Tuesday, 6 November 2012

Blowing Bubbles

In a recent book, How the West Was Lost,  Dambisa Moyo analyses the decline of the economies of the USA and Britain. 

The most effective section of the book is the analysis of how a policy of home ownership for all (as followed in Britain and the USA) has diverted investment from economically useful sections of the economy into a meaningless property boom. Leaving aside, for now, the sub-prime crises, (miss-selling of mortgages to individuals clearly unable to pay for them), the 'democratising' of home ownership has done little, it is argued, beyond funding a property bubble energised by the rising demand of the baby boom generation. Interestingly, in the various reviews of this book that I looked at on-line, none mentioned this section of the book. Possibly because for a British readership, totally seduced by home ownership, the conclusions would be just too hard to take.

Moyo's main argument is, that by investment in home ownership, money, that otherwise would have been available for useful investment is misallocated. Industry, R&D and infrastructure investment is starved of funds.  Furthermore, the gains that property generates are unjustified and over the long term unsustainable. She cites the American economist Robert Shiller as suggesting that over the long term, the employment cycle of the baby boomers, the return will be sum zero.  

I had a look at the property prices of recent years. I bought my first house in 1979, a small three bedroom terrace house in Crawley which cost me, and the building society, £18,500. The website zoopla lists the house next door, virtually identical, at almost exactly ten times that £172,500. Admittedly we have had a great deal of inflation since 1979 but that much? So what is £18,500 in 1979 currency worth now? According to the Bank of England inflation calculator, £76,797.

The house in question is the third from the right.

So, my first house has risen in value by more than twice the rate of inflation. If I had bought anything else 1979 its resale worth would have fallen greatly in the first year and continued to do so. So why is a 1979 house so different? The house is far from high tech. The windows were single glazed with wooden window frames and partition, 'stud walls' separate the bedrooms.

Yet, this tiny house, indifferently built and subject to steady deterioration, has done better as an investment than even the most speculative of stocks. The 'market' always knows how much something is worth, right? But this is quite irrational. The price has been driven up by nothing other than the imbalance between supply and demand and as it does so it has made the cost of one of the most basic needs, housing, irrationally higher.  

A mortgage is a debt that needs to be serviced monthly, unlike a savings account that one can add to when convenient. Taking out a mortgage is entering into voluntary debt slavery. But not doing so, in the high inflation times of the last forty years, is to allow any savings you have to be eroded by inflation. So property is sought after. And why is it so sought after? Because it's such a great investment. But these are artificially contrived prices, as irrational as the numismatic pricing logic of used postage stamps.

In the event of rising inflation anyone who does not participate in this property game loses out. Their value of their savings is washed away as governments increase the money supply to pay for the infrastructure improvements that are not being funded by the citizens who might otherwise be buying bonds. It is inflation that makes not getting on the property ladder so hard. 

It is said that at the peak of tulip mania, in February 1637, some single tulip bulbs sold for more than 10 times the annual income of a skilled craftsman. Subsequently many fortunes were lost when the bubble burst and prices returned to normal. Of course, no right thinking persons gives a rats about a few wealthy 17th century speculators having lost their shirts, but if housing prices are a speculative bubble and we all lose our shirts, what then?

In Britain land available for building property is kept in short supply. It's not as if it is in particular short supply but getting farm land, for example, rezoned for house building is difficult. Additionally, areas of outstanding natural beauty, are difficult to get permission to build on. These rules contrive to keep new house building land in short supply.

So far so good then. As long as the demand for houses exceeds supply prices should still keep rising. 

The UK house buying pattern has been, as soon as one is earning enough, to buy a small property and use the equity thus earned to leverage to a larger one and to do this repeatedly. Most people hope to stay employed up to retirement age and then turn their housing investment back into cash as a retirement nest egg. The baby boomers, those born between 1946 and 1964 are now moving into retirement mode. Those boomers expect to do nicely out of sustained high prices. Well, if the 1946ers retired in 2010 and sold up immediately their houses will have got top prices. But are there enough big spenders coming along to maintain prices? 

The UK birth rate, at last measurement, was 1.94 children per women. This is rather below the replacement rate of 2.1 and well below the baby boom peak of 2.95.  Barring extraordinary immigration then, in the long term, through population demographics, we can expect housing demand to fall. 

The housing market is a system with positive feedback. Increasing prices drive demand and falling prices reduce it. When demand falls so will property prices. People dithering on the verge of selling will then sell quickly and prices will fall still further. Those hesitant about buying because of falling prices will wait longer and this will also suppress demand. Even if nobody downsizes at all prices will start coming down as the oldest die off and release houses for resale. 

And so the bubble bursts...

And what then? Prices will continue to fall, with houses perhaps finally reaching their true value as the last of the boomers retire in 2038. All those who've participated in the housing game, unless they got out quickly, will see their gains fade away. All those years of voluntary debt servitude, faithfully paying into that mortgage will have been for nothing. And what about those missed opportunities to invest in stocks that might have improved infrastructure, created new jobs and some sustainable, real wealth?  And there's more. A generation of really shitty houses have been built in the UK. Flimsy, tiny and not energy efficient. But hey, what builder needed to go for build quality when houses were  rising in value like rockets?  

But the real worst of it is that those people who thought they'd found an inflation proof way of investing for their retirement will have been cheated. Instead they'll be obliged to rely on their state and any private pension plans they might have. And pension funds, thanks to that sub-prime crises, have all taken a huge hit anyway. All thanks to the widespread home ownership. 

How the West Was Lost by  Dambisa Moyo is recommended.


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