Free falling

Today’s mortgage approvals numbers came out at a record low (see this comment for why we love mortgage approvals so much). Weakening mortgage approvals is no surprise – the housing psychology is moving to a bear market from a buyers perspective, and the mortgage lenders are strapped for cash so the number of willing providers of finance is collapsing. But it’s the pace of the decline that is startling. This free fall in lending creates a vicious spiral, with a subsequent free fall in house prices. Our adjusted mortgage approvals number now predicts that UK house prices will be dropping by at least 15% year-on year by December this year (see chart).

Like any free fall, the damage is a function of where you jump from. Sadly for the UK economy, we start from the highest point in the western world. Recent research from the Bank for International Settlements (BIS, see graph 3B) looked at the house price to income per capita ratio (this is the housing market equivalent of the P/E ratio) across a selection of economies. They then compared the ratio to the 1995-2005 trend to get an idea of how far each country’s housing market has deviated from its historical ratio. As at 2007, the UK housing market was the most overvalued, closely followed by Spain. The UK housing market was twice as overvalued as the US housing market, so we certainly shouldn’t rule out the possibility of the UK having a property meltdown worse than that in the US.

Housing market crashes historically take two to three years to work their way through, and given that the past decade has seen the biggest housing boom, there is every reason to expect that the following bust will be bigger and will take longer than has been the norm. If things continue deteriorating at the current pace, then pain in the financials and construction sectors will spread way beyond the likes of Bradford & Bingley or Taylor Wimpey.