Posts Tagged ‘adam posen’

file1241241390188

It is a little odd. The UK enters its worst downturn ever recorded; average wages increase at a rate that is much slower than inflation meaning that for some time average households have been getting worse off, but what do house prices do? Sure they crashed in the US; they crashed across much of Europe – especially in the troubled parts of the region – they crashed in the UK once too, but that was back in the 1990s.

But this time around, prices fell – a bit – but right now, and without doubt, they appear to be on an upwards trajectory. Some say there are similarities between the UK economy over the last few years and Japan 20 years ago. There is one glaring difference, however. In Japan house prices crashed and went on crashing. In the UK, the story has been quite different. So why is that? And can we expect a happy ending for the UK housing market?

Now Vince Cable has joined the ranks of those who fear that the government may be creating a housing bubble. He was interviewed on the ‘Andrew Marr Show’ yesterday, and said: “I am worried of the danger of getting into another housing bubble.” But frankly the warnings have been coming from every quarter and indeed from every quintile or even decagonal.
There is more than one side to this debate. What the UK needs is more construction, and more new houses.

One figure being bandied about at the moment is that every pound spent on construction stimulates the economy by £3. A residential construction boom needs mortgages to be made available. The danger is that mortgage supply will rise, demand for housing will increase but supply won’t. If that were to happen we might get higher house prices, but it is questionable whether UK plc will be better off.

In fairness to the chancellor he is trying. When he recently unveiled his latest initiative for his Help to Buy Scheme, he invited house builders along to hear his announcement first hand. And there are signs of a pick-up in construction. After falling to its lowest level since 2001 in the first quarter of this year UK construction activity rose 0.9 per cent in Q2, according to the ONS.
A rough rule of thumb might go like this: a buoyant mortgage market leading to more construction is good, but one leading to higher prices but not more construction is bad.

Yet the UK media seem obsessed with the idea that rising house prices is a good thing. If we get the slightest hint that house prices are set to rise, certain newspapers splash it all over their front cover. In recent days we have seen the media say over and again: the weather is hot, Britain is winning in sport and house prices are going up!

But why is it really seen as a good thing when house prices rise? Why are the UK public so convinced house prices can only ever rise? One argument to justify the argument that house prices can only ever rise in the UK is that the UK is an island and land is in limited supply. If that is so, how is it that house prices have fallen in Japan, which you may have noticed is also an island based economy?

Ex MPC man – a man famous for his ultra-dove-like view on monetary policy, a man who continuously voted for more QE, and indeed called for QE being used far more imaginatively – Adam Posen penned a piece for the ‘FT’ this weekend and he made a good case. In an article headlined “The cult of home ownership is dangerous and damaging”, Mr Posen said: “There is no iron law that higher-income economies must have higher rates of home ownership: Mexico,

Nepal and Russia all have home-ownership rates of more than 80 per cent, while the French, German and Japanese rates are 30-40 percentage points lower. The US and the UK rates sit between them at about 65 to 70 per cent.”

Mr Posen’s main point is that because in the UK our home is our main financial asset, he said: “We incentivise middle-class households to leverage the bulk of their savings into a highly volatile, difficult to price asset.”

There is one point about the housing market which gets overlooked. Sure housing has proven to be good investment over the last few decades, but the reason for this is not because house prices keep going up, it is because housing investment is just about the only form of investment available to the mass market that employs leverage.

You borrow 75 per cent of the value of a property, and the property doubles in value, your equity increases fivefold. Leverage is also available to private equity companies, which is why they enjoyed a boom during the noughties, but leverage of investment trusts was one of the factors behind the stock market boom that led to the 1929 crash. Leverage is appealing but it is also dangerous.

But here is a theory – just a theory – as to why the Brits so love the idea of house prices as an investment.

The Brits have bought into a story. It was a story that had its roots in the 1960s and 1970s. At the beginning of this period, house prices to income were quite cheap. Over the following two decades four things happened. Firstly, as mortgages became more widely available, house prices to income rose. Secondly, as productivity grew, real wages rose. Thirdly, inflation meant nominal incomes rose very sharply. Fourthly, for much of this period, real interest rates were negative, that is to say the percentage rate of interest was less than the percentage rate of inflation. These four factors, when combined with the magic of leverage, made buying a house an incredibly lucrative thing to do.

During this period the idea was born that when you enter the housing market the best thing to do was buy the most expensive property you could. This period also saw the birth of a new metaphor, ‘the housing ladder’. The story that emerged during this period is so strong that people still think its lesson applies today.

But is that right? House prices are no longer cheap relative to incomes. Real incomes have not been rising for some time. Nominal wages have been rising only very slowly. Sure, real interest rates are negative again. But what will happen when the baby boomers retire, and many of them try to downsize, using the spare equity in their homes? What will happen if real interest rates rise, because of actions beyond the control of the Bank of England? See: The Great Reset 

The narrative of the UK housing market suggests that house prices always go up. But many of the facts that created that narrative have changed.

When pieces of the narrative are changed at a later date, the overall initial impression is unaltered. The narrative changes us, and retrospective changes to the narrative don’t reverse the original effect it had on us. If we were to find out years after we first heard the story that that actually Cinderella, was a manipulative little so and so, we would probably still think she had an evil step mother and sisters.

Until that is the narrative is proven to be wrong beyond any doubt. But by then, it may be too late to do anything about it.

For other examples of the power of the narrative see:

The narrative: Suckers for a good story

Property bubble: is this a yarn that can only ever have an unhappy ending? 

Is BP a victim of the narrative? 

Entrepreneurs need to diversify more

Facebook results: suddenly its valuation does not look so daft 

© Investment & Business News 2013

It’s two for the price of one. A new acronym, and a new (ish) idea. And QE, by the way, is so very 2012.

The thing about QE is that it is not really money printing. The Bank of England buys government bonds – not from the government – but from banks. But one day the bonds will mature, and when that happens, the effects of QE will go into reverse. Besides, there is another point. To acquire this money from the Bank of England, banks have to give up what is considered to a very safe and liquid asset – namely bonds.

Now if QE involved buying bonds at zero interest with no maturity date, directly from the government, that would be called creating money.

QE is not what they call helicopter money. It is not the equivalent of scattering money from a helicopter. It is more like scattering money from a helicopter, and sucking up certain assets from the ground at the same time.

What QE does do, is push up the price of bonds, making other assets look cheap, thereby either stopping certain assets from crashing, or indeed making them rise. So house prices or equities rise in price, and we may feel more confident and spend more, and businesses may invest more. That strategy does not work as well when the asset that rises is oil – or indeed gold.

But some say that the Bank of England needs to target its QE more precisely.

This is what happened in the US. Some QE was used to get rid of so called toxic waste from banks’ balance sheets and as a result – goes the argument – banks are in better shape. Some of it was used to buy corporate bonds, ergo – goes the argument – the US has seen a swifter recovery than the UK.

So what can the Bank of England do? Former MPC man Adam Posen wants to see it buy bonds in a kind of public bank, charged with investing into business.

Recently, Adair Turner – chairman of the FSA and one of the men who was at one point thought to be in the running for heading up the Bank of England after Mervyn King – called for what he described as overt monetary financing, or OMF. This is helicopter money, it is QE targeted at certain assets, and it is something Mervyn King is dead set against.

He said it’s not up the central bank to do such things, because then it would be engaging in fiscal policy. Rather, he says, it is up to the government. But the government wants to make cut backs. If the government spends money it is slated for being reckless. So we get £375 million of QE, and still the UK is limping along bottom.

Before we close, it may be worth reminding ourselves of words spoken by Adam Posen last year when speaking to the ‘FT’. He said: “I personally view the teeth-gnashing and garment-rending about what’s fiscal and monetary as too much drama for too little content.” He then added that the Bank of England holds “anguished religious ethics” about QE.

So maybe we need to move from QE to OMF. Or is that blasphemy?

For Lord Turner’s speech  discussing OMF, see: Debt, Money and Mephistopheles: How do we get out of this mess?

http://www.fsa.gov.uk/library/communication/speeches/2013/0206-at

©2012 Investment and Business News.

Investment and Business News is a succinct, sometimes amusing often thought provoking and always informative email newsletter. Our readers say they look forward to receiving it, and so will you. Sign-up here