Monday, September 01, 2008

What goes up ....

Back in 1979, house prices were 12% above the long term historical trend. By 1982 they had corrected to 12% below.

In 1988, house prices were around 30% above long term trend. By 1996 they had corrected to 32% below.

In 2007, house prices were once again 30% above the long term historical trend. They currently stand at 20% above and they are correcting. If history is anything to go on then you could reasonably argue for an overall 40% fall in house prices from the peak in 2007.

However, this isn't something to be surprised about. It is not unusual for a complex dynamic system that is deformed out of shape to return to a more stable equilibrium, once those deforming pressures are removed. In our case, the deforming pressures were caused by the current spending spree of future revenues (i.e. debt).

Any correction is almost always imperfect and tends to overshoot (as per the oscillation of a pendulum). The violence of the oscillation depends upon how much dampening is involved in the system and how much the system was distorted by.

I mention this because the current calls for a drop in interest rates and for government intervention in the housing market are all about maintaining a distortion and this brews up even more trouble for the future.

House prices aren't so much falling as returning to historical norms from a position financed by debt. You can only buck the market for so long and unfortunately we have borrowed too much against the future. The state we are in was obvious in 2005/6, unfortunately things were all a bit too gung-ho back then.

It's not going to be pleasant, it's going to be tough and we should bolster the safety mechanisms to protect the poorest in the community. The silver lining is that a fall of 40% should kick-start the market and help first time buyers much more than any interest rate drop would.