However, in the early 1990s, the inflation rate was much higher. Therefore, there was a much bigger fall in the real house prices. In real terms, the prices fell by 37.4% from a peak in the second quarter of 1989 to the trough in the last quarter of 1995.

So far, in this housing bust house prices have fallen 14.6% and are forecast to have fallen 16% by the end of the year.

The other big difference between the last boom is that interest rates are significantly lower in this crash. Home repossession rates in 2008, have not yet reached the rate of the last crash.

However, the level of transactions in this crash is even lower than in the early 1990s. This is due to the credit crunch and the difficulty of getting mortgages.

The Royal Institution of chartered surveyors suggested that Rentable incomes have fallen for first time since 2003.

Buy to Let landlords have the highest repossession rate.

• 1. Low inflation of CPI 2% +/-1
• 2. Consider wider macro economic objectives such as growth and unemployment.

Therefore, the MPC’s primary target is low inflation, but the second objective enables them to give less importance to inflation if there is an unexpected shock to the economy.
Many argue the MPC have done a good job. Between 1997 and 2007, they kept inflation low whilst maintaining strong but sustainable growth. Unemployment fell and the UK enjoyed the longest period of growth on record (16 years). It appeared the MPC had avoided the old boom and bust cycle.

However, the MPC have been criticised

1. For allowing a boom in house prices which was unsustainable. Now house prices are falling the economy has suffered lower growth
2. Ignoring the impending recession and giving too much importance to temporary cost push inflation. e.g. David Blanchflower criticised MPC for keeping interest rates too high for too long. The dramatic cuts in rates, show how the MPC perhaps admit they were too high for too long.

However, in defence of the MPC

1. The MPC were not asked to target house prices with interest rates. Arguably this was a micro economic problem. If they had increased interest rates in 2004-05 to reduce house prices it would have caused lower growth even when inflation was on target. Rising house prices reflected shortage of supply and excess lending. The boom in house prices was undesirable, but, it needed to be tackled by measures other than interest rates.2. The recession was mainly caused by the global credit crunch outside their control. The UK government could have done more to regulate the financial system.
2. Many were surprised at how quickly the UK Economy slid into recession
3. Also the cost push inflation presented a difficult dilemma. The MPC feared that if they cut rates as inflation was increasing it could lead to permanently higher inflation expectations. The MPC were not confident oil prices would fall.

In hindsight, interest rates could have been cut earlier in 2008. The concerns over inflation have been outweighed by the much more serious decline in growth and rise in unemployment. This may have caused a sharper downturn. But, it was not the main cause of the recession - far from it. The main cause of this recession was the combination of a global credit crunch, falling house prices and decline in consumer confidence.

Overview of MPC at Bank of England

What Will Happen to Mortgage Rates?

After the Bank of England’s decision to cut interest rates by 1.5%, there was a predictable scrutiny of the high street banks to see whether they would pass the cut on to consumers.

Interestingly, one of the first banks to announce they would pass the cut on was Lloyds TSB and its mortgage subsidiary Cheltenham & Gloucester. The other part nationalised banks, Halifax, (HBOS) and Royal Bank of Scotland have all stated they intend to pass the cuts on. The only two to avoid trimming their rates so far are HSBC and Barclays (both of whom avoided requiring government funds)

However, even if banks do cut their standard variable rate by 1.5% there is no guarantee that all mortgages will be cheaper. In the boom years, anyone with any sense would remortgage to a better mortgage deal. To stay on your mortgage lenders standard variable rate was an expensive mistake to make. What will happen now is that banks will reduce the number of offers and special mortgage deals. The days of tracker mortgages 1% below the base rate are over. It will be harder for people negotiating a new mortgage contract to get a deal which offers any discount on the standard variable rate. For example, the Abbey, Halifax and Nationwide have all been increasing their tracker rates to new customers. The number of tracker mortages on offer has also nearly halved. Therefore, although the banks standard variable rates will be falling, many will not see the equivalent reduction in mortgage payments they might expect.

The Libor Rate

The libor rate is the rate at which banks borrow from each other. This is very important for determining the rate at which commercial banks want to lend. The good news is that this has come down. On Friday the Libor interbank rate fell 1.07% to 4.5% the biggest fall since 1992; suggesting an easing in lending conditions and making it more practical for banks to cut their own rates.

Availability of Lending

As many have pointed out the problem with the credit crunch is that banks don’t want to lend because they are desperately trying to improve their balance sheets. Therefore, although loans may appear cheaper, banks will not be in a rush to lend. With property prices falling, banks will be requiring large deposits to protect themselves against negative equity. Therefore, although mortgages may look cheaper, many first time buyers may still be unable to get a mortgage - even if they would like to get one. - Reducing the cost of borrowing is not really the problem; the problem is a shortage of funds, liquidity and confidence for lending.

The Devil’s in the Detail.

Even people on tracker mortgages may not necessarily find themselves with lower rates. This is because some tracker mortgages have what is known as a collar clause. What this means is that your rate follows the base rate upto a certain point. But, if base rates fall below 3%, the bank does not have to pass the lower rates on. (At the same time, these collar mortgages also often have an upper rate as well.)

Forecast for Interest rates into 2009.

The outlook for medium term interest rates is for them to fall and remain low. Although interest rates have been cut to 3%, many analysts suggest rates could fall to 2% or even 1%. This is because so far, the recession has been much steeper and deeper than expected. Unemployment is rising sharply. Output is falling across different sectors from manufacturing to retail. The housing market continues to drag the economy down.

Inflation is widely forecast to fall sharply from 5% to 2%, some in the MPC now fear that inflation could drop below the government’s target of 1% - raising the ugly prospect of deflation. The bank will certainly be keen to avoid this.

Recent Trends in UK House Prices leave you with a feeling of vertigo.

UK House Prices 2007-2008

After the last boom house prices fell for 4 years before entering another boom.

Why are UK House Prices so Volatile?

• Limited Supply. Difficult to increase supply during period of rising demand
• Confidence plays a big role. When prices rise, people jump on the bandwagon. When prices fall, nobody wants to buy.
• Interest rate changes have big impact in UK, where mortgage payments play a high role.
• Shifts in mortgage lending. During boom periods mortgage lending criteria relax. When house prices fall, lenders become worried over negative equity so make it more difficult to borrow aggravating the fall in prices.

Future House Price Trends

- Will we have future Boom and Busts?

Probably, Many reasons for past boom and bust will remain in the future. Mortgage lending may be better regulated, but, the supply constraints, have if anything got worse.

Interest rates are now at 3%, well below the CPI measure of inflation.

Interest rates have been cut on the back of a string of poor economic indicators, suggesting the economy is in its most serious slowdown since 1981.

It remains to be seen whether this bold move to cut rates will actually stimulate the economy. Interest rates may not solve the problem of recession because:

• Interest rates have a time lag
• Banks will not pass the full 150base points onto consumers
• Confidence is so low, people don’t want to borrow anyway.
• Banks don’t want to lend mortgages because of liquidity problems

Nevertheless it is good news for borrowers and the long pressed housing market.

See: The Case for Lower Interest Rates

Other development in the Housing Market include:

• House Prices drop £30,000. According to Nationwide statistics, the average UK house price has fallen to £158,872 a 14.2% fall since last year.
• Nationwide also revealed that the average time for completing a house sale has increased to 12 weeks. This is due to the reluctance of homeowners to cut prices in response to falling house prices.
• Slump in Mortgage Lending: Net Mortgage Lending in the UK was negative for the first time since records began in 1993. The value of new loans extended was £100 less than repayments for existing mortgages.

Those Who Gain From Falling House Prices

First Time Buyers Trying to Get on the Property Ladder. House prices have fallen at least 15%. This means the average house is about £20,000 cheaper. This reduces their long term mortgage repayments and standards of living. (The problem is that although house prices have fallen, it has become more difficult to get a mortgage, but, this might change in future)

Homeowners Who Wish to Upsize. If you live in a modest two bedroom house in the north but wish to move to a 3 bedroom house in London, it is now easier. This is because a 20% fall in a £100,000 house means you receive £20,000 less. But, a £200,000 is now £40,000 cheaper. Therefore, the move is now £20,000 cheaper. This might benefit couples who have more children or need to move to London. (House price falls have been strongest in areas like London.

(Renters. If you rent, lower house prices could lead to lower rents. However, because no one wants to buy, demand for rented accommodation is strong, therefore rents are not falling, but increasing. However, if the fall in house prices was permanent, rents may follow house prices in the long run.)

Those Who Lose From Falling House Prices

People Who Bought a House at the peak. If you  bought a house in July 2007, you will have seen a big fall in the value of your house. This leaves you with negative equity (Home value less than the mortgage outstanding) This is particularly a problem for those forced to sell their house because of unemployment. It is even more of a problem for those who got 100% or 95% mortgages.

Those Who want to downsize. This is opposite to the argument for those who want to upsize.

Estate Agents. Lower House prices mean smaller commissions. Furthermore, housing transactions has slumped giving them two problems.

People Who Remortgaged to Buy 2nd Homes. Some people bought housing as an investment in the expectation of rising prices. They are now left with negative equity.

Reverse Mortgages. Some elderly people were relying on their house value to provide for their retirement through a reverse mortgages which unlocks the value of the house. There value is now less.

People Who Are Unaffected by Falling House prices

People who have no intention of selling. If you buy a house and have no intention of moving in the next few years, lower house prices don’t have much effect. Although house prices are lower,

Renters. Renters are mostly unaffected by falling house prices.

See also: effects of falling house prices

It is hard to say, though I think another 12 months of falling house prices is likely.

If you look at historical UK House prices, in the last housing bust, house prices fell for 4 years. 1989 Q3 (£62,782) to 1993 Q3 (£50,128)

There were of course, some differences in the 1990s. In particular, interest rates were more important in the boom and bust; there wasn’t the same.

Next year, is likely to see a significant fall in interest rates which could make buying more attractive. But, the market needs to see mortgage lending become less stringent to really kickstart the economy.

The other factor is that the economy faces a serious recession and rising unemployment. This will lead to higher mortgage defaults and arrears.

My advice is to watch the market closely, basically, when national house prices start rising for 2 consecutive months will be an excellent time to buy into the market. I doubt there will be a double dip in house prices.

If house prices fall another 10-15%, there is great potential in buying for the long term. The current crisis has really caused a fall in the supply of new houses. When demand is able to return, prices could be pushed up again. (long term forecasts for house prices)

In recent data, house prices reached there lowest levels for 2 years, with prices falling especially in London and South East. The only good news is that property transactions increased 5%

Major effects of the credit crunch

• Difficult to borrow, especially difficult to get mortgage.
• Bank of England cutting interest rates is leaving us with negative real interest rates. Inflation currently 5.2%, interest rates 4.5% (and interest rates likely to fall to 3% soon
• Recession, causing unemployment to rise
• Lower real incomes. Workers accepting pay rises below or close to inflation to protect jobs.
• Falling Stock Markets

How To Survive Credit Crunch

• Don’t worry about buying a house. Prospects for buying a house will probably be much better in 12 months, when house prices have stopped falling. The next 12 months is an opportunity to save for a deposit if possible. In the current mortgage climate, it is even more important to save for a deposit, to enable a better mortgage rate.
• Keep a track on Savings. Although we have negative interest rates. Banks are keen to improve their balance sheets so are offering attractive rates for savers. Northern Rock, Abbey National and Halifax all are offering saving rates above the base rate. This is a way to protect the real value of your savings.
• Worried about safety of Banks. My advice is that if the bank / building society is British, your savings are as safe as you can get.
• Investment diversification. If you own shares you will have seen the value of your share portfolios fall. However, on long term price to earnings ratios, share are good value. They may continue to fall in the short term, but, in the long term, are liable to rise. Amidst the uncertainty, many are buying into gold stocks.
• Remortgage. Just because it is difficult to get a new mortgage doesn’t mean you shouldn’t continue to try and get the best mortgage deal. Even now, the benefits of remortgaging and avoiding your bank’s standard variable rate is as great as ever. (Checklist for remortgaging)
• Paying off Debt. Levels of personal debt in the UK are at an all time high. (See: Debt levels in UK) We are now waking up to the necessity of reducing debt and increasing our savings ratio. The current low rates of interest should be seen as an opportunity to pay off more than the minimum payments. Remember, even if interest rates fall to 3%, they could easily increase to 6% within a couple of years. Avoid the temptation to take on more debt because interest rates are so low. As usual, it makes sense to pay off the highest interest rate paying debt first. (10 Tips for paying off debt)

Anyway, the economic outlook is pretty grim at the moment.
Confidence amongst manufactures has fallen to -60
Unemployment is rising sharply.
Gordon Brown and Mervyn King have both admitted the economy is entering a full blown recession.
Housing market continues to freeze up, causing few house sales and falling house prices.
Banks still reluctant to lend despite injection of cash into the banking system by government.

Although inflation is still way above target, the collapse in oil prices means inflation will definitely be coming down next year. With inflation forecast to come down, the Bank of England may feel free to aggressively cut rates to try and avoid a lengthy recession.
In addition to a loosening of monetary policy, the government is also proposing higher spending to boost Aggregate demand through expansionary fiscal policy. (despite the increase in government borrowing and National Debt)

I think interest rates of 3% are a possibility for the end of 2009. It depends how deep the recession becomes and whether the economy responds to the lower rates and higher spending.

2009 will not be a good year for people living off savings, but, it will be a good year for people like me with large debts. If interest rates do fall to 3% buying a house will become very attractive - as long as people can actually get a mortgages.