By Will Hutton, the campaigning British economist and former editor of the
Observer
When the house-price bubble bursts
We are colluding in the mania of falsely elevated house prices. They fuel
our extravagant lifestyles but we are heading for trouble
Will Hutton Sunday November 17, 2002 The Observer
The housing market has become the centrepiece of the British economy and,
increasingly, our society. It drives our economic growth. It triggers
extraordinary rates of growth of consumer spending, so that whole
industries, ranging from luxury car importing to the travel trade, would be
unsustainable without it. It is entrenching a new apartheid of rich and
poor neighbourhoods. It privileges the old over the young. It makes fools
of us all. Not only do we seem powerless to respond - we collude joyfully
in the mania.
Economic policymakers are anxiously debating whether the current rate of
increase in house prices, running at 30 per cent nationally and perfectly
capable of delivering another year of double-digit growth, represents a
bubble. The concern is that we will collectively over-reach ourselves and
some unexpected economic shock will cause the process to go into reverse.
Hundreds of thousands of borrowers would be distressed, houses would be
repossessed. In wider terms, the growth engine would be suddenly turned
off, with devastating results.
This is the fear that prevented the Bank of England's monetary policy
committee from cutting interest rates last week, so dramatising the mad,
lopsidedness of the current economy. Since 1995, GDP has grown by 18 per
cent. The service sector has grown by 28 per cent, while industrial
production has grown by... zero. This year, consumer spending will rise by
more than �25 billion compared with last year. All of it will be financed
by taking equity out of our homes by continuing to mortgage ourselves at
record levels. We have become masters in borrowing to finance our
lifestyles under the pretence of investing in our house.
Last year, the trade deficit was �33.5bn, reflecting the crazy
overvaluation of the exchange rate, the continuing low productivity of
British business and the very high level of consumer spending; this year,
it will be of the same order. One way of easing the pressure on business
would be to lower interest rates and thus the exchange rate, but that would
risk giving the housing market extra impetus.
The Bank of England is paralysed, cast as a fretful bystander. All it can
do is to warn, as deputy governor Mervyn King did last week, that the
housing market is ominously high and the rate of consumer borrowing
unsustainable.
One wishes the pain on no one, but the hope has to be that the housing
market is in an unsustainable bubble that will soon deflate. House prices
would return to earth and the imbalances in the economy, and their impact
on our society, would begin to unwind. Young couples would have a chance of
buying a house; others, besides the super-rich, might have a chance of
buying in Britain's attractive neighbourhoods; lower interest rates would
help those who want to create and build businesses. We could start to live
in a more normal and less fevered country.
The greater worry is that this is not a one-off bubble but, rather, an
overheated part of a long-term transition to an economy with permanently
high house prices. Such a transition will not be smooth; if we know
anything about markets, it is that they have upward and downward spikes
and, after a long upward spike, some painful downward correction is almost
inevitable.
My dispute with the luminaries of the Bank of England and Treasury goes
back more than 15 years. As a Keynesian, I believe the prime source of
economic instability, economic imbalances and investment preferences is the
character of the financial system and its complex inter-relationship with
the rest of the economy, the heart of the Keynesian argument.
For example, what matters as much as the mortgage rate in determining the
demand for property is the availability and terms of mortgage credit. In
other words, if I can get a mortgage on six or seven times my income as at
present, no questions asked, and which can be repaid over, say 50 years,
then that has as significant an impact on my ability to pay for my house as
the mortgage rate.
Financial deregulation has opened up precisely this world. Moreover,
non-regulated banks and building societies have a natural proclivity to
relax their creditworthiness terms as property prices go up, so adding fuel
to the fire.
The policy response is obvious. The Bank of England should be able, as it
once was, to douse the financial sector's enthusiasm to overlend by
quarantining some of its cash, and warning that any bail-out would come at
a high price. I suggested this in an IPPR pamphlet, Good Housekeeping, in
1991. Eleven years on, I stand by it.
Buckets of contempt have been poured over my head for such views. First,
argued the representatives of conventional wisdom (at that time, both
Mervyn King and the then deputy governor, Sir Edward George), what was
fuelling the house price boom of the late 1980s was not financial
deregulation but expectations of inflation and tax relief on mortgage
interest payments. Once the tax incentive was removed and Britain enjoyed a
long period of low inflation, property would lose its allure. Constraining
banks' and building societies' lending policies served no purpose.
Today, it is obvious that the result of financial deregulation in a
low-interest rate, high-employment economy in a densely populated island
with necessary planning controls encourages high property prices. To take
the heat out of the process and open up more sophisticated policy options,
we need to have some leverage, over and above interest rates, on the
lending behaviour of banks and building societies.
We also need more houses. We have to consider building a new city in the
South-East with 250,000 homes. Probably the best site would be the Medway
towns.
New Labour, in its search for 'economic credibility', adopts the orthodox
view of the world; a return to regulation is anathema. The result is a
house price bubble, emerging social division, an over-inflated service
sector, the near certainty of a difficult retrenchment and the promise of
more of the same.
As I argued 11 years ago, offering the financial system deregulation has
wider economic and social impacts that have to be addressed. That is the
trade-off. It may offend the high priests of free markets and free finance;
that does not make it any less true.
