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The housing crisis is a feature, not a bug

Yes, prices could crash. No, it won’t help you.

September 01 2022, 13.33pm

Millennials stuck paying exorbitant rents could be forgiven for hoping the current economic turbulence will translate into a house price crash. To those weighed down by rising housing costs and the apparent impossibility of ever buying in economic centres like London, Brighton and Oxford, a recession might feel like a price worth paying for the prospect of house prices plummeting back into view.

But in recent history that has not been allowed to happen.

Consider the most recent major economic crisis, the credit crunch. As it peaked in April 2009, then-chancellor Alistair Darling announced a £1bn rescue package for Britain’s housing market.

Among the measures was financial help for projects where new housing had been built, but couldn’t be sold due to falling prices. The government would take an equity stake in some of the developments, while others would be turned into social housing.

The government could have left the developers to drop their prices until someone wanted to buy and let the market do its work. 

But the government took the exact opposite approach: house prices, which were already unaffordable to many in London and the South of England, had to be propped up.

“The government chucked a lot of money at developers to effectively take market sale stock out of the market and convert it either into socially rented or private rented housing,” says housing market analyst Neal Hudson. “They were trying to avoid having an excess of sellers forcing down prices in the market.”

Not only did the government step in, but lenders avoided getting out the big stick with homeowners struggling to pay the mortgage – nobody wanted a repeat of the early 90s, when mass repossessions forced a glut of properties onto the market, and drove down prices at considerable social cost.

As a result, the 2008 financial crisis had far less effect on house prices in Britain than in Spain and Ireland. They dipped — but then recovered. 

The ratio of average house prices to average household earnings, which measures housing affordability, fell in 2008 but then recovered in most places, firstly in London (where it reached a new high as early as 2010 before rising further), then the rest of England. By 2021, the North East was the only region of England where housing was more affordable than it had been in 2007. In London, the South East and East Anglia, house prices are now more than ten times annual household earnings, while they are approaching that level in the South West. Pockets of economic growth around Manchester are also seeing house prices rise faster than incomes - the house price to earnings ratio has risen noticeably in Trafford and Stockport, and to a lesser degree in Cheshire East and Manchester itself. 

These ratios are similar for low earners and cheaper properties - and even the ratio of relatively cheap homes (the 25th percentile of local house prices) and average earners is above ten-to-one in thirty-seven local authorities, and between eight and ten in a further sixty-two. All told, that’s nearly a third of all English local authorities where a fairly cheap home costs eight times the average salary.

But the desperation of politicians and financiers who’d normally preach market economics to artificially prop up house prices against the dynamics of the market poses an awkward question: is Britain politically and economically dependent on house prices that are widely agreed to be unaffordable?

And what does that mean if – as some predict amid the cost of living crisis – house prices are now set for a fall? 

Property votes swing both ways

Ever since one of Britain’s largest ever state-mandated transfers of wealth – Thatcher’s Right to Buy – parcelled up property assets for the upwardly mobile working classes, rising house prices have been seen as a vote-printing machine for key demographics, in particular high-turnout middle-class Baby Boomers.

And while there may be millennial votes in making home-ownership more affordable – particularly in southern ‘blue wall’ seats where decades-long Tory majorities are disintegrating – actively falling house prices could lose as many votes as they gain in the short run.

“People I talk to have all said they would be happy to have stagnant house prices on the grounds that their house price has already gone up by a lot. ``We don't need it to go up any more, we can be magnanimous and allow it to just not go up any more’,” says economic commentator and banking expert Frances Coppola. “But when you start saying ‘how would you feel about house prices going down?’ ‘Oh, no, no, no, that's our money, that's our wealth’. 

“There's a huge difference between accepting that it might not go up any more and accepting a loss.

“People want their own house prices to go up but they want their kids to be able to afford houses. The cognitive dissonance is astonishing.”

While house prices are out of control in southern cities such as London, Oxford and Brighton, they are more affordable to working millennials in red wall seats

In March last year, The Economist looked at housing developments in seats like Blyth Valley – won by the Tories for the first time in 2019 – where working families had bought homes on incomes that wouldn’t scratch London’s housing ladder. In County Durham - where the Tories now have more than half the MPs, compared to precisely none before the last election - the average home cost 4.42 times the average local income in 2021, actually down from 5.12 times in 2008, and less than a third of the ratio in Wandsworth, where Labour won control of the council this spring.

Many Tory-held marginals in the Midlands, such as Bolsover in Derbyshire, are peppered with Help to Buy developments that are snapped up by middle-income 30-somethings. They now benefit from rising house prices. 

Loans going underwater 

A housing market correction could be painful – for these red wall voters, but even more so among first-time buyers in the London hinterland. 

Hudson recalls the experience of the early 1990s. “The impact is biggest in the most expensive of markets – prices ramped up and then collapsed most in London and the South of England.” 

Recent buyers would be left in negative equity – their home would be worth less than the value of their mortgage. Their loan would be ‘underwater’. 

Coppola was among those who faced negative equity in the early 90s crash. 

“You're stuck – you're trapped in your house, you can't move, because you've got to repay the loan and the house is worth less than the loan. From the bank's point of view, those mortgages are subprime. And they have to take provisions against them because the default rate rises on underwater mortgages.

“People who are most likely to be underwater are also those who tend to be most exposed to economic crises. They tend to be younger, poorer people, first time buyers, doing jobs that are more exposed to unemployment and wage cuts. And also the mortgage is eating up a higher proportion of their disposable income. And they have less assets that they can draw on – they don't have savings, they don't have things they can draw on to maintain their payments. So they're more likely to default.”

“Even drops that start out not leaving many underwater can generate panics that become amplifying and leave more and more underwater,” adds former Bank of England senior adviser Tony Yates, who says that banks could cope with a gradual, managed decline in house prices – if there was a way to achieve one.

Regulations introduced after the 2008 financial crisis mean Britain’s banks are more robust than before – the Bank of England’s stress tests, which assess whether banks could cope with an economic crisis, factor in sharp house price falls. In the exceptional event that a housing market ‘correction’ was so severe it plunged price-to-income ratios back down to the levels of twenty years ago, however, some banks might be rendered insolvent due to the effect of so many underwater loans.

Nevertheless, analysis by Hudson published last month - tellingly titled ‘This Is Getting Scary’ - warned that because homeowners now have bigger mortgages relative to their income than in the past, they are at greater risk from apparently limited interest rate rises than would have been the case in the 80s. He calculates that the impact of mortgage rates at 3% in 2022 is equal to that of interest rates at 14% in 1980 - borrowers’ income now is much more exposed. 

Bank of England interest rate rises look set to push mortgage rates well above 3%, and the cost of living crisis will reduce borrowers’ ability to pay - increasing the risk of repossessions and forced sales.

We expect the impact of higher mortgage rates and the rising cost of living to be seen first in lower activity levels. However, the scale of the crisis and the absence of any significant government support makes a large fall in house prices increasingly likely,” Hudson’s analysis stated. “Ever higher mortgage rates will continue to stretch the gap between what sellers want and what mortgage-based buyers can afford. For example … a mortgage rate of 4% suggests prices would be nearly 40% over-valued. This would require a 28% price fall to get average UK house prices back to an affordable level.”

Whether younger renters could take advantage of falling house prices depends on the context in which they fell. In an economic crisis – and there are few other circumstances in which prices would fall sharply in a short period of time – unemployment and lenders’ caution would likely restrict bargain-hunting to investors and speculators with enough capital to play with. In that sense, any impending house price collapse will do little for young renters unless they’re sitting on significant inherited wealth.

Built-in cannibalism 

But what is the attraction of runaway house prices for governments?

Rising house prices can drive an economic ‘feel good factor’, as in the late 90s, where people feeling flush with housing wealth start spending – and borrowing – more. This in turn drives more economic growth, albeit of a debt-fuelled variety. 

“When house prices tank, the economy gets a heart attack,” says Coppola. “And similarly if you want to engender a [recovery], you pump up the housing market. That's what George Osborne did in 2014, 2015, Help to Buy to bring about a recovery just in time for the 2015 election. It was all about that.”

"I think people have the illusion that they are better off with rising house prices,” says Yates. “All these factors contribute to a certain marginal voter being susceptible to policies that pump up their house price values.”

This, however, might prove a very short-sighted strategy. Cannibalism is practically built-in: ageing homeowners want to protect the inflated house prices they’re sat on so they can use the money to help their children and grandchildren afford those same inflated house prices. 

“You’ll never see a solution that does anything other than try and erode the value of housing in real terms, or relative to incomes,” adds Hudson. “Ultimately we as a nation, the idea that you would have a sudden correction in house prices of 20, 40 percent, doesn’t lead to good outcomes in the country because of the centrality of housing relative to both the financial system but also to people’s wealth.”

Home ownership in Britain peaked as long ago as 2003. Rising prices are delivering wealth to a smaller group of people than before – perhaps explaining why the consumer booms of the 80s, 90s and 2000s have not been repeated since 2010.

Britain’s economy could function perfectly well without inflated house prices – as Yates says, small groups profit from the status quo, but at the expense of others. Money spent on rent by those who can’t afford to buy is money that can’t be spent on activities that might stimulate the economy. 

But getting to a place where housing is more affordable isn’t easy – economically or politically. Increased private housebuilding, even once it gets past local opposition, is more effective at eroding house prices over time than quickly reducing them. 

“A lot of the evidence around housing supply is that it takes a long time to have an impact, and it’s better at creating the conditions where incomes can rise faster than prices rather than correcting house prices themselves,” warns Hudson.

“There's no quick and easy solution to this,” says Coppola. “I wish there were.”

No easy way out

Former cabinet minister Sir Oliver Letwin found developers built new homes slowly enough that they don’t reduce local house prices through supply and demand – which defeats part of the point of increasing supply. Developers say they are forced into this by the high prices they have to pay to buy the land to build on. Releasing much more land for development could fix this, but again faces considerable political hurdles – ‘save the Green Belt’ and all that.

Higher property taxes could reduce housing demand and house prices in expensive areas, but these are electorally risky. New social housing could drive some landlords to sell up, releasing their properties for homeowners, but is better at protecting the poor from rising prices than actively lowering them. 

Working from home would make it easier for people to live away from key cities – which would push prices up in some areas, but lower them in places like London and Oxford. Central London prices fell during the pandemic as people fled the city, before rising as people returned. But sustained change would require a much greater government commitment to both home-working and regional economic rebalancing than the current incumbents are capable of – and regional economic rebalancing is a challenge that has foiled British governments for decades.

The US city of Minneapolis managed to at least bring rents down through pioneering reforms that moderately increased the density of housebuilding and pumped money into affordable housing. By actively expanding public engagement beyond the usual ranks of ageing letter-writing homeowners, city leaders were able to build broader public support for the changes. But not everyone was happy – a legal challenge by environmentalists threw a spanner in the works this summer. 

‘Big bang’ liberalisation of planning laws is unlikely to fly. The British government’s grand planning reform – with mandatory housebuilding targets for councils and heavily curtailed routes for local opposition – was significantly watered down after entirely predictable opposition from Tory councillors and MPs. It was almost perfectly pitched to scare the life out of Middle England.

Progress is not impossible. Ageing homeowners want their kids and grandkids to be able to buy homes themselves. There’s polling evidence that support for housebuilding and council housebuilding is rising. It will need a government with courage and clarity of purpose, but also savviness and tact, using both high-profile reforms and low-profile incremental changes.  That government would have to distinguish between vested interests and legitimate concerns, marginalising the former while addressing the latter. Numerous reforms have been mooted – some would work better than others. Social home building is a must.

But it will take time – which requires either a period of single-party dominance at Westminster, or cross-party consensus. And time is both necessity and enemy – nothing will undermine the claim that housebuilding cuts house prices as much as the time it will take for those prices to fall.