Iended. An era of rising house prices fueled by cheap money is coming to an end. Central banks have created a huge housing boom, and soon they will have to deal with the aftermath of the bubble bursting.
In China, it is already happening. Banks in the world’s second-largest economy have been ordered to bail out property developers so they can complete unfinished projects. Mortgage boycotts are on the rise as people unsurprisingly feel unhappy about paying home loans for properties they can’t occupy.
New home sales have plummeted and housing starts have nearly halved from pre-pandemic levels, creating problems for debt-ridden real estate companies, the banks they borrow from, and the broader economy. The real estate industry accounts for about 20% of China’s GDP. Rising house prices are a thing of the past.
The U.S. economy contracted for the second straight quarter in the three months through June, one factor being a rapid slowdown in the housing market. In the two years that began in the spring of 2020 with the coronavirus pandemic, U.S. home prices soared, rising 20% in the year to May. But the market is cooling rapidly, with the average price of new homes falling sharply in June.
Britain appears to be bucking the trend. According to Halifax, the country’s largest mortgage lender, house prices are rising at an annual rate of 13% – the highest level in nearly two decades. Here, too, things are changing.
Last week, the Office for National Statistics released housing affordability figures based on the ratio of house prices to average income. In Scotland and Wales, the ratios were 5.5 and 6.0 respectively, down from the peaks reached during the 2007-09 global financial crisis. In England, the ratio is 8.7, the highest since the series began in 1999.
There are regional differences within England. In Newcastle upon Tyne, the average housing cost is 12 times the annual income of the bottom 10% of income earners. In London it was 40 times and now it is almost certainly higher. The ONS data covers the period to March 2021, and house prices have easily outstripped wages since then.
At times, housing has become too expensive for potential buyers, but the prolonged period of ultra-low interest rates means it will take time to reach this reality checkpoint. The central bank makes it unaffordable by ensuring that monthly mortgage repayments remain low.
This is true all over the world, which is why house prices have been rising from New York to Vancouver, Zurich to Sydney, Stockholm to Paris.
At least until now. Central banks in the West are aggressively raising interest rates, making mortgages more expensive. Even before the Fed last week announced a second straight 0.75 percentage point hike in official borrowing costs, a new borrower was paying about 5.5 percent on a 30-year fixed home loan — double what it was a year ago. This growth explains why fewer Americans are buying new homes and why prices are falling.
The harmful mix of house prices is rising interest rates, collapsing growth and rising unemployment
In the U.K., the Bank of England cut rates to 0.1% at the start of the pandemic and has stayed there for almost two years. That has allowed homebuyers to get term mortgages at very competitive rates, which hit a trough of 1.4% last fall. But banks have been tightening policy since December, and those mortgages will rise when the fixed term runs out. The average home loan interest rate is now 2.9%.
Central banks say the highest inflation in decades means they have no choice but to tighten policy – but they do so at a time when major economies are either in recession or heading for one. The harmful combination of house prices is rising interest rates, collapsing growth and rising unemployment. Only the last of them is missing, but if the winter is as severe as policymakers expect, it will only be a matter of time before the benefit queues are extended.
Last week, the International Monetary Fund released forecasts for the global economy that were no doubt grim. The fund noted that all three major growth engines — the U.S., China and the euro area — were stalled, and said risks were heavily skewed to the downside.
According to the International Monetary Fund, the global economy has grown by less than 2 percent over the past half-century: 1974, 1981, 1982, 2009 and 2020. Russia has completely stopped gas supplies to Europe, and stubbornly high inflation or a debt crisis are among the factors that could lead to a 2023 addition to the list. A global real estate crash will guarantee that it does.
That’s not to say there’s no good reason to want to clear the housing market glut. Soaring housing prices discriminate against young people and the poor, misallocate capital to unproductive assets, and increase demographic pressure by preventing couples from having children.
However, central banks are trying to cleverly take advantage of a soft landing, in which the recession is short and shallow and unemployment rises enough to ease upward pressure on wages, but still moderate. A house price crash was not part of the plan, as it would ensure a hard landing.
There is no interest in repeating the mistakes of 2007, when the U.S. subprime mortgage crisis triggered a near collapse of the global banking system and led to the last Great Recession before the pandemic. This is why the Chinese government is trying to support property developers, and why Western central banks may stop raising interest rates sooner than financial markets expect. We have been here before.