Get housing costs down – for our future and our economy

IF supporter Tim Lund explains why the current focus on demand-side measures hurts both the younger generation and the broader economy

The problem with most of the current economic policies from both the government and the opposition (Ed Balls recently provided the latest example of this trend) is that they are dominated by demand-side thinking – e.g. a call for “urgent” action on growth, leading to short-term measures which are supposed to “kick-start” the economy; for Ed Balls it’s a stamp duty holiday, for George Osborne it’s a temporary relaxation of planning controls.

They are both right to view construction as a viable source of growth, but both are wary of tackling the supply-side problems which have resulted in persistently low levels of house building. This will be for two reasons. First, understanding the supply side of the economy is much harder – you need a real understanding of the factors which lead people to invest, or not. It is much easier to stick to arguments about the demand side, positioning yourself – as does Ed Balls – as calling for more growth.

The other reason for evading the construction supply side is that it is all too painful, and in particular that sorting it out will mean a comparable hit to the demand side of the economy as it endured during the banking bust of 2008. In fact, it is unresolved business from that era.

The overwhelming fact is that, thanks to the lack of supply, house prices and rents are way higher than they should be, and investors know it. In such circumstances, investors are never going to be keen to invest more, since they are likely to see the value of their investments fall. That favourite idea of politicians – encouraging first-time buyers, as Ed Balls wants to do with his stamp duty holiday – will be just another way of loading people in the 20s and 30s with debt, in parallel with other current policies such as student loans.

What has to happen is for the value of property to fall enough to attract investors – that really is all. There are loads of people who want new places to live, and there are billions locked up in pension funds (and other investment vehicles),  looking for something offering better returns than 50 year loans to the government offering 0.04%.

The downside is that this sort of price correction will severely damage the balance sheets of our conventional financial institutions – the banks and building societies who lent all that money to current homeowners in the run-up to 2008. It will cause severe short-term pain, but the alternative – something like the decades of stagnation Japan suffered following the collapse of its stock market – is much worse.

And it will particularly hurt the younger generation, because with conventional lenders rebuilding balance sheets overextended into loans to their elders, 20-somethings are left to be targeted by pay day lenders.

What has gone wrong with a the housing supply side is another – and complex – matter which we hope to return to…

Posted on: 10 October, 2012

7 thoughts on “Get housing costs down – for our future and our economy

  1. Barry Pearson

    I don’t understand what point is being made here. What is being proposed?

    We have too few houses for the number of family units who want to occupy them. I think everyone agrees upon that. The law of supply and demand tells us that this will result in high prices. This isn’t “way higher than they should be” – who is to say what they should be?

    So we surely agree that we need lots more houses. What is the proposal to achieve this? Is the answer to this hidden in that last sentence: “What has gone wrong with a the housing supply side is another – and complex – matter which we hope to return to”? Isn’t the response to this problem “correct what is wrong with the housing supply side by building more houses”?

    Why would people build more houses if the price of houses is artificially reduced? Don’t we want prices to fall “simply” as a result of building lots more houses?

  2. Darren Freemantle

    Food and shelter are the most basic of necessities. Rising food prices are correctly interpreted as bad news. Rising property prices, however, are seen by most people (and the media) as a good thing. The strain placed on young people trying to find shelter and the ever increasing levels on debt burdened upon them are almost completely ignored. Hence you have the nonsense spouted by media commentators and politicians that the banks need to make mortgages ‘more accessible’, as if piling even more debt on the younger generation is the answer. The increase supply and bring shelter prices lower is obvious to anyone with a basic grasp of economics, not least because it will free up further disposable income from cash-strapped families that can be spent on more productive areas of the economy. However, this notion is in conflict with much of the population that will never accept lower property prices let alone vote for them.

  3. Tim Lund

    Barry – you’ve understood it perfectly:- “Isn’t the response to this problem “correct what is wrong with the housing supply side by building more houses”?” There is no question of artificially reducing house prices, but if they get down naturally to a point where their price no longer risks falling further, there will be more incentive for the private sector to build more.

  4. tom

    Barry: “We have too few houses for the number of family units who want to occupy them. I think everyone agrees upon that.”
    Yes.
    “The law of supply and demand tells us that this will result in high prices.”
    Yes.
    “This isn’t “way higher than they should be””
    Yes.
    But, there are other reasons why they are “way higher than they should be”. One of them is the availability of buy-to-let and the massive expansion of an unregulated rental sector. This has the effect of increasing the price of housing that is for sale, as it adds a whole extra group of people (and money) who are in competition to buy that housing. The fact that rents are unregulated means that it is a very effective market strategy by these investors to drive up house prices, because they can recoup the increases through higher rents.
    Another is the current historically incredibly low interest rates, which have the effect of rescuing those people who bought housing beyond their means in the period up to 2008. These people have been rescued from the fate of those in previous recessions – negative equity, repossessions – but let’s be clear that this is a specific strategy that has the effect of maintaining artificially high house prices.

  5. Tim Lund

    Tom – as long as ‘buy-to-let’-ers let as well as buy, their tenants are not pushing up prices elsewhere, even if they take supply out of the market for owner occupation, so the impact is neutral. If demand from ‘buy-to-let’-ers actually means that developers produce new build for them, then it takes pressure off prices for owner occupation. Only if ‘buy-to-let’-ers are hoarding empty properties can they be driving prices up. It is scarcely credible that this latter possibility outweighs the former.

    You are of course right about low interest rates.

  6. tom

    Tim, I just came across this again and realised I never got around to replying!

    “as long as ‘buy-to-let’-ers let as well as buy, their tenants are not pushing up prices elsewhere, even if they take supply out of the market for owner occupation, so the impact is neutral.”

    I disagree. BTLers increases the demand for property to buy / reduces the supply of property for owner occupation, as you say – surely this must push up the price of property to buy? This creates more tenants, and more demand in the rental sector. But – you say – this creation of more property for rent and more tenants should balance out, and rents should stay flat? I disagree, because the rental sector will charge whatever the market can bear, and if tenants are unable to afford to buy, and wish to have somewhere to live, they have to bear it!

    If we had a sufficient housing stock, BTL would not be such a problem, but given the shortage BTL serves as a lever to increase the price of both buying and renting.

    “If demand from ‘buy-to-let’-ers actually means that developers produce new build for them, then it takes pressure off prices for owner occupation.”

    As far as I can see, in the areas where housing is a particular problem – ie London/the south east – developers are producing as much new build as they possibly can (subject to finding bits of land and getting planning permission), and it’s insufficient. There’s massive pent-up demand from a generation of priced-out owner occupiers, which would more than take up the slack from any death of BTL given a price-readjustment.

    Of course, there’s also a jobs problem going on, in that most of the jobs (and a lot of the best ones) are in London/the south east, but that’s for another debate…

  7. Tim Lund

    Tom – you write “BTLers increases the demand for property to buy / reduces the supply of property for owner occupation, as you say – surely this must push up the price of property to buy? This creates more tenants, and more demand in the rental sector. But – you say – this creation of more property for rent and more tenants should balance out, and rents should stay flat?”

    We can agree that prices for owner occupation will be higher than they would otherwise – the supply is reduced and the market clearing price will be the higher price which the more reduced section of would-be property owners will pay. I’m thinking here of “how many would be owners would pay £x” compared with “how many would be owners would pay £x + y”, which will be a larger number (assuming y is positive). In other words, the standard downwards sloping demand curve of micro-economics, which is the simple behavourial model behind the shorthand of reduction in supply pushing up prices.

    The reverse of this is that supply is correspondingly greater in the rental market, and a similarly downward sloping demand function will mean that “whatever the market can bear” will turn out to be lower. So I don’t say rents will stay flat – I say they will be lower – certainly lower than they would otherwise be.

    You write “given the [housing stock] shortage, BTL serves as a lever to increase the price of both buying and renting.”, which implies you think pricing in the rental sector is taken from that in the owner occupied sector. If so, it means there is not a normal downward sloping demand curve in this market – which is very unlikely. It would also mean that, historically, the ratio between house prices and rents is constant. However, as you know from the chart I sent you and others Jan 22, constructed from the GLA Housing dataset as explained, but which I don’t know how to paste in here, house prices have risen appreciably faster than rentals in the last 10 years – which is what my model would predict where the rental sector is increasing in importance.

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