Sunday, 12 December 2004

Housing market looks vulnerable

The Economist warns that the housing boom is looking shaky.

In its report titled "Flimsy foundations", The Economist points out that house prices are falling in Britain and Australia, but are still rising in the US and France. But in all these countries, prices are at historical highs.

Calculations by The Economist suggest that house prices have hit record levels in relation to incomes in America, Australia, Britain, France, Ireland, the Netherlands, New Zealand and Spain. In other words, ratios of prices to incomes are now above levels that have proved unsustainable in the past. Taking the average ratio of house prices to incomes in 1975-2000 as a baseline, American house prices are now almost 30% overvalued...

Japan provides a nasty warning of what can happen when bubbles burst. Japanese property prices have dropped for 13 consecutive years, by a total of 35% from their peak in 1991. Yet the 36% rise in real house prices in Japan in the seven years to 1991 was actually less than the increase over the past seven years in all but one of the eight countries listed above where prices appear overvalued.

According to The Economist, some economists thinks that the housing market is prone to bubbles. One reason mentioned is imperfect information: "no two houses are exactly alike and there is no central exchange where prices are instantly recorded". Another reason is the absence of short-selling, which often serves to moderate price rises in other markets like the stock market. A third factor that tends to encourage bubbles is that when property prices rise, the value of property as collateral rises, allowing banks to lend even more.

Calling the housing market a bubble is one thing. Knowing exactly when it will burst is what most people really want to know.

In my opinion, if anything is going to burst the housing bubble, it will be rising interest rates. With most economists expecting the US dollar to fall over the coming months, that looks to be a likely scenario in the US. The US housing market looks increasingly vulnerable.

See also "No bubble in housing?"

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