House prices have been rising for two months, according to the Halifax index. Great, the house-price bust is over. Well, probably not, because this is not a clear trend by any means. House prices were up in January, down in February, March and April, up again in May, but down in June, and then up in July and August. So, over the year so far, down in four and up in four.
The increase in house prices arose in the first place because of the easy availability and low price of credit. People could borrow huge multiples of their earnings with little or no deposit. Now it is hard to get a mortgage at all without a large down payment. The price of risk has risen.
When I bought my first house, in the early Eighties, the standard loan was three or three and a half times your wages. The chart (above) shows what is called the house-price-to-earnings ratio, which is a measure of what people can afford. It plots the ratio of average house prices against average male full-time earnings for the past quarter-century or so. The average of the series, between April 1983 and January 2002, was 3.61, which looks reasonable. But then, because of the easy availability of credit, the index rose to an unsustainable 5.84 in July 2007.
At that time, average house prices in Greater London were approximately 11 times average earnings. The scale of these price increases was much larger in Britain than in the United States.
Wages take the strain
The housing bubble burst in the second half of 2007, when dream homes turned into nightmares. House price/earnings ratios nationally fell back to 4.39 as of August 2009. My guess is that, when this is all over, house prices will eventually fall from peak to trough by around a third. However, it is perfectly possible they may well undershoot on the downside by more than that, as they did in the early 1990s, before they recover. Already prices have fallen by roughly 20 per cent on the Halifax measure and probably have at least another 10-15 per cent still to fall.
In our new era of flexible labour markets, it is wages that are taking much more of the strain than we have seen in the past. Firms can cut pay by reducing hours, shifts and even hourly rates rather than firing their workers. Obviously, many workers' incomes have been reduced, which in turn lowers their spending. And there are nearly four million self-employed people in Britain; their incomes are likely to have fallen markedly, as there is little or no work coming in. Returns on savings are also low. Falling incomes represent a downward pressure on house prices. Average house prices in an area will fall if average wages in that area fall. That's common sense.
How much have wages fallen? The table below shows the movement of the experimental earnings statistic, the Average Weekly Earnings, based on the Monthly Wages and Salaries Survey (MWSS), which is a survey of the earnings of employees in 8,500 firms. I plot the series both with and without bonuses for the private sector. Bonuses are down a lot. This measure is likely to be an improvement on the current one, the Average Earnings Index (AEI), which uses the same data, because the Office for National Statistics (ONS) makes an adjustment in the AWE for the exclusion of the smallest firms (those with fewer than 20 employees).
This will be a big problem in a harsh recession, when marginal firms are especially likely to be hit hard. So, this month, the ONS announced that it was ready to switch to the AWE as its main wage measure. Why plot pay in the private sector only? Well, pay in firms hit by recession is likely to respond to market forces much more than that in the public sector. If firms can't afford to pay because they can't sell their goods, wages will fall, partly through a reduction in workers' hours but also as bonuses are cut.
Private-sector pay growth has fallen through the floor. It remained flat throughout 2007, at about 4 per cent, despite a spike in bonuses at the beginning of that year. The UK entered recession in April 2008 and from that point wage growth fell steadily; as you would expect, bonuses appear to have been much lower in 2009 than in 2008. Between January 2008 and July 2009, according to this index, pay including bonuses fell by 0.3 per cent, compared to a rise of 3.8 per cent in the public sector.
Sit it out
If incomes are falling and it is hard to get credit, if there are several million households in negative equity, unemployment is rising and there is a large stock of unsold houses, it is hard to understand how house prices could increase any time soon. I guess if you are an estate agent or a seller it is optimal to say it isn't so. And, as we know, last month house price/earnings ratios actually went up - from 4.36 to 4.39 - because house prices supposedly increased, though average earnings hardly moved at all. So, please explain to me exactly the source of those house-price increases? I suspect we are going to see more down months shortly.
Apart from people on low-interest tracker mortgages almost everyone is worse off than they were a year ago. Few people on trackers are moving, because they can't buy a new tracker at anywhere close to the low rates they are paying. Those in negative equity presumably are not going to move, either: most will just sit it out if they can. In addition, there are the folks who are in an even worse position because they can't cover their mortgage payments.
Repossessions are not usually associated with rising house prices. So the workforce becomes less mobile and unemployment increases. Falling wages and reduced credit don't look good for house prices. Sorry, but someone has to tell it the way it is. And it seems unlikely that house prices have reached the bottom yet.
Watch an interview with Professor Blanchflower