Time to let the housing bubble burst



The housing market is, almost certainly, a bubble. As the graph of inflation-adjusted house prices above (taken from HousePriceCrash.co.uk) shows, there has been a steady rise in the real cost of a home over the past fifteen years. Like most other bubbles, it is a product of sustained government policies designed to privilege a special interest group – in this case, homeowners.

Government after government has tried to keep the bubble inflated to avoid their wrath. The more people throw their life’s savings into housing, the more the pressure on government grows to protect these investments. The consequences for the rest of the country have been ruinous: increased cost of rents, urban sprawl, inflation and a shortage of affordable homes. The poor – who are also the least electorally engaged, and so less important to politicians of all stripes –have been especially hard-hit.

In an ordinary industry, the huge demand for housing would provoke a big increase in homebuilding, including at the lower end of the market. But the supply side of the housing sector is tightly bound by the planning system. The planning laws in this country are a classic case of NIMBYism. Increasing the supply of homes in an area will reduce the cost and value of homes already there, so local authorities have no incentive to ease regulations to increase supply. Such is the flaw in democracy – established groups can use government to restrict competition and enrich themselves.

So, rather than tackling the supply side of housing and trying to create more homes, the government throws money at the demand side. But this only makes the problem worse. Shared equity schemes and artificially-cheap credit, created by the Bank of England, all lead to increasing prices without a corresponding increase in supply. Home buyers depend heavily on borrowed money, so the political pressure on the government to keep the price of money low is enormous. And the higher prices grow, the greater the pressure is to make borrowing cheap. This whole mechanism entirely divorces interest rates from their true function, which is to reflect the supply and demand of money – ie, savings and borrowing. This disrupts relative prices (and thus the structure of production) across the whole economy, and fuels the bidding war over houses.

If government’s protection of house prices was removed – most importantly, the planning system that depresses supply and the artificially cheap credit that inflates demand – the supply of houses that people want to live in would rise and house prices would fall. Homeowners should not be able to use government to protect their investments at everybody else’s expense. With a looming housing crisis and house prices at an all-time high, it's time to let the bubble burst.