No sign of housing bubble, says Bank of England. Is this reasonable?

From the Daily Mail:

The Bank of England yesterday said it is ‘closely’ watching the UK housing market for signs of a new and dangerous bubble.

The central bank’s Financial Policy Committee, set up to protect the financial system, said ‘the recovery in the housing market appeared to have gained momentum and to be broadening’.

It said mortgage approvals in July were 30pc higher than a year earlier. Average house prices in August were up 5pc ‘and had risen more in some parts of the country, particularly London’.

The recovery has fueled fears that Britain is heading for another housing bubble, stoked by state-backed schemes such as Funding for Lending and Help to Buy.

The Bank insisted there was no sign of a bubble developing.

Is the BOE’s insistence that there was no sign of a bubble developing reasonable?

Take a look at this graphic created by Neal Hudson (Website: ) which shows the evolution of median house price to earnings in England from 1997 to 2012. As The Economist newspaper would say in its typically pithy manner “Housing hots up!”

** Click on graphic to see evolution from cool blue, representing ‘Under 3′, to red hot, representing ’10 & over’. **




There is a conventional bias in viewing such things as asset prices in terms of a household’s net worth {PV (Asset – Liability)} and then rationalizing that the costs of servicing the liability are affordable because of the low rate environment. 

It is important to add other elements to this.

What I am saying is nothing new: looking at the balances sheet, considering cash flows, and putting an emphasis on commitments are part and parcel of seeing money in non-neutral terms. In the case of homeowners in England there is the fundamental question of how long it will take to service the liability, in this case mortgages that are a far bigger multiple of income today than they were a decade ago, in an economy where the value of labour is at a discount and the power of capital trumps all other business considerations making the nature of employment increasingly precarious.

Hyman Minsky , in his 1986 book Stabilizing an Unstable Economy put it this way:

To analyze how financial commitments affect the economy it is necessary to look at economic units in terms of their cash flows. The cash-flow approach looks at all units—be they households, corporations, state and municipal governments, or even national governments—as if they were banks. (Minsky 1986, p. 198)

In terms of servicing, cash inflows must be greater than cash outflows –a basic reserve constraint, as Minsky put it or survival constraint as per the common terminology– but the fragility occurs the longer one is required to service these commitments. Can most people say with certainty that they can afford to service a mortgage for the rest of their working lives?

On the one hand, the quality of housing stock may be better now then in decades past: people desire creature comforts and consume conspicuously in order to keep up with the Joneses but the greater the stock of debt the greater the servicing burden. But on the other hand, absent steadily rising incomes that outstrip the cost of living over the period of mortgage, something that has not happened for the past generation, something will have to give: current consumption must be curtailed, or the stock of consumer debt must rise in order to fund consumption (needs to wants).

When governments bank on the wealth effect to spur economic growth they would be wise to remember that the greater fool theory, especially with respect to housing as a driver of growth, has an endpoint, one that often looks like this:





George Cooper on the market for assets versus the market for goods and services

1.3 A Slight Of Hand

Now re-read Samuelson’s passage, only this time look out for the slight of hand in the final sentence:

 What is true of the markets for consumers’ goods is also true of markets for factors of production such as labor, land, and capital inputs.

The passage provides a convincing explanation of how equilibrium is established in the marketplace for goods, but when it comes to the markets for labour, land and capital inputs, there is no explanation of the mechanisms through which equilibrium is established. For these markets we are offered nothing better than proof by assertion. This logical trick is pervasive in economic teaching: we are first persuaded that the markets for goods are efficient, and then beguiled into believing this to be a general principle applicable to all markets. As the failure of Northern Rock and Bear Stearns show it is unsafe to assume that all markets are inherently stable.

1.4 The Market For Bling

We can easily find a counter example to Samuelson’s well-behaved supply-and-demand driven markets. In the marketplace for fine art and luxury goods, demand is frequently stimulated precisely because supply cannot be increased in the manner required for market efficiency: Who would pay $140,000,000 for a Jackson Pollock painting if supply could be increased in proportion to demand? The phrase “conspicuous consumption” was coined by the economist Thorstein Veblen to describe markets where demand rose rather than declined with price. Veblen’s theory was that in these markets it was the high price, the publically high price, of the object that generated the demand for it. Veblen argued that the wealthy used the purchase of high-priced goods to signal their economic status. (Footnote: “The Theory of the Leisure Class” Thorstein Veblen, first published 1899.) Veblen was the original economist of bling – if you’ve got it you want to flaunt it.

Fortunately for the high priests of market efficiency, Veblen’s observations can be dismissed as minor distortions within an overall economic environment that responds in a rational manner to higher prices. That is to say, even at a price of $140,000,000, the market for Jackson Pollock paintings is irrelevant to the wider economy.

1.5 When The Absence Of Supply Drives Demand

While the markets for bling can be dismissed as economically irrelevant, there are other much more important markets which also defy the laws of supply and demand, as described by Samuelson. While Veblen identified the rare conditions in which high prices promoted high demand, we can also consider the much more common situation in which low or falling supply promotes high demand.

Today’s oil markets are a case in point, where constrained supply is prompting higher speculative demand. While consumers of oil are reducing their oil purchases in response to supply constraints and higher prices, speculators (investors) in oil are moving in the opposite direction and increasing their purchases.

This simple observation of how consumers and speculators respond in different ways to supply constraints gives us the first hint that a fundamentally different market mechanism operates in the markets for assets to that which dominates the markets for goods and services. This effect is not confined just to today’s unusual oil market: Who would invest in the shares of a company if that company were in the habit of issuing more stock whenever its share price rose above a certain level?

As a rule, when we invest we are looking for an asset with a degree of scarcity value, one for which supply cannot be increased to meet demand. Whenever we invest in the hope of achieving capital gains we are seeking scarcity value, in defiance of the core principle that supply can move in response to demand.

To the extent that asset price changes can be seen as a signal of an asset becoming more or less scarce, we can see how asset markets may behave in a manner similar to those of Veblen’s market for conspicuous consumption goods. In Veblen’s case it is simply high prices that generate high demand, but in asset markets it is the rate of change of prices that stimulates shifting demand.

Frequently in asset markets demand does not stimulate supply, rather a lack of supply stimulates demand. Equally price rises can signal a lack of supply thereby generating additional demand, or, conversely, price falls can signal a glut of supply triggering reduced demand.

George Cooper, The Origin of Financial Crises: Central banks, credit bubbles and the efficient market fallacy, (Petersfield: Harriman House Ltd., 2008), 6-8.