Monday, 17 November 2008

HousinK... From Boom To Bust

We have clearly entered a secular bear market for the Finnish housing market.

The interesting question is to figure out if it is the financial crisis that is bringing the Finnish housing market down or the reverse. An expectation of the a deterioration of the housing and economical markets is putting pressure on bank business model (based on continuous rise of price).


(Click for zooming)


The blue line represent some normal trend extrapolated based on 40 years data. It's what I think should have been the trend, if we didn't have episodes of boom and busts... Assuming that housing price trend always goes few percent above inflation rates. Note that this chart shows housing price inflation adjusted (if price goes up 6% and inflation is 4% then real growth price is 2%).

The Red line, represents future trend that shows a return toward trend line, with an overshoot toward lower level. As all episodes of boom and bust, people are either ultra optimistic or pessimistic...

Obviously, in order to have an overshoot to the downside, you need to have a specific event that triggers it. I suppose we will get it at some point, around 2010...what would it be? not sure...a futher deterioration of the stock market? A more prolonged and severe recession that is currently forecasted by economists...or down the road, a sudden recovery that fuels inflation to level that forces interest rates to be raised to historically high level? ...which could then explain further deterioration in 2010, pushing prices to reach 1998-2000 levels...
Regarding the last point (higher interest rates down the road), it could, as well, explain the recent move from banks to add a new clause to any new contract that allow them to unilaterally raise interest rates, should they need to. Let's call that "the poison pill"...

So for those one that are on variable rates, fixing it when rate are low is a useless procedure since it will require a change from old to new contract that will then include "the poison pill"...let me know if you don't get the idea ...

Inflationist scenario : Another thing to highlight is, if inflation down the road is getting higher and house price don't appreciate (stay stable), then in real term it would mean that price are falling...that could be a scenario if recovery comes faster than people think...

Deflationist scenario : The economy doesn't recover, but instead is drawn into a Japanese type deflationnary trend or a 1930's U.S. type deflationnary, then house price goes down fast the first years then slowly trend downward... wage growth disappear as the global slump, bring excess capacity i.e too many people looking for jobs putting futher pressure on delocalization and pushing wages lower...

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13 comments:

Eric said...

It seems like you have a very valid point when it comes to the state of the housing market. Thanks for your coverage to date, it has been GREAT! And I'll likely keep visiting this blog no matter what economic topics you choose to write about.

Perhaps a name change for the blog would be in order though.

Should the "Finnish Housing Bubble" blog have a one year birthday party in Helsinki?

HousingFinland said...

"Should the "Finnish Housing Bubble" blog have a one year birthday party in Helsinki?"

I was thinking about that...inviting as well the head of huoneistokeskus, Kiinteistomailma etc... as well as this young guy...can't remember his name...karvinen...no...yeah: katainen, Mr "sounds"...

Andrew said...

There appear to have been an absolutely terrible number of people about to lose work in Finland in the last month.

Many companies say the same thing about sudden drops in demand. Some are temporarily stopping work at this point in time but it seems alarming if this does not reverse.

http://newsroom.finland.fi/stt/showarticle.asp?intNWSAID=20327&group=Business

Back in September it seemed possible this would happen because of the developments in India and China.

HousingFinland said...

When you enter a deflationnary period, that's the type of phenomenon you will witness...

As price fall, so do profit...company cut jobs and people confidence plummet, so they save more then prices fall further...here you are with this vicious circle ... that could clearly explain why oil price and other commodities have been falling a cliff...

Where is the Chinese hunger for oil...back in june, it was the story to explain why oil price was around 140$, now at 55$ there are little interest...

Coming back to Finland, That could be the reason why the finance ministry has decided to cut income tax next year...as inflation as all but disappeared...

Now, deflation is a threat because policy makers have let the credit bubble run for too long unchecked...the free-marketeers got it wrong...unfortunately.

So in this situation all asset class prices are falling...from real estate to stock market.

Now, back in june, you wonder if the ECB wasn't kind of bluffing in the poker sense when it raised interest rates and was warning of inflation threat....
The idea being that you can fight deflation by giving the idea that there will be inflation i.e promise or forecast that price will rise but within the stability criteria (at around 2%)...

I have always been in the camp of deflation when i started to see personal debt at record level, even greater than the late 80's..in fact for most countries...

Let's see if policy makers, finally, will be innovative and able to fight it.

Andrew said...

Housing Finland i think you are incorrect with some of your observations.

Finns seem to be losing their jobs because there are either no orders for what they make or the competitors have cut prices. Volvo last month had a similar order collapse.

And inflation is still very high. With all the creative money schemes going on it could easily go higher - even as rates come down.

When Trichet was wondering if inflation was about to explode food inflation in Finland was over 8%.

HousingFinland said...

"When Trichet was wondering if inflation was about to explode food inflation in Finland was over 8%."

This was a temporary effect...due to the oil bubble, and credit expansion that allowed household to live beyond their mean...thus buying more than they earn (just look at the debt level, which is far greater than 100% in the Helsinki capital region (200%??))...

Debt building was allowed and permitted prior to the financial crisis...this has, now, ended.. double digit credit expansion is something from the past and will not be witnessed at least on the household part for another decade or two.

Now you enter in a deflationnary period...where many people will lose their jobs (capacity reduction, local and global demand falling) and at the same time, they will see the value of their asset decline. Their behaviour will be most probably change and could be as follow:
-Buying less, saving more
-Buying Cheap and only what's needed.
-travelling less abroad and more locally
-eating less in restaurants

This will push price lower.
1st: disinflation
2nd: deflation

I don't think government or any institutions can fight these forces...even by printing money (please latest Economic nobel prize articles from Krugman about the liquidity trap...)

Now I have seen clearly price of food increased, without any justification. The only reason behind is monopoly and cartel scheme played by market players such as valio, K-S market setting price.

One big cartel player is clearly the government in the alcohol and gambling sector. Only this week it agreed to increase by 10% price of any alcoholic beverage...

I think the EU should look into that and dismantle this cartel , the sooner the better...

Coming back to food, Russia has massive reserve of wheat, barley etc.. it can't even store it!...Since the ruble has weakened considerably against the Euro and Wheat price in open market has collapsed, it should prefigure much lower price for any wheat related products ...but yet you see companies such Fazer and co, pushing price of bread higher...that's a non sense mainly due to lack of competition and past massive consumer credit ... but then it's a matter a time before price comes back to trend since consumer will change its behaviour, buying cheaper and less...then it will certainly force those company to either lower the price by passing lower commodities or go bust... that's the free market unless they chose to move toward socialism...

So I reiterate, inflation is the battle of the past...now they are trying to avoid deflation spirale.

In the US is even more pronunced..just look at the 10 year treasury bond at 3.5%...the 3 month TBill at 0.11%!!! and the 3 ears TBill at 1.4%...So the market s pricing very very low inflation going forward..that's not inflation, neither disinflation...it's deflation...

I think quite many speculators believed in sustained high inflation and bought real estate and stocks...they got it wrong and are paying a very high price...

Andrew said...

Housing Finland

I do all my own shopping now in NZ. I can buy the same milk quality of 2 litre for 4.28 or 3.24 in the *same* shop by the simple act of selecting the lower priced container. This does require some effort by me. And helpfully (and surprisingly) my shop tells me the per litre or per gramme price of each item sold:-)

It makes sense that inflation will come down when more people like me chose to spend less money while still consuming the same amount.

Similarly i am wanting to consume a house in Helsinki at the moment. I want the same product but i am looking for where the price is 20% lower. Or i will pay the marked price if it goes up in value after i buy.

I wonder if the house transfer tax of 4% will be cut? Has that happened before in Finland - one way for the government to help their building friends.

As for deflation, when a central bank loans out money *only*, then deflation is possible. But when it gives people money, that it does not require to get back, then deflation is impossible.

So the banks have been recapitalised and they dont spend. And then they are recapitalised again and again and again. Eventually this money will be spent. Alternatively we get massive public works programmes. And the workers are paid these pieces of paper called currency. Therefore there will be no significant deflation ever.

Fazers prices and NZ milk prices reflect a certain reality. The water level is being increased to float all boats - and *then* comes the long hard struggle back to a vibrant economy.

One single country cannot do this successfully but if there is a global coordinated move to float all boats then all boats *will* be floated higher. In high inflation the banks get hurt and the consumers win. But if you give the banks free money they cannot be hurt. It is a reset of the debt bomb. But even so consumers are tired, worried, and fear debt. The more they experience fear now the worse the outcome will be later.

Dont underestimate the ability of the helicopter forces to do whatever is needed.

As for Krugman, he received a Swedish prize created by a man who made his fortune by making it safer to blow things up:-)

And in economics the Swedish or scandanavian solution is what happens when banks are taken into public ownership and given tax payers money and the management are replaced by public servants.

You might note that what is happening today is not *anything* like the Swedish plan *yet*. Nothing like it at all *yet*.

So i think your crystal ball technology needs some adjustments to reflect this reality:-)

HousingFinland said...

Thanks Andrew for you comment.

I'm not saying that inflation won't be an issue back at some point...

By the way hyper inflation episode have always been bad for everybody : banks and consumer.
Here in Finland, during the 70's house price fell by 50% inflation adjusted...for the ECB, it's the main cause of high unemployement level that we have today...

Another point about Hyper inflation, look at Germany during Weimar time in 1933...we all kow so well what happen in the social and political front...and Finland Today we start to have some hints at what could happen if such situation were to unfold...

So for the moment, we will be disastrous to think that inflation is the threat today...it's like fighting the battle of tomorrow.

We have not even entered yet in the deflationnary spiral, we are still in the disenflation phase. So I think for the moment it's too early to call for inflation.

I understand that some investors have had this view and bought housing, stocks to protect themselves about what was going to be hyper inflation...they got burn.

I think people who have had this view are still losing a lot of money. My point is at the moment, is to protect your savings i.e not losing (stock market and housing are all in downward trend).

I suppose I should put an article regarding Inflation vs Deflation..and let people push forward ideas, maybe some have information that we don't know...

Andrew said...

housingfinland

For sure the worry is deflation from the central bankers point of view but i think fundamentally deflation is impossible if deflation means a steady long term decline in prices. It just wont happen. Instead sufficient money will be produced to ensure prices are at least stable and when prices begin to rise the money will be removed from the system. I think the bankers solution and plan now is to create sufficient inflation. Bankers never fight inflation of course. They create it. And now we have a very easy money policy and it will get easier.

Wiemar Germany was a special case because Germany had punative war reparations to france and i think America that it could never pay and since the payments were in German currency it could legally default just by printing the payments and once the payments were made it could move forwards with a new beginning.

It is of course very simple to create inflation - bankers do it all the time, therefore the opposite is impossible if by deflation we are talking about a long term decline in all prices.

HousingFinland said...

"if by deflation we are talking about a long term decline in all prices."

We have already been living with long term decline of price for many products:
-Electronics: computer
-Car

Now housing and stock market were inflated just by debt accumulation. This could have worked as long as the system was allowing debt to grow and as long as the consumer was willing to bear it...Today this idea has totally collapsed... We are now entering what could be debt-deflation.

I'd like to remark that house price, adjusted to inflation, over a very long term (100 years) is very stable. Along the way you episode of boom and bust.

Now you might have the impression that price had risen a lot during the 70's but so did the price of almost any items (ask people how much there were paying for a bread during that time...most probably it has been multiplied by 100? from that time...just guessing).

My point here is that housing should not be seen as a speculative tool therefore its price should stable over time. At least it should guaranty a protection against inflation but not the type of gain we have had in the past decade where prices where multiplied by 2 or more in the capital region...

Land cost should be as near as zero, as it produces nothing, therefore non build land should be highly taxed in order to avoid the type of speculation that we had and we are having in Finland. Unfortunately, the Finnish housing minister has done absolutely nothing... I think that will be the next shoe to drop, in the year or two to come...

Andrew said...

Falls in electronic prices are partly to do with technology and partly to do with cheap labour from the East. That labour has been paid for by cheap debt which the east has also financed, but the money saved by the east was manufactured in the west. That game may now be over. We risk therefore having to pay full price for our toys.

Finland has enjoyed a somewhat miraculous period due to clever planning. My wife for example, along with many other young women was encouraged to qualify as an electro mechanical engineer - although she diverted into marketing and so forth. Finland also levered off micro engineering expertise to be well positioned for minaturisation of so much of what we use today. So naturally that kind of economic boost gets translated into better housing. Finland has become one of the most well off countries in the world so i am told? So the price of housing reflects that somewhat.

Yes many things are going down in price at the moment and yet inflation is still high. If inflation goes lower we can expect massive unprecedented printing of money. Already you must have noticed that even Germany has massively bailed out its banks? The Spanish banks etc have all been fed by the ECB.

The Nordics somewhat predictably helped Iceland. The tap is open. Sooner or later you will notice the water level rising.

None of this means that difficult times are not coming .

HousingFinland said...

I never said that inflation will not be a treat one day...it will.

But that is tomorrow battle.

In fact if you had not purchased inflated or deflation hit asset such as housing and stocks you would be better off.

An example :
On the stock: yesterday you would buy for 1000 euro 50 shares of YIT @20€, today you would get 350 @3€ shares...

If housing comes back to levels of 2006, you will be better of :
-roughly 6% on the purchase price
-rougly 4% on interest paid to the bank
That's quit big considering the leverage and the number of year that people have sign to (20-30 years!)

The main point, I'm trying to make is that even if deflation or diseflation in its weakest form appear, it's disastrous if you have taken debt at the highest level...

So I rather prefer to wait and see that central bankers have effectively circonvented the deflation threat, and as soons as I see that inflation is picking up, I change my startegy.

No ideology on my side, only pragmatism...

Anonymous said...

Now, is the best time to write about the economy, since it will affect on policy on all levels.

Have you seen the change on the Russian foreign policy it is following very rapidly oil price.

I wonder why ? Actually I don't but ...

Why the arrogant attitude has change so much in past few months?

Funny oil is honey for all over the globe.