We really need to sort out the housing market before it destroys our economy

Every big financial bust there’s ever been has been preceded by one common factor – a big boom.

Economics in general seems to struggle with this. The boom times are seen as “normal” and the busts are seen as aberrations. This is partly because economists are terrible at understanding debt.

But it looks as though they might be starting to wrap their heads around it.

And the worst type of debt of all? Our old friend, the mortgage…

Guess what – more debt makes your economy more risky

Turns out that a mortgage isn’t just a millstone around your neck. It’s a painful thing for an economy to bear too.

The International Monetary Fund (IMF) has looked at how the growth of household debt (predominantly mortgage loans) affects an economy. It’s quite a pertinent theme right now. In 2008, median household debt among advanced economies was 52% of GDP; now it’s 63%.

Turns out, this probably isn’t a good thing.

In the short run, says Nico Valckx on the IMF blog, “an increase in the ratio of household debt is likely to boost economic growth and employment”.

However, in the longer run (and not that long – three to five years later), “those effects are reversed”. Economic growth ends up being lower than it otherwise would have been. It also “substantially increases the risk of a banking crisis”.

In other words, debt simply borrows growth from the future and in the meantime, makes your financial system more vulnerable to catastrophic disruption.

The more indebted your economy is, and the faster that debt grows, the slower future growth will be, and the greater the odds of a financial crisis.

Anyone who works in or anywhere near finance should already understand this, of course. Adding leverage (borrowed money) to anything – an investment, a business – makes it riskier. Why would it be any different for the wider economy?

But economists do have a blind spot where debt is concerned (partly because they argue that every debt is someone else’s asset and so it all cancels out somehow).

Anyway, it also turns out that the most destabilising form of household debt is mortgage debt. The irritating thing is that every time someone makes the argument about debt being a problem, some smart alec will come along and say: “Oh, but what about the other side of the balance sheet?” When mortgage debt goes up, “hey, it’s OK, because the value of houses is going up too” – as if the two things aren’t directly correlated.

Then, when the crash comes along the value of houses collapses, but the value of the debt stays the same. And all of these twits scurry back to their spreadsheets and start making noises about bailing out the banks and consumer irrationality and deviations from trend growth, rather than acknowledge that they were simply wrong.

The basic problem is this – mortgage lending is pro-cyclical. That means that when house prices go up, lenders become even more eager to lend against them, with ever fewer precautions in place. Just think about it: when do you get 125% mortgages – top or bottom of the market? That’s right – the top.

So you have a kind of financial doomsday machine. The more precarious the debt pile becomes, the more aggressively extra debt is added on top of the existing debt. No wonder it always ends in disaster.

Even before the crash comes, it’s unhealthy for the wider economy. As Martin Sandbu points out on his FT blog, evidence from the Bank for International Settlements suggests that “financial growth pushes resources into activities that produce assets easily pledged for credit” – houses, in other words.

Those industries, in turn, tend to have lower productivity growth (which is at least partly because the construction industry is heavily subsidised and coddled by government, and therefore doesn’t have any incentive to boost efficiency and productivity, unlike manufacturing, for example).

How to end the property boom and bust cycle

So what can we do stop this tedious, destructive cycle?

Increasingly, I think the best answer is to restrict the flow of credit into the housing market. The Bank of England (and other central banks) can’t realistically set the base interest rate purely with an eye on the housing market. So you’d have to make it specific to property.

The Bank is already trying to do this with various “macroprudential” approaches on tightening up mortgage lending, but there might be other structural things you could do.

One idea would be to make mortgages in the UK non-recourse loans, as they are in many parts of the States. In this case, if you can’t pay your mortgage, and your house is repossessed, then the bank gets whatever it can raise from selling the house. If that’s not enough to repay the debt it gave you, then tough. It can’t chase you for the rest.

That would increase the level of risk taken on by the lender, and also introduce an element of counter-cyclicality. How happy would you be to lend someone 125% of a property’s value if doing so put you, rather than them, into negative equity right away? You might think twice about it – certainly if house prices were at record levels.

Also, we need to strip away all the house-builder subsidies, starting with Help-to-Buy. Make the sector work harder for its profits. At the moment, being a successful housebuilder is about market timing. You make sure you don’t buy too much land near the top, and you make sure that you’re not a forced seller near the bottom. That’s how you make money and that’s what separates the industry survivors from the constant casualties.

But if you can start to make the property market less about riding a wave of credit and government subsidies, and more about building better houses, more efficiently than your competitors, then we might see better productivity, and not all have to live in rabbit hutches and feel grateful for it.

There are plenty of other ideas for sorting out the dysfunctionality of the system (my colleague Merryn has a good one on inheritance tax that we’ll share with you later this week, and the land value tax is another one that always comes up), and I think it’s time we gave them serious consideration, before the next bust comes along. We’d love to hear your views in the comments below.

  • Anil

    One thing that may help is if interest on property debts is not allowed for tax purpose. I know some countries already restrict the interest in this way.

  • Ian Heath

    Truly excellent article. However, we can’t risk abruptly removing current financial incentives for builders. We still need to incentivise an increase in the housing stock. Removing the cyclicality will help but I doubt it would be enough.

    • Carl Wells

      surely high current house prices are sufficient to stimulate house builders to increase the housing stock. The issue is a combination of too many people in the country, many of whom are not terribly productive when you look at UK productivity figures, regulatory restrictions on building, and the focus of economic activity in the South East of England while the North is neglected.

  • Michael Ross

    Two things to rememberr in discussions about the shortage of housing.

    One is not to blame the planning system – it is a system for allocating land – the problem with land allocation for housing is that it is a no-win option for local politicians and national politicians will not give them a strong lead and an incentive to allocate – such as the proceeds from a land value tax. If the planning system is tasked to allocate land it will do so. At the moment it is primarily tasked to protect the Green Belt.

    The second is to be aware that ‘housebuilders’ do not make their profits from building and selling good houses (in the way that car makers make profits from building and selling good cars) but from buying land and developing it to accommodate the maximum possible number of housing units.

  • AAJ

    I agree with the points raised in the article. I think that we should go further to restrict all debt. I like the French approach of limiting debt so repayments are no more than 1/3 of income. You can also restrict BTL debt, like the EU wants to being based on the landlord’s income – very unpopular with landlords.

    I wonder how many houses is enough? Many people have several homes. Should we limit how many houses people have? Should there be enough say, to have 3 homes each? Should simply keep building until every field is a city? Just thinking out loud.

  • Hugh Jarsse

    I’m not sure making loans non-recourse is a good idea; mortgages effectively then become leveraged bets with potentially big upside and very little downside, giving punters an even greater incentive to take one out – heads I win, tails I lose only a very small amount (the cost of taking out the mortgage). Obviously banks should be cognisant of the risks they are taking on but that is fantasy land and especially in boom time when they’re happy to issue credit with gay abandon. Whether loans are non-recourse or not the bank is on the hook either way except with the latter it can lay claim to the mortgagees other assets to the extent that house resale creates a shortfall against the value of the mortgage. Subsidy removal is a no-brainer but this should also include preventing the Bank of England enacting policies which prevent market corrections and act as indirect subsidies. If the UK is going to improve it’s productivity money needs to be lent to growing businesses, not being loaned so that it can be dumped into ‘safe’ bricks (heavily subsidized and government backed) which generate very little return for the economy. Speculative activity must be driven out of the housing market if it is to ever remove the boom and bust cycles, so things like Buy to Let and foreign ownership of housing (especially to leave empty) needs to be serious looked at amongst other things.

  • John Maseratis

    This article – and the comments on it – gave me several perspectives I had not previously encountered. Excellent stuff !

  • Captain Nemo

    One thing the government should have thought of (I expect it’s too late now) would have been to introduce a Mortgage Tax. If the lenders absolutely refused to charge a sensible interest rate, then the Mortgage Tax could effectively top it up. The revenue this would have raised could have reduced the tax burden on those not on the Housing Gravy Train while putting a damper on silly house prices.

    Of course, anyone with a mortgage would consider this a terrible idea!

  • John, this article is exactly what I and others have been blogging and tweeting about for some time. Only you put it better than I ever could!

    Yes, the only way to take the wind out of the housing market is to take money out of it like LVT, not supply more money to it as with Help To Buy. Simple economics.

    In fact I agree with everything you have written!

  • UnderstandingIndustry

    Nice to see a finance-oriented outlet publish a piece on this critical issue that makes sense.

  • Mateen

    Well written article. I agree Help to buy scheme is majorly responsible for inflating the housing market trapping the mortgage owners at a time when the interest levels are at all time record low. Things will only get worse from now on once the interest rates will begin to rise and the markets will suffer from political uncertainty.

    For some mysterious and uncomfortable reasons there is no attempt from the government to regulate the builders as far as pricing is concerned.

  • MK22

    I am puzzled why anyone with a knowledge of economics would be unaware of the obvious effects of debt, in any shape or form, on economic growth. That housing, certainly in the UK, is grossly overpriced I thought was obvious. From the problems I am having selling my house (and therefore buying another) it would appear that, whilst valuations are not collapsing (yet, give it few months), the market is collapsing because no one is buying because no one can sell! I leave it to the “experts” to pontificate about what that means for our economy as a whole. (And then there will be BREXIT and EU nationals selling up and leaving for home.)

  • Andrew Nicholas

    It’s economics 101 and needs no special consideration. The planning rules in this country are ridiculously prescriptive, time (and money) consuming and counterproductive. Loosen planning rules – that frees up supply to meet the burgeoning demand. It’s not rocket science.

    • Ben Jamin’

      The value of land(location) reflects the totality of all externalities in the spatial and economic environment. So if planning increases aggregate land values, which they do, then that is a very good thing indeed.

      Problems only arise when those land values are then capitalised into private rental incomes and selling prices, as they then act to transfer incomes from one group in society to another.

      It is access to this mechanism that drives up demand. That not only only makes housing unaffordable for typical UK households, by also leads to an over consumption and over supply of immovable property.

      That is, when a market is unfair and dysfunctional, even with a massive over supply, housing will still be unaffordable for typical working households.

      Its solely our choice of what to tax and what not to that causes issues in the housing market. Supply is not the cause.

  • Peter Edwards

    Sorry the housing market is way passed fixing the government tinkers too much and our economy will go down with it.

    We had a beautiful system where the private sector and the public sector built roughly 50-50 houses for families to live in. But the came Thatcher and she destroyed that, all in the name of making a homeowner democracy.

    This is what happens when you believe wholeheartedly in a free market economy.

    • smspf

      The Tory announcement to construct no more than about 120 affordable homes at 80% of market rate, i.e. £450k, ish, will help no one other than the lenders to increase balance sheet.

    • Horiboyable .

      Please visit many ex USSR states, even today where many houses still have dirt floors and outside toilets. Do you really want to go there.
      Why have China and Russia never returned to Marxist philosophy?? Because it simply ends up in catastrophic failure wherever it has been implemented. Do you really want to go to the epic failure of Venezuela?

      Do some simple research, work out how many baby boomers are about to retire in the west which are expecting UNFUNDED pensions which means it will have to come from the next generations which are all loaded up with Uni debt, are working in low paid jobs, plus they will have to service the 1 trillion debt that has built up since WWII and WW1. Yes we are are still servicing debt from WW1.

      You see when you run a socialist ponzi scheme, you continually need more culturless drones coming in at the bottom to pay out the ones at the top. Enter the Poles, Africans, Syrian, and anyone else that can fog a mirror and let them in your country under the guise of being refugees that are need of our help and protection and turn them in to debt slaves, they are not too smart so they wont realize they are being shafted. This is the end of socialism in the west unfortunately we will see a lose of rights first and then followed by some violence. That is the nature of the beast.

      • George Carty

        Pensioners always rely on the goods and services produced by the younger generations: the only difference between “funded” and “unfunded” pensions is a few degrees of financial intermediation.

        Pieria: The foolishness of the old

        • Horiboyable .

          “Pensioners always rely on the goods and services produced by the younger generations”. Government pensions here in the UK are very new, only just over 100 years old, so that is not always, in fact it is a very small sample of time and back then the commitment was very small you had to be over seventy five years of age and it was only a few shillings. Things really got stupid after the second world war and politicians went mental with promise after promise, which the hens are only now coming home to roost. EVERY western government is insolvent and they will begin to default on their sovereign bonds, like the whole of Europe did in 1931/32.

          There is not a recession coming but an economic collapse. Do not forget that by law pension funds are required by law to purchase sovereign bonds so I am expecting many very old people to be poor and we will need to adapt quickly because the state will no longer be able to provide for its citizens and we will have to return to a more community based support structures like they had in the old days.

          Marxism collapsed Russia and China and now the west is going down that old familiar road. God I wish people would read history instead of watching XFactor & JK.

  • Ben Jamin’

    The elephant in the room is that freeholders are not paying their full housing costs. This pushes up demand, selling prices, rental incomes and the consumption of immovable property.

    The cost of housing should include compensating those excluded from valuable locations via the tax system ie a 100% tax on the rental value of land. This would increase housing costs by around £150bn pa.

    That would reduce the selling price of land to near zero, and the average selling price of a UK home by nearly 2/3rds. Furthermore it would allow the market to rationalise our existing housing stock, eliminating excessive vacancy and under occupation.

    The redistributional effects would increase the disposable incomes of working households by >£10K pa, making housing optimally affordable, when measured by ratios of discretionary incomes to prices/rents.

    Only when we equally share the scarcity value of land can housing be optimally affordable and optimally allocated.

    • FriarStuck

      We have far too much tax already, it tramples over property rights, and governments are rubbish at redistribution.

      By the way with regard to your emotional argument on slavery, if we accept that people have self ownership, then respecting property rights means respecting self ownership.

      Of course you LVT chaps might argue that a person is monopolising a bunch of water and carbon which should be taxed at the 100% of the rental value.

      • Ben Jamin’

        What confers a moral property right to own land?

        And yes when any resource supplied for free by nature gains a scarcity value those excluded from its use should be compensated for their loss.

        When we tax goods and services supplied by human effort, it distorts incentives to produce them, thus shrinking our stock of wealth and welfare. Yet the opposite happens when we tax land as the market is better able to allocate it to those wishing to produce from it. This should guide you as to the morality of taxing one or the other.

        • FriarStuck

          Everything in nature is scarce. Taxation has never solved the problem of scarcity.

          • Ben Jamin’

            The air you breathe isn’t scarce.

            But imagine it did become scarce and the government sold off the rights to it to some corporation, who you’d now have to pay in perpetuity.

            As you could imagine, the shareholders of that corporation would get very rich while you get poorer. Excessive inequality would now be baked in to our society wouldn’t it?

            Instead imagine that we were all equal share owners in that corporation. Yes, those that used more air would pay more. But because we all get an equal share of its scarcity value, then those that use less get compensated for their loss. Thus equality is restored.

            Thats all the LVT does. It reduces inequality arising from the uneven productivity and distribution of natural resources to zero. A prerequisite for a true meritocracy.

            • FriarStuck

              Now a real world example:

              Oil is scarce, a few corporations have almost exclusive access and distribution rights to it.

              The government applies enormous taxes on oil and oil companies, the taxes do not make the oil less scarce, it also makes the oil considerably more expensive for the consumer, and government efforts at redistribution have made inequality worse not better.

              • Ben Jamin’

                A tax on something that is inelastic in supply(scarce) cannot change its selling price one jot.

                The price of oil is set by that at the margin of production. Canadian tar sands. Due to the location, oil there is costly to extract. So the price the Canadians sell for it the cost of labour and capital expended.

                However, the best location in the world to extract oil is Saudi Arabia. There due to favorable conditions, the oil is very cheap to extract. Yet, due to the laws of supply and demand, they sell their oil at exactly the same as the Canadians. The difference in profits between the two is called economic rent ie Land. That can be taxed away at 100% with no effect on prices or efficiency.

                In fact that’s exactly what Countries all around the world do, either by taxes or profit shares (if they have the sense). Norway has grown a huge sovereign wealth fund from not letting private oil companies exploit their resources as private property.

                It’s dumb not to apply that principle to land in all its forms.

                • FriarStuck

                  What you’re saying doesn’t stack up with reality.

                  I don’t want to get side tracked, but QE and ZIRP have inflated the price of assets including oil, allowing unconventional oil extraction methods to be profitable.

                  Specifically, the tar sands extraction in Canada wasn’t developed until the oil and energy crises of the 1970s, and is on the increase since QE and ZIRP, not to mention some very generous subsidies from the Canadian government over the years;.

                  In an economy without this sort of intervention, companies producing stuff at twice, three, times the cost of their competitors go out of business (your notion that everyone sets their prices according to the least productive or marginal producer, is specious. If this were true nobody would go out of business. You need to read the text books on marginalism again).

                  The tax that governments apply to oil does nothing to address its scarcity, and makes it harder for firms to do business.

                  As I said in another comment, artifical price controls (in this case QE and ZIRP), be it on oil, housing, or anthing else, cause inflation and/or shortages.

                  • Ben Jamin’

                    “In an economy without this sort of intervention, companies producing stuff at twice, three, times the cost of their competitors go out of business (your notion that everyone sets their prices according to the least productive or marginal producer, is specious. If this were true nobody would go out of business. You need to read the text books on marginalism again)”

                    Er that’s rather the whole point. Those whose costs are highest are the ones at the margin. When either supply goes up or demand goes down, they go bust.

                    Anyway, this is fruitless as you think you have to know best. You don’t. That’s how we learn. Good day to you.

                    • FriarStuck

                      And according to your own theory if marginal producers fail, prices will fall to those of the next most productive producer.

                      The truth is that high prices pumped up by cheap money allowed unproductive producers entry into markets, rather than unproductive producers inexplicably keeping prices high.

                      Take for example shale oil producers in the USA, who went into business after QE sent the price of oil over $100 a barrel, not before.

                      Given this LVT would just be more bad government intervention trying to ban symptoms caused by previous government intervention, and would introduce a whole new set of unforeseen and intractable problems.

            • FriarStuck

              Also, you’re assuming that people who have land, only have it for parasitic/speculative purposes and not productive use.

              It’s cheap money that has allowed speculative ownership of land to become profitable.

              vague and inherent concept of the immorality of land ownership, or the
              assumption that all land is owned for the purposes of speculation, is
              missing the point, and a tax aimed at addressing these imagined problems is attempting
              to ban the symptoms and not address the cause.

              • Ben Jamin’

                No I’m not assuming that at all.

                I’m stating that due to is irreproducibility that unless the scarcity value of land is equally shared then inequality and dysfunction are baked into our society and economy.

                That is the sole cause of issues with housing, as anyone who can do some basic maths can also confirm. ie what conditions make housing optimally affordable for typical working households. See my original post that you commented on.

                • FriarStuck

                  “I’m stating that due to is irreproducibility that unless the scarcity value of land…”

                  This “scarcity value” as you put it, is magnified massively by the current banking and monetary system, without which unproductive land purchased purely for speculation has very little value.

                  I have no problem with people purchasing land for productive use, which is beneficial to everyone without them having to pay any taxes to a government or protection racket that claims to be helping the poor.

                  A land tax punishes the later in an attempt to redress imbalances in the former without fixing the real problem.

  • andrew moffat

    An interesting article and some equally interesting comments, including that of a tax on mortgages, which might alleviate some of the speculation and excesses.
    However, everyone appears to have missed the elephant in the room, probably because it is a ‘politically-incorrect’ elephant and many people are fearful of inviting the opprobrium of the media and so-called ‘informed’ opinion. The fact is that so long as this country continues to import 300k immigrants (net) each year, there will be unusually high demand for housing and, in consequence, greater pressure on the green belt, on roads, utilities and infrastructure. This is not rocket science; it is common sense.
    Assuming this problem remains unaddressed then, yes, there will continue to remain an acute housing shortage because demand will exceed supply. Supply can be met but only by gobbling up the countryside. The countryside, however, is a heritage for future generations.

  • FriarStuck

    From the article:

    “. The Bank of England (and other central banks) can’t realistically set
    the base interest rate purely with an eye on the housing market. So
    you’d have to make it specific to property.”

    This is an inadvertent, but very good argument for getting rid of central banks full stop and allowing interest rates to be set by the market, rather than by committee.

    Artificial wage and retail price controls were abandoned as a serious policy over 40 years ago because it caused shortages and inflation.

    This is exactly what we see in the housing market today (shortages and runaway inflation), and for exactly the same reason, politicians attempting to control prices, or specifically the price of money.

  • amjad hussain

    Banks are probably preparing for the bust and preparing people for interest rate hikes and reposessions, it’s natural that they’ll make it look like a response to public feedback – just as their employees and agents in government use fake and skewed polls to show that they are only doing what the people want.
    Anyone who studies the interest ased banking system on a fundamental level will realise that it’s a very crude organised scam that can’t go on forever and will inevitably be superseded soon.
    They diluted precious metal coins until they became unrecognizable and worthless, then drank toasts as they provied the impossible (ask the elders and they’ll tell you with certainty) non-solution whereby they grew money on trees (paper promissory notes i.e bad unfaithful cheques), and are going digital, they’ll probably blame bitcoin and the like (which they are promoting through reverse psychology despite the apparent trash talk) after plundering it totally, then attempt to start their own “safe and regulated” imaginary global currency since they like the idea of using sanctions – to keep countries who speak out or act against bullying – struggling with disease, turmoil and illiteracy just so they can call them stinky backward refugees and terms like “koto kala” ngrs.

  • John Cook

    I’ve been in housing and property all of my career. One thing became clear years ago – the more people can afford to spend on property, the more they will bid and the more prices go up. The Help to Buy scheme only results in self defeating higher house prices. Ridiculous. The article has some good ideas, but without a large building program of properties let at social housing rents in areas with plenty of work / shortages in the workforce, we will only be playing with the problem. The vast number of former starter homes being let at rents subsided by the ballooning housing benefit cost need to be released back into the market for first time buyers. The price falls / increased affordability will follow.

  • Karl Crompton

    A land tax payable by the land owner on second homes would force the wealthy to sell there coastal village holiday bach’s back to locals.
    BTL land lords wouldn’t be able to pass it onto the tennent as increased rent, as tennents pay the amount of rent that they can afford. The tennent would simply move one street over, to where the rent is affordable again.