Graham Macdonald, MBE
MBMG International Ltd.
Nominated for the Lorenzo Natali Prize
Will UK House Prices collapse in 2013? Part 1
One thing which has been very resilient in the face of adversity
is the UK housing market. Nationwide reckons that UK prices are
down by more than 12%. This may not be stunning but, when
compared to other countries, it is not too bad a result. As a
comparison, the average cost of a house in Spain is down 31%, in
America it is down 34%, in Ireland it is over 50% off its peaks
of a few years ago.
Let’s face a few facts here. The UK has not exactly set the
world alight with its economy. It is basically in a recession,
unemployment stubbornly refuses to drop and the family earners
have been hit hard with a combination of higher taxes, poor wage
increases and inflation - a triple whammy.
This begs the question why has the housing market not crashed?
The main reason is money is now cheap. Interest rates are very
low, in fact they are as low as they have ever been. Up until
the end of the Conservative government in the early 1970’s, UK
rates remained no lower than 2% and no higher than 10% with an
average of around 5%.
Then in 1973, global inflation forces UK rates up to almost 13%
and it kept going higher until reaching its peak in 1980 at 17%.
Inflation was gradually brought under control and rates slowly
came down to around 5% in the mid-1990s. It stayed at about this
figure for well over a decade and then things started to get
interesting as the Global Financial Crisis took effect. The Bank
of England (BoE) took action in early 2008 and cut rates from
5.5% in January 2008 and kept cutting until they were at 2% by
December of the same year. Things did not stop there, though;
three months later rates were down to 0.5% and that is where
they have stayed ever since. To put things into perspective,
rates never dropped this low during two World Wars or the Great
Depression. The lowest they went down to was 2%.
However, the BoE view things differently these days and,
according to them, we are in more economic pooh than we ever
were in the first half of the last century. But at least in
those days we were in charge of our own destiny whereas now we
just seem to copy what the Fed does.
If this is so then why haven’t we suffered as much as them when
it comes to the cost of buying or selling a house? Well, the
fact of the matter is, there are more forced sellers in America
than there are in the UK. Over the last couple of years the
amount of home repossessions runs to just over thirty thousand
per annum. This is a lot less than levels incurred during the
property crash of the 1990s.
In America, things are a lot worse. Almost 100,000 homes are
seized every month. There is a good reason for this number and
that is much of the property financing is done via
‘non-recourse’ loans. This means that if the borrower can no
longer afford to pay the loan then he/she just ups sticks and
walks out. The lender then takes over the property but that is
it and cannot make any further claim against assets or earnings.
This cannot happen in the UK.
However, not everything goes the borrower’s way in the US. One
of the more common mortgages is ‘long term fixed rate’. Compare
this to the UK where it is much more usual to take out something
which is more akin to short term variable rates. Thus, any cut
in the base rates is of far more benefit to the UK borrowers
than their counterparts in America. Despite this the UK is still
in the metaphorical pooh and all this means is that it has
prolonged the inevitable but necessary correction. The simple
fact is that property in the UK is not exactly cheap.
Let’s look at some recent history. In the ten years that
followed from 2001 the average cost of property rose by 94%
whereas earnings only went up by just less than 30%. To put it
in plain English, you do not need to be Einstein to see that
when the former has risen by more than three times the latter
then see that something is not quite right. If you look at the
history of property prices then you will see that, eventually,
after any large increase then they ‘revert to the mean’ and make
the necessary adjustments.
It is interesting to note that The Economist reckons the prices
of the UK property market are as much as 28% too high. They are
not alone: Fitch - 25%; Deutsche Bank - 34%; Morgan Stanley -
25%; International Monetary Fund (IMF) - 30%. It must be said
that the very low interest rates over the last few years do
distort things and, as such, are keeping property prices well
over where they should be. This can be seen by looking at the
average rate of the UK Consumer Price Index (CPI) over the last
couple of decades - this has been at around four percent. The
present rate is just over 2.5%. The implication is that the
correct base rate should be about seven percent per annum.
However, the lenders have to make money too and will add on
between 1% and 2% for themselves and this is why many mortgage
rates are approximately a couple of percent over the base rate.
To put things another way, the Standard Variable Rate (SVR)
should be about double of where it is now. This would mean that
your mortgage payments would be double what they are now and
nobody would be walking around saying there is a recovery or
“the market is stabilising”. Whilst prices are not volatile at
the moment it must be recognised that there is a massive
underlying weakness. The amount of completed purchases is almost
half of what it was five years ago. Theoretically, this is
ridiculous as potential purchasers should be able to take
advantage of lower prices but the lenders have been tightening
their purse strings - they have returned to the pre-sub-prime
era of high deposits and lower income mortgages. (Maybe they
have learned something after all?)
Buyers are not the only ones with problems. The drop in the
average price means that many people who bought when near the
peak of the housing market cannot now afford to sell as it would
mean they would get into negative equity and so sell the house
for less than they paid for it. This not only affects the sale
of the present property but also, potentially, any new one they
want to buy since they would have to find money for the move and
also cover the deposit for the next property. Not an attractive
proposition when you have just had to take a hit on what you
have just sold.
The problems do not stop there. The re-mortgaging of present
property has dropped by more than a quarter in comparison to
what it was last year. This may not sound too important but what
it does do is tell us that there is not enough equity in the
property to be able to re-mortgage it.
Even property owners who do not have a mortgage could be
affected as prices are invariably linked to available credit so
if the price of property heads south then so does the value of
what you own.
To be continued…
Giving me the Creeps
Ronald Niebuhr’s ‘Serenity Prayer’ talks of having the serenity to accept
the things I cannot change, and granting the courage to change what I can.
It is with this in mind, that I write this article.
Ponzi schemes always succeed for a while. The inability to verify the real
value of underlying assets is not the only reason for this. People genuinely
want to believe in them. This is evident not just in bull market conditions,
but is even more noticeable in bear markets when traditional asset classes
are not performing strongly. The guy promising the steady 10% a year returns
can always attract enough people who want to believe the story. If you
repeat something often enough, you may even begin to believe it.
This abundance of new Ponzi’s is evident in the number of avoid (read: Avoid
like the Plague) asset analyses that MBMG Asset Management has produced
recently on investments built around utterly illiquid and unquantifiable
underlying assets such as student accommodation, litigation funding,
receivables, forestry, traded life/endowment policies, even care homes and
fancy tree oil funds. The assets themselves may have value, but the
investment method of many schemes distorts this over time so that a
valuation gap develops. When you mark your fund pricing to model, instead of
marking-to-market, an investor can be pretty sure that the number on their
latest valuation is not accurate. Marked-to-model funds quote a performance,
with the idea being that they retain surplus returns in good times to fill
shortfalls in inflows in bad times. As long as new investment keeps coming
in, they can keep paying out at the quoted price.
However, it is what happens when new investment dries up that you see the
truly creepy effects of marked-to-model pricing. Investors who try to
withdraw when the actual performance falls below quoted value may find that
they are either prevented from doing so by a suspension of redemptions or
are paid a much lower amount virtue of a discretionary reduction. This is
known as a Market Value Adjustment. In a sustained period of negative
performance, where the fund’s underlying asset has become increasingly
divorced from the marked-to-model price, such suspensions or write-downs
tend to become inevitable. This valuation gap means that it is not a
question of ‘if’, but a question of ‘when’ significant investor losses will
occur. This is the creeping neo-Ponzi.
Central Banks have done the same with capital markets. The valuations rely
upon a model of Central Bank support and not genuine economic activities.
Traded global assets have become neo-Ponzis too. As artificially priced as
some of the aforementioned funds above, the question to be asking is, “What
will trigger the collapse of Mark-to-Fantasy pricing?” Will it be an
inflationary or a deflationary bust? When will it happen, and what should
I accept that Ponzi schemes, from Ivan Kreuger at Swedish Match in the
1930s, to Bernie Madoff and the neo-Pons of the twenty-first century, will
always be around. They’ll always succeed for a while. But it never lasts.
The above data and
research was compiled from sources believed to be reliable.
However, neither MBMG International Ltd nor its officers can
accept any liability for any errors or omissions in the above
article nor bear any responsibility for any losses achieved as a
result of any actions taken or not taken as a consequence of
reading the above article. For more information please contact
Graham Macdonald on [email protected]