The UK housing market frightens everyone. Homeowners fear that prices will fall, wiping out billions of pounds of undeserved home equity gains. Renters fear that prices will not fall, thus locking them out of the opportunity to own a home. Banks are petrified that a housing correction will expose their balance sheets to unbearable losses. Meanwhile, the government is equally terrified. A housing slowdown threatens to push the economy into a recession, reduce tax revenues and generate a banking crisis that can only be resolved with a taxpayer-financed bail out.
How did the UK housing market become such a fearful monster? In my view, the answer is straightforward; our collective misery is the product of a grotesque union between unfettered finance and suffocating state control, which has distorted the UK economy into a mangled mess. Despite its dreadful nature, this desperately malfunctioning market is rarely described in such terms. Instead, demand, supply and above all a shortage of housing are believed to be the primary causes of our housing-induced anxiety.
Let us start by dismissing the notion that there is a housing shortage in the UK. Although rrices are a product of highly regulated supply and credit driven demand, the market "clears" at a price that equates demand with supply. In this sense, there is no "shortage" of housing.
There are, of course, millions of people who would like to buy a house but do not have the resources to purchase one at the prevailing price. There are also other people can buy, but only after taking out mortgages that diverts a huge proportion of their disposable income to debt servicing.
Over the last decade, banks mercilessly worked over this latter group. Banks have made available billions of pounds for mortgages. With a mixture of fear and greed, many first time buyers have signed away a lifetime of income in order to own a home. Today, personal sector debt has reached breathtaking levels. It is now highly doubtful that much of it can be paid back, and for the first time since the 1720 south sea bubble, the UK is on the brink of a systemic financial sector meltdown.
Housing supply is perhaps the most misunderstood part of the market. First, in terms of physical supply of dwellings, the UK has rather a lot of housing. In fact, it currently has around 26 million dwellings. There are around 60 million people living in the UK at the moment, which means that there is one dwelling for approximately every two people.
Furthermore, the number of dwellings is increasing. Back in 1991, there were about 23.5 million homes, so we are up almost 2.5 million homes in about 17 years. Unfortunately, housing construction is also the most regulated activity in the UK. A person may own a piece of land, but she can do nothing with it without the permission of the state. For the last twenty years, the state has used draconian planning procedures to limit the number of new homes to about 200,000 each year. Why it should be so is a mystery, but the quantity restriction is impervious to demographics, income growth or household size.
Recent construction activity has focused on flat conversions or multi-occupancy dwellings. There is a sad irony here. The vast majority of Brits would prefer to live in a house, rather than an apartment. However, people’s true preferences rarely figure in madhouse we call the UK housing market. Planning restrictions creates a nest of perverse incentives that pushes the construction industry into building what the state will permit rather than what people want.
The consequences of this socialistic control of supply and extravagant credit have been appalling. It has generated enormous wealth for older homeowners, while placing a generation of younger homeowners into a lifetime of crippling debt.
The housing market has also distorted the economy. It has promoted the financial sector, and crippled manufacturing. Instead of developing productive capacity, credit has been channeled into financing housing transactions, which has left some people richer than they should be, while leaving others with more debt than they can pay off.
Today, around one worker in five works in the financial sector while just one person in ten works in manufacturing. So far, the UK has got away with this lop-sided economic structure by financing today's consumption with tomorrow's expected income. However, it cannot go on for much longer. People simply cannot absorb any more debt.
It also created a new class of naive property speculators who believe that these distortions can be exploited to generate huge capital gains. In the past, this belief was vindicated. However, the UK housing market is treacherous terrain. The banks, which have driven up demand with easy credit, are now pulling away. Housing prices can not grow infinitely, and a reversal is under way, threatening to impoverish many buy-to-let investors.
The collapse of Northern Rock signaled the end of the credit-financed housing boom. Mortgage approvals are now down by around 40 percent. House prices began falling in July last year. UK banks are experiencing increasing mortgage default rates, while write-offs for unsecured debt have skyrocketed. Unsurprisingly, the first sector to show signs of a slowdown was financial services, while the rest of the economy looks likely to move into recession sometime this year.
Therefore, it is not hard to understand why people are so afraid. While the planning restrictions will survive, it alone will not prevent a dramatic reversal in prices. The unfolding housing market correction threatens to expose all the underlying weaknesses of the UK economy and all that fear will be replaced by pain and loss.
Data sources:The numbers on house dwellings come from
table 101 , which can be found on the misnamed Communities and Local Government website. Employment percentages were calculated using ONS data; LOMA for banking and finance and LOLO for manufacturing.
It is amazing how the main stream media miss the really big financial stories.
