Category: markets

Many readers, not all, will be familiar with the Herengracht chart shown above. As Wikipedia explains, the index – of house prices along the Herengracht canal in Amsterdam – was created by real estate finance professor Piet Eichholz of Maastricht University. Eichholz was frustrated by the tendency of papers to take a ‘long run’ view of house prices that only went back 20 years or so. He suspected there was a myth which says that real-estate values go up significantly over time, and that this is especially true for central city locations, so he began studying transaction records for the Herengracht area going back to the mid 16th century. More than 300 years of data should be sufficiently ‘long run’, right? His data ended up challenging that myth. Note that the chart here is adjusted for the Dutch retail price index.

Continue reading “Trend or mean reversion?”

The chart shows the Japan housing index 1975-2018 Q1. There is a fascinating history behind this but I won’t go into that now. The point is about the risk of something similar happening here. Banking and insurance capital models work on the principle of Value at Risk, i.e. the amount required to sustain a loss over a specific time horizon, to a specified probability. For example, the advanced Basel IRB model has a time horizon of 1 year, with a probability of 1 in 1,000. The Solvency II model has the same time horizon, but a probability of 1 in 200. So the first would last us from the succession of Cnut the Great in Denmark in 1018 until now, the second from the birth of Karl Marx in 1818 until now.

But I wonder. Could the probability of a Japanese-style collapse here in the UK (or anywhere else in the West) be only 1 in 200? Ask most professionals in the business of capital management and they will say so. The fact that it happened in Japan doesn’t mean it could possibly happen here. Japan is such a terribly different, utterly different place from Britain, that no connection can be drawn between the two scenarios.

But I still wonder. There is a good FT article (31 August 2018) by Gillian Tett about a Japanese central banker warning that a financial crisis was about to explode. Déjà vu, he was saying, presumably not in Japanese, referring to the banking crisis sparked off by the collapse of the baburu keiki, or bubble of the 1980s, leaving about $1tn of bad loans.

If it happened there, could it happen here?

Here’s an intriguing chart I found in the archives. This is the nominal mortgage cost of the average UK house from 1980 to the end of 2017. Don’t take it too seriously. The crude methodology is as follows. Take the average UK house price from the Nationwide index, andihe short term interest rate for the relevant quarter, adding on 50bp for the likely spread charged by the lender. It turns out the nominal (not the real) cost of the interest charged has not changed significantly since 1980.

I have to pinch myself every time I look at this. Impossible! Think how much earnings have gone up since the days of pinstripe suits and hairstyles that were a fire hazard.

But it’s true, because we forget how high interest rates used to be. In March 1980 the average house would cost you about £23,000. But the interest would have been about 15%, so the interest cost would have been about £3,500 a year. Fast forward to the end of 2017, when the average house now costs over a quarter of a million. But the interest rate has fallen to below 2%, resulting in an interest cost of about £4,500. Result: no housing crisis, housing is very cheap! Indeed a member of my immediate family was offered a deal of 1.8%, immediately halving the cost of rent.

As Ian Mulheirn suggests, see e.g. my post here, is it the fall in global interest rates that has driven the phenomenal increase in housing prices across the world?

Of course it’s not nearly as simple as that, but enough for now.