As you know, I am looking at the UK and Spain as the epicenter for the next leg down in the housing bubble. Spain suffered massive overbuilding while the UK had a huge run-up in prices.
The Blogger at UK Bubble is on to something in her analyses. It’s a good site that is now on my blogroll. In a blog entry over the weekend she was thinking about how the New Labour housing bubble was going to be in comparison to the huge bubble that popped in the early 1990s under John Major.
During the last 20 years, the UK had the misfortune of living through two huge housing bubbles. The first was carefully nurtured under a Conservative government, while second happened under New Labour. Thus, it would seem that housing bubbles are non-party political beasts.
We see the current house bubble through the prism of the last one. Therefore, it might be useful to compare these two extraordinary periods. Before comparing them, it is important to date them. I will use a simple rule. Over the long term, there appears to be a steady relationship between house prices and average incomes. Historically, this ratio fluctuates between 2 and 3. When the ratio rises above 3.5, I assume that house prices have departed from long-run fundamentals and the bubble has begun.
-UK Bubble, UK Bubble: Comparing bubbles, predicting the crash, 18 May 2008
Well, UK housing prices are well above those levels. One other typical statistic that had a ‘steady relationship’ that I remember from the late 1990s, when British bankers were still cautious after the last downturn, is salary to mortgage debt. The figure used to be a standard ‘no more than 3 times income,’ even if you were a banker who worked in the city and depended upon a huge bonus.
After the Russian devaluation crisis of 1998 passed, mortgage lenders started to change their ways and 3x income became 3.5x which became 4x until it crept up to 6x. That means one could make 30,000 pounds (about $60,000) a year and supposedly be able to make monthly payments on a mortgage of 180,000 pounds ($360,000) without a hitch. Anyone who has ever had a mortgage knows those figures are pure insanity.
Just as with the mortgage to income levels your trusty banker used as a rule of thumb, those average income to house price levels have shot up too.
In the case of the Conservative bubble, the [price to income] ratio only reached 4 in December 1987, and it peaked at 4.8. Therefore, for long periods, one could argue that house prices were only marginally detached from incomes. At the time bankers and estate agents used this argument extensively.
In contrast, the price to income ratio in the Labour bubble shot up rapidly, passing 4 within a few months, and almost reached six at the peak.
-UK Bubble, Comparing bubbles, predicting the crash, 18 May 2008
That’s because a lot of poor sods could take out a mortgage for 6x income. Now, this has all come undone and house prices in the UK are falling. And these ‘homeowners’ are stuck with a mortgage they couldn’t ever possibly pay. Only now that writeoffs are happening are bankers becoming more conservative. But, its too late. Defaults are already on the rise. The house price deflation genie’s out of the bottle.
See: Credit Crisis Timeline for a full list of writedowns and capital raising by institution and a timeline of the credit crunch.
See also: Other posts under the label ‘UK.’