Falling house prices are bad for the economy
Housing was a leading indicator of the last recession; is it now heralding the double dip? Chancellor George Osborne could find the property market undoes his best efforts to keep the economy growing.
House prices turned down in the late summer of 2007, almost as soon as the credit crunch squeezed. It was well over a year before the wider economy was declared to be in recession however. Housing has had a strong bounce since then, but all the signs are that the recovery was only temporary.
After a wave of would-be home-buyers chasing a limited supply of property we now have restrained demand but a rush of properties onto the market, boosted by sellers who no longer have to pay for home information packs. The higher capital gains tax rate no longer makes owning second-homes or buy-to-let so attractive either.
The fall in demand is a direct reflection off the chancellor’s austerity measures. Buyers are worried about having jobs or earning overtime; they don’t know if they’ll have to move to find work but they know taxes, including Vat, are rising and state-benefits may shrink, and they can work out that the only way for mortgage rates to move is upward.
And the more commentators like me warn that prices are falling, the more that even those buyers without financial worries decide that there is no point buying an asset whose value is declining. Certainly there’s no need to rush to buy before prices rise further.
But if reduced confidence is reducing the wish to buy, in a circular argument, falling prices reduce confidence. The pre-crunch spending boom was largely based on rising property values: it gave the collateral for borrowing more or for equity release, but it gave a feelgood factor even to those that did not realise their gain. Rising prices encouraged non-owners to buy. And the leverage of mortgages meant a small rise in values becomes a big rise in the owners’ equity and thus their confidence.
On the downswing, the equity erodes quickly and the feelgood factor falls at least as fast.
That should worry the chancellor ,but he should be worried too about the effect on the banks. Writing back expected losses on loans allowed the banks to report large profits for the first half of 2010. If property values fall substantially again, those losses will return, eroding the banks’ capital and thus curtailing the amount they can lend. That will mean fewer loans for small businesses.
And if the banks see values falling, they will toughen their lending criteria again, making it even harder for prospective first-time buyers to borrow and thus limiting the amount they can pay for properties – putting more downward pressure on prices.
The pessimists argue that the UK housing market is still 20 or 30 per cent overvalued. It would take only a 5 per cent fall to undermine the economic recovery however. A rising housing market is the best driver of the economy: a static market may at least save Osborne having to review his forecasts.
