Friday, July 4, 2008
Britain's Housing Slump - Collateral Damage
The latest blows to the property market will pound the economy too AFTER the longest and biggest boom in post-war history, it is payback time for Britain’s ever more troubled housing market. As shares in homebuilders wilt following the failure of Taylor Wimpey, the country’s largest, to raise urgently needed capital (see article), there are wider worries that Britain may revisit the trauma of the early 1990s, when a housing bust led to a deep recession. With activity in the services sector at its lowest since October 2001, the economy looks perilously vulnerable to falling housing wealth and the collapse in mortgage finance, residential investment and property transactions. The mortgage market has already plumbed unprecedented depths. Figures released this week revealed that a mere 42,000 loans had been approved to buy homes in May, well under half the number a year earlier and below even the trough reached in the early 1990s. New approvals are closely watched because they point the way to house-price changes (see chart). The declines that started late last year are continuing apace, according to Nationwide Building Society. House prices fell by 0.9% in June, leaving them 6.3% lower than they were a year earlier. The outlook for both the mortgage market and house prices is grim. On July 3rd the Bank of England’s survey of credit conditions reported that lenders intend to restrict new home loans still more over the next three months. Following the latest statistics on mortgage approvals, Capital Economics, a consultancy, said that it expected house prices to fall by 15% in the 12 months to December 2008. It is forecasting a further 12% decline in the following year. The interplay between the distressed mortgage and housing markets is likely to get worse as more homeowners find themselves with negative equity (meaning that their homes are worth less than the loans on them). Working out the numbers affected is tricky, says David Miles, an economist at Morgan Stanley, an investment bank, and for many the shortfall may be quite small. With those provisos he reckons that a 15% fall in house prices could push 1.2m households under water; and a 20% decline might affect 2m, as many as in the dog days of the early 1990s. As everyone involved in property, from homeowners, estate agents and lawyers to builders and their workmen, feels the pain, there will be wider effects. There are three main ways in which the housing market’s malaise may infect the economy. Each threatens to do considerable harm. The first channel is through lower residential investment. Housing starts fell by 24% in the first quarter when set against the same period in 2007 and things have got worse since then. Kate Barker, a member of the Bank of England’s monetary-policy committee, recently said that the probable decline this year would be on a much bigger scale than in the slump of the early 1990s. The likely fall in investment could slice over a percentage point off GDP growth in both 2008 and 2009, according to Ben Broadbent, an economist at Goldman Sachs, an investment bank. A second way in which the housing slump will hurt the economy is by slashing the demand for consumer goods linked to property transactions. When people move they typically borrow some extra money to pay for equipment to kit out their new home. That source of demand will take a big knock, since the turnover of homes may fall by 30-40% this year. The effect, estimates Mr Miles, could reduce GDP growth by a further 0.2-0.3%. The third route is through the decline in property wealth, and this is a matter of considerable controversy. For many years it was taken for granted that there was a strong relationship between house prices and consumer spending (see chart). More recently the Bank of England has cast doubt on the link. The apparent breakdown in the relationship in the early years of this decade, when consumers did not respond to a surge in house prices by spending more, seemed to support the central bank’s view. This year too, shoppers appear unfazed by falling property wealth. Household spending rose by 1.1% in the first quarter of 2008 compared with the last three months of 2007. Official figures for retail-sales growth in May were so buoyant that they aroused incredulity in the City. But even if the strength of household spending in early 2008 turns out to be genuine, it may prove short-lived. Consumer confidence fell in June to its lowest level since March 1990, according to a survey by GfK NOP, a research outfit. Until this year the former link between house prices and spending appeared to have reasserted itself. In any case, the earlier breakdown noted by the central bank arguably reflected the influence of a long bear stockmarket in curbing consumer spending. According to Ray Barrell of the National Institute of Economic and Social Research, a 15% decline in house prices over the next two years would reduce the increase in consumer spending by one percentage point a year. The effect on GDP growth would be smaller, bringing it down by about half that amount over the next year, since much of the spending shortfall would leak out into imports. Clearly, the impact would be bigger if house prices fell more steeply. Putting these estimates together, the potential economic harm is evident. Mr Miles thinks the outlook is better than in the previous housing bust, because borrowers do not face the sort of shock produced in the late 1980s when the Bank of England doubled the base rate in little more than a year. Even so, the credit squeeze is raising effective borrowing costs as banks restore their margins on new and maturing fixed-rate mortgages. With inflation out of its box, the central bank can do little to help, and may indeed have to raise interest rates to show its inflation-fighting resolve. Coming on top of the erosion of consumers’ purchasing-power by soaring oil and food prices, the housing slump looks set to inflict some hefty collateral damage.