Friday, February 22, 2008

Short View: Destructive momentum in the housing market

(FT) Momentum, as we know from politics and securities markets, is a powerful force. However, it could be at its most damaging when it comes to housing.

Housing is illiquid. It is hard to trade and it takes time for supply to respond to demand. As a result, once house prices start to rise, they can develop momentum - until gravity reasserts itself and prices fall back to earth.

Factors that should affect house prices include affordability (a function of interest rates), incomes and demographics - the number of adults needing a first home.

However, Tim Bond of Barclays Capital points out that once house prices start to accelerate, people expect them to keep on rising at that rate. All other factors are swamped. As he says: "After a period of strongly rising prices, the expectational component comes to the fore and becomes the key factor determining real house prices."

If people see house prices rising, greed trumps everything else. In the short-term, this is a self-fulfilling prophecy.

The behaviour of bankers assists the build up of momentum. ABN Amro points out that US lenders have been lending at a higher proportion of purchase prices, even as those prices have taken a larger and larger share of the average first-time buyer's income.

The problem with momentum in housing, as in equities, is that when it goes into reverse, the falls can be dramatic. In the US, a plateau in housing prices has been followed by a fall - the S&P Case-Shiller index is now down about 8 per cent from its peak. Meanwhile, this week's data on US housing supply showed continuing falls.

There is every reason to expect the same phenomenon in countries such as Spain and the UK, which also have housing bubbles. In the UK, house price rises seem finally to have run out of momentum. We know what happened next in the US.

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