Winner of the New Statesman SPERI Prize in Political Economy 2016

Sunday 24 March 2013

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


  1. A really interesting point particularly in pointing out that this measure could be viewed as fixing a broken banking system as opposed to supporting housing prices that would otherwise fall. I wonder how such guarantees can be justified for housing and not for other forms of non-govt investment. For e.g. why not guarantee a firm's loan to invest in a new factory or new equipment etc.

    1. This is a good point, which Robert Peston has made on his blog. One answer might be that valuing investment projects is much harder than valuing houses, so the risk involved is greater.

    2. Mebbe. More concretely, houses are an investment AND a place to live, which profoundly influnences borrower behaver. Sub prime debacle aside, the mortgage is the last thing people stop paying making it less risky than a loan to a ltd company. Plus, as the housing market is proving right now, if you can't sell your house you can still stay in it. So again less risk, regardless of the frustration involved. That aside this is a vote winner in line with Tory rhetoric and dogma that also avoids the necessary debate about what acceptable risk looks like.

  2. One thing that causes endless confusion is use of the term government debt. This disguises the fact that it is a private sector asset. We don't refer to our deposits in banks as 'bank debt', so why do we refer to our savings held in government accounts as government debt? It is actually incredibly stupid to clamour for cuts in government debt or deficit spending. A bit like turkey's voting for Christmas

  3. I think the Coalition are being a bit cleverer here than people give them credit for. Newly constructed houses show up in the calculation of GDP, while purchases of existing homes do not. And giving the buyers of new homes an interest free loan of 20% must surely mean the difference between buying and not buying for many people.

    And returning to a comment I made a couple of weeks ago, how can someone calmly observe that "Before the financial crisis, mortgages worth 95% of the house value were quite common. Since the crisis, 75% is the new normal." and still assume that stimulus/austerity is the main issue in recovery.

    Having to come up with a 25% deposit, *especially* when 5% used to be usual, is a very serious disincentive to home buying, especially for the young. Construction generates about 7% of the GVA in the economy and about 6.5% of the jobs, so anything that helps construction to recover has to be seen as a good move. Osborne has found a way to inject money into the real economy, not just into the Bond market, so I think he should get credit for that.

    And by the way, Osborne announced another #3.3bn for other infrastructure projects, so how he comes to be "pretending there is no money" is a bit mysterious......

    1. I agree the scheme could help stimulate demand - which is what my post says. However how can you say 'Osborne has found a way to inject money into the real economy'? The construction industry has been badly hit in part because Osborne found a way of withdrawing money from the economy, by cutting back on public investment. Fiscal stimulus is a cure for demand deficiency at the zero lower bound, include demand deficiency caused by risk averse banks.

    2. That's just the same spin, I am afraid. Reducing the rate of stimulus is not the same as withdrawing money.

      The UK primary deficit is set to reduce from 5% of GDP in 2011 to rough balance in 2015 - if I believe the FT - but I don't. I think it will take until 2017. That is still a stimulus to the private sector.

      Also, Osborne announced a #40bn infrastructure under-writing scheme last July, and another #2.5bn in the current budget.

      And why do I say this injects money into the real economy? If you take home buyers who can't afford a 25% deposit on a newly constructed house and offer them an interest-free loan, this encourages new home construction. I don't think that's rocket science.

      But let's get to the real point: "Fiscal stimulus is a cure for demand deficiency at the zero lower bound, include demand deficiency caused by risk averse banks."

      That's a bit like saying "Tony Blair was the cure for poor educational outcomes in the UK".

      Tony Blair *wanted* to be the cure for education. He always said so three times. But wanting to be the cure and being the cure are two different things. How many years of fiscal stimulus have we had, to very little effect?

      You know who really knew how to stimulate the UK economy? Neville Chamberlain, who launched the biggest program of peacetime rearmament in 1935 funded by dept, and in a coup0le of years unemployment fell by a million.

      That's because the money was poured into the real economy, not just pushed in the direction of the Banks in the vague hope that they would do the right thing with it.

  4. Some other points
    1. It puts a bottom in houseprices. Which might not be a bad idea (seen isulated). Looks still a lot of hot air in the prices. King did probably an excellent job and not letting the bottom fall out (low interest and rather high inflation). Compare this to Holland with basically better starting conditions the RE market is completely messed up. Or to France and Belgium were everybody is expecting it to happen one of these days.
    The Dutch have a fund for it which worked with a low capital pretty well until they started to undermine the market at the worst possible time otherwise. Problem is it is all heavily correlated risk (nearly perfect). From a financial/risk pov a very bad time to start it.
    2. Bottom falling out of houseprices is imho a bigger danger than the bottom falling out of shareprices. It affects much more people and will affect the major part of consumption as well as new construction.
    And macro houseprices looks sort of ok in the UK, but regional is doesnot. Sigma looks huge so if things go bad huge problems can arise even idf houseprices remain stable. If big parts of the Northern English homeowners would go the whole country has a problem.
    3. The Social Democratic modell in its present form looks bankrupt in Europe (or anywhere else). Politics as a consequence has changed dramatically. Simply has become much more interest groups that fight for a piece of the existing cake (as opposed to going for growth and divide that). They all made an inventory and it simply appears that the cake misses several slices to keep everybody happy.
    Meaning for right parties they need to keep their voters happy and get the middle part. This policy does that very well. Homeowners heavily mortgaged are the middlegroup. People on welfare are simply not their voters.
    And the other way around taxes are increased for the rich while the outcome especially longer term looks simply negative (when lefties with or without beards come to power). Still done for political reasons.
    In the UK you see a split now in the right (made worse by not too intelligent policies of the Tories). But the same is possible on the left welfare and minimum wages splitting of back to old skool socialism (almost same potential).
    4. Off Balance Sheet is imho a very worrying trend. People lose oversight and when there is a panic the worst will be assumed. And like we see in Spain now an average debt is blown up in no time because of all the rubbish that comes up.
    Mixed bunch like all policies nowadays and heavily influenced by the basically populist political views that run European politics. Most of the time pure ad hoc not seen in a wider spectrum. Also on both points when traditional parties are in the government.

  5. You omit to mention that the main reason for a "chronic shortage of supply" is the fact that the UK has suffered from wave after wave of immigration. Why would house prices go down if the population is being artificially boosted? Obviously immigrants do not buy houses but contribute to the shortage by occupying the rented sector. Unless the proposed new limits on non-eu immigrants have any effect (which is unlikely) demand coupled with this budget initiative can only drive up prices. There is no demand through more jobs or increase in wages, and little from population growth. The main driver is the one you have omitted. "its the immigration growth stupid"

  6. To Rik 1.:

    House prices in the south east may look as if they still have hot air in them, but in the West Midlands they look scary cheap. You can get a one-bed flat up here for £45k, a decent small house for £75k and a nice four-bed for £130k. Having lived in London and Sussex for the fifteen years prior to moving here, that's quite terrifying.

    To Anon; the actual totals of net immigration are so small compared to the population that on a national basis they make virtually no difference at all to the pressure on housing. Particularly when something like 11% of privately owned houses are vacant / derelict now?

    Add in that some immigrants will live in conditions most of the natives wouldn't tolerate, and I don't think you have much of a point. The mess the rental sector is in is a whole different kettle of buy-to-let worms.

    1. @Chris
      1. Agree that there is probably still some hot air in the SE RE market.
      However the marketconditions are rather weird if I may say so most economic activity there (much more than on basis of a headcount, it looks completely out of balance to me). Plus foreigners using London RE as safehaven investment.
      Having said that looking at incomelevels/prices/longterm interest expectations there looks to be a lot of hot air.

      But my point is that it is probably under the present conditions the worst thing if the bottom would fall out of the RE market. It take confidence away by the what will it be (wet finger) 60% middle group who will likely stop spending. Certainly when pensions are also under heavy enemy fire.
      If possible, a not too big gap and not a bust-state let inflation do most of the job looks to be preferred. You open a can of worms that is difficult to close if you do otherwise. See what they did in Holland, they kicked the bottom out with silly policies (for that situation) and are now faced with low confidence consumers and a construction sector that goes bust.
      In that respect an extra stimulus (in the UK that is) for the RE market looks about right. I would not have been surprised if otherwise prices would have dropped (mainly because of no growth).

      Houses in the Midlands I not fully agree with your argumentation. Prices are low as there is nobody willing to pay for housing at 'normal' UK prices (prices cf standard of living/per capita GDP/and alike). Except for basically the SE all other regional economies in the UK are completely rubbish. Incomelevels imho are simply largely supported by transfers. So yes the prices you mention look low compared to the rest of NW Europe. But that is not the main determining factor which is mainly demand (by people who can afford it). And seen from that angle they still might have as much or even more hot air in it than the SE.

      Re immigration and houseprices. Agree low income immigration put pressure on things like the council rental market (where it is likley a considerable political problem), but will do it hardly on houseprices in general. Not at this moment.
      High income immigration largely not on average houses (only in the SE anyway and seen the houses they are buying via spilover effect only partially to the middle (probably more upper middle) part of the market. They are buying houses that the average Brit can only dream of to simply cannot afford. However they disturb the macro picture if I can say it that way. Overall it looks with the SE and rich/high end/foreigner market macro/overall better than it is for the average Brit.
      My point that the differences are so big that if say the North would fall through the ice it would have overall national consequences. While as a whole the market just could move sideways. In that respect some stimulus might not be a bad idea. Especially if you go for a letting the air out in moderation policies as nearly everywhere in Europe.

  7. All this will do is keep house prices sky high,they need to fall substantially so a house can be bought with the wages that are coming into the home,and not rely on the govt to provide the deposit.
    Let me give a scenario. If this offer is taken up by a young couple,they will as I did and most of us did stretch ourselves to afford the a decent home,now interest rates are at an all time low,it only takes a few percentage points rise and as we know wages are not keeping up and the govt could end up with a lot of defaulted mortgages and plenty of empty homes on their hands.
    What the govt should be doing is building social housing and putting a cap on private rents so those people who live in them can afford to save for their own home,with sky high rents this is an impossiblility.
    Thatcher was warned this would happen when she sold off council houses and now the chickens are coming home to roost

  8. This is fine in the short-term, but in the medium-term nothing will have been done to bubble-proof the market.

  9. Since the question of infrastructure spending has been mentioned, I think it's worth making a point.

    The Government of any developed country has a Budget in two parts. In the US they are called Entitlements and Discretionary, and in the UK DEL and AME.

    Basically, entitlements and DEL are spending that you can't really manage, because they depend on things like the state of the economy, the level of benefits, the unemployment level and so on.

    The Discretionary and AME are things you decide on a year-by-year basis, and the catch is that if you have a funding shortfall, you can't just decide to cut unemployment benefits, so a disproportionate share of the cuts falls on the parts you can control.

    That's why you so often see headlines about Defence cuts, or infrastructure. It's not because politicians hate the armed forces or building bridges. It's because they can only really control a part of the budget.

    And its getting worse. For example, in the UK budget, Social protection, Health and Education together make up more than fifty percent of the Budget, actually 59% or #397bn and those three are deadly to any politician who even thinks of reducing them. So cuts have to come out of the remaining 41% of the Budget.

    As far as I can see, the only way to get the non-Discretionary part of the Budget back down again is the long-term process of improving education and skills. I don't see some magic "legislative" solution.

  10. "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?"

    Actually, I have done so, quite often. It seems obvious to me that higher government borrowing is the least damaging - and most effective - way of reflating the economy.

    1. Martin - of course I know that, indeed everyone knows that, hence my 'virtually'. I guess I'm just frustrated that governments are still getting away with the line that we have to reduce borrowing in a recession, even though the harm that does is becoming so obvious.

  11. Does the Government not constantly take a gamble with tax payers money???
    After all does it matter if it is not your money!

    UK Property Rental


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