How cheap money built the housing crisis

Those who crusade against inequality can find no better proof of a wealth gap than in the housing market: while many home owners have found themselves unexpectedly wealthy from rising values, those who do not own their own home find it increasingly impossible to get on the property ladder. And the property wealth gap is also a source of generational friction, with those born after the mid-1980s typically being too young to have had the opportunity to buy a house while they could still afford it.

The paradox, of course, is that actually building a house is fairly inexpensive: has a useful calculator, which shows that you can have a three-bedroom house built for little more than £100,000, and of course a 2-bed flat costs considerably less than that.

The fundamental problem is that there is a structural under-supply of housing in the UK, which has become chronic due to archaic planning laws, preventing developers from offering enough supply: only just over 1% of land in the UK is zoned for domestic property. In effect, it is a shortage of land on which to build which accounts for the deficit in housing supply – estimated to be more than one million properties. The problem is high on the political agenda, but policy initiatives usually amounts to little more than tinkering around the edges of the issue: witness the government’s hopeless housing plan which was published to great fanfare earlier this year, but which is full of inadequate and downright harmful measures. Nothing less than a full-scale repeal of centralised planning laws will enable developers to make serious inroads towards offering the supply of homes which the UK so desperately needs.

So, structural problems can explain why there is a housing shortage. But it fails to explain the exorbitant rise in prices which have taken place in the last two decades. Between 1996 and 2016, the housing stock in the UK increased by 16%, but in the same period population growth was only 13%; in other words, the relative supply of housing was marginally better at the end of the period than at the beginning. But what did average house prices do? They increased by about 275%.

If you are looking for the reason why housing is so unaffordable to most people, you need to look away from mere supply of actual housing and focus instead on money markets. Because it is the flow of cheap money from central banks which has led to what is a classic asset bubble in the property market: a five-year fixed rate mortgage today costs around 2.5%, compared to more than 8% in 1996, and variable rate mortgages can be as cheap as 1%. The Bank of England has, in line with counterparts across the world, kept interest rates artificially low for decades, which lead to a stock market boom and bust in the early 2000s and the housing bubble which burst in 2007, but which was never allowed to fully deflate. Central banks came to the rescue with ultra-low interest rates and unprecedented quantitative easing (QE), all of which is continuing to this day and is inflating asset bubbles in a variety of markets. The BoE has, again like most other central banks, an official inflation target of 2%, and should accommodate interest rates to fight inflation if it exceeds this level. But the inflation measure which the bank uses is CPI, which, as we detail here, is a deceptive number which is tweaked using a variety of tricks – one of which is to omit the inclusion of house prices!

The supply of mortgage lending ballooned as house prices rose and people took out equity release loans or sold up and upgraded: mortgage lending went up by some 400% between 1996 and 2016, albeit with a significant dip in the period just after the 2008 financial crisis. If you already had a mortgage you were doing very well from increased equity in your house and the cheapness of lending, but if you were out of the market it became increasingly more difficult to get in as deposits required for first time buyers increased dramatically.

The housing crisis in the UK does not look like being solved anytime soon. There is no political will to tackle the restrictive planning laws, and there is even less appetite for increasing interest rates and watching a housing crash unfold which in turn will trigger a major (but long overdue) recession. Bubbles should be allowed to deflate, but this one is too big and the consequences too dire, so it will be kept at bay as longs as possible. On the other hand, while it doesn’t happen yet another generation is being excluded from the property market. And that is going to be uncomfortable for those in power as well.

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