Alice Cook fears we might be on the verge of a renewed housing bubble; according to the Nationwide, prices rose 1.2% last month, whilst the Halifax index showed a 2.6% gain.
To some extent, I share her concerns. With the house price-income ratio still above its long-term average, consistent prices rises from hereon would be bubbly. And she’s certainly right to say that economic policy should not support price rises.
However, much as I hate futurology, I doubt that prices have turned. In my day job, I recently gave four reasons to expect prices to continue falling.
So why does the data suggest otherwise? It could be quirks of the indices.
First, with housing turnover so low - mortgage approvals in April were less than half the 1994-2008 average - the samples in the indices are unusually low. And small samples are naturally more volatile than big ones. Which means that even if the trend in house prices is still down, there’s a greater chance of a blip up simply thanks to dumb noise.
Secondly, there’s an issue with hedonic indices.
To see what I mean, imagine that, in a month when prices were generally flat, more mansions were sold and fewer terraced houses. It would then look as if average house prices had risen when in fact - ex hypothesi - they hadn’t, and what had happened was that the quality of house changing hands had improved.
Now, to avoid this erroneous inference the indices try to adjust for quality, by using hedonic regressions, which control for obvious characteristics of quality such as the number of bedrooms, bathrooms, location and so on.
But these adjustments can only be imperfect; as everyone who has ever looked for a house knows, there’s big variety even among descriptively, quantitatively similar places.
And in today’s thin markets, it’s only the better houses that are changing hands. If the hedonic regressions don’t fully control for this - and they cannot - then the indices will show an increase in price when what has in fact happened is an improvement in the average quality of house changing hands.
Which brings us to a third quirk of the indices. In bad market conditions, such as now, the over-priced tatty houses which don’t sell aren’t included in the index, whereas in bubble conditions they do sell and are included. Which means that house price indices are upwardly biased now as they exclude rubbish houses; this paper by Will Goetzmann explains.
Now, of course, my pessimism about the housing market might be misplaced. But I’ll need more than one or two months of price data to establish this.
To some extent, I share her concerns. With the house price-income ratio still above its long-term average, consistent prices rises from hereon would be bubbly. And she’s certainly right to say that economic policy should not support price rises.
However, much as I hate futurology, I doubt that prices have turned. In my day job, I recently gave four reasons to expect prices to continue falling.
So why does the data suggest otherwise? It could be quirks of the indices.
First, with housing turnover so low - mortgage approvals in April were less than half the 1994-2008 average - the samples in the indices are unusually low. And small samples are naturally more volatile than big ones. Which means that even if the trend in house prices is still down, there’s a greater chance of a blip up simply thanks to dumb noise.
Secondly, there’s an issue with hedonic indices.
To see what I mean, imagine that, in a month when prices were generally flat, more mansions were sold and fewer terraced houses. It would then look as if average house prices had risen when in fact - ex hypothesi - they hadn’t, and what had happened was that the quality of house changing hands had improved.
Now, to avoid this erroneous inference the indices try to adjust for quality, by using hedonic regressions, which control for obvious characteristics of quality such as the number of bedrooms, bathrooms, location and so on.
But these adjustments can only be imperfect; as everyone who has ever looked for a house knows, there’s big variety even among descriptively, quantitatively similar places.
And in today’s thin markets, it’s only the better houses that are changing hands. If the hedonic regressions don’t fully control for this - and they cannot - then the indices will show an increase in price when what has in fact happened is an improvement in the average quality of house changing hands.
Which brings us to a third quirk of the indices. In bad market conditions, such as now, the over-priced tatty houses which don’t sell aren’t included in the index, whereas in bubble conditions they do sell and are included. Which means that house price indices are upwardly biased now as they exclude rubbish houses; this paper by Will Goetzmann explains.
Now, of course, my pessimism about the housing market might be misplaced. But I’ll need more than one or two months of price data to establish this.
And the other thing about the Halifax and Nationwide indices is that they miss out repossessed properties that are sold at auction without mortgages. These prices are lower than conventionally sold ones, and the number of repos will rise as unemployment does.
Posted by: Tom Freeman | June 05, 2009 at 01:35 PM
Your excellent point on the failings of hedonic regressions is supported by anecdotal evidence on the ultra high-end of the housing market, where buyer liquidity is freer and posh estate agencies therefore more upbeat. Set against this is the dismal data on new mortgage approvals (less important for the uber rich) which you cite.
Posted by: Sam Langfield | June 05, 2009 at 04:45 PM
consistent prices rises from hereon would be bubbly
Exactly. I'm not making out any expertise but I did write just before the banking bubble burst that there would be a false comeback, a false dawn before the big crash.
It's time to make one's plans now.
Posted by: jameshigham | June 05, 2009 at 04:59 PM
In the same way that the Great Crash had several upturns, this housing market will have them too - but to no better effect. The US is well over a year ahead of us and they "may" be seeing more stability or " lesser " falls, but they are still seeing a downward trend which is yet to flatten
Posted by: kinglear | June 05, 2009 at 08:40 PM
There is no bubble now. We may drop up to another 30%, but at that time there will be real bargains that we have not seen in the last 40 years. Buy, Buy!
Posted by: Gas Analyzer | July 07, 2009 at 04:51 AM