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Economic Conundrum…Boom, Bust Or Both? Does Anyone Have Any Answers?

The International Monetary Fund (IMF) spoke out yesterday regarding their fears of another housing crash and the impact this would have on the economy. However, these warnings came on the same day that national indicators apparently signalled an imminent cooling in the UK housing market.

The deputy managing director of the IMF, Min Zhu, said the monetary body views global housing as a major threat to economic stability and believes another housing crash could occur unless government’s around the world step in to combat rising prices.

Warning that over two thirds of the last 50 systemic banking crises were preceded by worrying boom and bust cycles in house prices, Mr Zhu called for nations to implement macroprudential monetary policies to cool markets and increase the sustainability and resilience of housing systems in order to limit the possibility of housing bubbles developing.

It is however worth remembering that, whilst Zhu specifically referred to housing concerns in countries such as Israel and Hong Kong, the IMF recommendations were issued in regards to the global housing system, and it is difficult to generalise across such a wide and varied market, or collection of markets, in which there is no possibility of homogeneity due to the number of variables involved. For instance, while house prices in Canada are now 33% above their long-term average compared to incomes, in Greece that ratio is down 7%, and prices compared to wages are 27% higher than their long-term average in the UK, while they are 5% lower in Spain.

Mr Zhu’s recommendations, made yesterday, came a day before the Royal Institute of Chartered Surveyors (RICS) released figures as part of their Residential Market Review which appear to show that the housing market in Britain is finally beginning to slow down somewhat.

Simon Rubinsohn, chief economist at RICS, said:

“What we are really seeing is some of the very strong upward momentum starting to come off the housing market, as a lack of supply, higher prices, more prudent lending measures and some of the talk from the Bank of England are creating a level of caution among sellers and buyers.

“The most visible indicators of this are the revised downwards price expectations for the next 12 months and the flatter picture regarding new buyer enquiries. In particular, we’re seeing the London market level off.”

According to Rubinsohn, the fact that, in May, the number of new homes entering the market declined for the fifth consecutive month in a row, combined with evidence that demand for property in London also diminished for the first time in two years, serves as evidence of this slowing down of the market.

Respondents to the survey reported that banks are currently lending less than they were, with average loan-to-value ratios for first time buyers dropping by 0.7% in April. RICS also announced that respondents to their review had reduced their UK house price expectations for the coming year from 3.9% to 3.6%, the lowest it has been has December last year. This was accompanied by an even more drastic reduction in their expectations for London house prices, which they now expect to rise at 5% a year for the next five years, representing a significant downgrade from the 9% figure that previously represented their house price predictions for the capital.

While admitting that the new MMRs have contributed to the trends indicated by the report, Rubinsohn was also clear that this was not the entire picture:

“There is some evidence to suggest that the Mortgage Market Review has contributed to a tightening of the funding market, although it is hard to disentangle this from other factors which are now impacting on the sector and to know whether it will simply be a temporary influence as lenders adjust to the new environment.”

Figures recently released by the Bank of England (BoE) seem to support RICS’ findings. The BoE’s data highlighted a reduction in  mortgage approvals in April, the third consecutive time they fell. Additionally, the drop itself seemed somewhat significant. The number of mortgages granted fell from 66,563 to 62,918, a reduction of 3,645 on the previous month. This represents the largest fall in the past nine months

The MMR rules were introduced by banks earlier this year in response to prompting and advice given by the Bank of England, who believed they would have a dual effect on Britain’s rapidly heating housing market. They believed the tougher regulations would make it harder for people to get a mortgage, thus stemming demand in order to bring it more in line with faltering levels of supply, as well as reducing the risk posed by low deposit, high loan to income mortgages which, according to a recent report, had risen to their highest levels since the final quarter of 2008.

So, good news all round then? The market is cooling, house price rises are slowing, we are going to have sustainable market growth, the housing market isn’t going to crumble, financial stability won’t be threatened and we can all avoid economic Armageddon. Unfortunately, as ever, things are not that simple.

As Simon Crone, Commercial President at Mortgage Insurance Europe points out:

“when we talk of a house price bubble in the UK we are predominantly referring to London, which many will know is fuelled significantly by cash buyers and foreign money. Indeed, it has been pointed out that if the Bank is looking to ‘kill’ a London-centric house price bubble, it needs to instigate a far more nuanced approach rather than rely on the macro-prudential tools available to the FPC such as increasing Base Rate or increasing lenders’ capital requirements. Not only might these measures (if introduced) have little discernable impact on the London market but they may actually impede the other regional housing markets which can in no way be said to be emulating the increases we have seen in London.”

While many commentators are quick to dismiss claims that the London house price bubble is being inflated by cash only buyers, there is reliable evidence to support Crone’s assessment. Respected UK housing market analyst Neal Hudson points out that the most common buyer type on properties over £400,000 are all-cash purchasers. It is worth noting that the average house price in London is £435,034. Furthermore, 36% of house buyers are currently cash only purchasers and, as with so much else in the UK, this phenomenon is essentially Londoncentric.

Another potential spanner in the works is the amount of high loan to income mortgages still being issued. While the newly introduced MMRs and moves by the two state owned banking groups to limit the amount of high loan to value mortgages it allows seem to be having an effect, it is still relatively common practice to issue four times income mortgages, particularly in London and especially on properties worth more than half a million pounds. The fact that Lloyds Banking Group recently announced they are introducing a strict four to one limit begs the obvious question: what was their previous limit?

Concerns regarding these high loan to value mortgages have increased exponentially recently, with various commentators pointing out that these risky mortgage types were a prominent feature of the housing crisis that hit in 2008, which caused the bottom to fall out of the market.

Vince Cable expressed how “appalled” he was to hear that some banks had recently been lending on low deposit mortgages with property that totalled five times income value. The business minister explained that history had shown us mortgages with loan-to-value ratios of 3 to 3.5% were safe; he suggested the BofE should therefore consider capping mortgages at this level. Speaking on the Today programme, Mr Cable said these measures should be introduced as soon as possible to ensure that the “boom in house prices, particularly in the south of England, doesn’t destabilise the whole economy.”

Pretty sound advice from Mr Cable, considered it was thanks in large part to the lending of subprime, N.I.N.J.A and high loan-to-income value mortgages that left housing markets so vulnerable when the economic meltdown in the US in 2007 triggered the global economic crisis.

So what do advisers at the BofE think of Cable’s suggestions?

Well, soon to be deputy governor at the BoE, current monetary policymaker Ben Broadbent, disagrees. According to Mr Broadbent, the business minister is mistaken in comparing current trends with the housing market circumstances which existed before the crash. According to Broadbent, the current upturn in the housing market is unlike debt-fuelled booms of the past because, unlike those past booms, it is not predicated on bad credit. He added that it was more important to watch leverage than it was to pay attention to prices.

Writing in the Telegraph, Jeremy Warner describes the “bafflement” of both the BofE and the Treasury regarding the exact causes and implications of the virtually unexplainable “boomless boom” that seems to not only be driving the economic recovery, but also serving as the fundamental characteristic of large and diverse areas of the economy itself. While the Treasury is happy to take credit for the resurgence of the market, rising levels of employment and increasing output, in actuality the current economic circumstances in which Britain currently finds itself has left them scratching their heads just as much as their counterparts over at the Bank.

In trying to define the current state of the world economy, Min Zhu attempted to describe the inner machinations of the powers that be and the influence these potential decisions could have on the world economy as a whole. What he said regarding the international consensus towards macro-prudential policies is as revealing as it is poignant:

“The tools for containing housing booms are still being developed. The evidence on their effectiveness is only just starting to accumulate. The interactions of various policy tools can be complex.”

Bafflement seems to be the default state for macro-economists at present. In short, no one knows what is going to happen next.

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