Housing Bubbles and Booms
Not every boom is a bubble, though most of them become bubbles. Not every boom ends in a bust, though most of them do. In the present situation, one needs to be careful to distinguish between the two types of rapid price increase.
In the United States and in the United Kingdom, it is clear that the housing boom has been a bubble. In the United States, the bubble has already burst — the only question is when the U.S. housing market will reach its low point. Britain is following the same track, but is somewhere between six and twelve months behind.
There are some important differences between the two markets. For most purposes, the British housing market can be regarded as a single market. There are, of course, regional variations which largely reflect the distance from London — the Inverness market fluctuates in a different cycle from London. But, over time all the regional markets tend to move in a similar rhythm.
In the United States, the regional differences have been much more important. The housing bubble, which is now receding, is the first nationwide housing bubble in American history. In the past, Americans have been drawn into local or regional housing booms, like the great Florida boom of the 1920s. This time the U.S. boom ran throughout the States.
I think that must have been caused by the universal availability of cheap credit, the same influence as created the boom in hedge funds and private equity. If the availability of credit is the chief determinant of house prices, then Florida and Chicago are likely to share in the boom and in the recession. Regional differences become secondary influences, as they are in the stock market.
The fall in the house market has wiped out very important assets of the banking system, leading to the collapses of Bear Stearns and Northern Rock and the distress of other banks. It is difficult to put a figure on the contraction of credit that has resulted. The I.M.F. has suggested $1 trillion, which is an impressive round number. What has actually been lost is a multiple of the fall in house values, since there is a multiplier effect on credit and on the willingness to lend. A bank which has lost a billion dollars in the housing market, or some derivative of the housing market, will feel itself to be short of capital and will seek to draw in as much cash as it can. It may well go from over-generous lending to exaggerated borrowing, which will take it from being a net lender to being a net borrower. This banking squeeze is pronounced both in the U.S. and the U.K.
However, there are other global price rises which are not bubbles. The oil market has risen to record highs, with Brent Crude at around $108 a barrel. This cannot be merely a reflection of excess liquidity, since the oil price has continued to rise at a time when credit was becoming much scarcer. In the case of oil there are non-monetary reasons for higher prices, including the high level of demand from Asia, the geopolitical risks of dependence on Iran and the physical loss of production in Iraq. The rise in oil prices extends to rises in products dependant on oil, particularly foodstuffs. There is a global increase of grain prices, causing most suffering in Africa and in the less developed Asian countries. These are not speculative increases, but are reflections of real economic and political factors.
I do not believe that the world is on the edge of another Great Slump, but the combination of the deflationary effect of the collapse of a widespread housing bubble with the inflationary effect of higher prices for oil and food does present Governments with the most difficult economic problems since the 1970s. It was then called “stagflation,” to reflect stagnant inflation. Both horns of the stagflation dilemma now look sharp and threatening.
Lord William Rees-Mogg
April 11, 2008