January 19, 2014
The Washington Post used a standard that would have shown subprime loans to be a great boon to tell readers that a housing program by the conservative government in the UK has been a “winner.” The Post’s declaration of the program as a winner is based on the fact that the program, which allows people to buy homes with a 5 percent down payment, has allowed many people to buy homes who could not otherwise afford them. This was true of zero down subprime mortgages issued during the housing bubble years also.
The Post is also confused in its assessment of bubble conditions in the UK. The article implies that existence of a bubble depends on the rate of price increase as opposed to the level of prices, based on this view it tells readers that there may be a bubble in London, but little risk in the rest of the country.
The chart accompanying the piece shows rapidly rising prices in the London market, with prices rising at a more modest pace in the rest of the country and still below their bubble peak in 2007. However the level of prices in the UK is shown as being more than five and a half times its 1983 level. This implies an inflation adjusted increase in house prices of almost 140 percent over the last three decades. Rents have shown no comparable increase, which indicates that house prices are not being driven by the fundamentals of the housing market.
At some point it is likely that house prices will fall to a level more consistent with the fundamentals of the UK housing market. At that time, the beneficiaries of the Conservatives’ homeownership program will be winners in the same way that subprime purchasers in the United States were winners following the crash here.
It is also worth noting that the increase in consumer spending mentioned in this article is likely directly related to the renewed run-up in house prices. People are likely spending against the wealth in their home. This is the well-documented housing wealth effect which shows people increasing annual consumption by between 5-7 cents for each additional dollar of housing wealth. This wealth effect was the reason that the savings rate fell to nearly zero at the peak of the bubble and then rose sharply after house prices collapsed in 2007-2008.
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