Brian Gaynor: Floating high in our housing dream

The economic environment in the Northern Hemisphere is incredibly contradictory. Stock markets are in meltdown after the collapse of one of the greatest speculative bubbles of all times. This has caused a huge destruction of wealth.

At the same time restaurants, hotels and retail outlets are bursting at the seams as consumers continue to spend at a hectic pace.

This is totally inconsistent with past experiences, when the loss of wealth through a sharemarket crash has normally led to a sharp reduction in consumer spending.

So what is going on? Are individuals impervious to their sharemarket losses or is some other factor helping them to maintain their confidence and spending?

The Nasdaq boom and bust ranks with three of the great speculative binges of all time; Holland's tulip mania in the mid-17th century, the South-Sea Company bubble in England in the early 18th century and Wall Street in the 1920s.

The Nasdaq Composite Index has now fallen 77 per cent since its closing high of 5048.62 on March 10, 2000. This is still short of the 89.2 per cent plunge in the Dow Jones Industrial Average between September 1929 and July 1932; the Nasdaq has another 617 points to go before it is classified as the worst stock-market crash of all time.

The investment industry in North America and Europe is shrouded in gloom as the Nasdaq, and most other major stock markets, continue their relentless decline. Although many stockbroking firms are publishing positive research, senior members of the industry are far less confident in private. They believe that the accounting and other scandals in the United States will continue to affect investor confidence, and it will be at least another year or two before the full impact of the Nasdaq bubble has been purged from the system.

Warren Buffet, who didn't allow himself to be seduced by the technology euphoria, told a recent conference in England, "I could make a case that the stock market has now fallen to fair value, but I don't believe it has. Considering the corruption in US accounting and the normal risk premium investors would expect, I don't think the market is yet fairly valued."

The negative wealth effect of falling sharemarkets is not having its usual impact on consumer spending because of booming residential house markets.

In the past 12 months, housing prices in the United States have risen by 7 per cent, France 8 per cent, Spain 16 per cent and Britain 21 per cent. Housing markets in regional areas, particularly in the United States, are much stronger than the national average.

Individuals have turned their backs on shares and are putting their money into property. They have been encouraged by financial institutions that are falling over themselves to lend to the sector. This in turn has boosted house prices, consumer confidence and spending.

The housing market is one of the hot topics in the Northern Hemisphere with economists and commentators arguing whether there is a bubble or not. (Type in "housing bubble" on an internet search facility and see the huge number of articles on the subject.)

There is plenty of evidence to show that the strong property market is having a positive impact on economic activity.

The Bank of England compiles statistics on mortgage equity withdrawals, that is borrowings that are secured against housing, but not invested in it. In the two years ended December 1998, total mortgage equity withdrawals were just £0.2 billion ($6.5 billion), but in 1999 they began to take off. In that year consumers borrowed £10 billion ($33 billion) against the equity in their homes, £13.4 billion ($44 billion) in 2000, £24 billion ($78 billion) last year and a whopping £18.9 billion ($62 billion) in the first six months of this year.

The latest six-month borrowings represent 5.3 per cent of total personal post-tax income.

A survey by the Bank of England showed that 32 per cent of respondents cited a rise in the value of their house for the extra borrowings and 31 per cent said it was a cheap way to finance additional loans.

The survey also found that most of the mortgage equity withdrawals were used for home improvements including furniture, carpets, appliances and so on. The rest were used to buy cars, fund holidays and purchase other items.

Other Bank of England figures show the ratio of household prices to earnings is nearing the pre-crash 1989 peak, but there are also arguments suggesting the housing boom can be sustained.

Interest rates and unemployment levels are expected to remain low and there is strong anecdotal evidence that redundancy money is going back into housing. This is based on the belief that £20,000 ($65,000) spent doing up the kitchen will add £40,000 ($130,000) to the value of a property.

Across the Atlantic, several prominent economists are arguing that the United States is in the midst of a classic property bubble. Highly regarded Morgan Stanley economist Stephen Roach says: "The basic message is that post-bubble shakeouts don't end quickly. To me it is like peeling away the layers of an onion. Nasdaq was the first layer to go, followed by IT and then telecom. But there are still more layers to come off this onion. They include the dollar bubble, the property bubble, and the biggest bubble of them all - the American consumer."

Roach quotes research showing that housing prices have risen three times more rapidly than rental income as the main reason for his concerns.

The state of the housing markets in Europe and North America is extremely important, because their strong performance is boosting consumer confidence and the ability and willingness of individuals to take on more debt and to spend this money.

Germany and Japan, the only two major industrial countries not experiencing a housing boom, are in the doldrums because of low consumer confidence and spending. They offer a warning about global economic conditions if housing markets in North America and Europe collapse.

The housing market was also highlighted in our media this week after Barfoot & Thompson released strong Auckland September sales statistics and ASB Bank chief economist Anthony Byett published a bullish report entitled "On the verge of another housing surge".

Byett expects the average Auckland house price to increase by 12 to 14 per cent this year, well ahead of the United States, but behind Britain. The driving forces behind the buoyant market are low interest rates, net inward migration and a shortage of supply.

Two economic statistics reflect the impact of the strong housing market on the New Zealand economy:

* Bank lending to the household sector increased by $4.8 billion to $74.2 billion in the August year. Based on the Bank of England surveys, some of this has gone into furnishings, appliances and other consumer items.

* Retail sales for August were 7.3 per cent ahead of the same month in 2001. Furniture and floor-covering sales increased 18.9 per cent and appliance sales rose 12.3 per cent. Furniture and floor-covering sales have been the strongest by far over the past five months, reflecting the strong state of the housing market.

Except in Germany and Japan, strong residential housing markets are continuing to prop up consumer spending, even though individuals have suffered huge losses on the world's stock markets.

Economists and business people will be keeping a close watch on housing markets, because a downturn there would have a big impact on consumer spending and the world economy.

* Email Brian Gaynor