From the TUC

“Help to Buy” & the end of rebalancing

29 Jul 2013, by Guest in Economics

Yesterday Business Secretary Vince Cable warned that the Government’s ‘Help to Buy’*scheme could create a housing bubble.

He joins a long list of economists warning that the scheme is dangerously flawed.  As NIESR’s Jonathan Portes and Angus Armstrong wrote soon after the announcement:

The economic rationale for designing a mortgage market intervention in this way is almost impossible to understand. There are well-known market failures in both the retail and wholesale markets for mortgages, so there’s plenty of scope for radical reform. But, instead of explaining what problem it is trying to solve and how, the Treasury has created yet another subsidy for banks. Worse still, the structure of the subsidy will weaken competition even further by propping up incumbent banks and perpetuating an unreconstructed housing finance market with fundamental weaknesses.

What about housebuyers? To the extent that they see any benefits, it will push up demand and hence prices, resulting in further distortions in an already distorted market. This will redistribute wealth from the poor to the rich and from those who don’t own houses to those who do. It will neither build any new houses nor make existing ones more “affordable” in any meaningful sense.

My own initial take was that this could only be understood as part of a move towards abandoning any attempt at economic rebalancing (at least in the near term) in favour of returning to the old model of asset price and consumer spending led growth.

Today’s money and credit data from the Bank of England paint a worrying picture. Mortgage lending grew by almost £1bn last month (down on the previous month but still expanding) whilst lending to non-financial firms continued to contract.

All of which makes a recent paper from Cox Business School in Dallas all the more timely (brought to my attention by Cormac Hollingsworth on Twitter). The paper looks at the US experience over the past two decades and concludes that rising house prices are associated with declining commercial lending and lower firm investment.

As house prices rise, banks choose to allocate more of their lending to housing finance and less to other areas – including business lending. As the authors conclude:

We find that from 1990–2006, a period of strong appreciation and booms in many housing markets, rising housing prices have some negative effects on firm investment. The channel at work is the bank’s choice of capital allocation. We find in areas with high housing appreciation, banks increase the amount of mortgage lending and decrease the amount of commercial lending as a fraction of their total assets. This allocation results in firms receiving reduced loan amounts, paying higher interest rates, maintaining lower leverage ratios, and reducing investment. If anything, firms should have more, instead of fewer, investment opportunities in the face strong housing returns and economic growth. The strong negative effect of housing returns on investment suggests that reduced debt capital supply from banks is the primary reason for lower leverage and investment, and not a reduction in the firm’s demand for capital.

In a passage that could almost be directed at the Chancellor, they argue that:

Policymakers have argued for the need to support important asset markets, such as housing, with the intent of increasing consumer wealth, consumer demand, and real economic activity… Such intervention may very well increase consumer wealth and consumer demand; however, if the banks are interested in reaping the returns in these supported markets at the expense of commercial lending, firms may be unable to increase investment and real activity in response to that demand.

In other words it may well be the case that ‘Help to Buy’ actively sets back attempts to rebalance the economy – it may encourage more mortgage lending and push up house prices, this may then encourage the banks to redirect yet more of their lending towards the strengthening housing market at the expense of non-financial firms with potentially serious implications for business investment.

“Help to Buy”, in its current form, looks increasingly to be a dangerous and misguided policy.

*Actually given that the likely impact of this policy will be to push up prices, I am inclined to refer to it as the ‘Making Harder to Buy’ scheme.

2 Responses to “Help to Buy” & the end of rebalancing

  1. Chris Cook
    Jul 29th 2013, 10:48 am

    There’s no chance of a UK credit-driven bubble because the banks simply do not have the capital to support it.

    London is a special case, being a foreign cash-driven bubble.

    What this is about is that QE is running out of puff, although it is still necessary to stop the banks bleeding to death. Land prices now require direct government intervention to support them and thereby keep the banks’ balance sheets whole during a multi-decade run-off period.

  2. Cantab83
    Jul 30th 2013, 6:59 pm

    “The paper looks at the US experience over the past two decades and concludes that rising house prices are associated with declining commercial lending and lower firm investment.

    As house prices rise, banks choose to allocate more of their lending to housing finance and less to other areas – including business lending. “

    While I don’t doubt the correlation, I dispute the implied direction of causality.

    Investment (i.e. business lending) is usually driven by expectations of demand, and so surely it is the lack of demand that is the real cause. If so then it is the squeeze on wages compared to profits that is the primary problem. If profits rise and wages fall there is only one possible outcome: an excess of saving. These savings have to go somewhere though, and history shows us that when demand is weak that “somewhere” is invariably speculative assets like property. This then drives the rise in house prices.

    Thus both house-price inflation and underinvestment are driven by the same root cause: low wage growth compared to profits. The excess profits drive excess saving and property speculation, while the the low wages result in weak demand and investment. It is because rising house prices and falling investment have the same root cause that they are correlated. The only caveat to this I would add is that once housing bubbles begin to grow they tend to become self-inflating through positive feedback. When this happens the housing bubble itself becomes the dominant driver.

    What this demonstrates is that you cannot run economic policy with a single lever, namely interest rates and an inflation target. Nor can you even assume that simply expanding your macro toolbox to include the management of one of either house prices or wages will be sufficient to bring about greater stability. Because of the interactions of wages, investment and house prices, and the tendency of house prices towards instability, you need to manage all three. That means setting targets for house-price inflation, wage growth and investment, and then also having the appropriate macro levers (or fiscal incentives) in place to ensure that you can meet those targets.

    Of course the other lesson to be learned from both QE and the Government’s Help-to-Buy scheme is that the political and economic establishment in this country is more worried about negative equity and falling asset prices than it is about unemployment, investment and real wages. That speaks volumes about this country’s economic priorities.