Archive for Most Recent Stories

The Most Amazing Chart of the Last 5 Years

While I was busy beating my chest yesterday over low yields in the USA and my many dismissals of a “bond bubble” in the USA, I conveniently left out an even bigger bull market in bonds.  Last night, Spain sold 10 year bonds at 3.06%.  That’s the lowest yield since 2005 and fast approaching a record low.



This is incredible in my opinion.  I mean, it’s not incredible that a credible central bank can control interest rates if it really wants to, but the fact that we’re at record lows is simply stunning.  Even more amazing, the average yield to maturity on Greek, Irish, Italian, Portuguese and Spanish debt has fallen to 2.19%, the lowest since 1998.

What’s interesting here is that Spanish 10 years have not only averaged twice this level since 1991, but that Spain’s debt to GDP continues to worsen (it was 93.9% in Q4).    To be honest, I don’t know exactly what’s going on here and there are probably too many moving political pieces to really know.  Obviously, the central bank backstop is the driving force, but the market seems to be pricing in something even more extreme than that.  In essence, it looks like European debt of all types is once again becoming indistinguishable to a large degree.  This sort of convergence implies that there is a greater chance of a supranational entity in Europe’s future which makes the incomplete monetary union reflect something more like the USA where there is a unified Treasury, Central Bank and currency system.  I’ve written in some detail about the strong likelihood that Europe is moving towards a United States of Europe of some type.

I don’t know where this is all headed, but it sure looks like the easy money has been made in peripheral bonds.  A more unified Europe would be great in my opinion, but we have to wonder if the market isn’t unrealistically optimistic about what lies in our immediate future with regards to how unified these nations are actually willing to become.  A central bank can piece this together for a long time, but at some point after multiple depressions and rebalancings via wage channels (including depressions as we’ve seen in the periphery) there needs to be real political change and that’s where the rubber meets the road on how much a Spanish bond really resembles a German bond.




The Metamorphosis of the Bond Bears

This MarketWatch article really jumped out at me given the extreme hatred we continue to see with regards to the bond market.  Out of 67 economists surveyed not one of them expects bond yields to fall:

“Jim Bianco, of Bianco Research, points out in a market comment Tuesday that a survey of 67 economists this month shows every single one of them expects the 10-year Treasury  yield to rise in the next six months.

The survey, which is done each month by Bloomberg, has been notably bearish for some time now, with nearly everyone expecting rising rates. In March, 97% expected rising rates. In February, 95% expected yields to climb. And in January, 97% held that expectation. Since the beginning of 2009, there have only been a handful of instances where less than 50% expected rates to rise.”

That’s a pretty incredible statistic.   In late 2012 I noted how several mainstream economists were throwing in the towel on their misconceptions about “bond vigilantes”.  But that was obviously naive of me.  It’s clear that economists still think interest rates have but one direction to go – up.  This argument appears part ideological and part ignorance.  And the story, while largely the same, has taken on different versions over the years:

I don’t know about you, but it seems like all of these commentaries are just different versions of the same ideological hatred of bonds, some fundamental misunderstanding of the monetary system or politics masquerading as economics.   How long does this story have to be wrong before we start to seriously reconsider whether the underlying narratives are based on anything remotely resembling the reality of our monetary system and our financial system in general?


A Better Buffett Bet….

In an interview today on CNBC Warren Buffett said he couldn’t find someone to come to the annual meeting to explain their position against Berkshire Hathaway going forward.  He wants a big short to come in and explain the bear case.  But this strikes me as a common case of bad benchmarking (and frankly, a layup to make Buffett look good since the odds are heavily in his favor).

Buffett shouldn’t be asking for someone to explain why his firm will do poorly in the future.  He should be asking for someone to come in and explain why anyone should own Berkshire Hathaway relative to a highly correlated index like the S&P 500.  In this manner, owning a long only alternative is similar to being bearish on Berkshire in that you believe the highly correlated index will outperform his firm.

I think there’s a pretty strong case going forward that Berkshire likely won’t outperform the S&P 500.  Among the more basic arguments:

  • Berkshrie has become so large that it is becoming, by definition, a huge part of the economy and a broader index.
  • As the firm has grown performance has lagged.  Berkshire has underperformed by book value in 4 of the last 5 years and in 5 of the last 10 years.
  • When comparing the market performance the firm is starting to look more and more like a version of the S&P 500:



  • On a risk adjusted basis, it would not be unreasonable to argue that Berkshire exposes you to performance that is similar to a broader index, but exposes you to substantially greater non-systematic risk.

Buffett shouldn’t be searching for someone to explain the bear case on Berkshire.  He should be looking for someone to explain why anyone should continue to hold his firm’s stock relative to a broader index.   Now, THAT would make for a fair and interesting discussion.

Why Do Americans Think Housing is Such a Good Investment?

The other day I posted this story citing a Gallup poll about how Americans think housing is the best possible investment out of most major asset classes.  This is extremely strange considering how widespread the data is on real estate and its poor real, real returns.  But it doesn’t explain why so many people believe this myth.

In a piece yesterday at the Washington Post Robert Shiller offered up his opinion:

“People remember home prices from long ago better than they remember other prices,” he says. “Ask anybody, ‘What did you pay for your home?,’ and they’ll remember even if it was 50 years ago. It will be some ridiculous number like $30,000. They then compare it to today’s prices, and it makes a big impression, and they forget there has been so much inflation since then.”

I think this is an excellent explanation.  It points to a common bias related to asset prices – past price fixation.  Past price fixation is our tendency to focus on past prices as justification for future buy/sell decisions.  The purchase price of a home is obviously an important figure because homes are such an important part of the household balance sheet.  So that price stands out in our minds.  But we only remember the nominal figure.  We don’t calculate anything close to the real, real return (the return adjusted for taxes, fees and inflation).  So we tend to overstate the returns in real estate and consider it to be far superior than it really is.  In essence, our behavioral biases fail us.

I think this not only explains the myth behind why people overstate the returns of real estate, but it also strikes another stake in the idea that consumers are in any way efficient or rational thinkers.  In fact, we tend to think in such narrow financial terms that we often make highly irrational decisions.  Our biases play a much more important component in our financial decisions than anything resembling order or rationality….

David Einhorn: we are in a new Tech Bubble

Pretty interesting comments from the latest David Einhorn letter.  The savvy hedge fund manager says we are indeed in a new tech bubble and has even formed an entirely new group of stocks in his fund that he has dubbed the “bubble basket”.   Here are some highlights from the letter:

“we have repeatedly noted that it is dangerous to short stocks that have disconnected from traditional valuation methods.  After all, twice a silly price is not twice as silly; it’s still just silly.  This understanding limited our enthusiasm for shorting the handful of momentum stocks that dominated the headlines last year.  Now there is a clear consensus that we are witnessing our second tech bubble in 15 years.  What is uncertain is how much further the bubble can expand and what might pop it.

In our view the current bubble is an echo of the previous tech bubble, but with fewer large capitalization stocks and much less public enthusiasm.  Some indications that we are pretty far along include:

  • The rejection of convention valuation methods;
  • Short-sellers forced to cover due to intolerable mark-to-market losses; and
  • Huge first day IPO pops for companies that have done little more than use the right buzzwords and attract the right venture capital.

The full letter is available here (for now).

Investing Across Asset Classes in Europe’s Recovery

By Tawhid Ali and Jorgen Kjaersgaard, AllianceBernstein

Europe’s recovery is becoming reality. In our view, successful investing in the continent today requires a selective approach that exploits dislocations by focusing on return-seeking assets across stock and bond markets.

The worst of the euro crisis finally appears to be over. After the most troubled countries exited recession last year, the recovery is broadening and the euro-area economy is poised to grow by 1.3% this year, according to our forecasts. Manufacturing indicators have turned up, unemployment has started to decline and the regional economic sentiment indicator is above its long–term average.

Of course, there are still risks. France and Italy are lagging, the euro could appreciate strongly and the threat of deflation looms large. On balance, though, we think Europe has shifted from recession and crisis toward modest growth and stability. So how can investors make money—in line with their risk appetite—in this tricky environment?

From Crisis to Stability

We think there are three components to getting it right in Europe today. First, identify the crisis-induced dislocations that persist and have created investing opportunities. Second, consider both stocks and bonds as return-seeking strategies. Third, be meticulous with security selection to avoid companies that haven’t yet shaken off their euro-crisis hangover.

European companies are in much better shape than they were before the crisis. They had about €800 billion of cash on their balance sheets in 2012 (the latest data available)—a 36% increase from 2007. Over the same period, debt-to-equity ratios have dropped about 10 percentage points to 48%. And profitability is still subdued, with return on equity stuck at much lower levels than the long-term history (Display, left). This suggests there is ample room for improvement in European companies’ earnings growth, yet markets have not fully acknowledged the potential.


Exploit Dislocations in Equity Markets

Indeed, in equity markets, investors still prefer low-beta stocks, which are perceived to be safer than high-beta stocks. As a result, the valuation gap between these two groups remains extremely wide (Display, right).

Meanwhile, stock correlations have continued to decline from elevated levels during the worst days of the crisis. This means that equities are no longer trading in unison to the tune of the market’s worst macroeconomic fears. In this environment, we believe the best way to take risk is to focus on stockpicking strategies which use deep fundamental research to find companies that have been neglected by the markets to date—yet have sustainable long-term earnings power that should be rewarded in time.

Focus on High-Yield Debt

Fixed income investors should also take note of improving balance sheet health. As European companies continue to deleverage, their ability to service debt improves. This means that risk premiums are likely to tighten from current levels and default rates should remain low.

This is good news for investors in euro high-yield debt—a market that has grown exponentially in recent years (Display below). And there’s more to come, as companies increasingly shift from bank finance to become bond issuers.



As banks recapitalize under the Basel III rules over the next two years, many lenders will utilize the bond market to issue high-yield debt. Separating the wheat from the chaff with careful security selection is essential to generating returns. As more issuers come to market, investors must be even more vigilant in selecting those capable of delivering value.

Outside financials, we would generally avoid BB-rated issuers, where spreads are tight and it’s harder to make money. But just a step down the credit scale, B-rated nonfinancials offer attractive high yields and investors are being more than adequately compensated for the risks.

It’s a challenging but exciting time for investors in Europe. By searching across the capital markets and using an active approach, we think investors can find a variety of ways that fit their personal risk appetite to capture the potential of the unfolding European recovery.

The views expressed herein do not constitute research, investment advice or trade recommendations and do not necessarily represent the views of all AllianceBernstein portfolio-management teams.AllianceBernstein Limited is authorised and regulated by the Financial Conduct Authority in the United Kingdom.

Tawhid Ali is Director of Research, AllianceBernstein European Value and Jorgen Kjaersgaard is head of European Credit Portfolio Management, both at AllianceBernstein (NYSE: AB)

Will Piketty’s “Capital” Actually Make a Policy Difference?

There’s no question that Thomas Piketty’s book “Capital” is the most important book of the year (which is a real bummer for anyone else who happened to write a finance/econ book in 2014).  He’s touched on a hot button issue and what will likely rage as the debate of our time.

But the real question is not whether the book is a smash hit (though Piketty’s publisher might disagree), but whether the book will actually steer the course of future policy.  This is interesting considering other books like Flash Boys and the almost immediate outrage that it caused.  Within hours it seemed like the FBI and SEC were initiating investigations and getting the policy ball rolling.  But all seems to be quiet on the inequality front.

And this gets to the major problem in Piketty’s book.  While the data appears convincing and certainly well researched there is a good deal of gray area in terms of how problematic inequality really is.  Of course, to some people it appears crystal clear, but to others Piketty’s book sounds like political ideology and little more.   But I don’t know if the people in the middle are convinced yet.

I’ve already expressed my view that Piketty might be overstating the argument to some degree and that the estimates about future growth appear almost naively bearish to me, but I also agree that inequality is a very real threat to our democratic and meritocratic well-being.  In that regard, this is much more a social debate and not so much an economic debate.  I also stated my case for a change in the way we tax investments like dividends and capital gains.

But I am also going to be honest – I don’t see material changes coming there any time soon.  And broader taxes like a wealth tax look almost impossible to me  - the political climate in the USA is just nowhere near big changes like that.  So yes, while the book is certainly the most important economics text of the year, I doubt it will move the policy needle by much because I think Piketty’s argument left too much to be questioned.

The Ubiquity of “Lost Decades”

By Robert Seawright, Above the Market

The financial crisis (circa 2008-2009) brought out discussions about “lost decades” in the investment markets, 10-year periods that suffered negative equity returns. It even prodded PIMCO to argue that the investment universe had fundamentally changed, that an “old normal” had been overtaken by a “new normal” characterized by persistently slow economic growth, high unemployment, significant geopolitical tension with social inequality and strife, high government debt and, of course, lower expected returns in the equity markets.

A Journal of Financial Perspectives paper from last summer considers how unusual it really is for equity markets actually to “lose a decade.” As it turns out, lost decades of this sort are not the exceptional episodes that only very rarely interrupt normal steady economic growth and progress that so many seem to think.

In the paper, Brandeis economist Blake LeBaron finds that the likelihood of a lost decade — as assessed by the historical data for U.S. markets via a diversified portfolio — is actually around 7 percent (in other words, about 1 in 14). Adjusting for inflation (using real rather than nominal return data) makes the probability significantly higher (more like 12 percent, nearly 1 in 8). The chart below (from the paper) shows the calculated return (nominal in yellow, real in dashed) for ten-year periods over the past 200+ years, and shows six periods in which the real return dips into negative numbers.



So a “lost decade” actually happens fairly frequently. As LeBaron summarizes:

The simple message here is that stock markets are volatile. Even in the long-run volatility is still important. These results emphasize that 10-year periods where an equity portfolio loses value in either real or nominal terms should be an event on which investors put some weight when making their investment decisions.

The key practical take-away is that those within 5-10 years of retirement (in either direction) who are taking or planning to take retirement income from an investment portfolio should consider hedging their portfolios so as to avoid sequence risk. Losses close to retirement have a dramatically disproportionate impact on retirement income portfolios. As so often happens, the risks are greater than we tend to appreciate.

Update: Predicting CD Rates

There’s been some chatter about Tom Sargent’s 2007 commencement speech.  It wasn’t really a speech so much as it was an anti-government generalization, but I found this comment by Alex Tabarrok interesting:

After he won the Nobel, Tom Sargent was “interviewed” in an ad for Ally bank in which his response was simply (and correctly), “no.”

I’ve discussed this in the past, but I wanted to update it because I think Sargent is very wrong here.   You may remember those commercials for Ally Bank where Sargent is sitting in a room and someone asks him if he knows where CD rates will be in 24 months.  Sargent confidently says no.   I find this so strange.  This blanket dismissal is some weird combination of rational expectations, efficient markets and the myth that interest rates are a price controlled entirely by the market.  And like Sargent’s anti-government speech, it’s wrong in large part because his views are jaded by political myths.

17 months ago, I said:

“When one understands how the monetary system works (see here for a detailed description) you know that long bond rates are just a function of short rates which are a function of the Fed’s expectations for future economic conditions.  So fixed income traders are essentially trying to constantly front-run the Fed’s expectations.  There’s some variance in long rates due to the element of market control, but in an environment like the current one I wouldn’t say there’s much.  (See here for a more complete discussion on this).

The short end of the curve where CD rates are pegged is even easier to predict in this environment.  And it doesn’t take a seasoned fixed income trader to understand this.   Short rates like CD rates essentially ARE the overnight rate.

I think there’s a very very high probability that this is also a solid two year prediction.  Throw in the fact that Q4 GDP is likely to be under 1% and I’d be willing to bet that CD rates will be roughly the same as they are now when 2015 rolls around.”

As you all probably know, CD rates are still near 0%.  If, in 7 months, interest rates are still at 0% (which I presume they will be) then it’s obvious that the Sargent commercial was wrong that “no one” can predict where CD rates will have been.  In fact, just listening to the Fed’s own forecast made it an exceedingly high probability bet.  Of course, there’s some guesswork in all of this.  Predictions always involve some guesswork.  But it’s a lot easier to make good predictions about future macro conditions when you have a sound understanding of the monetary system as opposed to working from this mythological premise that drives so much of mainstream economic thinking these days.

Chart of the Day: Is the Expansion “Long in the Tooth”?

This was a useful chart from the WSJ over the weekend.  It puts the current economic expansion in perspective:



We’re in month 58 of the current expansion, which is right in-line with the post-war average.  I’ve said that the current expansion is a little long in the tooth, but that it’s important to keep that in the right expansion.  While we’re probably closer to the next recession than we are to the beginning of the recovery, it’s also important to remember that the business cycle seems to be getting longer and longer.  As I noted earlier this year:

“it’s also interesting to note that the expansion phase of the business cycle appears to be getting longer.  You’ll notice that 3 of those 6 long recoveries occurred since 1982.  Are these anomalies or are they signs of a changing economic landscape?  I think they’re probably signs of a changing economic landscape and that means that a lot of the data that exists before the post-war era probably doesn’t apply.”

So yes, we’re long in the tooth.  But that doesn’t mean we can’t get longer in the tooth.

Has US household Deleveraging Ended?

By Bruno Albuquerque, Ursel Baumann, & Georgi Krustev (via VOX)

Household deleveraging in the US has impeded consumption and market activity in recent years, holding back the recovery. Despite substantial progress in balance sheet repair, a key question is whether deleveraging has ended or whether further adjustment is needed. This column presents time-varying equilibrium estimates of the household debt-to-income ratio determined by economic fundamentals. Taking into account the latest available data, the estimates suggest that the household deleveraging process may have ended at the end of 2013.

The balance sheet adjustment in the household sector has been a prominent feature of the last US recession and subsequent recovery. The beginning of the economic downturn in late 2007 broadly coincided with a sustained reduction in household liabilities relative to income – that is, household deleveraging – which contrasted with the strong build-up of debt before the crisis. From a peak of around 129% in the fourth quarter of 2007, the household debt-to-income ratio fell by 26 percentage points to around 104% in the fourth quarter of 2013, led by sustained declines in mortgage debt. While there is broad-based agreement that household deleveraging has acted as an important drag on the recovery, the lack of an obvious benchmark to which the debt ratio should converge makes the assessment of progress on balance sheet repair quite challenging. History appears to be of little guidance regarding the adjustment needs in the current cycle, as the recent swings in the household debt-to-income ratio are unusual by the standards of previous recessions (Figure 1).

Figure 1. Developments of the household debt-to-income ratio over current and past business cycles


Source: Federal Reserve Board and authors’ calculations.

Notes: Zero marks the start of each recession. According to the NBER, there have been 10 recessions in the United States since 1950, with the last one starting in 2007Q4.

New methodology to model household equilibrium debt

In a new paper we propose a novel approach to examine the question of how far US household indebtedness stands from its sustainable level at any point in time, by estimating a time-varying equilibrium household debt-to-income ratio determined by economic fundamentals (Albuquerque, Baumann, and Krustev 2014). This approach allows us to assess whether household indebtedness moved beyond what was suggested by its fundamentals during the recent credit boom, as well as to track progress in household deleveraging in the current phase of balance sheet adjustment.

We model the US household debt-to-income ratio in a panel error correction framework. We employ the Pooled Mean Group (PMG) estimator developed by Pesaran, Shin and Smith (1999) – adjusted for cross-section dependence – for a panel comprising the 50 US states (plus the District of Columbia) over the period 1999Q1 to 2012Q4. The data come from the Federal Reserve Bank of New York’s (FRBNY) Consumer Credit Panel, a nationally representative sample drawn from anonymised Equifax credit data. In line with the related literature, the long-run dynamics of the household debt-to-income ratio are modelled as a function of:

  • wealth (proxied by the house price-to-income ratio),
  • the cost and availability of credit (proxied by the nominal interest rate on conventional mortgages and the loan-to-value ratio),
  • the collateral available for borrowing (proxied by the homeownership rate),
  • income expectations and uncertainty (proxied by the unemployment rate), and
  • the demographic structure of the population (where we use the share of 35–54 age group in total population).

The model estimates point to a stable long-run relationship between the debt-to-income ratio and the explanatory variables. The difference between the actual and estimated equilibrium debt-to-income ratio (determined by the long-run relationship) is interpreted as deviations from ‘sustainable/equilibrium’ levels, the so-called debt gap.


Our results show that the evolution of the debt gap went through a number of stages (Figure 2). The debt-to-income ratio in the US household sector was broadly in line with what was suggested by equilibrium debt up to around 2002–2003. Since then, a positive debt gap started to emerge as actual debt rose at a faster pace than equilibrium debt. After mid-2007, the widening of the debt gap was reinforced by a decline in equilibrium debt reflecting deteriorating fundamentals, such as lower house prices, higher uncertainty, more pessimistic income expectations, and reduced collateral availability. These factors were partially offset by lower mortgage rates. The debt gap reached its peak in late 2008, broadly coinciding with the peak in the actual debt-to-income ratio. Thereafter, the gap began to shrink due to stronger deleveraging undertaken by households that outweighed the decline in the equilibrium debt ratio.

More recently, in the course of 2012 and 2013 the gap has shrunk not only due to on-going household deleveraging, but also reflecting a gradual stabilisation and subsequent rise in the equilibrium debt-to-income ratio. The latter is due to improving fundamentals – particularly rising house prices – and a declining unemployment rate. By the end of 2013, the gap between actual and equilibrium debt stood at less than three percentage points, suggesting that the deleveraging process may have ended or is about to end (given the uncertainty around the estimate of equilibrium debt).

Figure 2. Actual and equilibrium debt-to-income ratio and implied gap


Source: FRBNY/Equifax Consumer Credit Panel and authors’ calculations.

Note: Last observation refers to 2013Q4.

The aggregate results mask some heterogeneity across US states. At the time when the national debt gap was at its peak (2008Q4), all US states had a debt gap above zero, although with different deleveraging needs (Figure 3). The synchronised balance sheet adjustment across states carried out since then implied that, by the end of 2012, the number of states with severe household debt imbalances diminished markedly, in particular in those states with pronounced boom-bust cycles in their housing markets (Arizona, California, Nevada, and Florida), while several other states appeared to no longer face deleveraging pressures (shown in light blue). Heterogeneity across states, however, continued to be present.

Figure 3. Debt gaps across US states


Source: Authors’ calculations.

Note: The debt gap measures the difference between the actual debt-to-income ratio and the estimated equilibrium ratio for each state. A positive debt gap indicates a need for balance sheet adjustment due to the actual ratio being above the estimated equilibrium ratio. The states of Alaska and Hawaii are not shown for convenience.

Concluding remarks

The build-up in indebtedness in the US household sector since early-2000 – and the subsequent balance sheet adjustment that began later in the decade – are unprecedented by the standards of previous business cycles. After roughly 5 years of balance-sheet adjustment, the process of deleveraging in the US household sector appears to be broadly completed as of the end of 2013. Although the household debt ratio has started to increase again in the last two quarters of 2013, as evidenced in the FRBNY’s Household Debt and Credit Report, this will not necessarily lead to a widening in the debt gap. In fact, provided that the increase in the debt ratio continues to be accompanied by a rise in equilibrium debt, supported by the on-going US economic recovery, the debt gap could remain largely unchanged. On the other hand, a normalisation of monetary policy and a return to a higher interest rate environment might pose some challenges to the deleveraging process in the future by pushing down the sustainable debt-to-income ratio.

Disclaimer: The views expressed in this column should not be reported as representing the views of the European Central Bank (ECB) or of the Eurosystem. The views expressed are those of the authors and do not necessarily reflect those of the ECB or of the Eurosystem. 

*  The authors are employees of the External Developments Division, Euopean Central Bank

Is There a UK Housing Bubble?

By Sober Look

Home prices in the UK continue to rise to new highs, exceeding the pre-recession peak. The price increases started in London and have now spread nationally. Many families are quickly being priced out of the housing market. Some are calling it a bubble.

The Guardian: – UK house prices continued to accelerate in February, rising by 1.9% during the month and pushing the annual rate of inflation to more than 9%, according to the latest data from the Office for National Statistics.

Commentators warned of a “superbubble” and said the market was “out of control” as the official figures reported year-on-year prices rises of 17.7% in London and said first-time buyers had experienced double-digit price growth.

Just to put this in perspective, US home prices are now roughly at the levels they were a decade ago. UK home prices have risen over 40% over the same period.

UK vs US home prices


Many are blaming the Bank of England’s so-called FLS (the Funding for Lending Scheme - see overview) for flooding the market with cheap mortgages. Indeed the program has resulted in lower bank financing costs and lower mortgage rates.

FLS Chart 1 - Q2


But is all this cheap credit creating a speculative housing bubble in the UK or is there another factor at play? If you speak with British realtors, they tend to have one major complaint in common. The UK is facing a housing shortage as the post-recession home construction activity remains subdued.

England housing starts


Homes are being built at about half the rate needed to meet the pace of British households creation. But that is also partially the case in the US – so why such a divergence in house price trajectories between the two nations? The answer, according to Goldman, is that unlike the US and some other nations that went on a building spree during the bubble years, the UK was facing a housing shortage even before the financial crisis. The UK housing “bust” happened without the “boom”.

GS: – And, while the shortfall in house building has become more acute in the years since the financial crisis, the rate of house building was also inadequate before the crisis. Unlike countries such as the US, Ireland and Spain – where house building rose sharply in the years leading up to the crisis – the UK has experienced a post-crisis bust in housing supply, without having experienced a pre-crisis boom.

But with housing prices rising faster than wages, doesn’t it mean that this rally should be ending soon? Not necessarily. The acute housing shortage has put a similar upward pressure on rents as well, limiting housing options.

Purchase price vs rents as percentage of avg earnings

And while fewer people can purchase a home after the recession, those who can end up paying materially less on their mortgage than they would be paying in rent (thanks to FLS). They are jumping into the housing market and driving up prices.

Of course if the Bank of England pulls the plug on stimulus by raising rates or by imposing a more stringent lending requirement on banks, home price increases are likely to slow. The housing shortage however will still remain, resulting in higher demand for rentals. Whether paying more for home purchases or dealing with higher rents, one thing is clear: UK residents will be paying increasingly more for shelter in the years to come.