Taking a bet on house prices (with our money)

In overall terms the UK budget was more of the same. There were some very minor tax cuts in the short term (worth around 0.1% of GDP), matched by some reductions in spending which may be largely accounting tricks. From 2015 there was some additional public investment, financed by reductions in current spending, but again very small numbers. More politics from this totally political Chancellor.

So nothing here that will do anything substantive to help stimulate demand in the economy. As the Chancellor would say, don’t take my word for it - ask the OBR (para 1.7). Ditto for the monetary policy changes (although it is worth reading Andrew Rawnsley’s amusing take on this). But there was one rather interesting and potentially significant measure that might have some impact. The government will provide a buyer with up to 20% of the value of a new-build home valued at £600,000 or less, and initially this loan will be interest free. In addition, the government will provide guarantees for much of the portion of a mortgage above 80% of the value of a new or existing home. So, on the assumption that the biggest mortgage most can obtain at the moment involves 75% of the value of the house, the government will either directly provide an additional 20%, or insure a mortgage provider that does the same. Both measures will be available for three years.

One way to see this is as follows. Before the financial crisis, mortgages worth 95% of the house value were quite common. Since the crisis, 75% is the new normal. This requires first time buyers to spend much more time saving before they can buy a property, which is one factor behind the overall increase in UK household saving. This is a clear example of how additional risk aversion by banks can reduce demand in the economy. This new measure tries to undo this effect, so that we go back (for a time at least) to the pre-crisis status quo.

However another way of seeing it is as follows (see Martin Wolf for example). The reason banks are only lending 75% is that they think there is a significant possibility that house prices may have substantially further to fall. Although recently the market has stabilised after an initial decline, many (like the IMF) think that UK house prices are still overvalued. If prices fall by 20%, by providing only a 75% mortgage banks are still covered if the buyer defaults on the loan. With this new scheme, it is the government (which means us [1]) who will lose out. [2]

Will this help the recovery? More people wanting to buy houses will in itself do nothing to stimulate the economy, but higher prices could have some positive effect on house building, as builders rush to build (or finish building) before the scheme ends. In addition, an increase in housing turnover tends to raise spending on items like furniture. [3] Rising house prices may convince house owners more generally that they need to save less (for reasons that are rather more complicated than a simple wealth effect), or banks that they are more creditworthy. Finally, those that no longer have to save their 25% have some extra money to spend.

I suspect your views about this measure will depend a great deal on how you see the world before the financial crisis. If you see it as a world with too much personal debt, based on an erroneous belief that house prices could never fall, then the idea that the government wants to return us to that world may seem crazy. However, if you think that the current crisis is down to a broken banking system that has become excessively risk averse because of mistakes it made outside the UK housing market, then this measure is helping to correct an important distortion that is keeping the economy depressed.

Everyone agrees that the underlying problem with the UK housing market is a chronic shortage of supply. The first best solution is to raise that supply, producing substantially lower (and therefore more affordable) house prices, but there may be too many vested interests in high (and largely untaxed) land values to make that achievable. The current measure addresses a secondary form of inequity, between higher income earners with inherited wealth (who can afford to buy property in their 20s), and higher income earners without inherited wealth, who have to wait many years until they have saved a deposit before they can buy.

What this measure clearly does show up is how ludicrous the current government’s position on borrowing is. We are told that there is no room for additional government spending on infrastructure financed by borrowing, because the markets would not tolerate it (despite interest rates on that borrowing being really low). Yet this scheme involves additional government borrowing, to be invested in rather risky housing equity, and that is apparently no problem, because it is off balance sheet. Yes I know, as Tim Harford points out, George Osborne’s Labour predecessors played similar tricks, but they were not using these tricks to justify prolonging a recession.

And what about the argument that it bad to increase borrowing when debt is so high. This measure encourages the already highly indebted UK household sector to do exactly that! [4] Why does virtually no one in the media ask why it is apparently OK to encourage the private sector to borrow to spend its way out of recession, but the government is not allowed to do the same? Surely it should now be clear that this is a government with at least as strong an anti-state, anti-poor ideology as Mrs Thatcher, but with rather less honesty about what it is doing.      

[1] Often referred to as ‘taxpayers’ in the media, but with this government more likely the recipients of the future government spending that will be cut as a result.

[2] Of course the scheme itself will boost house prices, so immediate losses are unlikely. A real

danger is that this scheme gives the government a financial interest in keeping house prices high. To avoid house price falls (and the losses from defaults that would follow), the current 3 year scheme may become permanent, providing a very undesirable subsidy for homeownership.

[3]  As Chris Dillow points out, increasing housing turnover also raises tax receipts from stamp duty - the significant tax the government levies on house purchases. As this scheme is off balance sheet, it might even help the Chancellor reduce the official borrowing figures.

[4] Whether the UK household sector is over indebted is a complex question - see for example Ben Broadbent here