Friday 18 October 2013

UK Housing - A Look at Some Ratios

Steve Keen has an article in Business Spectator on housing bubbles, a topic he has written about extensively before.  Comparing various countries, he describes the UK as having the "Big Daddy" of all possible housing bubbles.  Certainly, his graph is impressive, showing a fourfold rise in real house prices in the UK since the 1960s.

The graph below is perhaps less impressive.  This shows the average house price in the UK divided by disposable income per head.  Also shown is the ratio of household debt to disposable income.


There are various interesting things here.  First, the ratio of house prices to income, whilst higher than average, is not greatly so.  The last figure in the graph is 112% of the average for the period.  It is clear though that this depends on the period being observed.  If we were to look at the figures only from the early 90s onwards, for example, current levels would look much higher.  Taking the data back to 1955 (the earliest figures I could find) wouldn't change the picture much.  The current level is 115% of the average over that longer period.

Another thing we can see in the graph is the massive rise in household secured debt over this period, from around 20% of disposable income to a peak of around 130%.  Although the rate of change of this ratio has varied over the period, it is only in the last few years that it has shown any material decline.  What is also interesting is that the three peaks in relative house prices all come after a period of relatively strong growth in the debt ratio (less marked in the first instance).

There are good theoretical reasons for expecting a relationship between the level of secured debt (most of which is mortgage debt) and house prices.  What is less clear is the causal nature of that relationship.  It could be argued that both the rise in house prices and the increase in debt are the result of an increased demand for housing, which is itself caused by other factors.  Those factors might be demographic, interest rate related, speculative or something else.

An alternative analysis would see the increase in debt as itself part of the explanation for the increase in house prices.  Under this approach, there would be some level of latent demand that is constrained by the lack of finance.  As more mortgage debt becomes available, perhaps as a result of developments in the finance industry, this demand becomes effective.  Certainly, the latter two periods of growth in debt ratios have coincided with significant financial deregulation and innovation.

As always, the true answer is probably a mix of both.  However, my own view is that the latter effect is probably the more important.  It might reasonably be questioned whether a demand for debt levels over 100% of income has really been lying latent since the 1960s.  However, I think it is quite possible that as higher debt to income levels become the norm, they set a new benchmark.  This generates a new layer of latent demand.  Thus, the standard debt ratio slowly grows over time (although of course it cannot grow forever).

As a further piece of analysis, I looked at the net equity in housing relative to income.  This is shown in the graph below.  This is based on the graph for house prices, but I have subtracted out the average level of secured debt per property. 


The shape of line is fairly similar to that for house prices but with less slope, reflecting the rising debt.  From this graph, the current level of this ratio is pretty much equal to its average value for the period.  Why might this measure be relevant?  Well, one possible factor is that people in the UK may regard the net equity investment in their home as part of their core lifetime savings.  They accumulate wealth during their lifetime and feel more secure investing that wealth in owning their own home rather than in financial investments.  Under this analysis, relative returns on different assets are less important.

On this basis, the ratio of net equity to income simply reflects a normal lifecycle of saving.  If additional debt funding is provided to the housing market, the net equity investment stays the same.  The total investment in the market therefore increases, which will result in increased house prices.

Again, whilst I don't think this is a complete description, I think there is an element of truth in this as a description of the UK housing market.

So, does this mean the UK has currently got a housing bubble?  I think the answer depends mainly on what happens with debt, which may depend a lot on what happens with interest rates.  If interest rates remain relatively low going forward, then it is quite possible that the debt to income ratio can remain at a high level for quite a long time.  If that can happen, the UK could quite easily avoid a significant fall in real house prices.

None of this however addresses the inequitable ownership of property in the UK, which is itself symptomatic of these trends.  This is something I want to look at in later posts.

Sources: ONS, Bank of England, Nationwide, DCLG, own calculations.


  1. I read both your post and Keen's with considerable interest. Housing is SUCH an important component of a healthy economy!

    "On this basis, the ratio of net equity to income simply reflects a normal lifecycle of saving. If additional debt funding is provided to the housing market, the net equity investment stays the same. The total investment in the market therefore increases, which will result in increased house prices."

    I include your quote as a focus for my comment. The source of debt funding is critical for a stable economy!

    If the source of debt is a bank, then the new loan perturbs the money supply. A change in money supply can be expected to have an influence on the price of all economic components.

    On the other hand, if the source of debt is owner-finance, there is no change in money supply. The effects of the change are limited to change in position for selling and buying parties, and the echoes of these changes as new owner-style/preference-effects disturb the fabric of established relationships.

    Thanks for another well-considered post.

  2. Thank you, Roger. I'm glad you find these posts interesting.

    I'm not sure what you mean when you say the source of the debt is owner-finance. Ar you talking about some non-bank lender or are you thinking of house purchase that is not in fact debt financed at all?

  3. Nick,

    Your question reminds me of the importance of assumptions and experience in economic conversations.

    In the western U. S., "owner-finance" would be a seldom used method of finance where the owner of property would take a contract from the buyer. The buyer would be "in debt" to the owner and would not actually have title until the contract was completed. The owner becomes a non-bank lender.

    (One wrinkle in this process is the existence of a trusted third party who holds a signed new title, valid upon presentation to governmental authority, that confirms title change. The third party usually monitors all payments and completes the transaction after verifying that the terms are complete.)

    The usual way of property transfer in the western United States is "cash out" transfer where the owner gets out completely, holding only cash at the end of the exchange. This results in a situation where the "REAL" new owner is a bank or other lending agency. The borrower is in debt to the bank until the contract is completed.

    From the standpoint of the borrower, both methods are nearly identical.

    From the standpoint of the seller, the methods are dramatically different.

    From the standpoint of the third party, the methods are dramatically different.

    From the standpoint of macroeconomics, the methods are dramatically different.

    1. Thanks Roger. That's interesting. I was not aware of that term.

    2. I've heard stuff about the current UK housing boom being largely based on cash sales of prime central London housing to people who live in Greece, Russia, China etc. Basically using prime central London housing as a sort of global reserve currency. I guess that strengthens the UK currency. I worry though that it could mangle the real function of the housing market.

      Another point, has mortgage debt interest increased relative to wages? Michael Hudson says that banks are aiming to gather an ever greater proportion of the economic output as mortgage debt interest. Are they succeeding?

  4. You show that house prices now are not all that high relative to incomes when compared to the 1960s. But I guess one issue might be that perhaps in the 1960s many people rented from landlords who owned the houses outright and perhaps rents were low relative to both house prices and tenents' incomes. That is a very different situation to having low income people saddled with massive mortgage debt.

  5. Hi Stone,

    Some good points there. I don't really know the answers, on the whole, but they give me ideas for things to look into for future posts. I think there are lots of issues with UK housing and I'm not trying to address them all here.

    Certainly, the pattern of house prices is quite disparate. The trend in prime London property you mention is part of wider regional imbalance in the property market. There is also the chronic inequality in housing wealth, which comes through not only in the problems for people wanting to buy their first property but also in high ratios of rent to income. Aside from the undesirability of this in its own right, it may have macroeconomic consequences.

    I don't know what the trend in the ratio of mortgage service costs to income is since the 60s. I'd guess it must have gone up, simply because of the huge rise in debt. I also read in the paper yesterday somebody commenting that although house prices are not so high relative to income, they are relative to earned income, i.e. excluding benefits. I'm not sure what the consequences of that might be.

    There's a lot that's been written on UK housing. In this post, I just wanted to play around with the price to income ratio thing in a way I hadn't seen before. And I think that looking at the numbers that way has made me think that perhaps the housing market is less susceptible to a crash than I had previously thought. But, because I think housing has played such an important role in UK macroeconomic development, I want to spend more time looking at other angles like the ones you've suggested.

    1. I almost wonder whether the end point might be lots more people renting because house prices are utterly unaffordable even with low interest rates and 95% mortgages. If rents are not too high and tenants have rights against eviction etc that might not actually be so bad. Am I right in thinking that in Germany most people rent and their housing system actually works fairly well?

    2. I think that there are many people now forced into renting due to the equity requirement, even if they could afford the mortgage payments and that has actually pushed rents up. Again, I'm afraid I don't know enough to comment on Germany, but I would expect there to be advantages in a system with a lower home ownership rate. However, that in itself is not enough and I don't really see the way it is happening in the UK as moving in the right direction.

  6. The Canadian experience was that looser lending standards allowed for higher home prices and correspondingly the debt levels. To give a quick summary, buyers needed to put at least 20% down, or else they were forced to get mortgage insurance from the CMHC. The CMHC rules were very restrictive, but were materially loosened around 1998 (working from memory). House prices, which were stagnant previously, took off like a rocket afterwards.

    The Canadian experience is possibly easier to analyse, as there are very significant centralised regulatory changes that can be lined up to house price moves. My understanding of the UK situation is that loosening of credit standards, if it occurred, would have been decisions by banks and building societies and so harder to line up with particular dates,

    1. There were various regulatory changes in the UK that could have been relevant, for example the abolition of the Supplementary Special Deposits scheme in 1980, which coincides with the start of a big increase in lending. This scheme was originally introduced in 1973 (at the peak of another rapid rise in house prices) as a way of controlling growth of bank balance sheets, following a relaxation of lending controls in 1971 through Competition and Credit Control. The rapid growth in lending from the late nineties is probably more down to financial innovation than deregulation.

      Thanks for that info on the CMHC rules in Canada. It certainly provides extra support for the view that the causes of rapid growth in debt are more often to be found in what is happening in the finance industry, rather than in a change in appetite of households for leverage.

  7. Nick,

    I have a new post at

    It begins by referencing this post in a favorable way. I then look at house pricing using bank loans as a money supply reference.

    After looking at the graphs, my conclusion is that money supply as represented by bank loans is not a good indicator for United States house prices. There must be other factors at play.

    Thanks for your interesting and informative post.

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