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Whether or not the nationalisation of Northern Rock turns out to be a good idea or a financial disaster hinges very much on what is going to happen to house prices. If they plunge and the bank's bad debts soar, the losses will be huge. If stability returns, the current slowdown will not matter too much because Rock will be able to trade its way through, although it will have to shrink a bit.
The real problem is not what happens in the next few months but whether the whole trend of rising house prices is going into reverse. Two independent studies published last week produced in their different ways other more fundamental reasons to worry about house prices.
However, they are not concerned with a downturn induced by the short-term problems of the economy. Their analyses point to a fundamental shift in economic conditions, which could mean that the great long-term upward trend in housing is about to turn the other way.
The first case was made by Tim Bond of Barclays Capital in his annual Equity Gilt Study. Although he took most of his data from the US, much of what he concluded is equally applicable to the UK. Having studied long-run trends in house prices, he concluded that the only reason people were prepared to pay as much as they did was that they expected further increases.
Homebuyers probably don't need an economist to spell this out for them, but it does underline how prices have lost touch with the underlying economic reality.
Bond highlights how people had only been able to enter this world of unreal pricing because of the exceptional conditions in world markets - the def lationary pressure from China, the glut of world savings and the willingness of central banks to cut interest rates at any sign of an economic slowdown. This has allowed the huge rise in personal debt that has driven the surge in house prices.
But the party is now over because global economic conditions have changed. Global inflation is back, and with it volatility. Central banks can no longer indulge the world's borrowers with easy money at low rates. The prop under the housing market has been removed and prices must fall.
The ABN Amro/London Business School produces the other analysis in its annual Global Investment Returns yearbook, also published last week. One section dealt with momentum investing - where investors buy what is going up and sell what is falling. It shows how the public's willingness to buy houses depends on whether prices are rising or not and on the availability of bank finance.
If they look good, people will take on more debt, and then small changes in the amount people are allowed to borrow, say from 75% to 80% of the property's value, have a massive impact on prices. Indeed, the authors reckon a 7% change in loan-to-value ratios causes a doubling of house prices.
The corollary is that as banks tighten up and the money is no longer available, as is now happening, the prices go into reverse. And just as they went up far more than you would expect, so too will they fall. IF in 2000 a stock-market investor had been asked to decide which industries or sectors would dominate the first decade of the new century, he or she would probably have gone for computer hardware and software and fixed and mobile telecommunications, with an outside bet on the media.
They would then have learned a harsh lesson. Thanks to the Global Investment Returns yearbook, we can see they would have lost 95% of their money on computer hardware; 88% on software, 67% on fixed-line telecoms, 62% on mobile telecoms and 53% on the media.
There was a sector in 2000 where you could have made almost 10 times your money in the next seven years. But who would ever have chosen tobacco, up 960%? It was followed more rationally by mining, up 667%, personal goods, up 521%and presumably reflecting the debt-fuelled consumer boom, and household goods, up 400%.
As Professor Elroy Dimson, one of the three professors at London Business School who compile the yearbook put it, this is the long-run triumph of the boring. It reflects the thinking of Warren Buffett, the world's most successful investor who avoids the new, the fashionable, the revolutionary and anything that promises transformational change.
Buffett's view is that investors should never confuse innovation with the opportunity to make money. He avoids new industries because they attract so many entrants that no one makes any money. Picking the handful that will survive and prosper from the many more that will go out of business is a question of luck not judgment, and that is no way to invest.
Reader views (1)
People really need to step back and look at the reality of the situation. The inevitable impact upon them personally, their employers and the economy as a whole is going to be huge with a recession yet to be accepted by the establishment. They need to look at the finances and get out whilst the going is still relatively good. The inevitable downturn will not be nice. Buy to lets and property as a whole is a time bomb that about to go off. Do you want to be the last person still holding the ticking device.
- Dave Singh, London, 19/02/2008 13:51
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