The global housing market

Residential-property prices are now falling in Britain and Australia, but have taken off in America and France

IN THE past three years, the total value of residential property in developed economies has increased by an estimated $20 trillion, to over $60 trillion. Granted, that increase is partly explained by the decline in the dollar; still, it is double the $10 trillion by which global share values climbed in the three years to 1999. Is this the biggest financial bubble in history?
The growing impact of housing markets on economies prompted The Economist to launch its global house-price indices in early 2002; these now cover 20 countries, using data from lending institutions, estate agents and national statistics. Our latest quarterly update shows that prices have risen over the past year by around 10% or more in 11 of the countries that we track (see table). Top of the league is South Africa, where prices surged by 35% in the year to the third quarter, pushing it into first place ahead of Hong Kong (31%).
Among developed countries, Spain has enjoyed the biggest rise, of 17%, over the past year, much the same rate as in 2003. However, in Australia, which topped the table for most of last year, house prices are now falling. According to official figures, average prices in the third quarter were still 8% higher than a year ago, but private-sector figures suggest that prices have fallen sharply in recent months. The Commonwealth Bank of Australia's index, which is more timely because it is based on prices when contracts are signed rather than at settlement, shows that house prices in Sydney were 15% lower in September than in December 2003; nationwide, prices fell by an average of 10%.
House-price inflation has also slowed significantly since last year in New Zealand and Ireland. In Britain, figures published by the Office of the Deputy Prime Minister show a 14% rise in prices in the year to the third quarter, up from 11% a year ago. But more up-to-date figures show that prices are now falling. According to the Halifax index, compiled by a big mortgage lender, prices fell in three of the four months to November. The volume of sales is also down sharply, as buyers are unwilling to pay asking prices. This in turn may signal further price falls to come. Barclays bank predicts that prices could sink by 20% over the next three years. Even the Bank of England has given warning that prices will fall.
In some countries, notably America, France and Sweden, the property market is still heating up. The average price of American homes jumped by 13% in the year to the third quarter - the fastest increase on record in real terms. Prices rose at double-digit rates in half of all American states; in five states, including California, and in Washington, DC, they soared by more than 20%. French house prices have increased by 15% over the past year, causing the Bank of France to express concern about the risk of a speculative bubble.
Calculations by The Economist suggest that house prices have hit record levels in relation to incomes in America, Australia, Britain, France, Ireland, the Netherlands, New Zealand and Spain. In other words, ratios of prices to incomes are now above levels that have proved unsustainable in the past. Taking the average ratio of house prices to incomes in 1975-2000 as a baseline, American house prices are now almost 30% overvalued.
If real interest rates are permanently lower, this could justify higher prices in relation to incomes. For example, real interest rates in Ireland and Spain were reduced significantly by these countries' membership of Europe's single currency. But several studies conclude that lower interest rates cannot explain all of the surge in house prices.
Japan provides a nasty warning of what can happen when bubbles burst. Japanese property prices have dropped for 13 consecutive years, by a total of 35% from their peak in 1991. Yet the 36% rise in real house prices in Japan in the seven years to 1991 was actually less than the increase over the past seven years in all but one of the eight countries listed above where prices appear overvalued.

Don't mention the B-word
In a recent speech, Alan Greenspan, the chairman of America's Federal Reserve, insisted that the growing concerns about an American housing bubble were much exaggerated. He went on to argue that the housing market is less prone to bubbles than the stockmarket, because homeowners cannot buy and sell their houses as easily as speculators buy and sell shares. People have to live somewhere and large transaction costs discourage trading.
Yet some economists reckon that bubbles are, if anything, more likely to develop in housing markets than in stockmarkets. One reason is imperfect information: no two houses are exactly alike and there is no central exchange where prices are instantly recorded. A second is the absence of short-selling. Suppose bullish investors push prices above their equilibrium level. In markets for shares or foreign exchange, such price rises might be moderated by other investors selling for future delivery in the hope of buying more cheaply later. But there are no organised futures or options markets for property, so with no short-sellers, optimists can keep driving prices up. Buyers' expectations about future house prices also tend to be based heavily on recent trends, so a rise in prices will also tend to boost demand further.
A third factor that tends to encourage bubbles is that banks have an incentive to lend as much as possible when property prices are rising, because this raises the value of their collateral. This gives prices an extra upward shove. But when prices fall, banks pull out, amplifying the bust.
There are plenty of symptoms of a bubble mentality in the United States, not least the surge in the turnover of existing homes to a record rate of 9% this year. Investors have been buying new properties and reselling within a year in the hope of a large gain. Economists at Goldman Sachs are concerned about signs of excess supply. The rate of growth in the housing stock exceeds the rate of growth in the number of households by a bigger margin than at any time in the past 40 years.
The global housing boom has been unusual in its strength, duration and ubiquity. Never before have so many countries had housing booms at the same time, driven largely by low interest rates. However, in its latest World Economic Outlook, the IMF warns that just as the upswing in house prices has been a global phenomenon, so will any downturn be-with corresponding adverse implications for global economic activity.