Ask anyone what the biggest determinant of house prices is and they’ll probably tell you it’s Supply/Demand, general economic conditions or local schools/amenities. All these answers are valid but not many nations have had as much cause to analyse house prices as the Irish and a recent study by the respected Economist Brian O’Kelly of Dublin City University stated that in fact, the thing that fuelled at least 50% of the boom seen in Irish house prices between 2002-2007 was the availability of credit.
A quick economic recap is in order here before I go any further: The year 2000 was the dawn of a new millennium and the buzz was all about the Internet and the high-flying NASDAQ – remember that bubble? Well, as we now know that bubble burst before too long – they always do; don’t forget that, people! – and the market came crashing down in a manner that cause great distress to US policy makers. The then Chairman of the Federal Reserve, Alan Greenspan, had up to that point presided over an unprecedented period of low inflation and growth in the US economy but was now faced with a career defining moment. What did he do to respond to this crash? He slashed interest rates to 2% and flooded the market with liquidity.
This didn’t stop the NASDAQ coming back to more appropriate valuations but it did prevent the crash spreading to other parts of the economy as those who nursed losses were simply able to borrow to cover them and they could pay later. The ‘sleep-easy’ factor returned to their lives and the continued to spend and live as they had before the crash, thereby keeping the broader economy buoyant. This is perfectly responsibly Central banking from Mr Greenspan but it did risk a) fuelling inflation and b) fuelling a debt bubble that would burst at a later date. He got away with a) but boy did b) come back to bite him!
So the principle largely began there: if people can always borrow their way out of difficulties they tend to be quite happy to do so and may even risk living beyond their means. Now this happened in some style in Ireland who, let’s not forget, had interest rates of 6% in 1999 just weeks before joining the Euro and adopting an interest rate of closer to 3% as it was for the harmonised currency at the time and the effects of this easy credit were wildly exaggerated by this and, to be fair, other factors as well but the point I’m making is that credit fuels house prices.
Fast forward to today and looks at what is happening. We’ve had another crash (of sorts) in the European economy as the debt problems became nationalised and the sovereign bond markets of Italy, Greece, Spain etc. are in big trouble. After playing with the problem for several months, the ECB has stepped in to give the politicians time to get their house in order and have supplied massive liquidity to the banks in the form of cheap loans. In December 2011 they supplied €489bn and again at the end of February 2012 a further €530bn of 3 year loans at favourable rates.
What will banks do with this money? Well, at first they will invest in assets for what is called the “carry trade” (buy long dated assets at high yields and fund it at a shorter part of the yield curve) – is it any surprise that stock markets in Europe are at 2 year highs as I write this in early March and Government bond yields are at a multi-month low? This is just what happened in the early part of the last decade too following the Tech bubble bursting (obviously tech shares didn’t rise but if you strip those out the market went higher) and it’s happening again now – then the money will make its way into their lending books and credit to consumers will improve. And that, right there, is what is going to drive house prices.
But we’re Britain and not in the Euro so it doesn’t affect us, you might say. Well, it will affect us because a) the interbank markets will become awash with this cash and the British banks are part of that anyway, just like happened when the Fed did it in 2001; and b) the British banks put their cap out and took some loans anyway this time round. Barclays took €8bn, Lloyds €14bn and so on.
Many people are saying the rise in house prices in February is linked to the removal of the stamp duty exemption but with London broker Coreco saying the average mortgage they put through in February was for over £450,000 and statistics showing the mortgage approvals at a record high in January, I don’t believe this is the sole reason. The ECB money from December is trickling through and it will continue to impact throughout the year. I expect we’ll see UK house prices recover a lot faster than people think.
The trouble is, how long will it last this time?
