Duncan’s Economic Blog

In praise of falling house prices

Posted in Uncategorized by duncanseconomicblog on March 20, 2009

According to this week’s Economist, house prices in Britain have fallen around 17.6% since this time last year (the exact number depends on which measurement one uses). That’s a lot. The same article reveals that house prices are up 150% since 1997. That’s even more.

The government, which committed to affordable housing in the manifestos of 1997, 2001 & 2005 seem to think that this fall is a problem. I welcome it. The government seem intent on ‘doing something’ to stop the fall. It shouldn’t. I am cognisant of the fact that 64% or so of people (voters) own their own homes. This doesn’t mean which should try and support prices.

I believe there are four primary reasons why high, and fast rising, house prices are a bad thing.

Inequality

High house prices cause inequality. They redistribute wealth from non- home owners to home owners. Broadly put, from the poorer to the better off and from the young to the old. I am fully aware of the interesting work done on asset based welfare by institutions such as the IPPR. My worry with this approach is it leads to statements like this, from Alan Milburn in 2003:

More flexible forms of borrowing could be developed with mortgage lenders. To date they have been overly cautious in promoting packages aimed at lower-income households.

Which has not exactly worked out well. Whilst I agree with his concern that:

In London the child of a home-owner will inherit an average £223,000, based on today’s property prices. The classmate whose family rents will inherit nothing.

I think there is a more straight forward answer. It’s called inheritance tax.

Debt

Rising house prices encourage people to take on even more debt, both in the form of mortgages and in the form of ‘home equity withdrawal’ loans. Lower house prices would result in a less indebted consumer. Mortgage debt in the UK is now something like 88% of GDP (the average in the EU is 50%). That’s silly. Consumers need to rebuild their balance sheets by paying down debt; this is harder with high prices.

It doesn’t make the UK better off

The country as a whole does not benefit from higher house prices. We can’t base an economy on people selling houses to each other at ever higher prices. If someone buys a house because they want to live there, then great. If someone buys a house because they think they can sell it on at a higher prices then this is a simple pyramid scheme.

Competitiveness

Higher house prices mean that British workers need higher wages just to afford to live/rent somewhere. This damages Britain’s ability to be able to compete with other countries.

And yet the government seems more concerned with the political danger of falling home values than the economic dangers of high house prices

There are two reasons, aside from those outlined above, why the government should not be attempting to support the market.

First, I’m not sure it will work. According the Bank of England gross mortgages lending in January 2009 was £13.6bn, down from £29.8bn in January 2008 – a fall of 54%. The government seems to believe that if we ‘can get the banks’ lending again’ than all will be fine. There are some interesting figures on page 33 of the Turner Report. In 2007 26% of mortgages in the UK were for buy to let landlords and a further 39% were ‘equity withdrawal loans’. I’d be more than happy to see these both shrink substantially.

I am not sure how much of the ‘problem’ is the banks’ unwillingness to lend and how much is potential buyers unwillingness to borrow. I don’t think that ‘getting the banks lending again’ will resolve the ‘problem’. I could be wrong.

Second, the UK government is borrowing an awful lot. I think this is justified and believe we will need to borrow more to combat the downturn. But we can only borrow so much. I would rather than government debt was increased in order to stimulate the economy directly rather than to revive asset prices. As the public sector takes on debt, I want to see private sector debt fall. I don’t want to see the government taking on debt and consumers taking on even more. That why lies ruin.

So what should we do?
We need to prevent another house price boom. There are various ways to do this. As a first step I’d like to see a 100% loan to deposit ratio enforced on banks ( i.e. they can’t lend more than their deposit base), that’ll put a natural break on lending growth. I would also be in favour of enforcing minimum loan to value ratios on mortgages.
Perhaps more importantly we need to build more homes. If the private sector won’t do that, then the public sector should. A programme of house building would be a nice stimulus to the economy.
The thorny issue is what we do with people who now find themselves in difficulties. There is a ruthless part of me that wants to cut them adrift, that says they should not have been so foolish as to buy homes they could not really afford. However they should not have been lent the money in the first place either and that the banks (with their legions of economists, loans officers, risk officers, etc) should take more of the blame.

If house prices are not allowed to soar again (and indeed are allowed to fall further in the near term) then these people will not ‘benefit’. Those who find themselves facing being repossessed can be helped in a targeted manner. It should certainly not to the case that non-home owners are asked, on mass, to bail out mortgage holders.

The government likes to talk about hard decisions and difficult realities. The reality is this: house prices were too high and that is a bad thing. We have to be honest with the electorate and say this.

10 Responses

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  1. CharlieMcMenamin said, on March 20, 2009 at 4:27 pm

    “There is a ruthless part of me that wants to cut them adrift, that says they should not have been so foolish as to buy homes they could not really afford.”

    No, what is needed is a workable scheme – not just the halfhearted stuff the Homes and Communities Agencies is trying to put in place – to convert mortgaged property into socially rented stock and thus allowing people to stay put as tenants. More generally, we need to come up with a system which makes it much easier and more financially attractive to move between tenures at different stages in their life.

  2. duncanseconomicblog said, on March 20, 2009 at 4:44 pm

    Charlie,

    I really like this idea. Do you have a link?

  3. I'm Charlie Really said, on March 20, 2009 at 5:08 pm

    Duncan, for some reason I suddenly can’t post under my own name ( Charlie McMenamin) but here’s you answer

    I was a bit wrong- it is CLG, not HCA

    http://www.communities.gov.uk/housing/buyingselling/mortgagerescuemeasures/

    But see the critics of the practicalities

    http://www.insidehousing.co.uk/story.aspx?storycode=6502225

    http://www.insidehousing.co.uk/story.aspx?storycode=6503024

  4. CharlieMcMenamin said, on March 20, 2009 at 6:32 pm

    Your blog wasn’t accepting my replies earlier, so I posted the links over at mine.

    • duncanseconomicblog said, on March 20, 2009 at 6:41 pm

      Seems to be working now… very strange.
      Thanks for the links.

  5. newmania said, on March 27, 2009 at 12:42 am

    I like this post , good stuff

  6. […] March 30, 2009 · No Comments I have been puzzled for some time by the apparently relentless bandwagon rolling in favour of local authorities issuing mortgages. I am less puzzled by the possibility of them doing it, and more by the arguments advanced in favour of it. Steve Reed, Leader of Lambeth, argues that it would be a way to “get the housing market moving again, stop the crash in house prices, and help bring the economic recession to a swifter end“. I cannot get my head round how anyone could believe that the problem in Lambeth is that house prices are too low.  Here’s a 3-bed terraced house in that local authority area, a bargain at just over £800,000. It isn’t just “Lambeth Tories” who think lower house prices are sensible and desireable, here’s a left-wing banker making the same argument. […]

  7. Jeremy said, on April 4, 2009 at 4:41 pm

    Nice to find someone who agrees. I stirred up a lot of bad blood when a voiced a support for falling housing prices.

  8. M Smith said, on April 7, 2009 at 12:43 pm

    Yes, this article is correct.

    Unfortunately, I don’t believe house prices are falling anything like enough. What I have noticed is that less desirable properties tend to fall while others stubbornly remain unchanged.

  9. […] Steve Reed, Leader of Lambeth, argues that it would be a way to “get the housing market moving again, stop the crash in house prices, and help bring the economic recession to a swifter end”. I cannot get my head round how anyone could believe that the problem in Lambeth is that house prices are too low. Here’s a 3-bed terraced house in that local authority area, a bargain at just over £800,000. It isn’t just “Lambeth Tories” who think lower house prices are sensible and desireable, here’s a left-wing banker making the same argument. […]


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