Tuesday, 10 April 2012

When will the bond price bubble burst?

Back in those crazy hazy days of the housing bubble, the quickest way to becoming a social leper was to suggest that property prices were overvalued. People didn't like to hear that their three-bedroom terraced homes might not continue to effortlessly and indefinitely generate wealth. In many cases, homeowners could becrangengry by an innocent comment like "house price inflation can't rise at 20 percent a year while incomes are growing at only three percent"

I was always staggered by the number of casual conversations one would hear in public about house prices. When I was in restaurants, my favourite and perhaps intrusive pastime was to earwig into conversations to see when people started to blather on about how much wealth was now embedded in their property. It was almost guaranteed that it if two middle-aged couples were together it would only be a matter of 15 minute into the starter before the great British conversation would begin.

Those were glorious days for homeowners. Walking along the High Street estate agent was a very comforting activity. The windows would be full of adverts blaring out six-figure numbers telling you that your net worth had just increased by 10 percent since Christmas.

It wasn't so much that people could not conceive that prices would crash. Many older homeowners remembered the early 1990s. Rather, the evidence kept contradicting any competing claim that prices were overvalued. London property prices looked overvalued in 2003, but then the increased sharply in 2004. The market looked overvalued in 2004; but along came 2005 proving that the top of the market had not yet been reached. With each passing year of double-digit inflation, it was harder to win an argument suggesting that home prices were richly priced. Arguments in defence of rising prices became circular; property will continue to appreciate because everyone expects it. Because everyone acts on that expectation, prices increase, confirming the initial expectation.

It wasn't just circular expectations that kept the fire burning. Fear played its part. People were afraid of missing out or being left behind. Moreover, it wasn't a groundless fear. Far too many couples found their dreams of homeowner ship shattered by the extraordinary pre-2007 house price inflation.

Then along came Northern Rock.....the rest you know.....

These days, it is hard to find anyone who didn't see the crash coming. Over the last four years, I've yet to find a single person who would admit to being genuinely surprised by the post-NRK collapse in UK property values.

There is a rough and imperfect parallel between the Blair-Brown housing bubble and today's UK government bond prices. Objectively, everyone senses that something is not quite right. The government is running up huge deficits, and the Bank of England is printing money to fill the gap. Yet today's bond rates do not reflect the strange and almost certainly unsustainable current policy regime.

Since bond prices are low today, despite massive deficits, then why can't they continue to be low indefinitely? If bond rates remain low indefinitely then what is the problem with large deficits? This is the logic that prevails within the Bank of England. There is no problem because everything is fine today. If it is fine today, then it must be fine tomorrow

But this is the problem with economic crises. We are lulled into a false sense of security. Asset valuations may go awry, but so long as there are no upfront economic costs, people see happy to go along for the ride. Then there is the correction and before you can say "I need a bailout", everyone is blaming someone else for the ensuing disaster.

UK government bonds seem mispriced. The question is when will the bubble burst? This year? Next year? Or in five years time? Whenever it happens, I can assure you that afterwards everyone will tell you that they saw the crash coming.


Stevie b. said...

Alice - nice post.

At least one thought for now. The small (but detached) 3-bed house we lived in on the outskirts of London cost the original buyer around £350 in around 1954-ish. Who was then to know for how long and to what (never mind inflation-adjusted) price the house would/will eventually go to?

Surely the same point can be made with the bond bubble? Who knows when it will burst? My lifetime? Yours? Tomorrow? Meanwhile we do just sort-of go with the flow and maybe try and hedge a bit if we're able. In the long run and as the UK is sovereign over its own money, inflation will eventually "bail us out", as it always has - in my lifetime anyway...and if some poor bond-buyers, pension funds and yes individuals suffer as a result of complacency and poor timing and lack of any sort of index-linked hedge, then so be it - life's like that, it's always been like that and it will go on being like that!

Caveat emptor!

Electro-Kevin said...

There hasn't been so much a housing 'crash' as a non-boom.

Inflation has done its bit but we haven't seen the obvious drops as we saw in the '90s.

One thing I'd say to Stevie B is that people had realistic expectations of owning houses from 1950s and onwards. That was the impetus for year-on-year rises.

Now that prices have gone so far beyond reach (and that the obsession is there among present owners - especially landlords) who is going to feed the market from the bottom ?

Syndicates of immigrants perhaps ?

Anonymous said...

Oh happy days

Man in a Shed said...

This is what depresses me most about our new government, they are just tinkering, the economic destination has remained as it was under Brown. ( Don't get me wrong I love what Gove is doing and IDS would like to do - but its all going to be useless if we go bust. )

Electro-Kevin said...

I recall similar to this just before the 1990s crash. Wildly over priced new builds the size of rabbit hutches.

£375k in North Bushey (where I used to live)and not too opulant an area. Feel free to take a tour (noting the use of mirrors and small furniture):


The end must be nigh, surely ???

Alice Cook said...

Electro Kevin.

The end nighed in 2008. Look outside your window; We are deep in the nigh zone.


Stevie b. said...

Alice - one of us is in the de-nigh-al zone - could be me - we'll see...