Housing Bubbles

Dominic Lawson was bang on the money with this piece in the Independent recently - about the insanity of rising house prices combined with the effect of artificially low mortgage interest rates.

Taken together these two policies represent a huge subsidy for people in relatively secure work   and with a big mortgage - because the value of low mortgage interest rates far outweigh any drop in this group's living standards over recent years.

The big losers are people in work but who don't have a mortgage - those who rent or people who have retired - yet government policy is mainly focused on helping existing property owners which is likely, as Dominic Lawson points out, to fuel another housing bubble.

The real solution is to build more houses particularly in the south east where demand is at its greatest - and that's where I think bonkers Boris Johnson might actually be right about a new 21st century airport in the Tames Estuary - which would free up the whole of the Heathrow Airport site and the construction of 300,000 new homes complete with first class transport links. 

Now that would take house prices in London down a peg or two.       

Help to Buy is a dangerous political placebo...
...but rising house prices are among the economic figures making Labour feel sick

Now here’s a paradox. The Labour Party is choosing to make the cost of living the central point in its attacks on the coalition: you’ve never had it so bad. So you might think that rising house prices would fit in nicely to Ed Miliband’s critique. Think again. The fact that house prices have been rising in real terms for the past three months is causing Labour to twitch and the Tories to feel chipper.

Odder still, this particular rise in the cost of living is the consequence of deliberate policy by the Chancellor, George Osborne: under the slogan Help to Buy, his last budget offered up to £130bn of tax-payer funded support as security for mortgages that banks would otherwise have refused to underwrite. That is on top of his Funding for Lending scheme, which was intended to increase the credit supply to businesses, but which in practice has flooded into home loans.

Given that the growth in the country’s housing stock has been extremely sluggish, even as family formation has increased, the result is obvious: homes are getting more expensive again, not just in London (where there never was a collapse) but across the nation. Yet, as I say, this is widely taken as good news for the incumbent government.

One reason for this paradox is that unlike standard purchases, the home is seen as an asset whose value can increase and thus provide a gain in wealth. And when its value – on paper— does go up, that tends to makes the owner feel happier. The fact that the same owner will realise that increase in wealth only if he sells without having to buy something else of similar size; well, that side of the equation only causes pain when people actually do need to buy again. But just 3 per cent of the housing stock is actually bought and sold each year, so during that time there are 97 per cent of home-owners sitting back and enjoying an increase in their psychic wealth.

This is only a disaster for first-time buyers; it is precisely such people, most of whom can put down just a very small amount of cash, that Osborne’s latest scheme is designed to help. And for all borrowers, the combined effects of keeping Bank of England rates at abnormally low levels and the simultaneous injection of vast sums into bank balance sheets through quantitative easing, has made it possible for those in secure employment to get mortgages for as little as 1.5 per cent per annum.

So happy days are here again? Maybe not for long. These low rates for borrowers are not just abnormal but unsustainable. Normally, base rates are about 2 per cent above inflation, and the cost for individuals to borrow against property is about 2 per cent above that. In other words, the normal rate for a home loan, with inflation at around 3 per cent as it is now, should be at least 7 per cent. And it will be, when the money printing tap is turned off, and the government can no longer simply underwrite the bond market by buying its own debt.

What proportion of those now borrowing at say, 2 per cent, will be able to continue paying the mortgage installments when they are at 7 per cent – that is, three and half times more, in terms of cash required to meet the bill each month? A lot less than 100 per cent of them, that’s for sure. This was exactly the mechanism that caused the credit crunch—and the annihilation of vast swathes of the banking sector. Cheap mortgages in the United States, admittedly many of them self-certified in a way which would now not be possible, suddenly became not so cheap when rates began to move up quite sharply in 2007. It then turned out that many lenders — or the firms to whom they sold on their loans— were completely unprepared for the scale of debt delinquency. Result: bust.

The other aspect of this debacle was that successive US governments, obsessed with the idea of extending home ownership to poorer families, had instructed the state-insured mortgage firms Fannie Mae and Freddie Mac to direct at least half their loans to borrowers with below-average incomes. George Osborne’s Right to Buy might not have the institutionalised lobbying power of Fannie and Freddie—which had senators and congressmen in their pockets — but as a financial mechanism it is identical.

The only good thing in this potentially disastrous policy is that it gives the Financial Policy Committee of the Bank of England the right to end the scheme after three years; and the new Bank governor, Mark Carney, said earlier this month that “if Help to Buy is contributing to an underlying vulnerability to risk in the UK economy, I would fully expect that the Financial Policy Committee would not expect to extend it.”

Yet this presupposes that the scheme had indeed been contributing to economic vulnerability, rather than sustainable growth. It is also what one would expect. Perhaps the biggest long-term problem with the British economy is the way in which too much money has — with the active connivance of successive governments— been sunk into housing, and not enough into goods which actually have productive potential. As Adam Smith, the great prophet of market economics, observed centuries ago: a home is a grand thing for the people who live in it, but contributes nothing to anyone’s revenue –including the owner’s (unless it is rented out).

Fortunately, it is now not just the unproductive sector of the economy which is emerging, blinking, into the sunlight. Manufacturing is growing, with the car industry leading the way: the industry at one point in 2012 became a net exporter, for the first time since the 1960s. That is nothing like the turnaround in the oil and gas industry in the US, where fracking has caused a doubling of that country’s energy exports in the last year alone: it remains to be seen whether the motley band of c-list celebrities, eco-fruitcakes and full-time protestors manages to block the expansion of the British gas-production business – and with it the chance for our indigenous industries to benefit as US firms have done from low-cost local gas.

Regardless, George Osborne has already been able to refute his opposite number Ed Balls’ charge, made in 2011: “We were told that public sector job cuts would be outweighed by the rise in private sector jobs…it has been a complete fantasy.” Yesterday the Office for National Statistics released figures showing that while public sector employment has fallen by 423,000 under the coalition, private sector jobs have increased by 1.3 million; and last year the rise in private sector employment was almost five times the size of the drop in public sector jobs.

These are the figures which have caused the almost hysterical outbursts within the Labour Party at Ed Miliband. Their original policy of waiting for the economy to win the election for them is past its sell-by date. Worse still for the opposition, Osborne’s highly political home loans policy is working like a happy pill – even though it’s a dangerous placebo.