The financialisation of the housing market

This is the original, long version of an article I wrote for the Guardian. The published version was edited down, and appeared on 28th January. This version was written on 11th December, 2017.

“If some of us grow rich in our sleep, where do we think this wealth is coming from? It doesn’t materialise out of thin air. It doesn’t come without costing someone, another human being. It comes from the fruits of others’ labours, which they don’t receive.”

John Stuart Mill

What has the Bitcoin mania in common with London house prices?  Both are speculative bubbles. Vast sums of money are poured into the apparently finite supply of Bitcoins and the fixed supply of London property. Both have exploded in value, albeit over different time periods.  Five years ago, one Bitcoin was worth £12.00. Today one Bitcoin is worth nearly £….?.  According to an expert, UK house prices are now over 150% higher in real terms than they were 20 years ago .  The ONS’s recent data shows that the nation’s land has effortlessly added £5 trillion to Britain’s net wealth since 1995. In 2015 the value of land increased by £280 billion, “the largest annual increase on record” according to the ONS.

As with Bitcoin, so with London property: speculators are convinced that prices will continue to rise – forever. Both are financialised: treated as financial assets that deliver revenues, rents or capital gains. (As intellectual property rights are transformed into ‘earnings’ – music, words, ideas and organisms can be added to the financialised list.)  The gains made from speculation in a financialised asset far exceed the ability to earn income from work or from investment in the real economy. Indeed, as average wages have fallen over the last decade, investment in property, for those that can afford it, has become a more certain way of securing both present and future income.

The dramatic rise in the price of an asset that has no intrinsic value – Bitcoin – can easily be explained by delusions and the madness of crowds. Not so property market price rises. These, contrary to conventional wisdom, are best explained by the financialisation of markets, not by a shortage of supply. Prices in for example, London, have been blasted into the stratosphere by a single propellant – finance. When the ‘fuel’ of private capital, mortgage credit, cash from the Bank of Mum and Dad is boosted by government subsidies and tax breaks, house prices rise.  According to the Evening Standard wealthy global, non-resident buyers have funnelled more than £100 billion into UK property over the last six years. When these footloose, often fraudulent global capital flows are fused with cheap mortgage credit – house prices rise.

Conversely, prices will fall when the tide of financial flows abates. Or when falls in real wages render unsustainable the ratio of prices and mortgage debt to income. That may already be happening as real incomes continue to fall, the Bank of England toughens up buy-to-let underwriting standards; the government phases in stamp duty rises for second properties, and the FCA considers tightening controls over buy-to-let bank lending.

While many experts agree that the housing market is financialised  – see here and here and here  – the government continues to pretend that the real cause of unaffordable housing is a shortage of new builds. This argument provides cover for further taxpayer-funded subsidies and tax breaks to the government’s property-owning friends, its close allies in the construction industry and property market; and to its supporters in the City of London.

But the evidence is clear: increases in the supply of UK housing, and a contraction of demand thanks to a fall in household formation, has failed to dampen prices. Figures from the ONS show that there were 27.7 million UK households by 2016, and 28 million dwellings, when last counted in 2014.  As the Director of Oxford Economics Ian Mulheirn argues, between 2001 and 2015 London’s household count rose by just under 10%, but the city added almost 12% more dwellings over the same period. And even the FT noted in November this year that:  “allowing for second homes — around 200,000 in England, down from over 300,000 a decade ago – and for those that are temporarily empty, there are clearly more dwellings than there are households.”

It seems that ‘conventional wisdom’ – the theory that house price rises are driven by a shortage of supply – does not usefully explain rocketing prices.

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Land has an advantage for financiers that Bitcoin lacks. It can be used as low-risk collateral with which to leverage additional finance, or new money. Indeed that is what many home-owners used property for in the 80s and 90s, when homes virtually became ATM machines. And that is what many buy-to-let owners use it for today: renting out property and using the monthly income to borrow more – for consumption or “to move up the ladder”.  Private landlords that, as part of Thatcher’s ‘Right to Buy’ scheme, purchased public housing can now extract twice the rent from today’s tenants than that paid by yesterday’s council tenants.

For home or buy-to-let-owners, property as collateral is a valuable source of additional borrowing and income. Sound collateral is also vital for the banking and shadow banking sectors, and is used to leverage new, additional finance. The de-regulation of credit in the 1970s had dramatically expanded bank lending. At the same time mortgages were securitised – turned into liquid assets that could be bought and sold in capital markets, to generate rents or returns.  Mortgage-backed securities (MBS) offer a high degree of liquidity (i.e. can be turned into cash quickly). Speculation in these securities offer what the investment management firm PIMCO calls a “ripe source of low risk alpha-generating returns for active managers.”

The extensive use mortgages on property as collateral for leveraging additional finance confirms property markets as financialised.

Why is the theory of housing demand and supply flawed?

Conventional wisdom has it that land, like capital, is subject to the forces of supply and demand. The most vivid failure of this over-simplified theory became evident in Ireland in 2006. Home construction peaked in that year. In a country of just 4 million people, more than 90,000 homes were built, and yet prices continued rising – by a whopping 11%.

As Josh Ryan-Collins and Laurie McFarlane argue in Rethinking The Economics of Land and Housing – while capital or capital goods latter can be created, depreciated and then destroyed, land is a gift of nature. It cannot be created and converted into capital. It cannot be produced or reproduced, or ‘used up.’ The total supply is fixed, permanent, and does not depreciate. Above all, land is confined by boundaries. Capital, by contrast, is mobile – and abhors boundaries.

“Capital and land are in competition for the same, limited spending power of the firm” argue Ryan-Collins and McFarlane. If land values increase, firms will be left with less for capital investment. Rising prices for land diverts capital away from the real economy – capital that could be used for productivity-enhancing, income-raising investment.

By conflating land with capital goods, mainstream economists misunderstand the impact of movements in land prices. Worse, mainstream economists lack an understanding of money. Unbelievably, most are trained to screen out the role that credit, banks and debt play in markets in general. Credit and money are treated as nothing more than a ‘veil’ over what is regarded as real activity in markets: the exchange of land, goods and services. This is unfortunate, because once excessive credit (money) is factored into the sale of finite assets like land – the inflation of prices and the rise of indebtedness, are not far behind.

If prices were to fall.

A managed fall in property prices would be good for young first-time buyers, and would help shrink the generation gap between elderly owners of property and millenials without. But such a fall would hurt many others. Since the reforms of John Major’s government, pensions have been made less secure.  House price appreciation has become the means by which the British “hoped to turn age into dignity” as the economist Noah Smith argued. But house price appreciation simultaneously worsened consumer indebtedness. By borrowing more to buy an expensive asset – the roof over their heads – homebuyers increased their wealth, but also their debts.  Today, Britons own £10 trillion of property wealth, but owe £2 trillion in debt. That may look affordable, but homeowners don’t pay off debts by selling the roof over their heads. They pay debts from income. But while debts have grown at 10% a year, household incomes have risen by only 1.5%. To avoid another private debt and banking crisis, the borrowing that follows property price appreciation must be dampened.

But, I hear you say, investment and speculation in property feeds public confidence in the economy and drives personal consumption, two thirds of the British economy, so a fall in confidence and consumption will be damaging.

While that may be so, the economic consequences of acquiescing in current volatile conditions must also be considered. An economy excessively dependent on consumption, property speculation and high levels of private debt is unbalanced and therefore vulnerable to shocks. Given that we have not yet fully recovered from the Global Financial Crisis, can we afford yet another catastrophic failure?

Second, rising intergenerational tension – between those safely housed, and the millions that are not  – leads to social unrest and political instability.

Third, a rise in land values leads both to a decline in the productive capacity of the economy and to lower incomes. While economists agonise or “puzzle” over Britain’s low levels of productivity it is increasingly clear that poor productivity is a consequence, an outcome of an economy based on speculative investment, which starves the economy of productive investment; investment which would in turn improve productivity and raise incomes.

What is to be done?

UK property prices could fall thanks to two major developments. The first – another financial crisis. Second, by way of a managed decline – one managed by public intervention. Clearly the latter would be preferable. So what could a government do?

First up for consideration, as the Smith Institute has argued,  is a Property Speculation Tax (PST) as used in Germany.   A PST would exclude those buying for a roof over their heads, and longer term investors. Its focus would be on curbing those engaged in rent-gouging and speculation, but could also include second homes and empty properties.

Second, the Bank of England, working with the Treasury and Debt Management Office should play a more active role in providing households and investors with short, medium and long-term assets that can be used to generate (pension) income in the future. Such public debt management would help government stabilise the public finances, and the Bank of England manage UK interest rates for safe and risky, short and long-term loans. At the same time the Bank would provide pension funds, firms and individuals with safer channels for savings than that offered by securitisation or the buy-to-let market.

Third, government should use its firepower to drive investment in capital and social infrastructure that would generate productive, skilled, high-income-generating employment. Higher incomes in the public sector would raise incomes in the private sector, making housing more affordable for those in employment. And a rise in incomes would increase demand for the goods and services of British firms, boosting productivity in the private sector.

Fourth, the Bank of England, working with the Treasury must manage speculative capital flows in and out of Britain, by taxing, not controlling, flows. The Tobin Tax is one example of how this can be done – by applying ‘sand in the wheels’ of such flows. Here’s why it is necessary: ‘capital mobility has a tolerance for criminality’ as Professor Robert Skidelsky once argued.  Accounting firms make profits by helping to expedite cross-border flows – including flows into London, one of the world’s biggest tax havens. Corrupt politicians and public officials in the poorest countries exploit capital mobility to wire illicit funds abroad, away from their own tax authorities. Oligarchs resident in weak economies shift often-fraudulent gains into jurisdictions such as that provided by UK taxpayers; a jurisdiction that can serve as a tax haven, but also one that enforces contracts and upholds laws.

These mobile flows of rent-seeking capital inflate the prices of Britain’s fixed land space, and thereby deprive British citizens of decent housing. They must be managed, not left free to weaken the economy and deprive British citizens of dwellings.

Those are four pillars on which to build a sustainable economy, and with it an affordable housing market. It will not be achieved by building more private housing, or by channelling more speculative finance, subsidies and savings to prop up the property market. An increased supply of private housing will simply increase the value of Britain’s fixed, immoveable land. And higher land prices will soak up the capital generated by firms and workers engaged in production; capital which could be used more productively elsewhere.

Faced by the failure to dampen prices, government, supported by neoclassical economists, propose only subsidies for the lending of more money (debt) to finance more speculation in UK property.

It is time to deflate that bubble – before the bubble further deflates the British economy

End.

 

 

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