Help to Buy?

House front in scaffoldsThe objections to George Osborne’s latest wheeze to assist the housing market are hardly worth discussing. They are almost too obvious. And they have been rehearsed at length in relation to similar, smaller scale initiatives that have already been tried.

The new “Help to Buy” scheme, announced in today’s Budget, aims to provide equity loans of up to 20% of the value of new properties worth less than £600,000. Households have to come up with a 5% deposit to participate. The Chancellor is proposing that the scheme be backed up with government guarantees sufficient to support £130 billion of mortgages. The guarantee scheme will start in 2014 for a period of three years.

Just about the only perspective from which this initiative makes sense is carrying through on an absolute determination not to add directly to the public sector deficit, but not minding too much if the guarantees get lost amongst everything else in the public debt.

So it probably makes perfect sense to the Treasury.

Otherwise, the scheme has almost nothing to commend it. The economic illiteracy it displays is remarkable. The fact that, coming from the current occupant of No 11, this is no great surprise is perhaps equally remarkable.

No sensible person disputes that our housing system is gravely ill. On the one hand, prices have almost returned to the levels witnessed at the height of the 2000s boom. But this time the macroeconomy is in a parlous state, real incomes are declining and mortgage markets are much tighter. At the same time new housing supply has collapsed to record low levels. Everything is very much out of kilter. Last year only 40% of the houses required to meet housing need were built. And those record low levels of construction have occurred while existing versions of the Government equity loan approach have been in operation. Needless to say these schemes have had almost negligible impact on supply so far.

The principal symptoms of our misfiring housing market are high prices and low levels of new supply. The two are, of course, related. Supplementary – and related – problems include the fact that those unable to access owner occupation are paying very high rents in the private rented sector and this is preventing them from accumulating savings to afford a deposit.

The broad strategies available to the government to deal with these symptoms are either to reduce prices to bring them within reach of household incomes or to boost the resources available to households to afford prevailing prices.

The former strategy is the one preferred by most housing economists and informed commentators. Delivering the strategy entails engineering an increase in supply. It could also involve regulation of credit limits for individual households to stop any relaxation of credit standards fuelling a price bubble.

Reduced prices would mean not only that the costs of servicing a mortgage would be lower but also that household finances would be more resilient in the face of the interest rate rises that will surely arrive eventually, unless the new Bank of England regime leads to the abandonment of all attempts to manage inflation. Reduced prices would also lead to a reduction in the deposit required to purchase a property, even if loan-to-value ratios stay the same.

The key question for this strategy is how to bring forth new supply. The Government has focused on changing the planning regime. This is supposed to lead to a significant expansion of private sector speculative house building. The Government has not followed the path well-trodden in periods of post-war reconstruction and invested directly in the construction of affordable housing. Nor has it been sympathetic to arguments that local authorities should be allowed to borrow more on the back of unencumbered housing assets.

I have blogged several times over the last few years that the obsession with planning is misplaced. It is of great benefit to construction companies to face as few constraints on their discretion as possible. So, of course, they will support arguments for watering down planning regulations. But weaker regulations are not automatically followed by builders springing into action.

The housing supply system requires a much more fundamental rethink, including looking closely at the increasing industrial concentration in the house building industry and the concentrated nature of ownership in the land market.

But the Help to Buy scheme largely ignores the intricacies of this debate. It focuses instead on the alternative strategy of trying to boost the resources available to households to afford prevailing prices. The Government’s proposed equity loan is interest free for the first five years and can be paid back on resale.

At first sight this sounds like it will help households access homeownership. And no doubt it will help some. It allows those who can’t afford to buy because they only have a 5% deposit to meet lender requirements for a 20%-25% deposit. Except that the scheme – like any scheme that boosts demand in the face of inelastic supply – is also likely to push up house prices. That in turn would increase indebtedness. Providing lenders with a guarantee against loss from more risky lending almost ensures that prices will be pushed up. Unless it is very careful with the detail of the guarantee, the Government is building substantial perverse incentives in to the scheme. We may find ourselves back on the fast track to subprime central.

The only way to avoid prices increasing in the face of increased demand is a sharp supply response. The government claims to expect this scheme to act as a boost to new construction. But at the moment we’re experiencing prices that are almost at record highs and we don’t find ourselves in the midst of a housing construction boom. So, absent significant institutional reform, it isn’t entirely clear quite what the Government is basing its expectation on.

The net result of this initiative is that it will help to sustain prices, which is great for older home owners, who may possibly be inclined to vote Conservative, and for house builders who would have properties they’d like to shift at current prices. But it is unlikely to do much to increase access and affordability for first time buyers currently locked out of the market.

Update (21/03/13):

My colleague Professor Bramley at Heriot-Watt has had something to say on this matter today. And what he has to say is not dissimilar to what you’ve just read. You can read Glen’s post here.

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6 replies »

  1. Very good post. HTB is the new IO.
    For tenants/savers/future FTB the budget was a nightmare.

    Even more worrying, the goverment is opening the emigration door to many youth.

    Why stay in a country where unemployment is high, cost of living is terrifying and houses are overpriced?

  2. “The housing supply system requires a much more fundamental rethink, including looking closely at the increasing industrial concentration in the house building industry and the concentrated nature of ownership in the land market.”

    Couldn’t agree with you more on the above.

    Isn’t another major problem that the government is propping up a zombie banking sector which would take a big hit if house prices dropped significantly and large numbers of homeowners were in negative equity?

  3. @margecsimpson – Absolutely agree. The weakness of bank balance sheets, which also acts against seeking to deflate house prices, is another dimension to the picture. I have mentioned that in previous posts but didn’t include it in this post.The mess we are in is in reality several degrees more complicated than I suggest here.

  4. You have made the mistake that so many people make that the property market is subject to the law of supply and demand like any other market – it isn’t, necessarily. It is affected, however, by the cost of money. When considering a house purchase, people do not necessarily look at the price of a property, they look at the cost of maintaining a mortgage and prudent punters look to spending 35-40% of their monthly income on their housing costs. If you compare the interest rates of the late eighties (9-10%) to the cost of money today, you will note that as money has become cheaper, the cost of property has increased commensurately. The cost of maintaining a mortgage, however, has remained the same as has the supply of housing. Increasing the supply of property will not affect prices as there is sufficient demand to absorb any such increase. An increase in interest rates, however, I would suggest, would have an affect on prices as the cost of maintaining a mortgage would increase.

    The so called “shortage” of housing has not necessarily affected the market. What is the greatest factor in the housing market is the banks’ unwillingness to lend on anything but the most strict criteria. I am not suggesting a return to “sub-prime” lending. I am. however, suggesting a return to similar lending practices that gave the many thousands of us who are a little older the opportunity to buy our first home. If the government scheme allows people to buy their first property on a 5% deposit (Just like I did. Just like you did.) then all power to it. Often the howls of protest over any government scheme to allow first time buyers onto the ladder sounds not unlike the sound of those who are already fortunate enough to own their own home pulling up the ladder up behind them.