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09/18/2007: "Falling house prices mark the end of the Great Stability "

Governments’ boast that they had succeeded in taming both inflation and the business cycle was always a hollow one. The lie was given by rampant house prices and commodities, massive speculation in investment structures that barely existed a decade ago and record levels of debt on both governments’ and households’ balance sheets. Monetary authorities succeeded in cheating recession after 9/11, which coincided with an incipient downturn, but economic activity continued to expand only at the cost of unsustainable strains in financial balances between the key sectors making up the economy. Thanks to a feeding frenzy in the housing market, none was more extreme (in terms of flows as well as balances) than the US household sector.

This US bubble has now indisputably burst and has taken with it a less extraordinary but equally unsustainable bull market in UK house prices. You do not even need evidence from house price databanks to realise that the psychological shock of queues of depositors outside Northern Rock branches has irreversibly increased risk aversion for borrowers, lenders and depositors on whom the debt mountain depends for both refinancing and growth.

My first post on the emerging liquidity crisis explained the difference between a liquidity hiatus (potentially short-lived) and a credit cycle (with much longer-lasting dynamics). Subsequent developments mark this out as a credit problem. A downturn in the economy, driven by credit rationing and balance sheet rebuilding, is likely. After fifteen years of barely interrupted expansion, forecasting a conventional business cycle path is bound to look hazardous. Weak real estate values, undermining balance sheets as well as cash flows in banking, households and institutionalised investment products, are a rare source of predictability. The house price story (UK and US) has featured regularly on this site (search term: house prices). This is the reason.