Home truths? How America's housing boom may be coming to a tricky end
Home truths? How America's housing boom may be coming to a tricky end
By Ralph Atkins, Scheherazade Daneshkhu, Keith Fray, Krishna Guha and Michiyo Nakamoto
Copyright The Financial Times Limited 2006
Published: October 24 2006 03:00 | Last updated: October 24 2006 03:00
Asudden slowdown in the US housing market has sent analysts scouring the globe in search of clues as to what might happen next. Will America's spectacular residential property boom end in a "soft landing" - for house prices and its economy as a whole - or are shocks of a more brutal severity in store, which could resonate far beyond its shores?
On one level, what they see is encouraging. Recent experience in the UK and Australia, to take two of the better examples, shows that a housing boom need not end in falling house prices and protracted economic stagnation, though a phase of growth below the usual trend is likely while the economy adjusts.
International comparisons are tricky in housing, for which there is no integrated global market in the sense that there is a global capital market. National housing markets differ in structure and the degree of integration between them is limited. Nonetheless, there is international evidence to reinforce the case made by Don Kohn and Alan Greenspan, vice-chairman and former chairman of the Federal Reserve respectively: that a soft landing is possible and may even already be under way inthe US.
Certainly, the US house price boom did not take place in global isolation. Rather, it was part of a great wave of house price inflation that swept unevenly around advanced economies beginning in the mid-1990s. The Organisation for Economic Co-operation and Development, the official think-tank for the industrialised world, describes this boom as "unprecedented" in its steepness, durability and geographical breadth.
Not only did a "historically high number of countries" see big house price gains, the OECD notes, but the boom was also "strikingly out of step with the business cycle".
In most of the hot markets, house price growth has peaked and since ebbed, but in some, including Spain, Ireland and Singapore, the boom is continuing. By contrast, house prices barely moved over the past decade in Germany and land prices fell year after year in Japan.
It appears that all the boom markets, including the US, were to some extent responding to common shocks. "There are common factors," says Raghuram Rajan, chief economist at the International Monetary Fund. "Clearly the level of interest rates worldwide has played a role. Also, to my mind, productivity growth across the world has been important in assuring people of higher incomes."
The price people are willing to pay for a home should go up when long-term interest rates fall - which they did, to exceptionally low levels globally since the turn of the millennium. They remain low today, both in nominal and real terms. The setting of low short-term rates by central banks played a part. However, Mr Greenspan argued it this month: "I don't think the boom came from a 1 per cent Fed funds rate or from the Fed's easing. It came from the collapse of the Berlin Wall." The end of communism had "brought billions of cheap labourers on to the scene. This was highly disinflationary. Bond yields fell, real interest rates fell and real asset prices, like house prices, rose dramatically."
Others point out that the step-up in productivity growth in the 1990s may have raised expected future incomes, meaning people became comfortable about borrowing more. Mr Rajan argues that house prices boomed in those economies where financial systems were more market-based, allowing people both to capitalise both on the decline in rates and, in effect, their future pay-rise prospects.
"One of the lessons you draw from the UK and Australia is that there are some fundamental factors holding up house prices. It is not just low short-term interest rates," Mr Rajan adds. "Also, to some extent, there is a certain amount of resilience. These are not fragile bubbles that if pricked will collapse."
Compared with some of the other housing boom countries, the US experience has actually been fairly unremarkable. Prices there increased by 56 per cent in the five years to the market peak of the third quarter of 2005 - but they almost doubled in the UK and Australia in the five-year periods that led up to their respective peaks.
Moreover, the US housing market is less richly valued than the other boom markets. A Deutsche Bank study shows that even though they are high by past US standards, price/income and price/rent ratios remain lower than they are in the UK, Australia or the Netherlands.
These countries are particularly interesting for America-watchers because they are further along the housing market cycle than the US (where, according to the Office of Federal Housing Enterprise Oversight, prices were still up 10 per cent year-on-year in the second quarter, though the rate of growth had slowed to only 1.2 per cent during the three months). In other words, the three have seen their housing markets cool off already, and with little impact.
Annual house price inflation in the Netherlands peaked at 20.5 per cent in late 1999, before slowing to zero by early 2003 with a slight upturn since. In the UK it topped out at 25.2 per cent at the end of 2002 and troughed at 2.2 per cent in late 2005, before picking up again to run at above 5 per cent. In Australia the peak came at 19.4 per cent in late 2003, with prices then slowing abruptly to 0.2 per cent by late 2004 before also rising again.
The data indicate that these movements in the housing market had little effect on the overall economy. In both Australia and the UK, growth slowed as house price inflation eased sharply but since then recovered. The Bank of England, which lowered interest rates by a quarter percentage point as the market cooled, has since raised rates again to 4.75 per cent. The Netherlands suffered a harder landing: when house prices stabilised, the Dutch central bank estimated it reduced gross domestic product by 0.5 per cent a year for two years.
Parallels can, however, easily be too simplistic. David Miles, an economist at Morgan Stanley in London and author of a UK government-commissioned study on the mortgage market, says: "One needs to be wary in believing that what has happened in the UK - or any other housing market for that matter - over the past couple of years can tell us very much about what is likely to happen in the US."
Housing markets vary in important respects - including the type of loans people use to buy houses, the level of home ownership, the ability to borrow against the value of one's home, and the size of the residential construction sector. The most important difference among the housing boom economies is the extent to which the availability of land and the regulatory environment allow new houses to be built.
In response to the price boom, for example, the UK and the Netherlands saw little change in supply of new homes: UK residential construction remained pretty stable at about 4 per cent of gross domestic product. In the US, Australia and Spain, however, there was a bigger jump in supply in response to price increases. US residential construction reached 6.3 per cent of GDP last year.
Dawn Holland, economist at the UK National Institute of Economic and Social Research, says the right comparisons to draw are "between the UK and the Netherlands on the one hand, and the US and Australia on the other".
The example of Australia is encouraging: it managed a reasonably soft landing. But Michael Ball, professor of urban and property economics at Reading University in the UK, draws a less favourable analogy - between the US and Germany during its post-unification boom in the 1990s, where construction grew to about 8 per cent of national income.
"A decline in output from that side has a fairly direct impact on the economy. Part of the reason for the German economic slowdown was that it was induced by a rapid slowdown in housebuilding," he says.
But he adds that this does not mean that the US need suffer the same effect, because "there is still a lot of demand for housing in the US" due to a strong labour market, favourable demographics and net immigration.
Overall, the international experience tends to support the view that home price inflation in the US may slow to near zero and remain there for some time but will probably not turn negative. This fits with historical US experience: there has not been a year of house price declines across the US since the second world war.
International experience also offers some clues as to how the end of the housing boom is likely to affect the broader US economy. In the UK, Australia and the Netherlands, consumer spending growth slowed for about two years following the peak in house price inflation, though there is some dispute whether all of this can be attributed directly to the loss of a "wealth effect" from housing.
Home equity withdrawal, which had soared as house prices rose in the UK and Australia, remained reasonably strong as price gains petered out, without in either phase having an obvious additional effect on consumption over and above the wealth effect. This provides some support to those who argue that the impact of declining mortgage equity withdrawal may be limited in the US too.
Evidence from elsewhere notwithstanding, there is still no guarantee of a soft landing for the US. House prices could turn negative, given the high level of unsold homes and a possible step-down in investor demand. The adjustment in the US construction sector could spill over into a sharper retrenchment of consumer spending and business investment, which could in turn diminish demand for housing.
And even a relatively soft landing in the US is likely to be more abrupt than for those markets where the price boom did not spark a building boom as well. With prices cooling, residential construction is in retreat and is expected to subtract a full percentage point from GDP growth in the second half of this year.
"It looks as if more of the adjustment here may take place through reduction of new supply," says Peter Hooper, chief economist at Deutsche Bank Securities in New York. "That may limit the downside risk to prices and therefore consumer spending in the US."
Additional reporting and research by Keith Fray, Ralph Atkins and Michiyo Nakamoto
By Ralph Atkins, Scheherazade Daneshkhu, Keith Fray, Krishna Guha and Michiyo Nakamoto
Copyright The Financial Times Limited 2006
Published: October 24 2006 03:00 | Last updated: October 24 2006 03:00
Asudden slowdown in the US housing market has sent analysts scouring the globe in search of clues as to what might happen next. Will America's spectacular residential property boom end in a "soft landing" - for house prices and its economy as a whole - or are shocks of a more brutal severity in store, which could resonate far beyond its shores?
On one level, what they see is encouraging. Recent experience in the UK and Australia, to take two of the better examples, shows that a housing boom need not end in falling house prices and protracted economic stagnation, though a phase of growth below the usual trend is likely while the economy adjusts.
International comparisons are tricky in housing, for which there is no integrated global market in the sense that there is a global capital market. National housing markets differ in structure and the degree of integration between them is limited. Nonetheless, there is international evidence to reinforce the case made by Don Kohn and Alan Greenspan, vice-chairman and former chairman of the Federal Reserve respectively: that a soft landing is possible and may even already be under way inthe US.
Certainly, the US house price boom did not take place in global isolation. Rather, it was part of a great wave of house price inflation that swept unevenly around advanced economies beginning in the mid-1990s. The Organisation for Economic Co-operation and Development, the official think-tank for the industrialised world, describes this boom as "unprecedented" in its steepness, durability and geographical breadth.
Not only did a "historically high number of countries" see big house price gains, the OECD notes, but the boom was also "strikingly out of step with the business cycle".
In most of the hot markets, house price growth has peaked and since ebbed, but in some, including Spain, Ireland and Singapore, the boom is continuing. By contrast, house prices barely moved over the past decade in Germany and land prices fell year after year in Japan.
It appears that all the boom markets, including the US, were to some extent responding to common shocks. "There are common factors," says Raghuram Rajan, chief economist at the International Monetary Fund. "Clearly the level of interest rates worldwide has played a role. Also, to my mind, productivity growth across the world has been important in assuring people of higher incomes."
The price people are willing to pay for a home should go up when long-term interest rates fall - which they did, to exceptionally low levels globally since the turn of the millennium. They remain low today, both in nominal and real terms. The setting of low short-term rates by central banks played a part. However, Mr Greenspan argued it this month: "I don't think the boom came from a 1 per cent Fed funds rate or from the Fed's easing. It came from the collapse of the Berlin Wall." The end of communism had "brought billions of cheap labourers on to the scene. This was highly disinflationary. Bond yields fell, real interest rates fell and real asset prices, like house prices, rose dramatically."
Others point out that the step-up in productivity growth in the 1990s may have raised expected future incomes, meaning people became comfortable about borrowing more. Mr Rajan argues that house prices boomed in those economies where financial systems were more market-based, allowing people both to capitalise both on the decline in rates and, in effect, their future pay-rise prospects.
"One of the lessons you draw from the UK and Australia is that there are some fundamental factors holding up house prices. It is not just low short-term interest rates," Mr Rajan adds. "Also, to some extent, there is a certain amount of resilience. These are not fragile bubbles that if pricked will collapse."
Compared with some of the other housing boom countries, the US experience has actually been fairly unremarkable. Prices there increased by 56 per cent in the five years to the market peak of the third quarter of 2005 - but they almost doubled in the UK and Australia in the five-year periods that led up to their respective peaks.
Moreover, the US housing market is less richly valued than the other boom markets. A Deutsche Bank study shows that even though they are high by past US standards, price/income and price/rent ratios remain lower than they are in the UK, Australia or the Netherlands.
These countries are particularly interesting for America-watchers because they are further along the housing market cycle than the US (where, according to the Office of Federal Housing Enterprise Oversight, prices were still up 10 per cent year-on-year in the second quarter, though the rate of growth had slowed to only 1.2 per cent during the three months). In other words, the three have seen their housing markets cool off already, and with little impact.
Annual house price inflation in the Netherlands peaked at 20.5 per cent in late 1999, before slowing to zero by early 2003 with a slight upturn since. In the UK it topped out at 25.2 per cent at the end of 2002 and troughed at 2.2 per cent in late 2005, before picking up again to run at above 5 per cent. In Australia the peak came at 19.4 per cent in late 2003, with prices then slowing abruptly to 0.2 per cent by late 2004 before also rising again.
The data indicate that these movements in the housing market had little effect on the overall economy. In both Australia and the UK, growth slowed as house price inflation eased sharply but since then recovered. The Bank of England, which lowered interest rates by a quarter percentage point as the market cooled, has since raised rates again to 4.75 per cent. The Netherlands suffered a harder landing: when house prices stabilised, the Dutch central bank estimated it reduced gross domestic product by 0.5 per cent a year for two years.
Parallels can, however, easily be too simplistic. David Miles, an economist at Morgan Stanley in London and author of a UK government-commissioned study on the mortgage market, says: "One needs to be wary in believing that what has happened in the UK - or any other housing market for that matter - over the past couple of years can tell us very much about what is likely to happen in the US."
Housing markets vary in important respects - including the type of loans people use to buy houses, the level of home ownership, the ability to borrow against the value of one's home, and the size of the residential construction sector. The most important difference among the housing boom economies is the extent to which the availability of land and the regulatory environment allow new houses to be built.
In response to the price boom, for example, the UK and the Netherlands saw little change in supply of new homes: UK residential construction remained pretty stable at about 4 per cent of gross domestic product. In the US, Australia and Spain, however, there was a bigger jump in supply in response to price increases. US residential construction reached 6.3 per cent of GDP last year.
Dawn Holland, economist at the UK National Institute of Economic and Social Research, says the right comparisons to draw are "between the UK and the Netherlands on the one hand, and the US and Australia on the other".
The example of Australia is encouraging: it managed a reasonably soft landing. But Michael Ball, professor of urban and property economics at Reading University in the UK, draws a less favourable analogy - between the US and Germany during its post-unification boom in the 1990s, where construction grew to about 8 per cent of national income.
"A decline in output from that side has a fairly direct impact on the economy. Part of the reason for the German economic slowdown was that it was induced by a rapid slowdown in housebuilding," he says.
But he adds that this does not mean that the US need suffer the same effect, because "there is still a lot of demand for housing in the US" due to a strong labour market, favourable demographics and net immigration.
Overall, the international experience tends to support the view that home price inflation in the US may slow to near zero and remain there for some time but will probably not turn negative. This fits with historical US experience: there has not been a year of house price declines across the US since the second world war.
International experience also offers some clues as to how the end of the housing boom is likely to affect the broader US economy. In the UK, Australia and the Netherlands, consumer spending growth slowed for about two years following the peak in house price inflation, though there is some dispute whether all of this can be attributed directly to the loss of a "wealth effect" from housing.
Home equity withdrawal, which had soared as house prices rose in the UK and Australia, remained reasonably strong as price gains petered out, without in either phase having an obvious additional effect on consumption over and above the wealth effect. This provides some support to those who argue that the impact of declining mortgage equity withdrawal may be limited in the US too.
Evidence from elsewhere notwithstanding, there is still no guarantee of a soft landing for the US. House prices could turn negative, given the high level of unsold homes and a possible step-down in investor demand. The adjustment in the US construction sector could spill over into a sharper retrenchment of consumer spending and business investment, which could in turn diminish demand for housing.
And even a relatively soft landing in the US is likely to be more abrupt than for those markets where the price boom did not spark a building boom as well. With prices cooling, residential construction is in retreat and is expected to subtract a full percentage point from GDP growth in the second half of this year.
"It looks as if more of the adjustment here may take place through reduction of new supply," says Peter Hooper, chief economist at Deutsche Bank Securities in New York. "That may limit the downside risk to prices and therefore consumer spending in the US."
Additional reporting and research by Keith Fray, Ralph Atkins and Michiyo Nakamoto
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