The Case: Greed and Avarice V Sense and Sensibility

Smoothing volatility in the housing market

“Once you get to the essence of anything, it becomes easy to see the problem and rewarding to implement the solution.”

Restoring the housing market is just like that and the benefits of doing this are of National importance.

Who thinks house price booms and busts are fun? We don’t!
The following is a reasoned explanation about how the UK could reduce or smooth-out entirely dangerous and unwanted price volatility.

This submission is given in the belief that if each tenet is checked for usefulness and correctness using the statistics and data available to government, it will be found that the recommendations set out are valid and should be duly adopted.

Main objectives in writing this paper:
To effect changes, so that the housing market avoids amplified booms and busts occurring in sync. with the wider economy.
To significantly lessen the pain experienced by thousands of people caught in extreme price swings, as has occurred in the recent past.

Basic hypotheses:
Money is actually a measure for any given amount of work. Work, and money are therefore basically interchangeable assets.
The amount of money in circulation at any one time depends upon the amount of effective work being carried out.
This means however that houses are in fact worth, only the amount that people can currently afford to buy them for, with earned (or alternatively earned and borrowed) money.
House prices therefore, are not determined simply by the supply of houses. They are more fundamentally determined by demand combined with the ability to pay, instead of by supply alone.

FIRST TENET Loan-to-Value ratio:
It is a mistake to divorce loan sizes from house values, because increased loan sizes actually MANUFACTURE higher house prices.
Unless there is a safety cushion of at least 25% of net equity (beyond which no loans are advanced), loans start materially affecting the prices of the very houses they are helping people to own.

SECOND TENET Loan-to-Income ratio:
The relationship between increasing/decreasing earnings and house prices:
When the earnings of individuals increase, house prices also increase by a multiplier of (currently) about 5X the increased earnings (this is the Loan-to-Income effect on house prices).
If average earnings plateau, house prices should stop increasing but should also still hold their value.
If average earnings decrease, then house prices should fall in sympathy, again in step with the above Loan-to-Income ratio.
E.G. if the workforce were to accept a reduction in pay and/or equally significantly; if the adopted ‘Loan-to-Income’ ratios themselves were to start being reduced, prices must fall in step with the resulting reduction in purchasing ability.

However, as people’s average earnings were not (in general) decreasing last year; this itself could not have been responsible for causing the recent house price falls.

What else could have affected house prices?
If unemployment should start to increase, this would affect local demand for, and hence the price of property.
This is a possible factor, but again this was not evident in Late 2007, when house prices started to fall quickly.

By deduction, the factors responsible for the recent falls in house prices are: –
Loan-to-Value ratios:
One of the most important reasons why house values are currently decreasing, is that average prices have resulted from unsafe Loan-to-Value ratios.
Demand was forced up by an over stretching of safe lending policies by banks and building societies.
However, when sufficient numbers of people became aware of this, they stopped buying; causing a drying up of demand and hence a sudden fall in house prices.

Additionally, whenever lenders simultaneously tighten up their lending criteria, either in the area of Loan-to-Value or Loan-to-Income ratios, this causes a further acceleration in the falls in house prices.

A significant thing to note about such price falls though, is that currently they are still falling back towards ‘reality’.

Estate agents have historically always exaggerated existing demand, in an effort to increase the house prices obtained for their clients, also on account of the percentage commission they’ll earn for themselves.
This is an extremely important aspect of the current situation.
This is BAD for the market and eventually causes painful corrections, because when people suddenly realize that the prices recently being achieved are too high (in relation to earnings) they just stop wanting to buy.  This then has a downward spiraling affect on demand for property in all locations, which further lowers house prices forming a powerful negative feedback loop.

Valuers, it should perhaps be explained, simply monitor and follow these trends using recent comparison transactions and the known current circumstances which surround them.
House valuations have relevance as they are actual calculations (arithmetic and paper) and can provide realistic benchmarks.
A good valuer is like a detective in that s/he needs to find out, in detail, what has been going on recently.

Our recommendations:
By analysis we have discovered 3 equally powerful tools for kick starting the UK housing market.
All of them are available to be put into use with immediately effect.

1. All lenders (banks and building societies alike) should set (or if not have set for them) a rigid Loan-to-Value ratio for all house purchases and valuers must know what that is.

That ratio should be set to ensure a minimum of 25% net cash equity value in a property when any mortgage loan is advanced. This is fundamentally important for the overall stability of property prices, therefore valuers must be told the sizes of the loans being offered in each case, so that they can monitor the Loan-to-Value ratio.

2. Anyone in the house-marketing sector who issues a house valuation should be a trained and accredited valuer. They should provide reasoned valuations and issue them in the form of a valuation certificate, also stating who the clients commissioning the valuations were as well as the purpose of the valuation. This means estate agents need to become more like valuers and stop charging percentages. They would also need to re-train to learn genuine valuation techniques.
A valuation should include a check on the Loan-to-Value ratios of any comparable evidence used, as part of the valuation process.
Valuers must therefore have privileged access to such information in respect of all transactions.

3. Differing Loan-to-Income ratios also need to be checked and compensated for in the valuer’s calculations because of the high gearing ratio between disposable wealth and the current level of house prices. A maximum Loan-to-Income ratio e.g. 3X the applicant’s joint net income, should be set nationally to ensure excessive borrowing does not skew prices. Therefore valuers should be fully informed by the lender about the applicant’s current income, so that they can monitor Loan-to-Income ratios, when comparing different transactions to arrive at the open market valuation of a house.


The reasons why no-one has so far flagged what is clearly a fundamental failure in the workings of the housing market are as follows: –
Primarily, the current estate agents’ business model shows that estate agents have no interest whatsoever in proper self-regulation when it comes to determining current house values.

This is very similar to the situation where the major banks’ lending policies have recently been found to be inadequately self-regulated.
Better valuation techniques are clearly required within the property sector.

Estate agents currently have no interest in holding to current (or provable) market values (in the short term).
Ditto mortgage brokers.
Ditto vendors:
Ditto buyers:
Ditto the stance of the press even:
In fact, at present, no-one at all appears to have any interest in regulating any of the fundamentals which actually work against the true market!
Instead everyone involved at any one time in housing market issues, wants price increases to help stimulate growth in sales (and in ‘notional’ savings, by way of increasing property prices).

Even government could be tempted to use the short-term advantages of not regulating the housing market, if it wanted house-price inflation to give a boost to the economy (instead of adopting better long-term strategies like e.g. increased manufacturing and trade).

However, the problem with continuing with such a ‘laissez-faire’ attitude is that we will continue to experience escalating and unsustainable house prices, resulting in more booms, followed by busts – just as we have seen in approx. 10 year cycles over the past 50 years or so.
This will result in increasingly dire “boom and bust” scenarios, bringing the average house owner ever-greater pain in terms of increased mortgage payments, together with periods of negative equity at the end of each boom.

Let’s hope that in these current difficulties, the powers-that-be don’t try to artificially re-establish recent, but unsustainable, demand and price-levels, because true market prices would first need to be properly established. In other words, last year’s prices are just that: Last year’s prices. Estate agents please take careful note.

The alternative we propose, is to first stabilize ‘the price graph’ at true current open market values. Then, steady increases in house values over time may become justifiable. This would help to keep householders’ budgets in balance; even when they face challenging external economic situations like the ones currently starting to present themselves.

This reasoning suggests that if we had done this during the last 10 years, the housing market would not have become frozen in the way that it now is and, house prices would have been more affordable than they now are.
In effect the market would not have had to go through such a painful or traumatic correction, as it must now go through.

Property Match web site:
Qualified surveyor since 1974 with wide-ranging experience. Supplying professional mortgage valuations, Home Buyer’s reports, full Building Surveys. Providing general advice to many during their buying and selling processes. Buying and selling houses for his own family.

Filed Under: Rigid Tools


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