Why Britain’s housing market has escaped the disasters of the 1990s

 
Ruth Lea
DESPITE economic woes, the British housing market is holding up reasonably well. According to the Office for National Statistics, house prices in September were 1.7 per cent higher than a year earlier in nominal terms, and only 2.5 per cent down on their 2008 peak.

Of course, there are qualifications. Higher prices are mainly confined to London. And when general inflationary pressures are allowed for, house prices in September recorded a modest annual fall. I’m not suggesting the housing market is buoyant (it is not). Neither am I saying that the housing market escaped a sharp correction as the economy slumped into recession in 2008-2009 (there was a sharp correction). But we have avoided the worst aspects of the early 1990s housing crash.

This is perhaps surprising when we compare the early 1990s recession and the last recession. In terms of lost GDP, the former was shallow. At its nadir GDP was only 2.5 per cent below its previous peak. By contrast, the last recession was the worst since the war. At its lowest point, GDP was 6 per cent down on the previous peak. And after four and half years of stuttering recovery, and a heroic 1 per cent increase in the third quarter of 2012, GDP is still 3 per cent down. Assuming modest growth in 2013 and 2014, I do not expect the level of GDP in the first quarter of 2008 to be achieved until late 2014.

Why then did the housing market perform so badly in the early 1990s compared with recent experience?

The early 1990s housing crash followed the late 1980s housing boom, which was driven by an over-heating economy allied with the consequences of financial liberalisation. Specifically, in April 1988 an interest rate cut to curb the pound’s ascent against the deutschemark boosted the housing market. By the second half of 1988, however, interest rates were raised aggressively to dampen inflationary pressures. The base rate touched 7.5 per cent in mid 1988. In 1989 it was increased to 15 per cent. Many affordable mortgages in 1988 thus became unaffordable in 1989.

Membership of the European Exchange Rate Mechanism (ERM), when Britain was locked into Germany’s high interest rates, provided the final turn of the screw. Falling house prices from 1989 to 1993 were devastating for highly mortgaged homeowners, many of whom fell into negative equity. A sharp rise in unemployment was the final straw for many, resulting in rocketing repossessions and forced sales. The pound’s expulsion from the ERM in September 1992 was, without exaggeration, the housing market’s salvation.

The worst of the horrors of the early 1990s housing slump have, thankfully, been avoided this time. There are several reasons for this.

The first, and most obvious, has been the ability of the independent Bank of England to respond rapidly to the financial crisis. The bank rate was down to 0.5 per cent by March 2009, has been there since, and will probably stay there for some time yet. Following on from this, affordability measures (particularly average mortgage repayments as a percentage of income) have recently been lower than in the early 1990s, despite higher house price to earnings ratios.

Secondly, lending practices in the mid-2000s were, perhaps counter-intuitively, more restrained than in the late 1980s. Loan-to-value ratios were significantly higher in the late 1990s, which made home-owners especially vulnerable to negative equity as house prices fell. There is also evidence of more forbearance and restructuring of loans by lenders when borrowers have fallen into financial difficulties, compared with the early 1990s recession.

The third reason is the puzzlingly better-than-expected performance of Britain’s labour market, which compares well with the early 1990s. Last week’s jobs figures showed that employment in the third quarter of 2012 was back to the level in 2008, even though GDP was 3 per cent lower. Granted that much of the recent improvement reflects a partial displacement of full-time by part-time employment, but the mere fact that employment has held up has undoubtedly supported the housing market.

Whatever our concerns about the state of our economy, therefore, homeowners can at least seek comfort that our housing market has escaped the calumnies of the 1990s.

Ruth Lea is economic adviser to the Arbuthnot Banking Group.