baldysblog.co.uk

There is much comment currently in the media about a “property crash” which in most ways, must surely now be inevitable to some degree and probably, not a totally bad thing. I can remember reading someone many years ago describing the key moment of a “confidence trick” as; “That moment when even sensible people suspend their scepticism and buy into something that in hindsight, they would never have under their ‘normal’ circumstances.”

What the writer was describing was people “wanting to believe” that something was true when experience should have told them better. I am sure that as Chancellor, Gordon Brown truly believed that he had banished “Boom & Bust” from the UK economy but of course he hasn’t and most likely, it can’t be done anyway there are too many other forces at play and beyond the control of a politician.

Past Lessons

Many years ago when I managed manufacturing units and bought plant, I always calculated 10% pa of the original purchase price as the annual cost of maintenance. Now in all honesty, rather like a brand new car, in the first few years this wasn’t the case but, over the lifetime of the plant, it was.

Later someone told me about the “Rule of 72″ which was based upon dividing any inflation rate into 72 to find out just how long it took for the value of anything to halve or double (your choice). So 10% inflation means that the price doubles or the value halves in 7.2 years. Now to be honest, it isn’t a very accurate “Rule”, play it on a spreadsheet and you will see what I mean but, in a rough and ready terms, it does give you a guide to work with.

House Price Inflation

Back in 1986, I was on a business trip to Malaysia with a colleague who knew the country very well. The Malaysian economy had been growing strongly but at that time, had hit a minor recession for the first time. We were in a Taxi with a very chatty Chinese/Malay driver who was moaning about how his house had “dropped in value” as a consequence of the current situation.

My friend asked him whether he intended selling it, the answer was No. He then asked him whether when the market price went up or down, whether the rooms got bigger or smaller and again, the answer was no. Yes a house is the biggest single purchase any of us will make but, a house is either a “home” or it is a financial investment and blurring the edges between the two, makes little sense which is what has happened in recent times.

Pyramid Selling

The little graphic attached to this article is in fact a shot I took of the Sears Tower in Chicago, it looks both the ‘shining city’ and also a pyramid. To be honest, I would suggest that buying property is little more than “Pyramid Selling”, it relies on new mugs – sorry, I meant First Time Buyers in order to work.

They need to “get on the ladder” in order to release the previous generation of “get on the ladder” people to move on which means that a previous generation… at the end of the chain, will be a pair of old farts who can now buy a house in Tuscany or whatever, to retire to on their Civil Service Pensions and hope and pray that their grandchildren will want to visit – unlikely but, we all live in hope.

This Government

I really do despise this so called Government for a whole number of key mistakes made since 1997 and including, have we ever had one who quite so recklessly went on “spending binges” at the same time as the taxpayers were doing the same ? Although I loath this Government sadly and in all honesty, the housing problem is not their fault directly, because they were never “in charge” of the economy anyway, no government and regardless of being to the right or the left, ever is. It was a vanity of Gordon Brown that having inherited a very good economic situation which he never acknowledged, he persuaded himself that it was all down to his ‘personal genius’ – hmm…indeed. Can we now expect the same GB as PM to accept the fault for any downturn in the UK economy – one suspects not.

The Wrong Business Model

The real “culprit” is the current “business model” which prizes “new customers” at the expense of existing ones and on a surge of cheap short term money gave unrealistic multiples of earnings to first time borrowers just because they were “new” which equalled growth in market share rather than the “boring existing customers” who actually paid their wages. How many of us have experienced on an insurance renewal finding that as an existing customer, we are required to pay a higher price for the same cover than a new customer would ? I certainly have.

Northern Rock is the classic example of “bankers” breaking the first rule of banking – “Never borrow short and then lend long”. This is a so called “business” that should never have been allowed to survive, the “mortgage book” is the real value and could have been sold on by liquidators within months so that borrowers would hardly have noticed a change in their personal circumstances. Of course, this now very much later, is exactly what will happen.

For what it maybe worth, my advice: If you want to borrow £100,000 and regardless of the interest rate offered, think £10,000 pa, £500,000 think £50,000 pa and so on, over the medium let alone the long term, you will be there or “there about”.

The Monthly Payment Concept

It is very simple, interest rates were kept artificially low, people borrowed at that level/rate and given human nature, who cares about the capital cost ? People judged buying their “home” on the monthly repayment cost just as they do the brand new car on the drive, “Can we afford the Direct Debit ?” being the only question.

The real problem has been that whilst people rejoiced in their property being worth say, 130% more today than when they first bought it, over the same period, their wages had only increased by say 40% – think about it for a moment. This all works whilst the roundabout continues to revolve at the same speed but what happens if it slows, worse, what if it stops ? Once the cheap money that banks could borrow on the international markets disappeared , the whole game started to unravel.

If you have a business model based upon consumer consumption relative to the “monthly payment” it will work fine just so long as capital and income work in relative harmony, break the link between those two and inevitably, problems will follow. For anyone with half a brain, when lenders started offering unheard of multiples of income and loans beyond 100% of purchase price, alarm bells should have rung loud and clear, they were counting upon ‘perpetual growth’ to keep their businesses afloat.

The market really doesn’t lie, it is a self correcting mechanism – true not kind but, it does work and always punctures the “King’s Magic Suit of Clothes”. There is a hope and possible “rescue” which is if, the western consumer economy switches from quantity at low prices to, quality at higher ones. Actually and inevitably, that is probably what will happen over the next 20 years because the “market” always self corrects and new opportunities arise for many though not for all. As to property, having got out of step, either prices must fall by probably 25-30% or there will need to be a bout of wage inflation to erode the capital value which will produce a similar result.