"Bubble Truths" and "anxiety about overpriced housing is overblown"

An article from the mainstream media brought interesting insight into a "bubble mind". In an interview, one of the famous Australian economists Stephen Koukoulas (with over more than 25 years of professional experience as an economist in government, as Global Head of economic and market research, a Chief Economist for two major banks and as economic advisor to the Prime Minister) asked simple question:

''What would you prefer? House prices three times' average incomes with 13 per cent interest rates or house prices four or five times' average incomes with interest rates under 7 per cent?
''The bottom line is the repayments are roughly the same.''

Economics used to be a science, not opinion field, so lets see how good scientist one of the Australian most famous economists really is.

According to RBA 1982 was the last year when Standard Variable interest rate was 13% and ratio between an average house price and average income was 3. An average repayment after purchase was 33% of the income (25 year loan, 80% LVR, deposit equal to 60% of annual income). 

Today, ratio between an average house price and average income is around 7 (according to RBA). Standard variable interest rate is 5.95%, repayment 45% of income (30 years loan, 90% LVR, deposit 70% of annual income).

First year repayment today is 36% higher than what it was when home prices were 3 times income and IR 13%.

But that is not the end of the story. Houses take decades to repay, so let see how repayments change over time.

In year 2, repayment was equal to 29% for 1982 buyer (IR dropped to 12.5%, income grew by 9%), and 43.5% for today's buyer (assuming IR and income growth stay the same). 

In year 3, repayment dropped to 25% of income for 1982 buyer (IR dropped to 12%, income grew by 11%) and 41.5% of income for today's buyer (assuming IR and income growth stay the same).

In year 4, repayment dropped to 23% of income for 1982 buyer (IR dropped to 11.5%, income grew by 5%) and 40% of income for today's buyer (assuming IR and income growth stay the same).

In year 5, repayment dropped to 21% of income for 1982 buyer (IR increased to 12%, income grew by 7%) and 38.5% of income for today's buyer (assuming IR and income growth stay the same).

Total cost of house ownership (including deposit) in first 5 years was 190% of income for 1982 buyer and 280% for today's buyer. Despite significantly lower rates, higher LVR and longer loan term, houses today are 47% more expensive in first 5 years than they were in 1982.

Over the life time of a mortgage (25 vs 30 years), today's potential buyer (with assumption that rates stay low) would pay more than twice in income terms for an average house than buyer from 1982.  

Economist Stephen Koukoulas says the anxiety about overpriced housing is overblown because the burden of today's big home loans has been completely offset by the saving from low interest rates.

Completely offset?
Don't worry and buy because "anxiety about overpriced housing is overblown"?!

What caused Housing Bubbles in UK

UK has recorder one of the most volatile house prices in the West since WWII. Many economists use UK as a prime example how "land restrictions cause housing bubbles".  But you they failed to provide evidence that UK home price volatility is caused by land restrictions and not something else. 

They overlooked the fact that beside tough land restrictions UK has the least stable and the most speculative banking system in the West. Maybe that has something to do with price volatility. Lets explore:  

If we look into history of UK banking you will find very interesting correlation between banking regulation changes and housing bubbles. 

Home prices in UK were relatively stable during 50s and 60s. Prices were slowly going up while government was slowly introducing "land development restrictions" in 1960s. This price growth could be attributed to land restriction regulation in addition to other causes (real income growth, etc.).

Suddenly, after decades of stability, house prices spiked in early 70s. Interestingly, that happened immediately after significant bank deregulation process: Competition and Credit Control in 1971 and big bank mergers in late 60s (during just two years in 1968, five big bank mergers occurred) . Competition and Credit Control relaxed bank reserve requirements, allowed deposit banks to participate on the market, removed interest rate collusion ... More interestingly, in 1970 (just before the bubble) new conservative government started relaxing many of the land development restrictions introduced by labour in decade before. Bubble burst and prices drop by 30% by mid late 70s. During this period of falling prices new labour government introduced new and tougher land restrictions but that didn't prevent house prices from falling.

Than, in late 70s, foreign exchange controls were lifted and 1979 Banking Act was passed. That coincided with the housing bubble that peaked in early 80s. This bubble was much smaller but real prices fell almost 20% after the burst. 

New conservative government started reforms that included removal of some land restrictions laws and big banking reform. In mid 80s ‘Big Bang’ reforms were passed (1986). These reforms caused expansion of  building societies and relaxation of lending standards. Deregulation turned building societies into real banks and enabled them to lend money freely. This was followed by big housing bubble of late 80s.   

Finally, world wide deregulation and globalisation of late 90s happened just before great housing bubble of 2000s. Lending standards were dropped, bank funding became obscure and credit issue relaxed. UK banking sector tripled in less than a decade. Speculations became global, included insurances, big funds ...    

This clearly shows that every UK housing bubbles since WWII occurred after a new bank regulation rules were passed (almost identical causation can be showed for USA, Australia ...). In some instances lend restrictions rules had been lifted before bubbles started inflation. These relaxations of land restrictions failed to prevent bubbles from happening.    

In addition, the theory that land supply restrictions cause house price volatility is very hard to apply on UK cities where population significantly declined over the last 40 or 50 years (Manchester, Liverpool, Sheffield ...). These cities did not require much of a new land to meet new demand, still prices were more volatile there than in cities with fast growing population and end even more land restrictions like London.

- Richard Davies, Peter Richardson, Vaiva Katinaite and Mark Manning of the Bank of England - Evolution of the UK banking system - 2010

- Peter Scott - The Property Masters - Taylor & Francis - 2013