Economics: How quickly we forget

The popular view is that the house price boom-and-bust of the 1980s and 1990s was an extraordinary, unrepeatable event, quite unlike anything else that has happened since the war.

But a closer look at the fig-ures shows that the similarities between the present and the past are rather more impressive than the differences. In particular, the idea that the terrible shock to the system of the fall in prices in the1990s has put an end to the cycle of house price booms and busts is beginning to look shaky. There is evidence that a strong recovery is coming, and that it would take a big rise in interest rates - an impossibility before the election - to block it off.

The chart shows house prices adjusted for inflation. It is clear that the collapses in the 1970s were every bit as bad as in the 1990s, with peak annual falls that were rather larger.

There was a smaller, but still sharp, fall in house prices in the early 1980s. The main distinction of the most recent fall is simply that it has been more drawn-out.

It is often said that the dreadful experiences of the last six years, and especially the problem of negative equity, have given home buyers such a good thrashing that it will deter them from ever getting involved again. But the chart confirms that previous lengthy periods of stagnant or falling prices did not deter home buyers from rushing back into the market, as soon as they were sure prices were rising.

There are some differences between the 1990s and the 1970s, of course. The most obvious is that, during the earlier price booms, high retail price inflation slashed the mortgage burden, which fell as a proportion of house prices and of incomes.

Negative equity, in which the value of a house falls below the mortgage, was therefore completely unknown because, as each year went by mortgage debts became more manageable.

By the 1980s, lots of people found themselves living in valuable and almost debt-free properties and were able to gear up again by borrowing, to buy more valuable houses, ahead of the next rise in prices. Because many people came out of the cycle of boom-and-bust in good shape, hindsight has wrongly put a rosy glow over the 1970s market.

However, it is the behaviour of home buyers that matters when trying to guess what will happen to prices. It is often forgotten that booms and busts were at the time painful for homeowners, though not for the same reasons as in the 1990s. Mortgage interest rates shot up, of course, but rather more important was the financial stress of double-digit inflation, peaking at nearly 30 per cent.

The contemporary nightmare was that with the cost of living shooting up, it was a gamble from month-to-month whether earnings would rise as fast as spending on food, clothes and soaring monthly mortgage payments.

A six-month delay in a pay increase to catch up with inflation was enough to devastate a family budget. This is not a plea for sympathy for oldies, but an illustration of how quickly the participants in a market are able to forget previous pain once conditions change.

What matters most is buyers' perceptions of whether houses are good value and whether current upward trends have built some momentum and are likely to continue. If so, there is an advantage in buying before prices rise further. Earlier bad experiences quickly become irrelevant.

Looked at that way, we have reached an important turning point, perhaps the most significant since 1989. According to the monthly building society figures, house prices stabilised three years ago, in the last quarter of 1993. They appear to show a faltering recovery since then, an improvement so unsteady that it is used to back the claim that housing market behaviour has changed permanently.

However, the picture shown by real prices, allowing for inflation, is rather different. Prices have continued falling right up to this summer, because inflation has been higher than the increase in house prices. There are reasons for this delay, of which the overhang of homeowners with negative equity - now declining - is one of the most plausible.

It is only in the last few months that prices have shot ahead of inflation for the first time since the end of the boom in 1989 (with the exception of a tiny blip in 1994).

Something really does appear to be stirring in the undergrowth at last, with annual house price inflation approaching 8 per cent and retail price inflation under 3 per cent.

The economic conditions have been ripe for a rise in prices for several years, because the ratio of house prices to income is nearly 40 per cent below its long-run trend. Houses are tremendously affordable, even assuming that last week's building society mortgage rate increases will be followed by further upward moves.

According to an index created by Merrill Lynch, the overall cost of housing, including capital growth, interest costs, tax relief, insurance and repairs, hit a 30-year-high in 1992, which explains why the falls happened.

On this measure, rising prices reduce the overall cost of housing. The brokers say that if real house price inflation rises to 6.5 per cent a year it will make the overall cost of owning a house negative again by 1998.

It is in those circumstances that an upward move in prices becomes self- reinforcing, particularly when those who have decided to rent during a stagnant housing market decide that by staying out of the market any longer they will reduce their chances of buying.

There is, in general, a lag between an upswing in prices and an increase in the number of houses sold, which at the moment remains low. But if this housing market cycle does resemble previous ones, turnover will follow prices upwards sometime next year.

And it is worth remembering that even a return to high single-digit annual rises in house prices could accurately be described as a boom in the 1990s, simply because it would be several times the general inflation rate.