Housing woes

It's appropriate that my first entry should be about housing. I've got a little bit obsessed about it. Housing and house prices are a fairly depressing aspect of economics to get obsessed about, for a large number of reasons.

1) House price economics is actually pretty complicated. There's a large number of things that will determine whether buying a house will be a "good decision" or a "bad decision", including future interest rates, inflation, how many houses get built, immigration, the health of the economy in general - predicting house prices is a difficult task. Trying to explain it to people usually results in headaches, both for you and for them.

2) Forecasters are often wrong about house prices. This is partly because of the number of factors in play, but also because house prices (in most economies) are highly prone to bubble behaviour - i.e. house prices will rise (and fall) above (and below) "economic fair value" prices, (whatever they may be - see 1) ! ), driven by speculative behaviour. Predicting house price changes is highly risky.

3) Housing markets work slowly. They take a long time to rise and a long time to fall. Claiming at a dinner party that "houses are overpriced and will fall" is a claim that will only be conclusively proved to be right or wrong years after the event.

4) There are lots of vested interests in housing. I'm one of them. I currently rent, and would like house prices to go down, since, in the long term, I want to make an investment in a house. Most people (in the UK at least) have vested interests the other way around. They want house prices to go up, since they own one. Estate agents want to drive prices up as much and quickly as possible in a boom (to encourage people to buy and sell), and as down as much and quickly as possible in a bust (again, to encourage people to buy and sell). Mortgage lenders always want prices to go up, so they can lend more money, and so the value of their security goes up, while politicians desperately want to maintain the "free" wealth creation (and stimulus to consumer spending) that house price inflation brings.

So in summary, being obsessed with housing just brings pain and suffering. There's nothing you can do to influence the housing market, you'll probably be wrong in all your predictions, and even if you're right, no one will thank you. Great.

Anyway - I'm highly bearish on UK property at the moment. The price of a house asset over the past 10 years has gone up to true bubble levels - there are absolutely no fundamentals that support current prices. I'll perhaps come back to this in another post, but right now I wanted to talk about what happens when things go wrong.

This has been prompted by the recent reaction of US policy makers and central bankers to the US housing crash and its fallout. Ben Bernanke has recently advocated some extremely odd responses to the fact that many households are under threat of repossession due to a combination of excessive monthly payments and an inability to reduce those through refinancing (since the value of their houses is now going down, rather than creating equity by going up). He is essentially recommending that, rather than repossess, lenders write off a proportion of the debt, potentially in exchange for gaining a claim on the equity appreciation upside in the future.

For example, if somebody had purchased a house 3 years ago for $300k using a dodgy sub-prime deal, and it was now worth only $250k, the original lender would, for example, write down the borrowers mortgage to $200k. The loan could then be refinanced on more normal terms. The bank takes some sort of credit to enable them to claim back their writedown when the house price starts going up again, and doesn't have to reposses the house, which is an expensive and socially destructive policy.

There are some good aspects to this. Repossession is undoubtedly a waste of resources (although the waste is not the same as the repossession process cost, since there is an advantage in repossession in allocating assets to those who can afford them). The problem is that if the banks really thought that this was a good deal for them, they would be doing it anyway. If Ben wants to get involved and add something useful than it has to involve either some kind of government guarantee, or taxpayer funded refinancing, both of which amount to a taxpayer subsidy to homeowners and banks.

I certainly hope that nothing like this gets proposed in the UK when the crash starts happening in earnest. Both homeowners and banks need to learn that borrowing/lending huge amounts of money to purchase an overpriced asset using large amounts of leverage is an exceptionally risky business. That riskyness brings great rewards, as can be seen from the people who have made large amounts of money from BTL (and selling out), but should also result in some casualities, in particular shareholders of overstretched mortgage lenders (Northern Rock shareholders should get nothing) and anyone who purchased in 2006/7, especially if they purchased a stupidly priced new build flat in any large city. Without some truly unforgettable pain, this whole destructive cycle of house price boom and bust is doomed to continue.