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Nobel Economist Proposes Solution To Eradicate Property Price Crashes

written by Bella Palmer

Regardless of whether you are own investment properties or just your own home, the prospect of falling into negative equity in the event of a property market slump is a nightmare. Thousands were badly burned when property prices crashed by an country-wide average of 15% in 2008 as the international crisis took hold. UK property prices had surged for years and buyers who took out mortgages towards the peak were left with expensive loans sometimes far in excess of the current market value of the properties.

Selling without taking a huge loss becomes impossible when a property falls into serious negative equity. While prices subsequently recovered and even surpassed 2008 peaks in some parts of the UK, especially in London and the south east, in others they never did. In Northern Ireland property prices are still 30% below where they were in 2008.

Nobel prize-winning economist Professor Robert Shiller, together with a group of academics, have, however, recently published a paper that proposes a solution they believe could protect home buyers from ever suffering from negative equity again. The research proposes that mortgages are tied to a financial product that would hedge against any property market crash. The derivative would, the paper argues, mean any losses would be compensated by gains from the hedge.

In the UK and USA, almost half of household wealth is tied to property prices. That has a knock-on effect, deepening any recession that hits the property market.  The economies on both sides of the Atlantic are strongly tied to property markets. That has positives and negatives. When house prices go up, economies tend to boom as consumer confidence burgeons. When they go down, the bottom can fall out of consumer spending.

Property industry experts were, however less than convinced that the solution proposed by Professor Shiller and the rest of the team working on the paper would work in practicality. Savills director of residential research Lucian Cook commented that the long term trend of rising house prices was the main reason why home ownership is so popular. It’s certainly, along with rental income, the main motivation to owning investment properties. The flip side of the derivative proposed would mean property owners would also not profit from rising prices.

Many commentators, including the think tank Civitas, see this as a positive. Without the incentive to profit from rising house prices, property would not represent a speculative investment. That would be expected to reduce demand and keep prices more stable, most probably reducing them. Such a development would appeal to the 80% of home owners who only view property as a primary residence.

In theory, were the proposed solution to be adopted as a mainstream component to mortgages, it would not mean there was no longer any case for owning investment properties. However, the model would change drastically to one where the business case would rest entirely on rental income. Investment properties would look like bonds or stable, dividend-returning shares.


This article is for information purposes only.

Please remember that financial investments may rise or fall and past performance does not guarantee future performance in respect of income or capital growth; you may not get back the amount you invested.

There is no obligation to purchase anything but, if you decide to do so, you are strongly advised to consult a professional adviser before making any investment decisions.

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