Given that we are still arguing over the causes of the Great Depression, the First World War, and the French Revolution it is perhaps too much to ask that we should have a clear understanding as to the causes of the Global Financial Crisis.
But the popular narrative rightly had housing in the mix. Grand-scale liquidity mis-match in banks and shadow banks, megalomania on the part of financial leaders, large-scale leverage, and copious use of synthetic credit – sure. But housing was definitely somewhere in there.
The Bank of England understands the centrality of housing to the UK financial system. If it didn’t it wouldn’t have its Governor talk about housing as the biggest risk to financial stability, or put out wonderful charts like this one:
But in releasing new macroprudential rules to govern mortgage lending in order to stop things getting out of hand, the Bank has basically said not only that things are not out of hand today, but also makes it the official position of the Bank that the market never got out of hand during 2006-2007. I have annotated in red a couple more charts from the Bank’s chartastic Financial Stability Report to show what I mean: a ceiling of 15% of mortgage lending to mortgages that are 4.5X income is out there in uncharted territory.
As a Londoner, I struggle to ex-post rationalise why thing are not already out of hand (although remind myself that London is not the UK). In Haringey where I live the median property is priced at around £355k, which is 10.5X median earnings for the borough. And while that’s towards the upper end of the scale of area-specific earning-multiples, it’s not at the top of it. Inner London more generally is priced at a multiple of just over 10 times Inner London earnings (which are much higher than the national average).
Ratio of lower quartile/median house price to lower quartile/median earnings, England and Inner London, 1997-2013
Source: DLGC, data here
Sure, it is not the Bank’s job to fix house prices. But wow! Price-to-incomes look white hot in a way that hasn’t typically ended well.
Of course, price-to-income ratios are just one valuation measure of housing. Another popular one is the debt service ratio (eg, the proportion of disposable income spent on debt service of which mortgage payments make up the lion’s share). The following chart and scenario projections come from Credit Suisse.
On this measure housing has rarely looked cheaper. But with the economy motoring, unemployment falling fast, and inflation ticking up, it is not hard to see why the forward path of interest rates is signalling a number of interest rate increases over the next 18 months that will increase the cost of servicing a mortgage and removing a crutch that many observers believe is supporting the market.
So, that causes house prices to fall, right? Maybe. But here’s the thing.
I am fortunate enough to have been able to buy a property a few years ago. And I’m not selling my property even though I think that the bit of the market in which I live is out of hand. The biggest reason is non-financial (I value my marriage), but there are financial reasons too. These financial reasons make me feel a bit like a de-risking defined benefit pension scheme. That is to say that the way I (and I think we) think of housing is better described as a hedge than as a punt. The price of the hedge is still important, but the goal for many is to be hedged so that they can stop worrying about their massive and unhedged liability. This may make immediate sense to some, but I will endeavour to explain myself in my next post.