Wednesday, November 6, 2013

Unique Demand in the UK Property Market

An incontrovertible truth in the UK is that of there being an extremely inelastic supply of housing. Predominantly due to the fact that development has already taken place to a saturated extent, and also a strong population of over 60 million, it is not so much the provision of more housing that plays its part in the housing market, but rather demand alone. In essence it is the demand for property that has the largest influence on housing prices, but of course, other factors also share the limelight.

Like any other modern economy, the device of the standard mortgage is heavily made use of, but still the lure of the sub-prime mortgage for those that would not necessarily be offered a mortgage under the traditional guidelines of assessment, has also affected the UK market.

This was most vividly depicted in the collapse of Northern Rock Bank in 2007, after its exposure to the US sub-prime crisis. Almost an exception to the rule, Northern Rock broke rank from what has traditionally been the structure of UK banks, but at the same time exhibited the temptation that all financial institutions have faced along the path of synthetic profits.

Invariably, UK banks are far more conservative than the average US bank, and they have usually prided themselves on their quantification of risk and underwriting strategies, and endeavored to keep their mortgage debt on their own balance sheets. After the bubble burst, the US ended up with large liquidity in the financial system, and many financiers remunerated on a commission basis devoted their time to the devising of novel financial strategies to attract these funds.

Thus came about many derivative products, not the least of which was the securitization of mortgage debts in large parcels and offering them on the capital markets. This practice eventually perpetuated the current financial crisis as defaulting sub-prime mortgagors faced foreclosure by creditors, and the logistical nightmare of administrating huge parcels of mortgages, accompanied by the frenzy of competing with sellers in a falling US property market saw creditors suffer enormous losses due to bad debt. The number of write-downs that eventually appeared on the balance sheets of well established and trusted corporations still has the market in a trance...

Given that the UK property market is one of extremely elastic demand, it follows that market sentiment is a powerful indicator of the health of the UK property market. When Northern Rock announced its exposure to the evil of the US sub-prime mortgage crisis, consumer sentiment placed its tail firmly between its legs, and demand in the UK housing market was quickly out to lunch. For some time prior, the UK housing market had outperformed other international property markets. Some estimated that UK property was overvalued to almost 50% away from long term trends, and when Northern Rock made its debutant performance of insolvency, and requested help from the Bank of England, property in the UK turned south overnight. The inherent sensitivity of UK demand for property was once again paraded for all to see.

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