UK house price crash - quiet before
the fall (2007)

There is an uncomfortable quiet right now. Like in the film Zulu, it is the quiet just before the embattled British soldiers catch sight of a massed army rising up across the horizon. It's the quiet before the fall.

Of course, I hope I'm wrong on this, but for some UK residents the battle for financial survival appears to have already begun. Of 179 properties recently up for auction in Covent Garden, 52 were repossessions.

The Financial news of the last 8 weeks adds little cheer. Banks have stopped lending to each other. Investors aren't buying up commercial debt. There's a rush to sell investments in house-builders, commercial property funds and any mortgage lenders suspected of being exposed to subprime loans.

In fact, a recent survey finds confidence in the UK financial sector at its lowest since 1990 - the time UK house prices last went into freefall. We've just seen the first run on a British bank since the 1800s. Queues of anxious savers were kept waiting outside Northern Rock branches. Then the contagion. Both Alliance & Leicester and Bradford & Bingley took hits on their share prices . Even Barclays looks to be feeling the heat.

Up on the horizon stands a looming threat - the end of 2-3 year fixed rate mortgage deals. This means that 2 million UK households are about to be hit with 7.5% interest on their loans - this at a time when our personal savings are at a 47 year low and already twice as many Brits are missing mortgage repayments as in 2006.

A cause for concern? 60% of the UK's wealth is now said to be tied up in housing, so the dramatic increase in speculative buy-to-let ownership (up by a factor of at least 33 in the last 10 years) doesn't inspire confidence. Following a series of interest rate hikes, landlords now find that rental incomes have fallen below their own mortgage repayments. This is forcing landlords to sell. Brand new buy-to-let flats up North can already be found being auctioned off at 60% of the price they were bought for in 2006.

Record numbers of Brits are now seeking debt advice. In London, where property prices peaked at 15 times average earnings, some young couples are spending a barely conceivable 50% of their post-tax income on mortgage repayments.

We should be worried. All this suggests to me that talk of a 1989 style house price correction would actually be to understate how bad today's bust could be. Our disposable income has fallen below 1990 levels under a mountain of debt. Outstanding household loans currently stand at £1.3 trillion in the UK, double the outstanding debt just 7 years ago.

That's a lot of money to pay back, particularly when people find themselves with negative equity. At minimum, rational homeowners with interest only mortgage deals might be tempted to hand back the keys. If this happens, it may force banks to auction off properties for whatever they can get for them... further depressing prices.

But the inevitability of falling house prices isn't the whole story. According to the Memorandum of Understanding between the government and the Bank of England, the Chancellor's bailout of Northern Rock should only have happened if the bank's troubles constituted "a genuine threat to the stability of the financial system".

Therefore, taking the Chancellor's actions at face value, it tells us that the entire banking system is in a jam. It's a lot more serious than a few borrowers, banks and shareholders getting their fingers burned.

So how should we be preparing for the worst?

Firstly, we need to recognise that now really isn't the time to be buying a house or taking on debt. If you stick to renting you won't feel hard done by or under siege should you see house prices falling and interest rates continuing to rise (as Alan Greenspan just predicted, incidentally).

Secondly, things could get really bad, like losing your job bad. It's a sobering thought. But look around. Jobs are already being shed in the financial and building sectors. The retail sector is also worried about what domestic belt tightening will mean for Christmas sales. Have a plan B.

Thirdly, the demand for cash isn't about to dry up. If the banks are crying out for cash today, you can bet that the rest of us will be crying out for it tomorrow. Make sure you can lay your hands on enough of it.

Ends | 5 Oct 2007 | The Leg

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Essential Reading:
UK financial crisis 2007 | 2008. Where to next?

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Graph: Over the cliff? % month on month increase/decrease in house prices in the UK.

Graph: Relative increases in house prices in Great Britain, France and the US since 1970. Note the precarious position of the UK where prices are much more over-inflated than elsewhere.

Graph: UK house price to earnings ratio graph by Thompson Financial/HSBC - a graphic reminder that house prices haven't been this overpriced relative to income for over 30 years.

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