Subprime: Reasons to be Thankful

Ten years ago, the GBP/USD exchange rate was 1.61. Today, it's 2.02. Over that timeframe, the Economist tells us, UK housing prices have risen by 211%, compared to just 120% in the US. Which means that in dollar terms, UK house prices have actually risen by 265% in the past ten years – more than double the rate of appreciation in the US.

As the Economist explains, the prick which caused the US bubble to burst was not overstretched valuations, but rather subprime mortgages:

What sets America apart is the time-bomb laid by subprime mortgage lending in the late stages of the housing boom. The way many of these deals were structured—two or three years of low “teaser” rates, which then switch to much higher tariffs—gave homebuyers with tarnished credit records a free option on house prices. If prices are expected to rise enough, borrowers may be willing to pay higher interest charges in order to keep the equity gains. If prices fall short of their hopes, borrowers have an incentive to default.

Or, to put it another way, if Alan Greenspan had wanted to burst the housing bubble, he probably couldn't have come up with a better way of doing it than to encourage the widespread sale of subprime mortgages.

(This also, by the way, helps to explain why the New York housing bubble hasn't burst: there are basically zero subprime mortgages in Manhattan.)

So the US might be going through some nasty housing-related pain right now. But if this pain has prevented the bubble getting much, much bigger, then maybe it's not such a bad thing. Because if and when the bubble bursts in places like the UK and Ireland (+251% in 10 years, in local-currency terms), the aftermath there could be much worse than it currently is on this side of the pond.