A Housing Market Crash is Good.

They will tell you it's bad.

That's why you should pay attention to the details in a narrative before buying it.

The price of a 150 sqm flat in London falls from a million pounds to GBP500,000. You tell me that's bad!!! Maybe it's bad for you because you own it or you are selling it, but it's clearly good for me, if I am buying it or if I intend to buy it in the near future.

When the house was costing a million, it was out of my affordability range, but now it's half the price, I could finally afford it.

A house that cost the developer GBP200,000 to construct could have been sold for GBP300,000 to a real estate company, which would then sell that to a first-time homeowner for GBP500,000. Because of speculative bubbles driven by wanton increases in credit and money supply, the house is sold for GBP1,000,000 thus pricing out millions of people.

The wanton increase in money supply and the resulting housing market bubble is seen as good because it creates so much phantom value for everyone in that club. The new homeowner has a house to live-in or an investment to put in tenants and collect rent. The bank has a million-pound asset (loan) on its books. The developer and the real estate company have all gotten more than they deserved.

After the GBP 1m transaction, every house around that neighborhood is revalued upwards. Homeowners have more equity; they can borrow more from the bank based on that. Everyone in the club is better off. Everyone who is not in the club is worse off because the prices have gone way out of their league.

Another round of wanton money supply raises the bar. Remember that money is created as debt (i.e., credit). The person who benefits from this increase in the money supply has more money to outbid everyone, he can pay GBP 1.2m for the house. Transaction done!

The value of the houses in that neighborhood all go up. Every other house on the block has now gone up 20%. Homeowners have more equity. They can borrow more from the bank. Banks’ assets go up. Everyone is happy. It's a big happy club and you are not in it.

Clearly, this game cannot go on forever. It has to stop at some point in time. Money supply cannot be increased in infinity. If it goes on forever inflation will spill out of the housing market into food and transport. When that happens, you can easily get hyperinflation, which destroys the currency.

Since, as a central banker, you do not want to destroy the currency, at some point you will have to stop the party. The printer has to cool off. When that happens, the housing market crashes.

But there are several ways the crash can unfold. The usual catalyst is “defaults”. You can buy twenty houses, but you can only live in one at a time. Those in the big happy club buy houses as investments and rent them out. They bet on the monthly rental cashflows to be enough to offset the monthly bond payments.

However, since wages and incomes of those that are not in the big happy club do not inflate at the same rate as the money supply, the ability to pay the rent does not catch up with the rising house prices and rising rents.

As the tenants (wage-earners) fall far behind the inflation in house prices and rentals, they begin to default. It happens slowly and then gradually. It's one tenant there who failed to pay rent in time, the next thing you know it's most tenants failing to pay in time. In the light of reduced rental incomes, the party has to stop.

House prices, lending standards get tighter, and normalcy is returned. The crash is a built-in control against ever-rising prices. It's the right event that happens at the right time. It's corrective justice.

However, our central bankers do not want a crash to happen, because it threatens the stability of the banking sector (so they say). Bank ABC gave Client X a loan of GBP 1 m for a house that is now only worth GBP 500k. Client X can walk out of the house and the bank can repossess and still lose 50% of their initial asset. They have to write down or write off GBP500,000.

The central bankers do not want this to happen. So, they print more money to cover the losses of the bankers. But printing money is exactly the problem that inflated the housing bubble. How do you fix a problem by doing more of what caused the problem?

The chart below, from IMF, summarizes it all.

The index peaked at 158 in 2008 when the housing market crash, originating in the USA, triggered the Global Financial Crisis.

Instead of letting the index fall all the way back to the base index of 100 we had in the year 2000, the central bankers caught the falling knife and pumped trillions in QE to get the knife to go up again.

Where are we now? We are at 168 thereabout. This is higher than the level that triggered the 2008 financial crisis. Clearly, we are due for a correction. but the central bankers won't have any of it. They won't allow the housing market to correct. They will step in with market support, being the buyer-of-last resort, and pumping an insane amount of liquidity to cover the losses that bankers are supposed to incur.

All this is done in the name of preserving the functionalities of the financial system. But the real effect is actually preserving the gains of the increasingly small group of elites with unlimited access to credit as each shake-off drops a few from that big happy club into the majority pool of those that do not own assets and have limited access to meaningful amounts of credit.

The “never-let-a-market-crash-happen” policy is unnatural. It creates and sustains a huge wealth gap.

This policy explains why a Boiler or Foreman at a factory in 1980 could easily afford to buy a house whilst an Accountant in 2020 struggles to achieve that feat.

So, before the man on the TV tells you that a housing market crash is bad, ask yourself who it is bad for? Who is peddling narrative? Before you buy the narrative, test its validity.

Ciao!

Financial Analyst, Cloud Accountant, Citizen Data Scientist, FPL Boss