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Let’s stop talking about a housing bubble. The property market is more dysfunctional than that

Ben Chu

An abbreviated version of this column appeared in The Independent on Sunday

Are we witnessing the inflation of a new housing bubble? This question seems to get put endlessly to our policymakers and politicians. The trouble is that it’s not a terribly useful way of thinking about the state of the British property market.

First we should define what we’re actually talking about. What is a bubble? The normal definition is that a bubble exists when people borrow money to buy assets (in this case houses) in the expectation that prices will rise indefinitely and banks lend money liberally because they hold a similar optimistic view of the future. These two forces push asset values into the stratosphere and heighten the likelihood of a sudden painful correction of prices (or bust) at some point as people realise en masse that their rosy vision of the future was dead wrong.

Yet prices can rise very fast (even as fast as they are at the moment, with Nationwide putting the annual growth rate at 5 per cent and 10 per cent in London) without signifying a speculative bubble. It is true that UK house price to earnings ratios are above historic averages, which could, in theory, indicate that prices are out of line with economic fundamentals in a bubbly kind of way. The average house price is now around five times average earnings, while the historic average is a multiple of four.

earnings to hosue prices Lets stop talking about a housing bubble. The property market is more dysfunctional than that


Yet other factors suggest those economic fundamentals have shifted, making higher mortgage to earnings ratios sustainable. For instance, interest rates (with base rates presently held down at record lows of 0.5 per cent by the Bank of England) are also considerably lower than they were in the past. That means the public can service a higher level of debt with a given income. Furthermore, the supply of new housing is much more constricted than it was in the past, thanks to a toxic combination of local nimbyism and land-banking by construction firms. And aggregate demand is also higher, pushed up by more people opting to live alone. Population growth is also putting pressure on the existing stock of homes.

As Martin Taylor of the Bank of England’s Financial Policy Committee (FPC) super regulator put it in a speech last week:

“If you have an economic recovery, rising numbers of households and very tight supply…it would be surprising if [house prices] didn’t [rise].”

That pretty much sums up the thinking of the Bank of England on the economics of the housing market. They simply don’t see a housing bubble – at least not yet. And they’re probably right. The fact that British house prices did not utterly collapse even in the massive recession of 2008-09 (as they did in Spain, Ireland and the US) is pretty conclusive evidence of a mammoth UK supply problem. And that is why those looking for the FPC to use its new powers to pull the plug on George Osborne’s mortgage subsidy scheme any time soon are likely to be disappointed.

Yet none of that means the Chancellor’s policy of subsidising home loans ‑ known as Help to Buy ‑ is a good idea. The absence of a bubble does not vindicate Help to Buy. And, indeed, I suspect that what most people are getting at when they ask whether we are seeing a bubble or not is something different. What they really mean is: are houses too expensive?

For first-time buyers who need to stretch their finances and take on potentially hazardous amounts of debt in order to get a toe on the housing ladder the answer is yes. They might be able to service the monthly interest payments now – but what if interest rates rise? For the wider economy (which is seeing ever more cash and debt being tied up in unproductive bricks and mortar rather than businesses which need capital) the answer is also plainly yes. Those already fortunate enough to be on the housing ladder may feel wealthier as a result of the rising paper values of their home – but they themselves will probably have to take out a bigger mortgage if they ever wish to move. Most people end up losing out. The broad public interest lies in cheaper housing.

As countless economists have told George Osborne in recent months the solution to the social and economic blight of expensive housing is to boost supply. They very last thing a government should be doing is pumping up demand still further by making it more attractive for banks to lend to people with small deposits.

Housing construction does seem to have picked up this year. Output of the construction sector in the third quarter rose by 2.5 per cent. But the building sector is recovering from an extremely low level, having fallen some 20 per cent in the recession, and no one seriously expects housing supply to come into line with demand in the near future. It is estimated that the UK needs around 250,000 new homes a year to meet growing demand. The present rate of completions is around 145,000. That imbalance means house prices will most likely continue to rise, with all the familiar and baleful consequences.

Our housing market may not be in a bubble, but that doesn’t make it any less dysfunctional, nor the Chancellor’s mortgage subsidies any less socially and economically destructive.

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