John Humphrys asks: are we at last pulling out of recession? Or are we simply seeing the inflating of a bubble that one day will burst?
Rising house prices are often seen as a sign that an economy is picking up. That’s certainly how things look in the United States at the moment where the cost of a house has risen over ten per cent in the last year and economic optimism has lifted accordingly. Here in Britain house prices are also on the rise, at the fastest rate for six years. So does this mean we’re at last pulling out of recession? Or are we simply seeing the inflating of a bubble that one day will burst?
One of the features of the ‘Great Recession’, as the economic dumps of the last few years have come to be known, was that the housing market essentially went dead. The building of new houses virtually ground to a halt despite the fact that the need for new houses, especially to accommodate younger first-time buyers, was and remains so great. At the same time anyone wanting to raise a mortgage found it next to impossible. Traumatised banks, still smarting from the effects of being ready to lend almost anything to almost anyone during the boom years, became unwilling to stump up new loans. The deposits they required in order to grant a mortgage became prohibitive for many people, especially first-time buyers.
The result was that house prices nationally (though not everywhere) fell, although not anything like enough to restore historic levels of affordability. The ratio of average house prices to average earnings remained far too high for many people to think of buying a flat or a house even if they could raise the loan.
The government’s approach to extricating Britain from the Great Recession while pursuing an austerity policy to reduce its own debts has been to encourage the Bank of England to flood the place with money. This increased liquidity has had a predictable effect on asset prices with both the bond markets and the stock markets rising appreciably. It’s also had an effect on the housing market.
Figures released this month showed that nationally house prices in March were 2.7% higher than a year before. In London the figure was 7.6% and in certain parts of the capital (not just the rich boroughs like Kensington and Chelsea, so attractive to rich Russian oligarchs) the rise was in double figures.
Part of the cause of this rise in prices has been deliberate government action to stimulate the housing market. Its Funding for Lending Scheme subsidised the cost of mortgages in an attempt to end the stand-off between unwilling lenders and potential buyers desperate to find ways to finance their house-buying ambitions.
In his Budget in March the Chancellor went further, announcing a new ‘Help to Buy Scheme’ to come into effect next January. This will provide help with equity loans for purchases of newly-built houses – a policy aimed at stimulating more new house-building. But the policy will also provide up to £130bn in state guarantees for up to 20% of the purchase price of a house to would-be home owners with only small deposits at their disposal. This is intended to encourage lenders to provide finance to this large group of potential borrowers, many of them young.
The government knows that part of the problem with the housing market is the shortage of supply, especially of new houses. In addition to these measures it is trying to lighten planning laws so that it will be easier for house-builders to build. Inevitably, though, such a policy encounters opposition so the effect on supply is likely to be delayed, at the very least.
In such a context many commentators are worried that government action on the demand side can have only one effect – a rise in prices, the very thing we are already seeing.
The simple economics of supply and demand tells us that if demand is increased without any matching increase in supply, then prices will rise. Furthermore, the very fact of announcing a policy not due to come into effect until next year creates an anticipation of rising prices so bringing them forward.
The government has not lacked critics warning it of the dangers it may be running. Last week, in its annual assessment of the British economy, the International Monetary Fund cast doubt on the idea that the government’s measures would lead to an increase in the supply of houses. Instead, it said, “the result would ultimately be mostly house price increases that would work against the aim of boosting housing access”.
The outgoing governor of the Bank of England, Sir Mervyn King, has been even more outspoken, saying of the Help to Buy Scheme: “There is no place in the long run for a scheme of this kind.”
In its defence the government points out that its stated intention is for the scheme to run only for three years. But there is some uncertainty as to whether it’s intended that the government itself or the Bank will have the responsibility for ultimately blowing the whistle on the scheme. And history suggests that is very difficult for governments to extricate themselves from policies that subsidise house purchase because of the perceived unfairness to people who come too late to benefit from the subsidy. It took decades for governments finally to abandon mortgage interest tax relief.
Cynics point out that in the meantime it is in the government’s electoral interests to see house prices rise because the ‘feelgood factor’ tends to rise with it, at least among those lucky enough already to own their own homes (disproportionately Conservative and LibDem voters).
But the wider effect of rising house prices is dire, they say. Making houses even more expensive simply redistributes wealth from the already impecunious young to the already well-heeled middle-aged and old. Furthermore, higher house prices encourage those who already own their homes to remortgage them in order to finance ordinary consumption – in other words, to borrow more in order to take an additional foreign holiday, exactly the sort of debt-fuelled consumption that characterised the last boom before it went bust. And finally, critics say, government guarantees of mortgage loans will encourage banks and other lenders to engage in riskier lending than they would otherwise be prepared to do – yet another feature of the bubble that got us into the current mess.
To these criticisms the government would no doubt say that they really do regard the policy as temporary and that it is necessary if the housing market is not going to remain in the doldrums forever. Furthermore, they argue, their policy is targeted on young, first-time buyers who would otherwise be without hope of getting on the housing ladder unless they were lucky enough to have rich parents. And they say they really are doing all they can to get house-building going again, so easing the pressure on prices.
So is it the right policy? Or are we just repeating an old mistake and blowing up a bubble that is bound to burst?
