Most people, if they are lucky, never get to see a property bubble during their lives. But those of us alive today have seen two distinct types of bubble in action:
- The first has been the Ponzi-type bubble sponsored by government lending policies, as seen in the subprime era and now in China. These take house prices well beyond the levels that buyers can repay out of income. Instead, the illusion develops that prices can never fall, and so buyers rush to take advantage of this ‘new paradigm’. Switzerland is another quite overt example of this type of bubble in action, with banks happily lending for 50 or 100 years – well beyond the borrower’s lifetime.
- Then there is the bubble where prices in the capital city go out of reach of the locals. Only foreigners, and those who work with the foreigners, can now afford to buy. This is very rare – last being seen in Japan and Thailand in 1991. But as the chart shows, it is happening today in London. Ratios of prices to salaries for first time buyers, for example, have moved to all-time record levels (red line), whilst ratios for the rest of the country have never recovered from the ending of the first bubble in 2008 (blue).
- Equally, as the Financial Times has reported, “whole sections of London have become completely unaffordable” for even solidly professional middle class families, whilst ” 34% of resale transactions in prime locations now involve international buyers, who also account for almost three out of four sales of new-build homes in prime central London.”
Leading investor Mark Faber described this phenomenon in a Barron’s article in July 1992, which the blog kept for historical interest as it had seen the problem develop in Bangkok and Tokyo whilst working in Asia at the time. Faber suggested it was the 4th stage of a 6-stage investment lifecycle, and was a rebound after the initial market collapse:
“The rebound in this Phase is very tricky. The economy is still doing well, and the rally is usually powerful enough to induce even the sceptics back into the market. If the fall from the previous market high has been very severe, many investors will be convinced that the market has already reached its ultimate low and is now recovering.
“I believe that time and psychology are important factors in determining whether this is true. A quick recovery within 6 to 18 months after the high (as is the case in London today) is a sign that the excesses have not been fully wrung out of the system. In terms of psychology, there is also a noticeable difference.
“People remain optimistic and confident about the economic prospects. Whereas at a true bottom, pessimism is rampant as a result of total wealth destruction.
“Usually the transition into the final collapse is very subtle. Usually there is no panic selling, but prices begin to drift lower and remain in a low-volume downtrend for an extended period, before credit deflation takes hold.
“Phase 5, which follows this, feels like a hangover after the previous financial orgy. Because the boom has been built on a major error of judgement and usually a lot of credit, on the day of reckoning speculators suddenly realise their past miscalculations and, because their dreams of huge profits fails to materialise, harsh reality sets it.”
However, though the end result may be the same, London’s current speculation has a different cause from Tokyo’s or Bangkok’s in the late 1980s.
Today’s foreign buyers in London (and New York, and other ‘global cities’) come from Asia, the Middle East and Eastern Europe. Many are not trying to profit from a new ‘hot’ destination. Instead, they fear social unrest and possible financial uncertainty at home.
Thus they are not investing for profit, but to avoid loss. As one foreign buyer told the blog – “I know I will probably lose money on my London apartment, having paid $10m for it But even if I lose 90% of the money, I will still have successfully moved $1m into Europe to support my family for the future.”