The Housing Crash

After the weather, the favourite topic of conversation to the British is house prices; and there has been a lot to talk about in recent years. Now with prices tumbling month after month much media coverage has focussed on the future of the housing market: how long is this downward spiral going to last? What does this mean for the long-term future of house prices? So many figures have been banded about by institutions and economists that now the public are lost. I believe that the answer to where we are heading can be gathered from consulting history.

The key figure that needs to be looked at is the ratio between average house price and average wage. This statistic avoids the complexities of having to accommodate varying inflation figures and unites the key statistics that relate to affordability. Since the end of the Second World War this ratio has fluctuated between around 3 and 5; for most of the last sixty-plus years house prices have varied between three times and five times that of the average UK wage. The key question to consider here is why did this historical pattern change in recent years? And the answer lies at the doors of the banks and building societies – the mortgage lenders. In past generations a mortgage lender would usually be happy to lend people around 3½ times their annual salary. This was the practise for many a year, and the result that this had was a readjustment to increasing house prices. If house prices started going up, which has occurred a number of times in the past, it was usually not before long that the peak in prices was hit and prices would readjust back down again. If you can only get a mortgage for 3½ times your salary then if prices start going above this you were unlikely to be able to get a mortgage and therefore prices would soon come back down as a result of fewer people being offered mortgage credit. This has been the main reason behind the fluctuation between the ratios of 3 and 5 times annual salary. As prices start going up and fewer people can get credit, therefore less demand in the housing market, so prices come down again.

So why has this pattern been betrayed in recent years. Simple, the banks became reckless with their lending. No longer did the 3½ annual salary limits apply. People were being offered 5, 6, 7-times their annual salary. So in the past when the ratio of house price to wage has reached around 5 it would start to come back down again, now that was not going to happen as people could get mortgages for these higher ratios, therefore prices continued to rise. Obviously this was unsustainable and those guilty of financial mismanagement are now paying the price (well actually the tax-payers are but that’s a different story).

So what now? Now the banks cannot and should not return to the lending patterns of the last few years but will have to go back to the good old days of the 3½ annual salary yardstick. This can only have one impact – house prices will have to fall to meet this level again. That might be painful for those who bought at the height of the housing boom, but it is good, and necessary, for the general populous. So now after this blip, a very significant blip it must be said, we should, over the next few years, return to our relatively mundane fluctuations, leaving us to concentrate on the weather once more.