Max Goldsworthy

What would happen to house prices tomorrow if the government announced that, in order to help people afford a home, they would contribute a flat £10,000 towards the purchase of any house? The answer is that prices would rise by £10,000. Why? Because the actual exchange between buyer and seller has not been changed – the buyer can still afford to pay what they could previously, and the seller can still charge them the same; the only thing that’s different here is that a third party, the government, has stepped in to pump up the numbers and take some extra losses on its chin.

This basic effect undoubtedly also applies to real world policies, such as Lifetime ISAs. For those unaware, a Lifetime ISA is an investment vehicle offered by the government where however much you personally save in it (up to an annual cap of £4,000) the government adds 25% of the value, provided the money goes towards the purchase of a first home. Whilst this condition does mean that the LISA has some redistributive effect towards people who are not on the property ladder, it cannot be ignored that throwing all this extra money into property transactions will have an inflationary effect on house prices like the one described above. In real terms, this inflationary effect means increased government spending, and hence a direct redistribution of wealth from the taxpayer and onto property owners.

It is for this reason that I consider the LISA, and any related policies aimed at using government assistance to make buying a house easier, to be bad policy. But they are far from the worst offender when considering policies that have, ultimately, led to the massive inflation of house prices we see today. To understand the main culprits we need to ask a slightly different question: if adding money into a transaction just inflates house prices, then what happens when a third party instead adds credit? The answer is that if more credit becomes available, then a person who would previously have bought a house at 30 might now choose to buy it earlier at 25, not wishing to throw away another 5 years on rent. A person who previously might have settled for a cheaper home will now decide to take a bigger loan in order to move somewhere more expensive. And finally, if this credit is made available to speculators via, say, buy-to-let mortgages, then more people will choose to invest in housing as a financial asset, particularly if they feel buoyed by the prospect of ever increasing house prices. All of these factors amount to a substantial increase in aggregate demand (and the demand for desirably located property seems to be effectively unlimited), and this increased demand corresponds ultimately to an increase in prices.

This has been the dominant story of house prices – particularly in the US and UK – for at least the past 50 years. For much of the twentieth century there were strict controls on how mortgage credit could be created; in the UK this meant that credit was pretty much only created by building societies and they ‘funded’ it primarily from household deposits. It is probably not a coincidence that during this period house prices held some steady relation to the average wage. But by the late 70s and early 80s a wave of financial liberalisation, some of it inevitable, but much of it deliberate and ideologically driven, allowed a greater variety of financial institutions – banks and international money markets – to start lending mortgage credit. These institutions all vastly prefer mortgage lending to business lending, because businesses have limited liability, whereas mortgage debt always has the property as collateral. After these liberalisations, house prices doubled in just under a decade, resulting eventually in the 1990 crash.

But such rapid expansion of the mortgage making industry was unfortunately only a glimpse of what was to come. Another innovation – securitization – allowed banks to repackage mortgage debt along with other assets and then sell them on to private investors, using the fees generated from this ‘service’ as yet another way to then create more mortgage credit. This fed the basic addiction behind the 2008 financial crash: banks searching for more and more ways of creating mortgage credit and spreading it thorough the economy via securities, based ultimately on either the illusion – or in some cases the explicit lie – that house prices and mortgage debt would stay as secure as they historically always had.

Whatever changes have been made in the intervening years, house prices today remain around the same as they were in 2007. The reasons for this are as much political as any thing else; it is far from original to point out that the Tory voting base is comprised largely of homeowners who do not want to see a drop in house prices. But this problem is not limited to Tories, as even when Blair was in power he pursued increased home ownership as a political objective, and increased availability of credit does go some way to achieving this. The issue is that any gains made in home ownership are achieved by saddling new home owners with previously unthinkable levels of debt. Regardless of who is to blame, and even if we could – as I very much doubt – muster a political coalition who wanted to see lower house prices, were willing to see lower home ownership, and who understood the necessity of credit controls for achieving this; it is not clear exactly what we could do to get finance back under control. Once unleashed, it is hard to get the genie back in its bottle.

It is for this reason that I believe the simplest approach to get housing back under control is not by tinkering around with market mechanisms, but actually by subverting these mechanisms with an expansive policy of new social housing – built by responsible debt-financing. The only serious opposition I see to this is that ‘debt’ is a complete bogeymen in our political discourse, and so I feel the need to elaborate on how debt-financing actually works.

First, the government borrows money from the bond markets at whatever the going rate is. Then, they use that money to build houses, either directly or more likely via sub contractors. Finally, they rent those houses out to people and ensure that the rent paid by tenants at least covers the interest on the government loans. The government would now have increased debt and increased annual expenditure on debt interest, but what people fail to add to the balance sheet is that the government also has increased income from the tenant’s rent – and they have also new assets to offset the extra debt. The reason this way of financing works is because the government, owing to its financial power and perceived security, is able to borrow at much more favourable interest rates than even the biggest private investor, and so it acts in this transaction partly as an investor, and partly as a powerful guarantor of the lender’s investment. The rent still ultimately flows from the tenant to the lender (via the government), but crucially this rent would be substantially lower than current market rent.

If we wanted to, the government could charge higher rent than just the interest on its debt, still charging less than market rent, and all of a sudden a policy that would be met with cries of “who’s going to fund it?” would in actuality be a positive revenue stream for the government. It is almost just a pleasant side effect that this policy would increase the housing supply and reduces the rent burden on vast swathes of the population – a reduction that might realistically spur economic growth. The only real risk with doing this is that, generally speaking, increased debt makes organisations more fragile. If the money went on dodgy contracts and the houses were not built or if, for whatever reason, the government was not able to successfully rent their new properties out, then their increased debt position really would become an issue. Hence this policy does require us to have some faith that the government could actually build houses and rent then out in a way that was at least cost neutral, but frankly, if they couldn’t achieve this with their access to capital in our current housing market, then why the hell would we be trusting them to run anything else?