UK House Prices Summer Bounce an Illusion
Housing-Market / UK Housing May 26, 2009 - 10:55 AM GMTBy: Andrew_Butter
The Value of Housing in UK: Update April 09…The Up-Tick is An Illusion. - The recent up-tick in house prices in UK was a glimmer of hope, I'm sorry to say that I think that's a false dawn.
Last September I wrote an essay putting the peak to trough in UK in the range 34% to 40% (Value of Housing Markets in USA and UK Past, Present, and Future ) (its gone about 20% now on the Nationwide), in January I had another look and said 33% peak to trough. (UK Housing Market Will Not Bottom Before 2012).
I had another look today. Sadly, uptick or not it’s still looking to me like my September projection, was about right, and it might be more like the worst case than the best case.
September to January was before the bankers in UK got completely found-out for the full extent of their collective stupidity and what that would do to the economy. That was what they had managed to cover-up for three or more years (courtesy of IFRS and the FSA), which was only revealed as a "big surprise" courtesy of the inconvenience of the first run on a bank in UK since Victorian times.
Now the consensus prognosis is about minus 4% nominal GDP growth in 2009 and 20 Year Treasuries drifting back up to 4.5% as the government that "Saved the World" goes begging for just one more dime just to tide them over.
Oh and sure Gordon, it wasn't your fault, it was them darned terrorists!
Background:
The way I looked at this in September which I’ve refined a bit, is to understand the other-than-market value which is the estimate of what housing should be priced at if the market was not in what International Valuation Standards calls "disequilibrium" (i.e. when it's safe to rely on the mark-to-market price). That's what George Soros simply calls "mispriced", which according to him is something that happens a lot (I would tend to agree).
Disequilibrium or mispricing can by definition be either "too high" or "too low" and the central notion of the analysis I did was that on average over a long time, markets are priced correctly (that's another way of saying "markets revert to the mean", "efficient market hypothesis" and/or "Farrell's Law #2" - take your pick).
That's why I was interested in the other-than-market value because by definition it's the line of equilibrium (i.e. the long term trend or the mean to which the market reverts), if you know that (or think you do) you can figure out how bad the market is mispriced (up or down).
Anyway I worked that out for both USA and UK. Interestingly the formula for both countries was the same, which provides a degree of confidence since the two countries are (supposedly) independent of each other.
Although I suppose they do appear to share a number of bad-habits with regard to fiscal prudence, and it's funny how that "special relationship" gets dusted-off every time UK gets in a fix - (that's why "The One Who Sits Next to God" sent a couple of broken down Land-Rovers and a contingent of totally ill-equipped troops (but darned brave and competent ones) to get their heads blown off in Iraq, it's all in the spirit of "shared values").
The structure of the formula was:
Equilibrium price = Nominal GDP per House / ƒ(LTIR).
Where ƒLTIR is a function of long-term-interest-rates (20 Year Treasuries), and the "function" is basically an "S-Curve" (broadly linear for long-term-interest rates between 3% to 5%).
Why that works is a little complicated to explain.
The central idea is that the "income" generated by a house is the utility value it provides it's owner, and that (a) the cost to the owner of receiving that utility is a function of the price of the house and interest rates (and how he finances that cost and his potential capital gain or loss is irrelevant to that value - for example the value of an office building is nothing to do with how much debt is actually collateralized by it).
And (b) on average over a long time the proportion of nominal GDP that populations deploy on the luxury of a roof over their heads looks as if it is constant over time (that's rather than selling the house, putting the money in the bank, getting the interest, and sleeping in Green Park Tube Station (very clean - good facilities too)).
A plot of the "model" against actual for annual data gave an R-Squared of 98.8% for USA from 1929 to 1995 (cycle to cycle) and 97.7% for UK for 1971 to 1996 (also cycle to cycle - (it's less data)). In other words it looks like it could be a pretty good model.
Market-Long-Waves
This chart is a plot of the estimated extent of over-pricing or under-pricing of US and UK house prices (the "equilibrium is zero so the extent of miss pricing is the actual price divided by the estimated "equilibrium" or "other-than-market price" take away one).
One thing that I noticed doing the analysis was that the extent of mispricing seems to go in "waves" for both USA and UK, and the really interesting thing was that the amplitude of a preceding was above the mean (the "up-wave") was more or less exactly reflected in the amplitude of the "down wave" that followed.
That's of course after adjusting for the arithmetic, which says that 50% above the mean on that chart is equivalent to a (1-1/150%) decrease below the mean (which I am embarrassed to say I didn't "twig" in September). This pattern interestingly also applies to stock markets (http://www.marketoracle.co.uk/Article9658.html), and I suspect that it applies to many markets.
The way that I look at that is that a period of mispricing above the equilibrium (i.e. a bubble), is like a stone thrown into a flat pond, it creates a wave that starts off "up" and then is followed by a "down-wave" (i.e. a bust).
(The other thing that was quite interesting was that the period of time that the preceding "up-wave" was above the equilibrium was roughly reflected in the period of time that the "down-wave" ended up below the equilibrium, although that's not as predictable).
The "stone" can be a period of natural or artificially generated economic growth as a "trigger" which pushes up house prices, then if you set interest rates below the rate of increase in house prices that allows people to effectively live in a house for "free"- for a while, and you get a bubble ("Money for Nothing & Chicks for Free" (Dire Straights)...everyone's dream; i.e. during the Lawson Boom in UK and the Brown/Greenspan Boom).
That is of course also unsustainable because like they say in Hollywood, "there ain't no such thing as a free lunch", which is why the word "Boom" is so often linked with the word "Bust" (perhaps it should be "Bubble and Boom"?)
That's illustrated by a plot of the change in house prices in one-year minus the 20 Year compared to the degree of over or under-pricing (UK data).
In other words that's a monetarist socio-conservative-marxist politician's Wet Dream, just tweak down the interest rates and bingo.
That deception works particularly well in UK because the population can be easily bribed to forget almost anything...so long as the "value" of their house goes up.
Get the house prices up and the average Brit will forget about lousy infrastructure, corrupt politicians, body bags and paraplegics coming back from Iraq, and a government that positively discourages free enterprise as a mechanism to create jobs.
If you need more jobs just create public sector jobs, like 50,000 jobs to make sure that foxes live a serene and dignified life and that parents don't smack their children and other "productive" good things like that; although paradoxically battering your child to death in UK is OK so long as you follow the Official Guidelines and do it in a Politically Correct way, case in point "Baby "P"". I never worked that out but then politics was never my forte.
Get that sorted and you can tell everyone they are rich and they don't need to do productive work anymore (like the stuff that generates economic value added that can be used to pay off debt), and so all the dirty jobs that require getting up in the morning can be outsourced - (Money for Nothing and Two Chicks for Free)!
That explains why the government policy in UK is to actively discourage new house-building, that's when the "landed gentry" (the people with houses) collaborate with the "Greens" and the "public-servant-fox-lovers" to stop any competitive supply coming on line which might drive down their house prices. And anyone who is not politically correct or well connected (helps to be a member of The Party), gets to live in a 120 sq ft damp basement with an outside toilet for $1,000 a month.
The irrefutable justification for that is that is this might take out some sterile mono-culture agriculture that requires huge amounts of pesticides and fertilizer (so as to pollute the groundwater so that men can grow tits, push their sperm-count down to zero, and get breast cancer; when they drink the water).
That way it's possible to produce food at "only" three times what it would cost in the Third World (so as those people can't do about the only thing they can do (agriculture), and can starve to death, so we can send them the surplus food as Aid so we can feel good about ourselves and tell people we "Saved the World")!
That also explains why you can get a house that is three times bigger in USA than in UK for the same amount of money.
There is a logic there somewhere but I must have missed it. So many things I don't understand, I must be mentally defective; that's probably because my dad smacked me for locking up my brother in the basement all morning when I was six- so it's not my fault; I'm the victim here!
UK house prices:
My estimate is that in 2007 UK house prices were 42% mispriced on the high side (I use the Nationwide Index - no reason really just they provide a nice Excel spreadsheet you can download from their site and their methodology looks pretty sound to me, they started using multivariate regression a while back so they must have someone competent over there).
Also the time of the "up-wave" (from the point it crossed the equilibrium line going up to the point it crossed going down) was about seven years.
So if this analysis is right, and history repeats itself (you have to put that caveat in - it's politically correct, it's like saying "well the last time I pointed a loaded shotgun at my foot and pulled the trigger I blew my foot off, now I'm going to try it on the other foot and see if "history repeats itself" - of course I might get lucky and there will be a Black Swan").
So if "history repeats itself"...then I suppose the current "bust" should last about seven years and the maximum amplitude of the mispricing on the low side should be (1-1/1.42) = 30% under.
Where does that go?
Well the 20-Year went down from an average of 4.5% in 2008 to 3.5% now, it even hovered around 2.8% for a while which might explain the "up-tick" (keep that up for a year and it will all be over), but it's heading back up as Gordon Brown is stating to find it harder and harder to squeeze any more milk out of the sucker-cow to pay off all the debts he ran up.
Not long now Gordon, the Brits will forgive just about anything, even blowing billions on a faith-inspired crusade to find WMD in the Holy Land (did you find them yet by-the-way, I lost track), they will never forgive one thing, that's when the "value" of their houses goes down.
And now that basically the majority of employment in UK is "public service" (that's when you get an indexed linked government financed pension plan for all of the emotional trauma you suffered protecting foxes etc...(except of course there isn't any money to pay the pension plans (small detail - just borrow more money, keep that up and the UK's credit rating might go down to B+ (bliss)), it's hard to see who is going to actually do any productive work that's going to pay for that debt?
So regardless of how you cook the inflation numbers, nominal GDP might go down? You don't even need Nouriel Roubini to work that out!
Assuming a 4% drop in nominal GDP in 2009, 2% growth in 2010 and 5% in 2011 (assuming the Conservatives are not as dumb as the last lot), put all that into the pot assuming they manage to keep the 20 Year below 5.0; give it a stir and you get:
That spells 40% peak to trough easily by the end of 2011. i.e. about 28% to go down from where they are now.
That's about where Nadeem Walayat put it (38% peak to trough - UK Housing Market Crash and Depression Forecast 2007 to 2012 and he re-confirmed that in UK House Prices Moving in the Right Direction According to RightMove); I have no idea how he does that, but he seems to get it right more often that I do).
Anyway, here's an idea Gordon, why not just stop throwing billions of pounds to pay off the gambling debts (and pensions) of incompetent bankers (and useless public servants (perhaps a better word would be public leeches)), and instead throw that at helping whatever productive industry is left create the jobs that are the only thing that can get UK out of this mess.
Or better still don't throw any money at anyone (every time you do that you can be sure the politicians and leeches will dip their sticky fingers into the pot), just stop borrowing to paper-over the mistakes of the excuse for a government that you provided, that way you can keep the long-term-interest rates down (that more than anything else will mitigate the pain in housing).
Then just take away 95% of the piles of red-tape that productive people have to deal with in UK to keep the millions of public leeches in work.
THEN get out of the way, and let the market do what markets do, eventually, heal themselves from the damage that pathetic New-Coke-Nanny-Marxists or whatever you call yourselves, cause.
By Andrew Butter
Andrew Butter is managing partner of ABMC, an investment advisory firm, based in Dubai ( hbutter@eim.ae ), that he setup in 1999, and is has been involved advising on large scale real estate investments, mainly in Dubai.
© 2009 Copyright Andrew Butter- All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.
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