Nationwide announced its latest monthly house price index results today. Most attention has focused on the annual fall of 10.5%, but from the October peak, prices are now down 11.5%, and by October the annual fall seems likely to be 14-15%.
Various political figures ask "What is to be done"? John Redwood mocks the government's hubristic boasting of the past, and suggest that as a major mortgage lender and participant in the money markets, the government has taken responsibility for mortgage markets and must now tell us what it will do. Vince Cable has told us what the Lib Dems would do...well, the less said about his scheme, probably the better.
But what is to be done?
Answer: at this stage, nothing. When an asset market is over-valued, and housing was and remains seriously over-valued, the correct thing to happen is for prices to fall. In the period from 2003 right up to the end of 2007, many experts urged that the housing market was special in some way, so that it was impossible for prices to fall. So even if the market was very significantly over-valued, prices would not fall but instead stagnate. I described this back in November 2005 as the "Keynes was right" view (p14 of link). If asset prices did not fall when those assets were materially over-valued, that would be bad economically - very bad if the asset were as important as housing, in which case there would even be an argument for introducing artificial inflation to achieve the necessary real price correction.
"Ah!", I hear some Lib Dem reader say, "But Vince Cable emphasized that all he wants to prevent is over-shooting." But that assumes that Vince Cable (or you, or me) has a sufficiently precise idea of how over-valued the housing market is in order to intervene at the right moment to prevent overshooting. But the truth is that no-one has a sufficiently precise idea of this. And if I did have such perfect knowledge of the path of asset prices, I would be making my billions, and so should you. Indeed, if the Bank of England knew better than the markets the precise path of prices of some asset, then there would be a good case for it to act so as to make billions for the Bank and through arbitrage to shift prices back to their correct path.
This does not mean that policy-makers should pay no attention to movements in asset markets. Indeed they should pay attention - and probably will do so more in the future than they have under the current inflation targeting regime, especially if there is a shift to price-level targeting. But this attention should not take the form of trying to manipulate prices or of second-guessing the Market.
Thus, all that we can really say with confidence at the moment is that house prices are too high and will fall further. Although it is plausible that price falls will over-shoot on the downside (that prices will fall too far), as policymakers we do not have anything like sufficient information to know how to intervene to prevent this without running the considerable risk that we thereby prevent prices from falling as far as they should have done - making matters worse rather than better.
What should have been done was to see the danger signals and to have had interest rates that were significantly higher as the house price crash began (incidentally, did you hear Fionnuala Earley this morning on Today trying to convince us that it isn't a house price crash - what, transactions down two thirds and prices down 11.5% in ten months isn't a crash? What would be? One can only sympathize with her having been sent out to argue the unarguable) - as the house price crash began we should have had higher interest rates, so that they could be cut aggressively at the right moment - not as the crash began, but rather first as wider economic impacts started to be felt and again at a moment we thought we might be nearing the turning point. Understand: these higher interest rate rises initially should not have hoped to prevent house prices from becoming too high, as if we were asset price targeters. We do not have the information to allow us to do that. Instead, the task should have been to place ourselves well to deal with matters once they became more difficult.
This is part of the wider sense in which the government has not placed the economy well to deal with difficult events. It is very dangerous to believe your own propaganda...
So, house prices will fall, and there is nothing to do about that, per se, except to note that the effect will very probably be deflationary, as I have explained before, and that will therefore have implications for monetary policy. In the wider sense, we must resist calls to limit the ability of firms to enforce their contracts, freely entered into, in respect of repossession. That would impair the functioning of the market in the future. We must also resist calls to restrict more-than-100% mortgages - a policy that would make matters worse. And we certainly should not accept calls to nationalise the banking sector's mortgage book to protect those that made bad loans from losing on them. In general, this seems to me like an occasion to remember one of Ronald Reagan's more profound lines: "Don't just do something! Stand there!"
