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House Price Outlook (7 July – 10 August 2008)

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This Month's House Price Crash Developments

> Nationwide: UK house prices fell 1.7% in July, down 9% (£17k) from their peak of £186k.
> HBOS: June house prices fell 1.9%, down 9.6% (£19k) from their peak. Also…
> HBOS: July house prices fell a further 1.7%, now down 11.1% (£22k) from their peak of £200k.
> Rightmove revealed that home asking prices fell £4,345 (1.8%) in July to £235,219.
> Nationwide said estate agents are reporting up to 40% of transactions are falling through.
> RICS reported that UK house sales have fallen to their worst level in 30 years.
> CML reported that house repossessions soared 48% in the first half of 2008.
> RICS said demand for commercial property fell to its lowest level in more than a decade.
> Gordon Brown announced that stamp duty may be suspended.

> Three more US banks collapse, bringing the total to 7 so far this year.
> S&P/Case Shiller reported US home prices down 0.8% in May, 18.4% off their peak.
> The NAR, the Commerce Department and the OFHEO all reported falls in US house prices.
> The inventory of unsold US homes and condos remained high at a 11.1 month supply.
> The inventory of newly built US single-family homes represents a 10 month supply.
> US mortgage rates spiked higher on fears for the economic outlook.
> RealtyTrac reported U.S. foreclosure activity up 53% and bank repossessions up 171%.

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Section Index

Which Way Home Focus on: Myth Busting >
News Review >
High debt burdens lead to loan defaults, foreclosures & falling house prices >
Banks curb lending, individuals and corporations suffer as credit evaporates >
Stock markets price in corporate woes and fall >
Central Banks try to help, lowering interest rates and pumping out money >
Their currencies fall in value as a result >
Commodities rise as currencies fall in value >
Disposable incomes fall causing loan defaults, foreclosures & falling house prices >

Which Way Home Focus on: Myth Busting

Myth 1: The Last House Price Crash (1989 - 1996) was caused by High Interest Rates

Many people believe that the last house price crash was caused by the increase of interest rates into the high double digits. In October 1989, the eve of the crash, base interest rates hit 15%. Mortgage rates were even higher at 17-18%. It is argued that we will not see another house price crash unless interest rates return to these giddy heights and with interest rates currently at 5%, the likelihood appears remote. This assumption is completely wrong.

The Correct View

The increase in interest rates was indeed a catalyst for the house price crash, but the crash did not occur because interest rates reached 15%. In fact interest rates reached such heights a number of times during the 80’s. They spent most of 1980 at 17%, ended 1981 around 15% and were 14% at the start of 1985. So high rates, per-se were not the problem.

The real reason for the crash, the key reason, is that interest rates doubled over a short space of time.

From the start of 1985 interest rates then began to fall, reaching a low of around 7% in May 1988. People quickly became accustomed to these lower borrowing costs. Cheaper borrowing allowed people to take out larger mortgages and to buy bigger properties. The property market boomed and prices rose dramatically. But the tide turned sharply and as rates climbed once more, many homeowners were caught off guard and out of their depth. From the low of 7%, interest rates increased by 8% to 15% in just 17 months. The doubling of the interest rate increased monthly mortgage repayments significantly, hitting existing homeowners with variable rate mortgages, while simultaneously preventing new buyers from entering the market due to the now higher cost of buying a home. House prices collapsed.

Drawing Parallels with Present Day

Following the 2000 stock market crash, the Bank of England lowered rates in an attempt to re-ignite an ailing economy. Between July and October 2003, interest rates were cut from 6% to a low of 3.5%. At this point thousands of first time buyers rushed into the property market and millions of existing homeowners re-mortgaged their homes, lured by the low interest rates on offer.

Unfortunately prudent buyers were heavily outnumbered within this low rate environment and many people borrowed to the limit of their affordability, making little provision for the possibility of higher rates in the future. By the time the Bank of England had raised interest rates to 5.75% in July 2007, they had increased by 64%. Mortgage rates increased by an even bigger percentage.

In the US, the impact was even greater. Interest Rates reached a low of 1% in 2004 and were subsequently raised to 5.25% by the middle of 2006, an increase of 425%. Under these circumstances a huge number of homeowners began to struggle to meet their monthly mortgage payments, leading to high numbers of foreclosures and the start of the sub-prime crisis. In response, banks quickly reigned in their lending activity so as to limit their risk, leading in to the wider credit crisis we are experiencing today.

So if someone tells you that the housing market won’t crash because interest rates won’t hit 15%, you are going to laugh and say that while size does matter, it’s all relative! It is not the level of interest rates which counts, it is the relative size of the increase which matters.

Myth 2: House Prices Recover Quickly Following a Crash

It is a common misconception that house prices recovered quickly after the last house price crash.

The Correct View

The key to dispelling this misunderstanding can be found in basic maths. If house prices fall 50%, they have to go up 100% just to break even (if a £100k house falls 50% to £50k, it has to rise £50k or 100% to get back to the starting point).

Taking the last house price crash as an example, according to Nationwide’s inflation adjusted house price data, house prices last peaked in the third quarter of 1989 at £62,782. The bottom of the market was touched at the end of 1995 at £39,360, 37% off the peak. It wasn’t until the first quarter of 2002 that house prices were able to recapture their previous high, just over 12 years later.

Readers will know that the economy currently faces much greater risks than those which were present during the last house price crash. The US dollar, the world’s reserve currency, is collapsing in value, the banking system is insolvent, central banks are being forced to pump masses of paper money into the economy in order to keep it afloat and homeowners are defaulting on their mortgage obligations at an accelerating rate.

Once house prices have finished falling the 50% I predict over the medium term, they will not recapture their highs for well over a decade, and maybe two. It takes a really dedicated (or foolish?) buyer to wait 20 years just to break even.

A Reflection on Last Month's Outlook

Last month I discussed predicting the future by examining key trends within the property market. One of the trends related to the acute stress currently being experienced within the financial markets. Another trend related to the reset dates of mortgages taken out at low interest rates in 2005/6. A couple of articles were published during the month which illustrate those concepts perfectly.

Acute Stress within the Financial Markets – James Turk of

Firstly, James Turk published the following chart which demonstrates that the present financial crisis is unprecedented. The chart is from the Economic Research Department of the St. Louis Federal Reserve Bank. This long-term chart illustrates the amount of money banks have borrowed from the Federal Reserve from 1910 to the present.

Here is the link:

Central banks exist to act as the 'lender of last resort'. This facility is used to keep banks liquid during a period of distress. That vertical line shows quite some distress!

2007 Mortgages Are Going Bad Much Faster than the 2006 Vintage - Wall Street Journal

The second article is from the Wall Street Journal. The paper reported that mortgages issued in the first part of 2007 are going bad at a pace that far outstrips those issued in 2006, suggesting that the blow to the financial system from U.S. housing woes will be deeper than many expect. The report shows that 0.91% of prime mortgages from 2007 were seriously delinquent after 12 months, meaning they were in foreclosure or at least 90 days past due. The equivalent figure for 2006 prime mortgages was just 0.33% after 12 months.

Evidence that lax lending standards were leading to higher mortgage delinquencies first emerged in late 2006. The first major casualty of the subprime credit crisis, New Century Financial Corp., imploded in early 2007. Yet the data from the FDIC and others suggest that lenders didn't substantially tighten standards until at least July or August 2007, when credit jitters hit Wall Street and financial stocks began to swoon.

With another $1.5 trillion of such mortgages due to reset over the next couple of years, things will only get worse.

Back to Section Index >

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News Review...

High debt burdens lead to loan defaults, foreclosures & falling house prices…

In the UK…
Nationwide reported that house prices fell £3,099 (1.7%) to £169,316 in July. The average house price is now down £16,727 (9.0%) from the peak last October. Estate agents are reporting up to 40% of transactions falling through and the average number of sales per surveyor is at its lowest ever level.

Halifax reported house prices for both June and July since the last outlook. In June prices fell £3,567 (1.9%) and in July they fell a further £3,066 (1.7%). The average house price is now down £22,249 (11.1%) from the peak last August.

Rightmove revealed that asking prices fell £4,345 (1.8%) in July to £235,219, a fall of 2.7% from their peak last October. The value of flats has been hit hardest in the past month, down 4%, while semi-detached and terraced homes are 3.7% and 3.1% lower respectively. Asking prices for detached homes have remained relatively stable.

Hometrack, the property data company, reported that buyers are paying on average 91.6% of the asking price when they purchase a home. A year ago they paid 95.1%.

The Royal Institution of Chartered Surveyors revealed that home sales fell to their lowest level in 30 years last month. Estate agents reported that they sold an average of 15 properties in the three months to the end of June, 40% lower than the same period last year and the lowest figure recorded since RICS began its series in 1978.

The Council of Mortgage Lenders reported that house repossessions soared by 48% to 18,900 in the first six months of 2008 as the credit crunch and stricter lending regimes forced more people into default. It is maintaining its forecast of a total of 45,000 repossessions and 170,000 mortgages in arrears of more than three months by the end of 2008.

It also said that UK mortgage lending fell by 32% in the year to June. June is traditionally one of the busiest periods for the housing market.

The Bank of England said that the number of mortgage approvals in June fell to 36,000, from 41,000 in May, the lowest level since comparable records began in 1999. Approvals for re-mortgaging fell to 84,000, the lowest since July 2002.

The world’s two largest property services firms suffered severe profit falls in the second quarter after fees from transactions were hit by the credit crunch. CB Richard Ellis revealed an 88% plunge in net profit while Jones Lang LaSalle reported a 69% drop in profits.

Estate agent Savills revealed that residential transaction volumes in London were down 45% year-on-year, with prices having been adjusted downwards 7.5% in London in the first half of 2008. ‘These difficult trading conditions have now spread to many parts of Europe where the number of transactions is declining as financing becomes more difficult to obtain.’

The Royal Institution of Chartered Surveyors said that demand for commercial property has fallen to its lowest level in more than a decade, intensifying pressure on landlords. Weaker retail sales, frozen expansion plans among the big banks and plentiful office space are to blame.

Also, during the month came news that Gordon Brown is considering a stamp duty freeze in an attempt to kick start the housing market. This is the guy who sold off half of the UK’s gold reserves when prices were at historic lows. The sale marked the very bottom of the market and gold has risen significantly in price every year since, making new record highs along the way. With a significant portion of our nation’s wealth gone forever, he should not make things worse by encouraging young home buyers to destroy their wealth by purchasing ridiculously overvalued homes at historically high prices.

In the U.S…

Home prices in 20 major U.S. metropolitan areas dropped another 0.9% in May and are now down 18.4% from their peak last July. House prices are also down a record 15.8% in the past year, Standard & Poor's reported. This is the 18th consecutive decline in prices. Prices thus are at the same levels as they were in the summer of 2004, which means four years of appreciation have been effectively wiped out. S&P's Case-Shiller index tracks sales of the same homes over time, so it's not influenced by the mix of homes sold in a period.

The Office of Federal Housing Enterprise Oversight reported that U.S. home prices fell 0.3% in May and are now down 4.8% in the past year. The OFHEO index has a broader geographic reach than the Case-Shiller Index but doesn't count homes purchased by subprime or jumbo loans. The index is based on the purchase prices of houses backing mortgages that have been purchased or guaranteed by mortgage giants Fannie Mae and Freddie Mac.

The National Association of Realtors (NAR) reported that the median U.S. home price sank 6.1% from a year ago in June to $215,100. Sales of existing US homes fell 2.6% in June to a 10 year low. Resales are down 15.5% in the past year and are down 33% from their 2005 peak. The inventory of unsold homes continued to weigh on the market at a 11.1 months’ supply at the current sales pace, the second-highest inventory level since the mid-1980s.

NAR also reported that’s its pending home sales index fell 4.7% in May, down 14% compared to the same period last year. About a third of sales are distressed sales, either foreclosures or short sales, in which homeowners accept less than they owe on the house, with the lender taking the loss.

The Census Bureau said about 6.1 million housing units are vacant and available either to rent or buy. About 10% of the homes built for sale in this decade are vacant, while more than 25% of rental units built in this decade are vacant, representing a considerable excess of housing units.

Commerce Department data showed that sales of newly built single-family homes fell 0.6% in June to an annual rate of 530,000 units, down more than 40% from a year ago. Builders continued to slash their prices to sell homes with the median sales price falling to $230,900 in June, down 2% from a year earlier. Despite these price cuts the number of homes on the market represented a 10-month supply at the June sales pace, down from 10.9 months in May. With builders having to carry the costs of those vacant houses, housing starts should weaken further this year until the inventory is worked off.

In a separate report, the Commerce Department reported that housing starts jumped in June, but only because of a change in New York's building code that briefly obscured a drop in single-family home-building. Total starts rose 9.1% but would have been down 4% if the code had remained unchanged. New construction of single-family homes fell 5.3% to a fresh 17-year low in June.

RealtyTrac reported U.S. foreclosure activity up 53% from June 07, bank repossessions up 171%, default notices up 38%, and auction notices up 22%. Foreclosure activity has now worsened for 30 consecutive months. One in every 501 U.S. households received a foreclosure filing during the month.

Mortgage rates spiked on inflation fears, with the benchmark 30-year, fixed-rate loan soaring more than a quarter percentage point to its highest level in nearly a year. "Market concerns about rising inflation, further weakness in the housing market and greater probability that the Federal Reserve will raise short-term rates this year all combined to push mortgage rates higher this week," Frank Nothaft, Freddie Mac chief economist said. Adjustable-rate mortgages leaped even more than their fixed-rate counterparts.

Back to section list >

Banks curb lending, individuals and corporations suffer as credit evaporates…

Bovis, one of Britain's largest housebuilders, said it would halt speculative development of new homes as it struggles to deal with plummeting sales volumes. The company is cutting 40% of its workforce.

Rival Redrow also announced job cuts, indicating that it plans to make 40% of its staff redundant.

Wolseley, the building and plumbing supplier that has shed 6,000 jobs over the past year, announced that it would cut more staff as it struggles with a downturn in its business. It revealed a 35% slump in profits for the 11 months to the end of June.

Northern Rock has begun a consultation process that will see the loss of around 1,300 jobs through redundancy. While the company will ultimately preserve a workforce of around 4,000 staff, the number of jobs lost through redundancy is expected to be around 1,300.

Struggling to recover from multibillion-dollar losses on real estate worried US banks are sharply reducing their loans to businesses. The scarcity of credit has intensified the strains on the economy by withholding capital from many companies, just as joblessness grows and consumers pull back from spending in the face of high gas prices, plummeting home values and mounting debt.

Three more US banks collapsed during the month, bringing the total to 7 banks this year.

First of all, on July 11th IndyMac Bank was closed down by federal banking regulators – the biggest bank failure so far this year. IndyMac was one of the nation's largest independent mortgage lenders, and had been hard hit by delinquencies and foreclosures. It faced a run on the bank as depositors rushed to withdraw money and its share price sank precipitously. Then, in early August, it filed to liquidate its remaining assets, wiping out more than $3 billion of shareholder value over the last 2 years.

Then came the closures of two insolvent mortgage lenders in Nevada and California. Financial authorities closed down First National Bank of Nevada after they had found the first lender to have engaged in unsafe and unsound lending practices that had depleted its capital. They closed down First Heritage Bank in California which was found to be undercapitalised.

During the month investors also fled from the stocks and bonds of U.S. mortgage giants Fannie Mae and Freddie Mac as fears mounted over their ability to raise capital needed to survive. The companies have been hit hard by the mortgage foreclosure crisis. Their shares are plummeting and their borrowing costs are rising as investors worry that the companies will suffer losses far larger than the $11 billion they have already lost in recent months. Now, as housing prices decline further and foreclosures grow, the markets are worried that Fannie and Freddie themselves may default on their debt.

Both companies reported results in the first week of August. Freddie Mac lost $821m during the second quarter, announcing $2.8 billion in credit expenses associated with increased housing delinquencies and foreclosure rates, and said that the value of mortgage-backed securities it holds had declined by $1 billion. Fannie Mae reported a loss of $2.3 billion in the second quarter. The company said challenging housing and mortgage market conditions and credit performance hurt its results in the quarter.

Mid-July Merrill Lynch reported a second quarter loss of $4.6bn. It is one of the biggest casualties of the recent financial turmoil so far. The losses included writedowns of $9.4bn and it announced asset sales aimed at raising $8bn in much-needed capital. Then, only 10 days later it announced a further $8.5bn share offering and a further $5.7bn in writedowns, linked to the sale of toxic mortgage securities. Including the latest share offering, Merrill has so far been forced to raise more than $26bn from outside investors. The bank revealed that it is selling $30.6bn of its securities to Lone Star Funds for just $6.7bn, or around 22 cents on the dollar. The cut-price sale could put pressure on other banks to slash the value of similar holdings, deepening their financial woes.

Citigroup posted a $2.5 billion loss following write-downs of $7.2 billion on its investments. The bank announced $4.4 billion in net credit losses and $2.5 billion to increase credit reserves.

Credit card giant AmEx said that even its most creditworthy, long-standing customers have felt the effects of the economic slowdown currently sweeping the U.S. It said it plans to cut staff and reduce other costs. American Express is known for catering to wealthier customers, but with bad debt occurring even in the superprime card segment, AmEx's earnings clearly show that the credit crisis is going upscale, which does not bode well for the U.S. economy.

AIG, the world’s largest insurance company, revealed that potential cash losses on its portfolio of credit default swaps tied to risky mortgage debt could be as high as $8.5 billion. The estimates are much higher than the $2.4 billion worst-case scenario disclosed by AIG in the first quarter. Credit default swaps guarantee underlying debt in the event of default.

Deutsche Bank announced sharply lower second quarter profits, including a further €2.3bn hit to the value of some assets and securities amid the credit crisis, including €1bn on residential mortgage-backed securities, €500m relating to monoline insurers and €300m in commercial real estate.

Wachovia posted $8.9 billion second-quarter loss.

Washington Mutual reported a $3.3 billion loss, stating that a record number of borrowers were unable to keep up with mortgage payments.

Natixis, France’s fourth-largest bank, said it would launch a €3.7bn ($5.9bn) rights issue after revealing that it would make €1.5bn of subprime-related writedowns.

Back to section list >

Stock markets price in corporate woes and fall…

Stock markets rose during July. Traders reasoned that falling oil prices would lower inflation and help kick-start the economy. Traders also took favourably to the rise in the value of the dollar (for more detail on both of these movements, see below).

The recent rally is nothing more than a upside correction within a primary downtrend. At some point in the near term I expect that any further rises in the major indices will be accompanied by progressively decreasing trading volume, indicating a lack of buying commitment. A sharp reversal will follow, taking the market down to new lows on high trading volume as panic selling re-enters the market.

Back to section list >

Central Banks try to help, lowering interest rates and pumping out money…

The Bank of England's Monetary Policy Committee held the base rate at 5%.

The Federal Reserve kept rates on hold at 2%, providing no signal that it intends to raise rates at its next policy meeting in September. The financial position of companies and individuals is still far too precarious to start raising rates. Expectations of a 0.25% rise in September have fallen to 17% from 43% last week. Expectations for an October rise have fallen to 32% from 64%.

The ECB also held rates steady at 4.25%, stating that they had “no bias” on future rate moves.

New Zealand's central bank reduced its benchmark rate by 0.25% to 8% stating that further easing could follow because of a weakened economy and deterioration in the international financial situation.

Brazil's interest-rate policymakers raised its key rate 0.75% to 13% in order to curb rising inflationary pressures arising from increased consumer demand and the worldwide surge in commodity prices. Consumer prices on an annualized basis are running above the country's inflation target of 4.5%.

Back to section list >

Their currencies fall in value as a result…

The dollar has rallied over the last couple of weeks, leading many to conclude that the good old days are back and the US economy is saved. However, nothing could be further from the truth.

If you examine the situation more closely you will see that the Dollar Index closed at 71.87 on July 15th, the lowest close since reaching its record low in April. It they reversed sharply, rising on 12 of the next 17 trading days, before closing at a 5-month high. I agree with James Turk of that central bank intervention is the principal driver for this change in direction. During this period central banks have sold their own currencies to purchase around $52bn of US dollars in the form of US Government securities, held for them at the Federal Reserve. These purchases have acted to prop up the value of the dollar, temporarily preventing it from falling off its perch.

The rally was then further exaggerated by traders covering their short positions (positions which profit from further falls in the dollar).

The long-term path for the dollar has already been set out by years of expanding US money supply. View the current rally as nothing other than a temporary blip.

Back to section list >

Commodities rise as currencies fall in value…

The rise in the stock markets and the dollar led to falling commodity prices. Just as the rise of equities and the dollar are fleeting, so too are the current falls in commodities. Commodities put in a strong performance in the first half of July with oil hitting an all-time record high of $147, aluminium hitting a record high, gold and silver making steady upward price progress. Over the last few weeks however, commodity prices have reversed and headed lower.

Oil’s fall was amplified by the unwinding of leveraged trading positions and also the rising dollar. Gold and silver were also impacted by the rising dollar and in addition by the perception of a possible decrease in demand for commodities and by large liquidations in the metal Exchange Traded Funds (ETF’s).

Despite the recent falls, the economy is still extremely weak. Banks and mortgage lenders are extremely weak. Corporations are extremely weak. Households are extremely weak. Big risks to the economy are still present and nothing has changed to reverse this situation. Governments will be forced to pump out huge sums of money in an attempt to re-inflate the economy. It will not be long before the fall in the value of paper money against real assets sends commodities back into their long-term upward trajectory.

Back to section list >

Disposable incomes fall causing loan defaults, foreclosures & falling house price...

UK consumer inflation hit a 16-year high of 3.8% in June, the Office for National Statistics said, nearly double the Bank of England’s 2% target.

Adding further inflationary pressure, British Gas announced that it is to raise gas prices by 35%. The decision, which followed EDF Energy’s move to increase its gas bills by 22% and its electricity bills by 17%, is likely to be followed by similar rises by other leading suppliers.

Furthermore, consumers were hit with a 9.5% jump in food prices in the year to July, as retailers stepped up their bid to pass on their own rising costs to customers.

Such price rises will continue into the foreseeable future.

The US Consumer Price Index spiked up 1.1% to 5% in June, the biggest year-on-year increase in 26 years. The unexpectedly large rise in the CPI was driven by a 6.6% increase in energy prices and a 0.8% increase in food prices.

The US unemployment rate spiked to 5.7% in July as another 51,000 jobs were lost during the month. This is the highest level in more than four years.

Eurozone inflation surged to a record 4.1% in July, up 0.1% from June, driven by high energy and food costs. The rate represents a new record. Eurozone inflation is currently running at more than double the 2% level the European Central Bank sees as providing price stability.

Eurozone factory prices hit a record high. Prices for products sold from business to business rose by an annual 8% in June.

Further afield, Malaysia's consumer price inflation soared to a 26-year high of 7.7% in June, a rise of 3.9% month-on-month. In the previous month the CPI index rose by 3.8%. Malaysia’s Central Bank is now likely to raise the overnight policy rate after holding it steady at 3.50% for the past two years.

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