The Economist is frequently a
mixed bag. Here is an article on the global housing market that pretty much
hits the right spot. Please consider House of horrors,
bursting of the global housing bubble is only halfway through.
MANY of the world’s financial and economic woes since 2008 began with
the bursting of the biggest bubble in history. Never before had house prices
risen so fast, for so long, in so many countries. Yet the bust has been much
less widespread than the boom. Home prices tumbled by 34% in America from
2006 to their low point earlier this year; in Ireland they plunged by an even
more painful 45% from their peak in 2007; and prices have fallen by around
15% in Spain and Denmark. But in most other countries they have dipped by
less than 10%, as in Britain and Italy. In some countries, such as Australia,
Canada and Sweden, prices wobbled but then surged to new highs. As a result,
many property markets are still looking uncomfortably overvalued.
The latest update of The Economist’s global house-price indicators
shows that prices are now falling in eight of the 16 countries in the table,
compared with five in late 2010.
Home Price Indicators
assess the risks of a further slump, we track two measures of valuation. The
first is the price-to-income ratio, a gauge of affordability. The second is
the price-to-rent ratio, which is a bit like the price-to-earnings ratio used
to value companies. Just as the value of a share should reflect future
profits that a company is expected to earn, house prices should reflect the
expected benefits from home ownership: namely the rents earned by property
investors (or those saved by owner-occupiers). If both of these measures are
well above their long-term average, which we have calculated since 1975 for
most countries, this could signal that property is overvalued.
Based on the average of the two measures, home prices are overvalued by about
25% or more in Australia, Belgium, Canada, France, New Zealand, Britain, the
Netherlands, Spain and Sweden (see table). Indeed, in the first four of those
countries housing looks more overvalued than it was in America at the peak of
its bubble. Despite their collapse, Irish home prices are still slightly
above “fair” value—partly because they were incredibly
overvalued at their peak, and partly because incomes and rents have fallen
sharply. In contrast, homes in America, Japan and Germany are all
significantly undervalued. In the late 1990s the average house price in
Germany was twice that in France; now it is 20% cheaper.
This raises two questions. First, since American homes now look cheap, are
prices set to rebound? Average house prices are 8% undervalued relative to
rents, and 22% undervalued relative to income (see chart). Prices may have
reached a floor, but this is no guarantee of an imminent bounce. In Britain
and Sweden in the mid-1990s, prices undershot fair value by around 35%.
Prices in Britain did not really start to rise for almost four years after they
American prices fell sharply, even though homes were less overvalued than
they were in many other countries, because high-risk mortgages and a surge in
unemployment caused distressed sales. In most other countries, lenders
avoided the worst excesses of subprime lending, and unemployment rose by
less, so there were fewer forced sales dragging prices down. America is also
unusual in having non-recourse mortgages that let borrowers walk away with no
An optimist could therefore argue that our gauges overstate the extent to
which house prices are overvalued, and that if markets are only a bit too
expensive they can adjust gradually without a sharp fall. It is important to
remember, however, that lower interest rates and rising populations were used
to justify higher prices in America and Ireland before their bubbles burst so
Another concern is that Australia, Britain, Canada, the Netherlands, New
Zealand, Spain and Sweden all have even higher household-debt burdens in
relation to income than America did at the peak of its bubble. Overvalued
prices and large debts leave households vulnerable to a rise in unemployment
or higher mortgage rates. A credit crunch or recession could cause house
prices to tumble in many more countries.
That analysis is about as good as mainstream media gets. However, The
Economist fails to address the global implications.
What happens if home prices plunge (and they will) in Australia, Belgium,
Canada, France, New Zealand, Britain, the Netherlands, Spain and Sweden?
How will those central banks react?
Except for France which has no direct control, I will tell you how. Central
banks will cut interest rates and/or launch various quantitative easing
All other things being equal, that is net US dollar supportive.
Moreover, if prices and transaction volumes collapse in China (and they
will), what will that do to the demand for commodities? In turn, what would falling demand for commodities in China do to the
economies of Canada and Australia?
The Economist asks "Since American homes now look cheap, are prices
set to rebound?"
That is a good question.
The Economist answers (correctly) "Average house prices are 8%
undervalued relative to rents, and 22% undervalued relative to income (see chart).
Prices may have reached a floor, but this is no guarantee of an imminent
However, The Economist fails to discuss the possibility that US rents are
artificially high due to people seeking rental properties after being
Moreover, income statistics are very skewed. Most of
the gains in income are on the "high end", not people in financial
Still, as I said, this article is about as balanced as one can expect from
mainstream media. It provides much opportunity for further commentary (both
positive and negative) from bloggers.
The Economist correctly states "The bursting of the global
housing bubble is only halfway through."
However, it's the non-discussed ramifications that