Entries Tagged 'uk housing market' ↓

After rescuing Bear Sterns, Freddie Mac and Fannie Mae, the American government decided that it had to draw the line somewhere and not use public funds to rescue Lehman brothers. The effect is that the big investment bank, Lehman Brothers has gone bankrupt leading to almost 20,000 job losses. However, although this is a high personal cost to those concerned, the repercussions could spread far across the banking and financial system.

It shows a year after the credit crunch started, we are far from reaching the bottom.

Lehman brothers were part of the ’shadow banking system’ - The banking system that doesn’t rely on deposits to fund loans. Instead Lehman brothers helped to sell on debt from other banks (including the notorious subprime loans). They were also heavily involved in derivative trading. Yesterday, as stock markets plummeted, traders tried to unwind $700bn worth of derivatives - a scale never seen before. Wall street admits that derivatives trading has grown so fast, that there is hardly any regulation of this trading.

What does the Future Hold?

The fact another big bank has gone under will send shock waves throughout the financial system. There are real concerns that the problem could spread. In the US, Ken Lewis, head of Bank of America, said he thought that up to half of the country’s 9,000 banks would ultimately go under or be taken over.

The danger is that the collapse of Lehman brothers will trigger a fall in confidence. Combined with the long standing shortage of funds, we could see higher interest rates (the libor interbank rate rose 0.5% yesterday alone) and the possibility of the credit crunch getting worse, pushing the economy further into recession.

A recession would only exacerbate the current problems. A recession would lead to more mortgage defaults - the last thing banks need at the moment. If home repossessions continue to rise and house prices fall; the losses of banks could grow even higher.

Economists such as Paul Krugman fear the worse, saying the collapse of Lehman Brothers reminds him of Russian Roulette

• Credit Crunch Explained

AIG a big insurance firm is the next finanicial institution that is in the firing line.

With house prices falling at their fastest rate for 25 years, there looks to be little room for optimism in 2009.

Already house prices have fallen by more than 10% from their peak in July 2007.

These are the main factors dragging house prices down at the moment.

Shortage of credit and mortgages. The number of transactions has slumped as people simply can’t get a mortgage. Many previously popular mortgages have been withdrawn, now mortgage companies are requiring large deposits of upto 25%

Falling confidence. WIth house prices falling at an annual rate of over 10%, there is little incentive to buy now. Potential homeowners are waiting for house prices to bottom out before buying. This lack of interest is exacerbating the downward movement of house prices.

Economy entering into recession. Unemployment is forecast to rise as the UK begins to enter its first recession for over 15 years. If unemployment increases to over 2 million, the rate of home repossessions is bound to increase creating more homes for sale.

House price to earnings ratios still relatively high. Because banks have become stricter in mortgage lending, buyers still struggle to buy a house. Sticking to 3 times earnings means average house prices are still out of the reach of many - especially if they require 25% deposits as some banks are encouraging.

• Why House prices are falling

How Much Will House Prices Fall?

Despite the downward pressure on house prices there are some factors which will help the housing market in 2009

• Interest rates are falling and could fall further as the recession and lower oil prices reduces inflation. If interest rates fall, the cost of mortgage payments will look increasingly attractive, especially compared to renting which has been increasing in cost. With base rates of only 5% and set to fall, mortgage payments are relatively low compared to the last housing crash when interest rates reached 12%.
• The Old Problem of Shortage of Supply. The housing crash has not changed long term demographics. The UK population and number of households is still increasing faster than supply. If anything, the housing crash has exacerbated the problem because the falling prices have led to a decline in new construction.
• Renting vs Buying. This housing crash won’t change people’s long term desire to buy a house rather than rent. In many areas buying is becoming a cheaper option than renting; this will come into play soon.

Conclusion.

At the moment there is a powerful momentum of falling house prices. In the short term, it is hard to see this changing, especially with the ongoing problems in the credit markets. Even half hearted measures like a freeze on stamp duty will do little to change the sentiments of the market. Therefore, I feel house prices will continue to fall in 2009, perhaps by 10-15%. However, I feel the crash will be less severe than in America and also, towards the end of 2009, there is the prospect for the slump to bottom out and house prices to gradually regain an upward movement.

- One thing is for sure, the housing market is always interesting! - We never seem to get stagnant house prices.

With house prices falling so rapidly and the economy plunging into recession, it is not a surprise many make the link between house prices and consumer spending.

I was surprised to come accross a report by a former member of the MPC, claiming there was practically no link between house prices and consumer spending / economic growth.

His logic was that, although some people lose out from falling house prices, others (first time buyers) gain from falling house prices. Overall, this leads to a neutral outcome.

However, I feel this is wrong. House prices are so important to the UK consumer, they impact upon our mindset and confidence. Also equity withdrawal become an important determinant of consumer spending by 2006. With house prices falling, and negative equity - equity withdrawal has dried up.

You can see the full article on my economics Blog - Affect of housing on economy

Barratts, one of the UK’s largets house builders, typifies the problems facing those exposed to the UK Housing Market. In the past 12 months, they have seen the price of new homes drop 6% to £183,000. However, more damaging than the fall in prices is the slowing down of sales, leaving Barratts with lower profits and cash flow problem.

The drying up of mortgages has particularly affected first time buyers and has led to the lowest number of property transactions for 30 years. The temporary increase in the stamp duty rate to £175,000, is unlikely to do much to kickstart the economy.

To Try and Increase Sales Barratt, like other property sellers is offering shared equity.

For example, you buy a 75% share in a house, with Barratt retaining the other 25%. The housebuilder gives a 10 year interest free loan of 25% of the house value. If the house price falls, you will still have to pay this 25%

They are also offering homeowners some insulation against falling property values, if a house is sold within 3 years, Barratt will pay uptop 15% of the house price loss.

It remains to be seen whether initiatives like this will revive the housing market. The fundamental problems - uncertainty of falling house prices, difficulty in getting mortgages, low affordability, are still likely to overshadow these offers.

If I was a home buyer, I would not rush to take advantage of the government’s one year stamp duty holiday. I think that prices will be lower by 10-15% within the next 12 months. I would wait for 9 months before buying, and I think many others will continue to wait on the sidelines.

Those selling their house are increasingly faced with the legal, but painful, practise of gazundering.

Gazundering is the term used to describe the practise of lowering your offer a few days before exchanging contracts. Because house prices are falling, sellers have the option of refusing the new offer or risking going back on the market to try and sell at an even lower prices

The national association of Estate agents say that half of all home sales are being affected by gazundering. The practise of gazundering often increases during falling property prices. When prices are rising - gazumping is more likely (people putting in a higher offer)

What can be done to Insure against Gazundering?

For home sellers there is little to legally protect against gazundering. One can try to keep in close contact with the buyers; one could try to exert moral pressure about the benefits of sticking to the original price. But, with 1000s of pounds at stake, a gentleman’s agreement may not hold much weight.

Exclusivity agreements are sometimes used to protect against gazumping.

Some insurance firms offer insurance against gazumping, so you might be able to get insurance. However, with house prices falling at a rapid rate, few firms are likely to be willing.

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Properties costing less than £175,000 (Nationwide average house price index has slipped quite a bit below £175,000 to £164,000) will face 0% property tax for the next 12 months in an attempt to kickstart the housing market.

With house prices falling at the fastest rate for 25 years, even this significant benefit may not be enough to persuade people to buy; there are good reasons to wait another 12 months, in which time house prices could have fallen by another £10,000.

Arguably, there is is a lot of political motivation behind this move; but, if it can help limit the extent of house price falls it may help limit a feeling of panic which has overcome the mortgage and housing industries. Previously I wrote of a danger that there may be an overreaction to falling house prices as nobody wants to buy when prices are falling so much.

The other good news for homeowners is that interest rates now look set to fall in October or November. Banks and building societies have already cut fixed rate mortgages in anticipation of lower base rates later in the year.

The average cost of a 2 year fixed mortgage has fallen from over 7% in July 2008 to 6.3% now.

Base rates look set to fall because of:

• An easing of cost push inflation
• Economy entering recession which will further reduce demand pull inflation.

After falling for 15 years, unemployment has increased by 70,000 during 2008. A report published today shows the amount of permanent jobs available has fallen to its lowest level since 2001. Many also predict a rapid rise in unemployment towards 2 million - a figure last seen during the 1991 recession.

This year, David Blanchflower has often been a lone member of the MPC calling for a cut in interest rates. He now feels the string of depressing news vindicates his call for lower interest rates.

David Blanchflower says, in an interview with Reuters that “We are going to see much more dramatic drops in output,”

Another factor that increases the likelyhood of an interest rate cut is the fall in oil prices. After reaching $150 in the middle of summer, oil prices have slumped to $105 as disruptions to supply have failed to materialise. Lower oil prices will help reduce the cost push inflation which caused the MPC such a headache. With a fall in inflation in 2009. it opens up the way for a cut in interest rates.

With house prices continuing to fall, lower interest rates would certainly be welcomed in that market as well.

With mortgage loans falling for the 12th consecutive month, the Bank of England admitted the likelyhood of further falls in house prices. Mortgage approvals were 33,000 in July down by nearly a third on last year. According to the Nationwide, house prices have fallen 10% in the past 12 months.

Mortgage approvals are a good guide to future house prices. With less mortgage approvals it means that demand for housing will remain weak as people struggle to get any finance or prefer to stay out of the housing market in existing climate.

Gordon Brown has suggested the government will bring forward a scheme to help first time buyers earning less than £60,000. The scheme is aimed at providing first time buyers with help to get finance. The government scheme involves giving an interest free loan to buyers in return for an equity stake in the house.

I am currently on holiday in New York, US. I will return to a regular posting schedule on September 1st.

Just as a side note, evidence of the US housing slump is quite evident here in Queens, New York. The number of vacated, foreclosed houses is increasing. Locals expect the problem to get worse before it gets better. This is even though the US housing market has been in decline for quite a while now.

There is a strong correlation between unemployment and the Housing Market.

When unemployment is rising, demand for buying a house will fall. If people are made unemployed they will be unable to afford mortgage payments. But, also, if people fear being made unemployed, they will avoid taking on the risk of a mortgage. Unemployment is currently low, but many expect a deterioration in economic circumstances.

In the last housing crash, two factors contributed to a sharp fall in house prices. These were

• Rising interest rates
• Rising unemployment (due to recession, which in turn was caused by rising interest rates)

Rising interest rates made mortgage payments unaffordable, and because nearly 2 million were made unemployed many others were forced to sell.

The current situation is a bit different. Interest rates are not high, but unemployment is rising and an increasing number of people will be forced to sell.

Unemployment and Negative Equity

Unfortunately, rising unemployment often occurs at a time of falling house prices. Therefore, those who lose their jobs and have a home repossessed, are likely to also have negative equity.

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