Financial Sight: The Housing Crisis Spreads to Europe

The housing crisis is not limited to the U.S. Last week S&P issued a warning that the housing markets in Europe and particularly in the UK and Spain are due a major downturn in a report titled “European Economic Forecast: Major Correction On The Cards As Housing Markets Turn Down.”

Business Credit Management reports:

"Europe's housing markets are overwhelmingly turning down. And in those countries where the housing bubbles have been expanding for longer, we believe the corrections could be severe and painful," said Jean-Michel Six, Standard & Poor's chief economist for Europe. "Particularly at risk are the U.K. housing market, where the financial crisis is exacerbating issues of affordability and general economic gloom, and the Spanish housing market, which is coming to terms with a largess of new homes."

Affordability has been declining constantly in the U.K. since 2001, with house prices averaging 3.4x incomes in the fourth quarter of 2007 against 2.4x at the same point in 2000. In turn, the rapid rise in prices has led borrowers to borrow more and over a longer period of time, pushing interest payments to 20.6% of incomes, the level they reached in late 1988 when the previous housing crisis began. Unlike interest rate shocks (such as in 1988-1991), affordability shocks cannot be reversed easily unless prices experience a severe correction. A simple calculation suggests that for the affordability ratio to return to its long-term average (early 1980s-late 1990s) of 2.5x, assuming incomes remain constant, prices would have to drop 27%. Ironically, a correction of this magnitude is close to the peak-to-trough fall in house prices expected in the U.S.

The combination of a sharp deterioration in affordability, scarce funding, and the economic slowdown are about to cause a major slowdown in the U.K. real estate market. Our central forecast assumes house prices to be flat or slightly negative on average in 2008, with a modest increase of 4% in 2009. This comes after years of double-digit growth.
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Data released by the INE, the Spanish statistical office, on March 26, 2008, strongly suggest that the market has now taken a dramatic turn. In the 12 months to January, completed house sales were down a staggering 27% on the previous 12 months. Sales of second-hand dwellings, representing 52% of total sales, fell 36% over the same period, while sales of new houses were down 15%.

Permits for residential housing seem to suddenly be acknowledging the shift in market trends, falling 40.6% in the 12 months to September 2007 (latest data available). Judging by the experience of the U.S. market, this sudden and brisk drop in permits in Spain, if confirmed in the next few months, would call for a major collapse in housing starts. The dip in permits is particularly worrisome given that the Spanish economy is heavily dependent on growth in its construction sector. Indeed, one in five jobs created since 2000 in Spain is in construction.

HBOS, Britain's largest mortgage lender, just released figures showing that March home sale prices in the UK fell by 2.5%, from February, after falling just 0.3%, the month before.

The Telegraph reported last week that:

International banks are scrambling to sell their holdings of Spanish mortgage debt at a steep discount, fearing that the country may be sliding into the worst economic downturn in its modern history. A blizzard of grim data has soured the mood, capped yesterday by a plunge in PMI purchasing managers' index to an all-time low of 40.9. Car sales fell 28pc in March, and even Madrid's legendary tapas bars seem to have lost their late-night sparkle.

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Traders says the market price for Spanish mortgage securities has begun to slide abruptly, replicating the pattern seen in the US last year. Large French and German funds and insurers appear to be liqudiating assets in a pre-emptive move, afraid being caught yet again in a violent downturn. Ismael Clemente, head of Deutsche
Bank's property arm RREEF in Spain, told a panel of experts in Madrid that foreign banks were now dumping Spansih mortgaged debt at a 40pc discount. Mikel Echavarren, director of the property consultancy Irea, said Spain's housing market was far weaker than the official statitics suggest, warning that prices could fall 20pc to 25pc. "All kinds of ploys have been used to disguise the true extent of the price falls, which we think are 5pc to 7pc already. Buyers have totally abandoned the market. We've had a wave of negative sales as people pull out of commitments already made," he said.

The Federal Reserve had a paper that looked at housing prices in 18 countries over a 35 year span. Adjusting for inflation, housing prices have traded in cycles. However during the last 10 years, housing prices have surged in most markets across the world.

This next table from the OECD gives a snapshot of the price to rent ratios and price to income ratios for each of the above 18 countries excepting Belgium. Spain and the UK topped the list in Price to Rent and where high on the list in Price to Income Ratios. The ratios were not that high in the U.S. compared to many other countries.