Debt is hanging around the necks of households, like Christmas cake on the hips.
Spanish researchers* have recently confirmed the existence of a long-run relationship between house prices and home loans, a so-called co-integrating relationship. Nothing particularly startling in that result. But dig a little more into the results and a more troublesome finding can be unearthed.
Like in the UK, Spanish home loans did not just grow alarmingly quickly in recent years, they are now markedly above their long-run trend and so too are house prices. As access to loans grew, house prices grew; and as house prices grew, the value of loans grew and so on. A co-integrating relationship; and one which was compounding terrible errors.
With house prices above long-run equilibrium levels there was an overvaluation of house prices, which fed through into a false sense of no over-indebtedness. A correction is now in process and the results of the study indicate that adjustment to trend will be lengthy.
The splurge on household debt will hang around the necks of households, like Christmas cake on the hips. A serious bout of debt dieting and restrained consumption is now on the cards. House price inflation will also be modest, because as banks reduce lending back to trend, house prices must fall back also. Any restraint in house prices will act as a substantial drag on household wealth and the ability to borrow and spend. Put simply, this all adds up to low economic growth into 2010 and beyond.
* Ricardo Gimeno, Carmen Martínez-Carrascal, The relationship between house prices and house purchase loans: The Spanish case, Journal of Banking and Finance, forthcoming, DOI@ 10.1016/j.jbankfin.2009.12.011