Are house prices heading for a 1990s-style crash?

At moments of crisis we turn to history to provide guidance to what lies ahead. With the housing market taking a turn for the worst, it is unsurprising that parallels are being drawn between the darkening conditions now and the last time price falls blighted the land in the early 1990s. We have taken a look at some of the key crash triggers then and now to assess what lies ahead for homeowners.

How bad was it in the early nineties?

House prices fell by 20 per cent between 1990 and 1993, according to the Nationwide building society, and 12 - 13 per cent on the Halifax and government measures. By 1995, they had dropped 30 per cent to 40 per cent in "real" or inflation adjusted terms.

Over the 1990-95 period 345,000 homes were repossessed and at least 2m households fell into negative equity, where the value of the property was worth less than their mortgage. It took until the late 1990s before the housing crisis came to an end.

How do conditions compare now?

Affordability

Then: In the late 1980s the ratio of house prices relative to income leapt from about 3.5 times to nearly five times in a number of years making it difficult for first time buyers to enter the market. 

Now: House prices are at even higher levels relative to incomes. The average home now costs 5.66 times average earnings, according to Halifax, and in the south-east of England the ratio is as high as seven times.

Verdict: A high price-to-earnings ratio is one of the principal reasons why a growing number of economists believe house prices have much further to fall. David Blanchflower, a member of the Monetary Policy Committee(MPC), which sets interest rates, says that house prices may have to drop by as much as one third for house prices-to-earnings ratios to be restored to sustainable levels.

Interest rates

Then: Interest rates were close to 10 per cent for most of the 1980s and at the end of 1989 they jumped to a terrifying 14.875 per cent. Even though the economy went into recession in the early 1990s high inflation means that rates couldn't be cut dramatically. Inflation, as measured by the Retail Prices Index (RPI) reached a high of 10.9 per cent towards the end of 1990.

These high interest rates proved crippling for homeowners.Confidence only began to return after the RPI fell back to less than four per cent and interest rates were cut to just over six per cent in 1995.

Now: Even though inflation is a problem - the RPI is 3.8 per cent, which is higher than the Bank of England would like - prices are rising at a much slower pace giving the authorities much more room for manoeuvre. The MPC has cut rates three times since last December - from 5.75 per cent to five per cent.

Verdict: Interest rates are nowhere near the problem they were at the end of the 1980s which is why some commentators, such as Martin Ellis, chief economist at Halifax, thinks a 1990s-style crash is unlikely.

Mortgage rates

Then: A leap in mortgage rates at the end of the 1980s was one of the principal triggers for the house prices slump. In 1987 the average building society offered homeloans charging a rate of 10.3 per cent. By 1989 the typical rate had jumped to 14.4 per cent, adding about £200 to the monthly bill on a typical £70,000 home. That's the equivalent of about £360 a month, or £4,320 a year, in today's money.

Now: Mortgage rates for new borrowers have jumped significantly over the past year as the credit crisis has struck, creating a payment shock for more than a million people. Homeowners who took out a typical two-year fix of about 4.5 per cent in 2006 face a repayment shock of about £200 a month - £2,400 a year - on a £200,000 loan, assuming they take the average two-year fix of six per cent.

Although this is a smaller jump than in the 1990s many households are hurting, especially as higher mortgage repayments have been coupled with a jump in energy and food bills. People have more debt on credit cards and loans than in the 1990s.

Banks and building socieities have also made it more difficult for borrowers by tightening their lending criteria: for example, reserving their best deals for people with a 25 per cent deposit or the same amount of equity in their home.

Verdict: It's bad, but not for everyone. More than 5m borrowers with mortgages that follow the Bank of England base rate have benefited from a drop in payments since December.

The mortgage hikes have been sparked by the crisis that has hit the financial markets worldwide. The Bank of England, in its latest Financial Stability Review, suggests that the worst of the financial crisis, may be over. If so, homeloan rates could start to fall in the next few months. Borrowers will be praying it is right.

Unemployment

Then: As the UK's economy plunged into recession the unemployment rate leapt to nearly 3m, shattering confidence and meaning hundreds of thousands were suddenly unable to meet their mortgage bills.

Now: Unemployment is at its lowest since the 1970s. Latest figures put the number out of work at 843,000, although there have been some worrying signs that it is beginning to pick up.

Verdict: Fears of an economic downturn, and even a recession, mean that even though the unemployment rate is low there are concerns that the jobs market will deteriorate. A sudden jump in redundancies could shatter already frayed nerves. However, unless there is a big leap in jobless numbers the impact is likely to be only short term.

Housing tax

Then: The seeds of the downturn were sown when Nigel Lawson, chancellor of the exchequer, cut the amount of tax relief allowed on mortgages in his 1988 budget. He made a fatal mistake by announcing a five-month delay before the tax relief cut came into effect. People rushed to take advantage of the relief while it lasted, creating a borrowing frenzy and a house price bubble: prices nationally rose 34 per cent  over the course of 1988 and in some parts of the south east they jumped by 50 per cent. When interest rates started to rise the bubble burst.

Now: Stamp duty remains a turnoff for buyers who are nervous about moving up the property ladder but there hasn't been a comparable tax trigger this time round.

Verdict: Chancellors have learnt from Lawson's mistake. Nowadays controversial decisions are introduced immediately

So what is in store?

A lot depends on whether the Bank of England is right and the worst of the credit crisis is over. If it is, mortgage rates start to fall and an economic downturn isn't severe price falls should be in single digits.

It it is wrong, and the crisis continues, confidence will continue to deteriorate and prices could continue to fall for years. Yolanda Barnes, residential research director at Savills, an estate agent, forecasts a 25 per cent decrease by the end of 2009 if the credit crunch continues.

More from Money Central:

Ten tips to survive a property downturn

The 10 most ridiculous fines of all time

Comments

[John]

Surely houses are three times more affordable now than in 1989. Why?
The ratio of house prices to average earnings is more or less 5 times now as it was in 1989 but interest rates are now 1/3rd of what they were then.

[Richard Boxer]

House prices. In all the debate about where house prices are going I see little or no reference to supply and demand. Unless previous research was woefully wrong we still have a housing shortage (2.5m homes required by 2016) Our new build rate before the credit crunch was below what was needed to meet this need. If supply is cut back now and demand returns then we could see even more dramatic pressure on upward house prices. Is the only relevant factor money supply?

[The Capital Multiplier]

The U.S. housing bust and global credit crisis is unfolding pretty much exactly as The Capital Multiplier newsletter predicted! The U.K. housing bust has also started just as predicted last year. Prudent investors who are fed up of seeing bogus low inflation statistics and disgusted with central bank attempts at bailing out irresponsible banks and borrowers, should visit www.CapitalMultiplier.com and sign up for a Free weekly newsletter to get invaluable insights that you won't find anywhere else!

[Peter Norris Devon]

This time is very different from the mid 80's crash...Then millions of people were losing their jobs whilst at the same time, mortgage payments were going through the roof 6% vs 13%. A very painful time. What might make this a crash is that some parts of the media seem keen on one.

[mathew Drain]

Is it not right that over 500,000 people lost their jobs in the building industry during the 90's downturn, without all the people losing work linked to the building industry, now that several big house builders have stopped any new sites not already under construction they will not need the staff further inflating the jobless number, added with the thousands of financial jobs going in the city and the lack of need for employees and falling rents in the commercial property sector there is going to be much higher unemployment and thus higher reposession rates contributing to much lower property prices.

[Lee Willis]

"Verdict: Chancellors have learnt from Lawson's mistake. Nowadays controversial decisions are introduced immediately"

or deferred until the chancellor in question has been promoted to PM and the change becomes Somebody Else's Problem ....

[Dean]

OK - we don't have the abolition of tax relief as a trigger this time, but there are several new triggers coinciding to kickstart the downward trend (aside from the Credit Crunch); introduction of HIPS, changes in the capital gains rules, death of buy to let mortgages and crash in commercial property prices, to name a few. Oh, and change of Prime Minister for one who looks like he's not really up to it.

[Ryan]

You’re missing two important points here:
1. History rhymes it doesn’t repeat itself. This housing stress is different because there is no interest rate shock. It is weaker than before because it’s collapsing under its own weight, leaving it extremely vulnerable to exasperation by future shocks, whether they be currency, interest rate, consumer spending, job related or whatever.
2. Real estate is no longer local. In isolation if the UK property market falls a bit, it doesn’t make much of a dent in the big picture. But it’s falling, or due to, in every country with flushable toilets. This is the beginning of a very real external shock mentioned in point 1, namely a global consumer slowdown, but it’s only the beginning.

[David Smith]

You didn't discuss the sky-high level of indebtedness of borrowers, both mortgage and other credit. How can this analysis make any sense without that?

[Peter Forth]

There was an earlier comment about supply and demand...of course supply and demand are a factor in housing prices but you must also look at the ability of the people who are making the demand to pay. If your median income cannot support support the mortgage payments for a house with a gigantic price tag, it doesn't matter that you want to buy it.

You guys sound like people in the US 12 months ago. Oh no, prices will never go down here! Newsflash - your home price to median income ratio is far WORSE than the peak in the US. Sorry to say but you've got a long way to fall still.

[John Anderson]

Without a doubt, the media is playing with the confidence of millions.

One wonders if some sections of the media have a political agenda. God forbid!

[Alf]

Lets hope the BoE is right with its prediction that the credit crisis is nearly over. The rather big cloud over this judgement is that the banking system is extremely reluctant to quantify its exposure. Oh and inflation it seems is knocking quite firmly on the door. I would hazard a guess this is chapter one of an all time epic.

[Colin]

"Chancellors have learnt from Lawsons mistake" errr 10% deferred tax?!!

[Bear of Little Brain]

Surely, what is different this time is the buy-to-let market, which seems to have enjoyed the kind of tax benefits that were once embedded in tax-deductible mortgage interest. If there has been a large number of loans made in the last couple of years for BTL, but on dubious documentation and unrealistic expectations, panic selling could quickly correct this market. We'll see.

[HP]

Why panic? what ever the variables the fact is this, in 10 years the prices will be higher, why because there is and always will be a shortage of good quality homes. People do not favour new builds so they do not fill the gap, also the old builds are surrounded by amenities. The other reason not to panic is the jobs that do go will mostly be those occupied by casual labour from abroad, who don't tend to be home owners. There will be a a blip but it will be around new builds, flats and over exposed land lords. Furthermore if i dont sell then my neighbour will not so you then increase the shortage.

[cyrjim]

There is no real reason for the fall in house prices other than that it suits the government and banks to have a breather. For ten years the rise in house prices has been remorseless and so it is time to stand back and have a rest. It is self regulating. It emulates life. Tides, moon, seasons. Weather pressure systems, where you have a high followed by a low. No one should be surprised. Prices will drop for a couple of years then level off before rising. Time now keep things rolling along without any great expectations, and go fishing. In five years jump back on the wagon and continue to make hay while that sun is shining.

[Ron]

I think that the article failed to emphasize a major problem that exists today, which did not occur in the 1980s and 1990s, and that is the financial LIQUIDITY of banks. Going forward over the next 2-3 years, in order to increase lending quality, financial institutions will be extremely cautious about higher risk lending. All bank credit rating agencies pay particular attention to banks' property exposure, which is considered higher risk. Bank lending is the oxygen of the property market. No matter what the taxes, interest rates and other factors are, there cannot be property demand without bank lending to the property sector. Lots of supply and thin demand equals falling property prices. These tightening bank practices always have considerable lag to take effect, so expect prices to fall substantially over the next 2 years.

[Jon]

Supply & demand does not drive people to spend more on something than they think it's worth. Just because there might be a "shortage" of houses (which I don't believe there is- how many new builds have been going up around me that aren't selling? And how many houses just aren't selling on rightmove?) it doesn't mean people will pay silly money for a poor house.

All my friends are late 20s with good jobs, and not one of them has bought simply because they cannot afford it. It is unsustainable as it is.

The problem with these current housing price drops are that there are no stupidly high interest rates, lower inflation than 1992, lower unemloyment, etc and house prices are STILL falling. If the above starts to change, we are all in for a bad time. The current rate of drop does not suggest that it's just going to flatten out- it's a steep curve!

Finally, concerning repossessions- in the first year of the 90s house crash, these were at 0.17% of houses in 1989. Last year they were at 0.23% (and this excludes any repossessions which aren't mortgage related)- the picture is worse than it was then. It is a slow process and it will take some time for us to see the real dark effects of the current problems- I'm guessing 10% drop this year, 15% next, then flat for a few years. A long time before any increases. London to be the biggest hit, as it is the most over-inflated. My workmate just sold a place for 15% below the estate agent valuation in london. The worst is yet to come.

I'm sure people will keep denying it (vested interest?? Homeowner?), such as halifax and nationwide- from "a modest in 2008" to "stay flat in 2008" to "modest falls in 2008" to "a single digit percentage fall in 2008". Very clever! Just keep reacting to every month's information! Genius.

[Citizen Smith]

Brilliant! Down with capitalism!

[Michael]

Fundamentals are stated above plus land is limited, the number of families (including single individuals as one unit) is rising, immigration is being encouraged and is required, the property investment community is significant, and housing is now a valid investment for a pension plan. No bubble in the UK. Problems come in 15 to 20 years time when all these factors work against price increase.

[sam p]

let me tell you my views on the btl market. first of all this correction will sort the men from the boys. but i think these uncertain times are making the men cry as well.

i've been a successful property landlord and devolper for the past 6 years. i expanded from 1 property to over 200 in over a 60 month period. money was easy to obtain and the rising property client fueled my ambition. over the last 7 days i have gone into panic mode as finance is no longer available and houses prices are in a downturn spiral. i know very well that if the banks dont lend and rents dont increase then do i hand the keys back to the bank and say thank you . my point is sweet and short . the banks are now sending the uk into recession. it wont be long until people start losing thier jobs and in return thier homes. alot of people are now suffering . the banks need to assess risk responsibly and kick start the economy again or we are going to be here for a very long time. maybe 5 to 10 years. if not longer.

[Pat]

This article, like so many others, confuses the late 1988 slump and the early 1990’s negative equity crisis.
In 1988 we had a remarkable bubble develop after the budget caused by the plan to abolish double tax relief for unmarried couples, bubbles always burst
In the 1990’s the world slump and rising unemployment, coupled with fragile confidence from the 1988 debacle and a rapid interest rate rises lead to further falls
What we are in, at the moment, is something like 1988, the issue is, will the storm clouds now gathering over the world economy in turn tip us into a recession or worse.
One final thing.
If my inertest rates are, say 10% and they rise to 15% as in the 1980’s then very roughly my payments go up 50%
If my inertest rates are 3% and then go up to 6% may payments have doubled

[David Nammory]

There is no mention in this article of several crucial players in the housing market:-
1. The Buy to Let investor. With Capital Gains tax now 18% a number of these investors will sell while they can.
2. GORDO's promise of a further 3 milion homes to be built.
3. The huge overhang of unwanted flats festering in our city centres.
These flats were built by government encouragement and is a momunument to shamefully inept and wasteful policdy decisions based on dictum, rather than an understanding of what homes people actualy want to live in. Is there any hope while these fools govern us???

[M GRAY]

The housing market will continue to suffer for at least twelve months. In a matter of weeks the market changed from being consumer driven to lender driven. Whether interest rates fall or not it is unlikely to be truly reflected in a change to your mortgage payments as lenders have not been passing on interest rate cuts to their customers.

The Northern Rock crisis will still impact on the market for at least another two years. Many of the borrowers with Northern Rock mortgages will not be able to find a new mortgage and many will face a payment shock that may match that of the 90s.

[Andrew]

Things are definately looking bad.

My 2 bedroom flat is the cheapest in town and the estate agent can't even get people round to view it!

The real trouble is that all the people in their early twenties have thousands of pounds worth of university debt and no equity. Unless you have wealthy parents getting a house before thirty is going to be impossible.

[Robert Hardy]

Another factor that has not been thrown into the mix is that large numbers of the young first time buyers who underpin the market have thousands of pounds of student debt and if they work in the public sector have fixed below inflation pay increases set for three years to come. If you are sanguine about job cuts then consider the spin off consequences of financial belt tightening, how many of the service companies dependent on city largess will survive, all those design consultancies media companies, a whole raft of small high income businesses, and with them the restaurants, coffee bars, wine bars etc. Furthermore in previous world recessions money had ultimately nowhere else to go but the major Western economies, that is no longer true. If we lose the easy money it might be very much more difficult to get it back.

[Trevor]

How can you compare affordability versus the early nineties without even so much as a mention of MIRAS?

It puts the +ve spin from Halifax into a little context.

[Neill]

If there is no work for the recent immigrants, many will simply return to where they came from.
Additionally have you seen the number of indiginous Brits leaving for NZ and Auz. I thought my age at 42 NZ would not want me. Punched in my details (Engineering degree etc) and found that I easily had enough points and more.

Additionally supply may miraculously increase especially if many of the second investment houses or repossessed unoccupied BTLs come onto the market.Thats the supply and demand argument taken care of.

This leaves us with the fact that a house is only worth what someone is able and willing to pay for it. To be able to pay requires most people to earn directly or indirectly money from adding some value to some thing in a global market.

That is what is going to dictate what happens to house prices eventually.

Additionally few people have cottoned onto why there is a lack of money to lend in the UK now. We have been a nation of borrowers not savers. We have been using the savings of Asians and Germans, through buying bundled mortgages, to buy our houses, cars, clothes etc with.

When sentiment for the pound is so bad, why do I want to invest in the UK. After all if I converted my Euro to Pounds last year and lent them to someone to buy a house, I have lost over 20% of the value of my Euro's. Great compensation for the 5% I yielded on Interest rates!

[clare walker]

Nearly Over?? We have not even scratched the surface yet! Without first time buyers. Unfortunately we have no Market. I am 25 and it was hard enough to get a mortgage 2 years ago, fortunately i had my parents help..What happens if you have not got this luxury...Save ???
Is that after we have our wages deducted from Student Loan, Tax, council tax,National Insurance, Increasing Rents,High Utility Bills, Ever rising food prices, petrol....The economists who predict timescales when it is going to be back to normal.....Try visiting a few places outside of London when gathering information.

[harry e]

A very congested island. Very low interest rates. High employment.

Tell that to the Japanese.

[Rob]

What shortage of housing? I don't see swathes of people on the streets and I don't see letting agents with no properties to let. Some of you guys are really sucked in by dodgy politicians and VI's.

It's a credit bubble causing a property bubble!! And as the credit bubble has popped big time, I'll leave you to work out the rest.

[Andy Johnson]

"Are house prices heading for a 1990s-style crash?"

No. It will be worse this time.

It is not primarily about interest rates. It is about the rate and extent of the build up of debt.

Under conditions of high inflation, thus high interest rates, this cycle is short.

This time inflation has been low and so have interest rates. Thus debt has built up for longer and to a greater extent.

The cycle is symmetric. Since it has taken over ten years to build up the debt it will be ~ the same time to dismantle it again.

Because inflation is low the nominal reduction in housing asset values will be similar to the real reduction.

Thus, a price fall of ~ 50%.

Simple, once you analyse the factors involved.

[NR]

I own properties in both the UK and in Australia, 2 in the UK and 4 in Australa. And my credit exposure is very low, below 13% of values. With the fall in the pound against the Oz dollar, the idea of bringing Australian dollars to buy in the UK is getting rather attractive, once the pound has bottomed out. The property market here is reliable as there is limited land and high population density. In Australia you dont have the same restrictions unless you are buying in city centres (hence the high prices in Sydney and Brisbane centres).

The UK market, because of these fundamental factors, has less room to fall. And globalisation means that the UK market is not just open to UK investors. Just as the Australian market has a lot of Hong Kong and other overseas Asian investors.

I would say that as long as you are not in it for the short term, and think about what you are buying, the property market is always going to be worth being in. For those who are renting - ask yourself if your rent is 1.5 times the mortgage you would pay. If it is, go for it and each month put away the extra 50% in an account for times when the interest rates go up.

If times get tough, learn to economise a bit on the nights out and eating out, shop on ebay for clothes and have fun with cooking at home for friends and TV. Dont let the market and advertising run your lifestyle. Remember it is about the pursuit of happiness, and the basis of that is control over your own life.

Good luck.

[Abdullah Dawood]

Boom and bust is a feature of today's economies, so we need to rise a level and look at the wider picture. Simplistically, mortgages exist to buy property but a more fundamental question is: should property be any different from other products we buy without borrowing? The lending culture is a profiteering culture that results in high prices of everything and thus destroying the real economy - hence discussions about the price to earnings ratio and so on.. After decades of emotional unrest about interests rates and inflation.. we need to smell the coffee and consider the alternative, a world without profiteering lending.. and what this new world might look like, some features: people borrow from each other, prices fall to affordable levels (what people 'really' can pay), repossessions drop to zero, banks don't get interest from borrowers any more, taxes on property becomes less because prices are less, construction becomes cheaper and building companies make less profit, rents come down, people breath sighs of relief and don't have to become experts in macro economics!

[nick]

I would just like to congratulate Andy Johnson on the most intelligent post i've seen on these forums. Wise words my friend!

[Celso]

How about supply and demand???? Number of houses available and number of people in need of one?? Surely it has something to do with prices?

[blogsouthflorida]

…and where there are down markets in stocks or real estate, savvy wealthy buyers step in to take advantage of great opportunities. In South Florida, the depressed housing market coupled with the weak American Dollar has created a great climate for the luxury oceanfront condo market. Europeans are bringing cash and obtaining prime luxury real estate for 50 cents on the dollar.

[brian]

if you go out on a binge, you will have a hangover. the bigger and longer the binge, the bigger and longer the headache. in the words of paul volker in a recent speech to a ny bussiness forum, "this crisis will be the mother of them all" the biggest bubble ever and the loudest bang to follow. property is more than likely to fall 40% from the peak !

[Rich]

I hope house prices drop a good 30% or so and then maybe I can get myself onto the property ladder!

[Hugh Reid]

Regarding the supply of housing, here in Glasgow it seems interesting that the vast majority of new housing is 2-bedroom flats. These are of no use to families, so must be aimed at either 1st-time buyers or buy-to-let. It might be interesting to see what happens here. If builders drop prices to encourage sales, will this have a knock-on effect on the rest of the market?

[R. Istbear]

A poster (John) says we will avoid a crash this time because Interest rates are lower than in the Great crash of the early nineties. Lower they may be but house prices are much higher in relation to earnings. Better to borrow 3 times salary at a high rate than 10 times salary at a low rate. The reason we have bubbles followed by crashes is that most people fail to grasp basic economics. As far as avoiding a crash goes, its already underway and is unstoppable.

[Paul Fay]

Two points.
N R suggests buying if the cost of renting is 1.5 X mortgage. In my world this is a dim and distant memory. Mortgages are typically 2 to 3 times rent, hence it makes no sense to buy. As someone who sold tgo rent, the interest on the equity virtually pays my rent allowing me to save for when prices come back down to earth.

Secondly, no one has picked up on the point that if people once needed a 5% deposit to buy a property but they now need 10%, this in effect HALVES the value of the property that they can buy for any given deposit. For those who have depended upon 100% mortgages - forget it.

I don't profess to know how far this market has to fall, however, I believe that it will fall.