Credit Crunch – Round two?

Date: July 1, 2010

The recent rise in house prices must be a false dawn and is likely to be followed by another crash

From 1999 to 2007 a massive supply of credit combined with relatively low rates and a limited supply of houses lead to a massive boom in UK house prices. With little regulation mortgage lenders found new and ingenious ways to lend to would be home owners. Rising valuations made people fearfully that they were not on the property ladder, those that were marvelled at their sudden increase in net worth. The rise in prices was nearly threefold between 1999 and 2007 whereas the growth of income per capita was more like 50% and houses were not exactly cheap in 1999, the actual low point was in 1994.

The great irony of the credit crunch is that so many people have actually done rather well out of it. When Northern Rock collapsed interest rates were slashed everywhere. The result was that people with tracker mortgages fixed variously at 0.5% to 0.95% over base rates for the life of their mortgage have seen their mortgage payments plummet and far from suffering in the credit crunch have actually been doing rather well. (I know someone who drew down the extra loan facility he had and put it back on deposit with his bank as it cost him 2% less to borrow than the bank was paying him to have it on deposit!)

Banks have reacted to the crunch by only lending to very credit worthy people and setting far more conservative loan to value limits, but because mortgages are still so cheap and because there are relatively few houses available to buy, house prices which had dropped by about 15%, have now risen in the first part of the year. This is crazy to my mind.

People are still thinking in terms of how much they can afford to pay each month and then seeing how big a mortgage they can get with that, rather than thinking whether this house that cost £200k in 2000 is really worth £600k today? Those that take out cheap mortgages today might regret it soon.

The last government’s reaction to the credit crunch was like a man who has been made redundant and instead of cutting his costs, remortgages his house and carries on spending at the same rate as before hoping that he will soon get another job. The result is that he still needs to cut his costs but he has the extra burden of greater debt. Now there will be thousands of government employees who will be made redundant as the new government gets to grips with the massive deficit and this contraction in government spending will affect the private sector too. The Bank of England is also talking about the need to increase rates as inflation is rising. On top of that, the Bank of England and ECB are reducing the level of lending support to banks which in turn will reduce the supply of mortgages.

Average house prices should reflect a multiple of between 3 and 5 times average salaries. They got up to 8 times came down to 6.5 times and have been going back up. I believe that they will return on their downward trend and do so quite soon. As average salaries are unlikely to rise by much over the next few years house prices have a long way to fall.

I look forward to hearing your thoughts on this matter.

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