Exploding the housing market myths
If you want to encourage divorce and speed up family breakdown then by all means build more houses
Monday 12 July 1999
Myth 1: "At the moment there are more buyers than sellers."
This is nonsense at an impressively large number of levels. Every time there is a sale there is a buy so sellers and buyers have to balance. What the proposition may mean is that prices do not clear the market because there is, on average, more than one buyer prepared to pay the transaction price for each house actually sold. And, by implication, the thwarted buyers cannot do anything about this. This proposition might be true of the demand/supply balance in a centrally planned economy where prices are set by bureaucrats and queues are endemic. But the idea that the asking price of a house does not move up when more than one person is prepared to pay that price is false. Price nearly always rises by just enough to make all but one potential buyer grumpily skulk off. If this didn't happen estate agents, who are the agents of sellers, are doing a rotten job.
Myth 2: "People are now buying houses as places to live in, not for speculative reasons."
The only real sense I can make of this proposition is that people are, supposedly, no longer trying to figure out what the price of the house they are about to buy might be in a few years' time. But people would be mad to "stop speculating" if that means no speculating about future values. "Speculation" means "thinking about". Anyone who bought a house without speculating on its future value is crazy. So this proposition boils down to one which asserts that people are myopic, irrational and ... well ... crazy.
Myth 3: "Inflation will now be low and that is bad for housing."
Real house prices are what matters when we think about the true value of bricks and mortar. The fastest fall in real house prices in the UK occurred in the mid-Seventies when inflation was at its highest. The greatest destroyer of the real value of houses in the UK has been inflation; house prices fell in the early-Nineties because interest rates increased sharply as the government tried to counter sharply rising inflation. (See Table)
Myth 4: "This time it's different ... we will not see house price booms like the Eighties again."
Why not? Certain fundamental features of the housing market have not changed: the amount of land in the UK is fixed; the supply of houses is (in the short-term) fixed; incomes tend to rise; people need to take a view on where they think prices are going in order to work out when to move and what kind of house to buy.
A somewhat more specific version of Myth 4 is ...
Myth 5: "People got burned in the late-Eighties, and they have long memories."
"Long memories" implies that people do not attach a great deal of weight to recent house price changes in forming a view on where prices are going. I know of no evidence that this is so, but plenty of evidence to the contrary. If one is trying to explain volatility of prices and of transactions in the UK over the past 40 years, it is pretty clear that an explanation which assumes people attach a lot of weight to recent conditions and very little to the more distant past in deciding when and what to buy has a better chance of success than an explanation which assumes "long memories".
Myth 6: "When the UK joins a European Monetary Union there will be a house price boom."
First, it is not at all obvious that when the UK does join Emu the European Central Bank's interest rate will be much different from the rate the Bank of England would set. Second, UK bond yields (which tie down the rates set by mortgage lenders on fixed rate loans) already have largely converged on Euro levels. (This is obvious if one calculates so-called "forward rates".)
Myth 7: "We must build four million new houses - largely in the South- east - or there will be a housing shortage."
If no new houses are built there will be no shortage - there will just be higher real house prices. If we want to stop real house prices rising as fast as they otherwise would, building lots of houses will achieve this and will encourage faster household formation rates. Encouraging faster growth in household formation is largely a euphemism for encouraging divorce and family breakdown. If you want to encourage divorce, speed up family breakdown and reduce green space then by all means build more houses. But to talk about "shortages" is misleading, unhelpful and probably harmful.
Myth 8: "House price differences between regions in the UK are far too great and are bad for labour mobility."
On the contrary, house price differences are likely to alleviate crowding in densely crowded areas by encouraging firms and workers to move to areas where the cost of living is lower. The South-east of England is already too crowded and transport systems are cracking. People should be encouraged to move to less crowded areas where houses are empty. Big regional house price gaps help this process.
Myth 9: "Prices just can't keep going up."
Fixed supply of land, rising incomes ... say no more.
Myth 10: "As house prices go up the value of the UK's stock of wealth goes up and we are, nationally, better off."
The problem with this is that UK houses are, overwhelmingly, lived in and owned by current and future UK households. Physical characteristics of houses do not change when prices rise sharply in a boom and it is those characteristics that are valuable. Price rises are a means of rationing demand to match supply; they do not make us better off. This is more obvious when we focus on land - a commodity in fixed supply and whosecharacteristics hardly change. Rising land prices, per se, do not increase national productivity and do not enhance standards of living.
Most of these myths are harmless enough but some are not. Myth 7 is very harmful since the government seems to believe it and appears to be acting on it.
David Miles is Professor of Finance at Imperial College and an adviser to Merrill Lynch.
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