This is a re-post of an article originally published on pundit.co.nz. It is here with permission.
There are three major but separate issues which constitute our housing problem: not enough quality housing; a speculative boom in house prices generating unsustainable inflation; an inability by people in reasonable circumstances to purchase homes. It is helpful to think about them separately.
There is not much one can do in the short term to increase the stock of quality housing by upgrading existing ones and building new ones. (In addition there is a need to upgrade earthquake-compromised houses and apartments, fix leaky homes, provide more land, while resources are being diverted to add office facilities to people working from home.) There is only so much the building industry can do even if it had been looked after better in the past. The record over the last few years has not been impressive but it is better than what happened a decade ago. However, the annual changes will be small compared to the total stock of housing – say an additional one or two percent – not enough to have a major immediate impact on the housing market, even if your long-run theories say it should in principle.
So more house building is not going to do much for rising housing prices in the short run. They are being driven by a ‘Minsky boom’, in which speculation creates its own momentum as investors buy houses to take advantage of the capital gains from rising prices (until there is the bust). The cryptocurrencies boom is an example.
Borrowing is critical in a speculative market because when the boom collapses some investors find they are unable to service their debts and become insolvent. Housing is a little different from, say, the cryptocurrencies, because many investors in rental housing cover their outgoings including debt servicing. They are vulnerable if interest rates rise – there is an expectation they will but we don’t know by how much – or if rental rates fall if, say, there was an increase in supply of housing or those renting found it easier to buy.
The government has taken a number of measures to take the steam out of the boil. Admittedly it tied its hands by refusing to institute a comprehensive capital gains tax on second housing although the brightline test has a similar but more limited effect. Other measures have been instituted too, including restricting tax deductibility of interest rate expenses on rented houses.
The impression is that the measures are slowly deflating the bubble, and that price increases are slowing down but are not yet stable. (Never forget that most who comment on house prices have an interest in their continuing the boil and will portray the data to make the inflation seem worse than it is.)
The impact will be complicated when house prices stabilise. Those who are renting out investment houses will find they are no longer making capital gains; hopefully they will be covering outlays with the rental revenue, but unless they have got their debt down they will not be making much profit. (A stupid scenario promoted by landlords is that they will then put up rents – why are they not doing so already?) My guess is that many landlords will trickle out of the market. (Where will they put their funds?) But they can only do this by selling the house to someone – presumably not another investor – and that is one less household renting, one more owner-occupying. (It’s a bit more complicated than that, but you get the idea.)
The story for one-home owners is different. Many who have been flipping the market or upgrading their housing will not bother. That means the number of houses offered on the market will decrease, which will reduce opportunities for those who have to move – say because of job relocation or a change in family circumstances.
In a conventional market these new circumstances might result in a fall in the market price. A significant fall – say more than 10 percent – is unlikely because housing is not a conventional market. In particular, one-home owners suffer from ‘nominal price rigidity’. Rationally, it might make sense to sell one’s home at a discount and buy another equally discounted home. But that is not the way home owners think. A drop in their house price is seen as a reduction in their real wealth; better to hang on and expect prices to return to what is judged as normal. (Landlords may think the same too, but may have to sell at a discount if their investment positions get undermined; there will not be enough of that to collapse the market.)
You can see why the government will be wary of taking measures which engender a significant fall in house prices. Stabilisation yes, but not a major decrease. The logic then is that while stabilising the speculative boom may be a good thing in itself, it will not offer a lot of advantage to those wanting to move from renting to ownership.
So the ‘affordability’ ratio, however defined, is not going to drop much. How then are the excluded to get into house purchase?
It is a distributional issue. The excluded have not got enough financial capital to deposit on a home as assessed by those lending. (Technically, the problem is they may have much human capital – prospects of earning – but without slavery, financiers are reluctant to lend on its security.)
The government is already inching towards providing additional support for first-home buyers. Here are three ways they could move further.
- Capital grants, like those 1950s’ suspensory loans which were written off after a number of years if the family was still living in the house.
- Capital guarantees, by which the state provided borrowing guarantees so that lenders could advance a higher proportion of cost of the first home that financial institutions would judge prudent.
- Share equity, by which the state takes an equity in the house so that when it is sold, the state takes a share of the capital gains.
Each has strengths and weaknesses but you will notice that in each there is a fiscal element and the state is exposed to risk.
The lesson is that the mainly neoliberal regime for the housing market since the early 1990s does not work: it has under-supplied quality housing, generated unsustainable house price inflation and excluded many ‘worthy' people from home ownership (while giving a rough time to those who depend upon rental accommodation). That should not surprise any properly trained economist; many of the assumptions which underpin the standard market analysis do not apply to the housing market. The nostrums based upon such simple analyses will continue to fail no matter how plausible they sound.
PS. Susan St. John and Terry Baucher are proposing to treat the total net equity in housing and residential land as if it was generating a 'fair economic return' similar to that in a bank deposit. (There would be an exemption of of $1m net equity per person). Home owners with expensive homes and low mortgages would pay more tax (and the rest would pay less). When in the 1970s I proposed a variation on this – a tax on the imputed rent on housing which is the additional value a household gets from owning their own home over renting it – numerous economists told me it was an excellent idea – it would both improve efficiency and equity – but it was politically impossible. Given the timidity of governments – red and blue – over instituting a comprehensive capital gains tax, I doubt those economists would change their mind.
Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.