Friday, September 14, 2007

Could it happen elsewhere?

As a consequence of the housing/mortgage crisis in the U.S., suspicious glances are being cast to other countries that have seen big rises in housing prices over the past few years. Will it prove contagious?

As I've argued before, the fundamental problem in the U.S. was a disequilibrium in housing supply and demand. Too few houses were build in 2002-2003 when demand boomed due to rock-bottom rates, leading to huge price rises. In 2005/2006, too many houses were built given underlying demand. Normally, temporary excess supply or demand is no big deal. The problem turned nasty due to subprime mortgage financing, which artificially boosted demand, made prices jump higher than they would've and now are corroding the markets.

Subprime financing is, as far as I can tell, mostly limited to the U.S.. But that doesn't mean that other countries will be exempt from falling prices due to overbuilding and excess demand. This week, The Economist summarizes a Morgan Stanley study which concludes that many countries have seen house appreciation far in excess of what fundamental factors justify, including the U.K., Spain and Sweden.

Let's compare the U.K. to the U.S.. Now, this is tricky because they have very different demographic profiles, circumstances and tastes. Nonetheless, I believe we can get some idea of housing trends comparing the number of housing unit completions to the estimated increase in the population (people have to live somewhere).

This graph shows that since 2004, more housing units have been built in the U.K. than the increase in population. While it can be argued that foreigners may be buying second homes in London, this situation obviously cannot last. The last time this happened house prices tumbled.

In the U.S. there's a clear, secular downwards trend in housing units per change in population (probably reflecting smaller families and more immigrants, who tend to be single upon arrival). Nonetheless, excess housing demand has obviously contributed to this ratio's fall over the last few years.

I don't know about the other countries, but things look bad for both the U.S. and U.K. Yet, maybe the fallout in Britain will prove less damaging due to less use of "creative financing". We'll see.