A tale of two house price crashes

How does the housing boom and bust that we’ve had this decade compare with the one of the late 80s/early 90s?

To see this, it’s best not to look at actual house prices: these declined only very gradually after the late 80s boom (although in a time of higher inflation, it felt like a bigger fall), and since about 1998, cash prices have been much higher than at the peak of the earlier boom. But of course people’s incomes have also got much higher.

We need to look at affordability. My graph below shows two key measures of this from the Halifax’s figures: the ratio of average house prices to earnings (the blue line, using the left scale), and the percentage of homeowners’ incomes taken up by mortgage repayments (red line, right scale).


A few things stand out:

• The price/earnings ratio went a lot higher in the 2000s boom, although it increased more slowly than during the pre-bust 1988 surge. The later boom in fact had three phases: robust growth from 2001 to 2004, then a pause for a year or so, then resumed growth from late 2005 to early 2007.


• The late 80s boom involved far higher mortgage costs than in the 2000s. This was partly because of the larger mortgages needed to buy the increasingly expensive houses, but was mostly due to the huge interest rate rises that the government used to snuff out the boom.


• On the downside, the price/earnings ratio has fallen much faster this time than last time; these things always tend to overshoot, but it suggests that the overall period of falling won’t go on for as long as it did back then. A long period of stagnation seems likely, though.


• Mortgage costs have also fallen far more quickly this time around, due to the unprecedentedly low interest rates. But this will partly be reversed as rates move back to more normal territory over the next couple of years.

All this illustrates that the two booms went bust for different reasons: in the earlier one, the government took harsh action to deal with high inflation and strong growth across the economy. The agonisingly high mortgage costs are what made the housing market fall. This time round, mortgages never got all that expensive, but once the credit crunch spread from the US, mortgages became much harder to get, which meant houses became much harder to buy; the fall in demand led to swift collapses both in prices and the number of sales. The relative lack of general inflationary pressure now has meant interest rates have been able to come down faster and farther.

In the US, an initial moderate downturn in the housing market from late 2006 is what sparked the credit crunch; this then caused further house price falls – among other things – both there and elsewhere. I suspect that if the US and the rest of the world had somehow carried on as was, then we would have had a similar situation – with a smaller home-grown credit crunch – before too long. In fact, the moderate inflation through 2008 would normally have meant higher interest rates, which could well have turned the housing market down.