Going lower

Originally posted on August 4 on Inside Edge 2, my blog for Inside Housing

Record low interest rates have been great for people with mortgages but terrible for the housing system as a whole.

Like the Bank of England’s decision in March 2009 to cut the base rate to 0.5%, Thursday’s further reduction to 0.25% is motivated by concern about the economy as a whole. But nobody imagined in 2009 that seven and a half years later interest rates would still be as low, still less even lower.

The result has been severe distortion in the housing market. What was only meant to be a temporary fix has instead become a semi-permanent feature of the system that has benefitted home owners and landlords at the expense of everyone else. The effect of Thursday’s small cut will be limited in itself but it means that effects of the low rate regime will be with us for much longer.

The money involved is staggering. People with mortgages are collectively paying £36 bn a year less in interest on them than they were before the March 2009 cut. That’s a substantial boost to the economy in itself, but it also means they can afford a bigger mortgage.

The savings have then been capitalised into house prices and asset prices have been further inflated by other monetary measures such as quantitative easing (restarted on Thursday) and Funding for Lending (a similar scheme was announced on Thursday).

According to the Nationwide, the average UK house price fell from £184,000 just before the credit crunch in 2007 to £150,000 in the first quarter of 2009. It is now £204,000.

That’s created winners and losers. Research by Savills for the Financial Times last year illustrated some of the big winners: buy-to-let landlords had gained £177 bn from capital growth over the previous five years while home owners in London had gained £563 bn.

The losers are most obviously people who cannot afford to buy or who have had to stretch themselves to the limit to get on the housing ladder. However, loose monetary policy has been accompanied by tight fiscal policy. One of the government’s key justifications for austerity has been to keep interest rates low. Renters suffering a cut in their housing benefit have effectively been paying more so that their landlords can pay less.

To her credit, Theresa May has recognised the problem – or at least some of the problem. One of the most interesting lines in the speech she gave during the brief Tory leadership campaign was this:

‘Monetary policy – in the form of super-low interest rates and quantitative easing – has helped those on the property ladder at the expense of those who can’t afford to own their own home.’

The question is what – if anything – she will do about it. Plan A will be to argue that the government is doing everything it can to help people get on the housing ladder. In an interview on the World at One this week (about half an hour in), Gavin Barwell’s response to the latest panic over falling home ownership was to list all the different flavours of Help to Buy and starter homes as evidence that it is pulling out all the stops.

On this point, lower rates do also mean lower borrowing costs for housing associations and the economic weakness the Bank of England detects may make house prices a bit lower than they would otherwise have been.

However, if May is serious about correcting the imbalance Plan A will not wash. The gains from Help to Buy are at best questionable. By enabling first-time buyers to make bigger deposits and afford more expensive homes, it has simply inflated house prices even further. The real winners are again existing home owners.

So what’s the alternative? One option would be to give the Bank of England a target for house price inflation or housing affordability to run alongside its target for general inflation. As advocated by Civitas recently, this would be an extra factor to consider in decisions on interest rates but it might also dictate further macro-prudential measures to control lending. For example, the Reserve Bank of New Zealand is also expected to cut rates this month but prepared the ground for that by tightening mortgage lending restrictions in July.

Another would be to take fiscal measures to correct the imbalance caused by monetary policy. Most obviously, the fiscal ‘reset’ promised in the Autumn Statement could move away from subsidising demand and raiding the affordable housing budget to pay for ownership schemes.

Ironically, the best way to boost home ownership in the longer term might be to support it less. The government could take advantage of low borrowing costs to finance more affordable rented homes and save on housing benefit in the longer term. The programme could include homes for rent to people saving for a deposit to buy in the open market.

Less obviously, and more contentiously, it could look to reform tax. The obvious candidate is stamp duty, which raises billions of pounds a year in revenue but is a tax on transactions and on new buyers. The burden could be shifted to existing owners via reform of the council tax, removal of the capital gains tax exemption on main homes or the introduction of a full land value tax.

In the speech I quoted above (now mysteriously deleted from the internet) Theresa May talked of creating ‘a country that works for everyone’. How serious is she about a housing system that works for everyone?