOE/FSA and ‘procyclicality’ of Basel II.
• Over-leveraged shadow banking system arose partly to by-pass
regulation.
• E.g. in 2004 SEC (Securities and Exchange Commission)
caved in to investment bank lobbying (e.g. GS, Lehman) to
reduce capital requirements on investment banks.
Why?
(2)
• Competitive advantage e.g. in securitization put pressure on
retail banks (e.g. Citi, Bank of America, Wachovia) to use offbalance sheet vehicles to by-pass capital adequacy rules.
• Distorted reward structure of originators of financial products
and of rating agencies.
• Herd behaviour of bankers.
• Poor modelling of risk, esp’y macro risk – short history based
on ‘the Great Moderation’ period.
• E.g. S&P decided in 2000: piggy-back mortgages were no
more risky!
(3) Examples: SIVs and CDS
• ‛Special investment vehicles’ were supposedly off-balance
sheet investments by banks, often very risky and not
transparent.
• As crisis unfolded, had to be largely brought back onto bank
balance sheets.
• ‘Credit default swaps’ traded between banks and other
financial institutions – not on open markets and not
transparent.
• Original insurance purpose - but in practice financial
instruments of mass destruction since they amplified counterparty risk.
“We structured the deal so it won’t
make any sense to you.”
Source: The New Yorker
Why?
(4)
• Globalisation made it possible to spread bad risks round the
globe.
• After the Asian Crisis of 1997-8, the Asian economies built up
huge foreign exchange reserves. Their excess saving kept
interest rates low for Western economies, fuelling credit and
asset bubbles.
• Bush administration keen to extend home ownership - via
private debt - to the poor.
Why?
(5)
• US tax regime stimulates desire for debt – unlimited tax relief
for mortgages.
• Fannie Mae, Freddie Mac, Fed Home Loans system with
implicit govt. backing created illusion of low risk options for
US borrowers.
• Walk away option from negative equity in US encouraged
risk-taking by households.
• Monetary policy errors in 2002-5: low rates led to desperate
search for yield – risky assets!
Why ?
(6)
• Oil and commodity price spikes driven by high resource-use
Asian and other emerging market growth spurt in 2006-7.
• Exacerbated by hedge fund and other speculation.
• Raised inflation and eventually cut real income growth in
industrial economies.
Why?
(7)
• Recent policy errors compounded crisis:
• Lehman Bros default.
• Failure by central banks in Europe to respond to crisis in
October and support well co-ordinated treasuries. See ‘The
folly of the central banks of Europe’
• http://www.voxeu.org/index.php?q=node/2488
• Initially wrong US bank rescue plan (TARP).
Household credit channel
• Central to understanding prospects in ‘Anglo-Saxon’
economies and how other economies differ.
• Shift in credit supply function e.g. ‘credit crunch’ has profound
effects not just on level of house prices and consumption but
on how monetary policy works.
• One channel in following chart:
Mortgage and
Housing Crisis
Lower Demand
for Housing
Less Home
Construction
Lower Capital of
Financial Firms
↓Home Prices &
Wealth, Slower
Consumption
↑ Counter-Party
Risk, Money &
Bond Mkts Hit
Slower
GDP Growth
Credit Standards
Tightened
on All Loans
Global Prospects
• All parts of global economy are now in Keynesian-style
demand-deficient recession.
• Fiscal and monetary policy solutions are well-known when
inflation is dead.
• Belated ECB interest rate and fiscal loosening to come.
• Stuttering recapitalisation of the banking system is in train,
plus ‘son of TARP’.
Prospects cont’d
• Eurozone policy failures have continued.
• In Nov-Dec. ECB cut interest rates less than fall in expected
inflation. In Feb. kept rate unchanged, so raising real rate.
• German fiscal policy late to grasp coming tidal wave on
Germany – hoped to free-ride on overstretched US fiscal
stimulus.
Blockages to sane policy
• 1. Endemic conceptual/model failure was to omit household
credit channel/financial accelerator from CB models.
Blockages to unorthodox monetary policy
or ‘quantitative easing’:
• 2. Old monetarist fear that “‘printing money’ is inflationary”
even after huge wealth destruction and excess capacity.
• 3. “‘QE’ is only possible once the policy rate is close to zero”.
• 4. Fiscal-monetary co-ordination need for QE.
Prospects cont’d
• Current problem is fear – as in 1933 in FDR inaugural.
• Great Depression and Japan-style ‘lost decade’ could be
prevented by sane policy.
• One big difference: fall in oil and commodity prices is very
good for Western households.
• Indebted US and esp’y UK households helped by lower
interest rates – unlike liquid Japanese.
Long term
• China and other ‘emergers’ will need new, lower, domestically
oriented growth strategy.
• Partial de-globalisation with reduced financial imbalances.
• Smaller financial services industry, lower levels of leverage,
tighter regulation.
• Suggests house price/income ratio will revert to lower trend.
UK in longer term
• Reduction in size of financial services industry is negative
supply shock.
• Saving rate has to be higher than in last decade.
• Government debt will constrain PDI growth.
• Lower value of £ is helping rebalance economy but takes time.
• Also helps top end of housing market hurt by collapse of City
jobs and bonuses.
Evidence from CameronMuellbauer-Murphy CEPR DP 2006
• Regional hp model based on inverse, solved out housing
demand function.
• Given housing stock, long-run income elasticity of real hp is
1.6, but income growth important in short run, shifts with
Credit Conditions Index.
• CCI level effect on long-run real hp.
• Interaction with nominal and real interest rate – credit crunch
makes nominal rate matter more, real less.
Hp evidence cont’d
• Strong momentum and downside risk effect: last year’s
appreciation translates into 0.4 for this year’s, but negative
return in last 3 years is negative for prices. Explains overshooting.
• Ripple effect from London, and London and SE sensitive to
stock market. Hence UK hp sensitive to health of financial
services.
• Model attributed most of rise in real hp since 1997 to income
and pop growth relative to stagnant housing stock; some to
shift in credit availability and low interest rates.
• Speed of adjustment has fallen because of Stamp Duty rise –
from 0.35 to 0.2 p.a.
• Slow and volatile adj. to long-run equilibrium: all factors
except supply side and interest rate now more negative than
last year: real income down; credit supply down; momentum
effect reversed; down-side risk ; net migration ; stock market.
Back of the envelope calculations:• Overvaluation in mid-2007, say -10%
• Lower income growth, -6% or worse.
• Reduction in long run credit, -5%.
• Lower interest rates, say +2% but could be better.
• Short run dynamics (credit, momentum, downside risk, income
etc.), say -7% or worse.
• Slow speed of adjustment means that hp could be away from
long-run equilibrium for long periods.
• Net effect -26% but could well be worse.
• Much depends on global outcomes.