Monday, May 12, 2008

So How Bad Is It…Really?

On the one hand, there are screaming headlines about the housing affordability crisis telling us that house prices are so high that some people might never own a home. There is a shortage of supply, and rents keep going up. On the other hand, there are more screaming headlines about property prices plunging, and repossessions rising, leaving people selling for less than they bought. Some houses have crashed to half their previous value. So what’s really going on?

While the crunch has been precipitated by the United States sub-prime credit collapse along with rising inflation pushing up interest rates, the bottom line is quite simply that short supply has pushed prices beyond the point of sustainability. Where once an average house would cost about three times average wages, it now costs around eight times average wages. At that level it becomes impossible for ordinary families to provide shelter for themselves, and sooner or later something has to give.

The balance can be restored by prices either falling, or by incomes rising, or a combination of both. Ironically, inflation can actually ease that process by pushing up wages, while cushioning the numerical fall in house prices. Even better it erodes the value of the debt home owners have incurred in pursuit of their dream. However, if the flames of inflation rage out of control it becomes an eternal game of catch-up where nobody wins.

The sub-prime crisis was created by the pursuit of endless growth in speculative gains, accelerated by leverage. In the end it will be resolved by a period of negative growth… also known as a recession. Already the Prime Minister has warned of the prospect of “the mother of all economic hangovers”. He’s not just whistling in the wind; it really could get that bad, and it is the most significant challenge now confronting this government.

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