'The house price crash starts in 2008'

by Fred Harrison, author of Ricordo's Law, Evening Standard UK–

31 December 2007–

Ten years ago, in my book The Chaos Makers, I forecast what would happen to the

economy in 2008: a house-price crash ahead of a wider recession.

My prediction looks like being confirmed: the latest survey of the housing market

shows house prices stalling in most parts of the country, with predictions of a fall

next year. Meanwhile, the Chartered Institute of Personnel now expects

unemployment to rise by 150,000 — taking the number of people out of work to its

highest level since 1997.

It need not have unfolded this way. In 1997, I submitted papers to Gordon Brown,

the new Chancellor. I explained that house prices would peak in 2007 because of

frenzied activity in the land market.

I warned that the downturn in house prices would presage a global depression in

2010 — unless he radically reformed taxes so that they were shifted away from

work and towards speculation in land. That way, investment would go into the real

economy instead of simply fuelling another property boom. Naturally, Mr Brown

took no notice.

Instead, he stuck with conventional Treasury policies. But handing responsibility

for setting interest rates to the Bank of England was never going to stop the

property market from soaring: lower interest rates might be good for business but

they also give landowners and speculators an even bigger return on their land,

fuelling a new property boom.

People are now being lulled into thinking Britain will still manage a 'soft landing'.

House prices may turn down over the next six months, according to the consensus

view, but they will pick up again towards the end of 2008. These assurances are

irresponsible.

They encourage first-time buyers to jump into the housing market when they see

prices weakening. But in my view, the decline in house prices will exceed 20%

over the next two years. The argument in favour of a soft landing is that the

'fundamentals of the economy — the basic strength of markets and major

businesses — remain sturdy.

This is exactly what Mr Brown emphasised in his New Year message at the

weekend. But it ignores two crucial facts. First, the causal mechanism between

house prices and the wider economy actually works in the opposite direction.

A decline in house prices is good news for first-time buyers but it is highly

damaging for the economy. We have grown to rely on property as the collateral for

our credit-funded consumption binge. Reduce the value of the collateral and

people's spending power is reduced, too. That raises unemployment and further

weakens people's willingness to buy property.

The historical evidence is clear: over the past 200 years, housing booms have

always been followed by recessions. Our economy is like a drug addict: the heroin

of house-price rises is bad for the body, but cold turkey is still a painful business.

Will there be a house price crash?

Property sceptics are predicting a serious downturn in the housing market, but will

there be a crash?



 • ANALYSIS: House price crash - could it happen to the UK?

• POLL: Will house prices rise or fall over the next 12 months?

• CALCULATOR: House price crash calculator

• BLOG: Will there be a house price crash?

• BUY-TO-LET: Is Britain facing a buy-to-let timebomb?

• ECONOMISTS: UK house-price bubble about to burst - IMF



The other reason Mr Brown's argument is wrong is that we cannot any longer

dismiss a house-price crash as just a local factor. The real estate sector is now

effectively a single global market; property cycles have converged.

The US cycle came to an end in 2006. The housing markets in Ireland and Spain

came to an end in 2007. Downturns in property prices are surfacing all the way

from Eastern Europe to the Far East. The remaining property markets will peak in

2008.

As the property dominoes fall across the globe, the ensuing financial crisis will

eclipse the present current credit crunch in the banking sector. It takes two years or

so for a recession to take hold after house prices have peaked. So I am satisfied that

my gloomy prediction of a full-blown recession in 2010 will turn out to be correct.

Can the Government soften the blows? Historically speaking, once a landmarket-led

frenzy has taken its toll, there is little governments can do to prevent

unemployment. Even so, ministers should now focus on two areas of policy.

First, they should avoid making the downturn even worse. If, for example, the

Treasury sticks with its plan to level down the tax rate on capital gains, there will

be a sharp drop in prices in the summer. Owners of buy-to-let properties are

waiting for the new tax year to offer their apartments for sale, when the CGT rate

will be cut from 40% to 18%. The effect will be a crash in prices, denting

confidence even further.

Second, ministers should lay plans for an increase in the output of affordable

houses over the next property cycle, thus restoring some confidence to the property

market. As things stand, I forecast Mr Brown will not achieve his target — three

million new homes built by 2020. Housing starts began to fall last year: this always

happens when the price of land becomes unaffordable. But if government offered

the right incentives, building firms could kickstart their construction programmes

and create some new jobs. In the longer term, ministers should give priority to

reforming the tax system.



Taxes which penalise people who work, save and invest should be reduced or

abolished. Given the bad times ahead, the Chancellor should give priority to

reducing income tax (which makes it uneconomic for some people to work) and

VAT (which reduces consumption).

Instead, a tax on land values would let government raise revenue from the value

created by investments in public infrastructure, such as the Jubilee line extension.

Such investments raise the productivity of the economy — for example, by getting

people to their place of work more quickly.

These gains from taxpayers' investments surface as rising land values: a flat in

Stratford, for example, will be worth far more when Crossrail opens for business.

But as the tax system stands, the public purse gets very little of the benefit back.

Shifting taxation so that owners of land paid an annual tax on that land's value —

rather than on the property sitting upon it, as council tax does — would also

discourage speculation and a new property bubble.

For the enterprise economy, a shift towards such a tax on land values is the most

benign way for government to raise revenue. Progressively reforming the tax

regime in this way would lift the spirits of the nation. It would give Britain a head

start as the global markets recover around 2012. It would place the housing sector

at the cutting edge of a new period of sustainable growth.

It will be hard to avoid bad economic news in 2008. Shouldn't that be all the more

incentive for political leaders to work together to agree a radical way out of the

cycle of boom and bust?



READER COMMENTS (4)



 

As recently as a year ago in Dec of 2006 when it was clear that housing
sales were declining in the US "experts" were predicting a rise of 10%
in US house prices with arguments about the strong economy

Actually a US-wide fall of of 6% is what happened (12% in some areas) and worse is yet in store.

Why do we in the UK continue to think it can't happen here?



- Tim, Bishop's Stortford Herts



Great article, right on everything.



- John Miller, Watford



Due to excess and greed we have unknowingly sold ourselves to more
prudent and productive nations and only foreign money can bail us out.
The alternative is for the powers that be (for a short while longer) to
print money, devalue the pound, make importing food etc too expensive
and this in turn will lead to hardship and hunger! What good is a 6 bed
townhouse if you can't afford a loaf of bread!



- William, London



Keep on with your forecasts, Fred. I think you’re spot on! Stagflation,
rising unemployment, and eventually recession, is the likely outcome
for the UK....and many other parts of the World. Cash is King!



- Mike, Cheam