Nicole Gelinas: Osborne's “Help to Buy” violates every principle of economics – and of fiscal governance, too
Nicole Gelinas is a contributing editor to the Manhattan Institute’s City Journal. Follow Nicole on Twitter.
George Osborne wants to help young Britons – by using them to keep bailing out the pre-2008 economy.
For more than three years, Chancellor George Osborne has insisted that his austerity goal is to reduce the size of the British state – and to unleash private-sector prosperity. The centrepiece of his Budget 2013 speech on Wednesday – his “Help to Buy” scheme for would-be house-purchasers – could help to smash those goals.
If Help to Buy works as advertised, it will lure yet another generation of Britons into unsustainable debt. Help to Buy will make Britons dependent, too on yet another expensive government entitlement programme. And even people savvy enough to avoid this new debt trap will suffer.
Rather than admit that the Coalition’s policy of tax hikes and front-line service cuts hasn’t worked, Osborne has devised a big distraction. Citing stringent bank-lending standards that “have put home ownership beyond the great majority who cannot turn to their parents for a contribution,” he proposed in the speech to “put that right – and put it right in a dramatic way.”
“Help to Buy” would work as follows. First, HM Treasury will commit £3.5 billion in capital over three years to help people purchase newly built houses for up to £600,000 without having to save up a big cash deposit. Instead, home buyers will be able to put just 5 percent down, and borrow another 20 percent from the government, interest-free for five years. Borrowers will have to repay the loan only when they sell the home.
And fiscal hawks shouldn’t worry in the meantime, Osborne said. Because the housing scheme “is a financial transaction, with the taxpayer making an investment and getting a return, it won’t hit our deficit,” he promised.
Second, Treasury will support £130 billion worth of mortgage loans with a direct government guarantee. “These guaranteed mortgages will be available to all homeowners” Osborne said, noting that buyers of all incomes could use such guarantees to purchase new houses or old. “Using the government’s balance sheet to back these higher loan-to-value mortgages will dramatically increase their availability,” he explained. This venture, too, will run for three years.
“Help to Buy” violates every principle of economics – and of fiscal governance, too.
Yes, it is frustrating that a young middle-class person – or even a middle-aged person – can work hard for years and still not be able to afford a house, especially in or near expensive London. And yes, it’s frustrating that banks have tightened their lending standards, leaving people who purchased when standards were lax stuck holding properties they can’t sell at a profit.
But the fact that an average person can’t afford a house is, by definition, a sign that houses probably still cost too much.
The numbers bear this out. More than a half-decade after the credit bubble burst, a home buyer must spend four and a half years’ worth of income to purchase a home, according to the Halifax House Price Index – less than the nearly six times he would have had to pay in mid-2007, but still 25 percentmore than the roughly 3.6 times their income they would have had to pay, on average, between 1983 (the first year that data exists) and 2000.
Put another way, to return to the pre-bubble norm, the average home today would cost £131,000, not £164,000 (obviously much higher in some areas than others).
The remedy for this problem is to let house prices fall. In the real world, if your customers can’t afford your product, you have to lower the price.
Coincidentally, higher deposit requirements and tighter lending standards help in that process. Think of a cash deposit as a lead weight tethered to a balloon powered by debt. Without that weight, the balloon can rise infinitely (until it bursts at the edge of the atmosphere).
This needed market correction has worked: prices are down 18 percent from their 2007 peak.
The problem is that absent massive government intervention to prop them up, house prices may not be done falling – when the Cameron government would love to be able to say a housing recovery took off on their watch.
Another problem is that falling house prices aren’t good news for existing home owners or home builders – two important political constituencies.
But it’s simple mathematics that while higher house prices are good for sellers and builders, they’re bad for buyers. Osborne unwittingly pointed up this contraction in his speech. “It’s a great deal for homebuyers,” he said. “It’s [also] a great support for home builders.”
Both of those things cannot be true. A home builder wants to sell his house for as much as possible. A home buyer wants to pay as little as possible. Buyers and sellers should be at odds; that tension is what makes for a healthy market. Now, Osborne wants to tip the scales in the sellers’ favor.
Osborne wants to tip the scale in favor of lenders, not borrowers, as well. The Chancellor said that the guaranteed loans would be “subject to the usual checks on responsible lending.” But lenders have no incentive to be responsible if they know the government is there to pick up the tab if things go wrong. Without the possibility of big losses, they’ll lend too much – and borrowers will owe too much.
Young people should be concerned that Osborne wants to use them as a vessel to bail out existing homeowners, home builders, and banks.
Of course, it is annoying to feel as though you’re throwing money away by paying rent for years. It will be far more annoying to learn that you’ve saddled oneself with debt that you cannot repay – and that you cannot move house for a better job opportunity or a growing family in five years’ time, because you still owe more money on your government-backed loans than your house is worth.
That is exactly what happened in America after President Barack Obama pushed a similar “First-time Homebuyer Tax Credit” in his 2009 stimulus. The credit offered new homebuyers $8,000 if they bought a house in 2009 or early 2010. But as Dean Baker of the Center for Economic and Policy Research found, the scheme was a boon for existing homeowners who “could sell their homes at prices that were still partially inflated …. This was good for these homeowners, as well as their creditors …. However, it was bad news for homebuyers who were persuaded to buy homes at prices that were often still above trend values.”
If buyers had waited, they could have bought for cheaper – often, more than $8,000 cheaper. “After the end of the … credit, home prices began to resume their fall,” Baker concluded.
The British programme carries an even bigger risk. In America, most mortgages are for 30-year fixed rates. Borrowers, then, are not vulnerable to sudden interest-rate swings. In Britain, most mortgages are for shorter periods and are tied to government interest rates when they re-set.
What happens to a person who purchases a home now when official interests are near zero, if that person must sell in half a decade’s time, when rates could be, say, five to seven percent? The seller will have to take a loss. Why? The new buyer, thanks to the higher interest rates, won’t be able to afford to pay as much for the house.
Luring more people into dependence on super-low interest rates also could lock the Bank of England into keeping rates far too low, too long. After all, the central bank doesn’t want to cause the next housing crisis in a few years’ time by hiking rates on mortgage borrowers.
But too-low rates spur inflation – pushing the cost of everyday goods and services up even for people who don’t take up Osborne’s offer to borrow too much.
Osborne is being a bit clever when he assures the British public that “a future Government would need the agreement of the Bank of England” to extend Help to Buy beyond three years. The problem is the Bank may have to support an extension of the programme, and even deeper direct subsidies for home buyers – or the Bank could find that nobody can afford to buy a house absent inflationary interest rates.
The most worrisome part of Osborne’s idea is his claim that it’s “a good use of this Government’s fiscal credibility.”
No – it’s not. What Osborne is proposing is a version of America has done for decades. Through entities like Fannie Mae, Freddie Mae, and the Federal Housing Administration, Washington has controlled the mortgage-market for half a century. Just like “Help to Buy,” mortgage lending under Fannie and Freddie was supposed to be off America’s official books. Fannie and Freddie were ostensibly private companies that enjoyed only government guarantees, not direct government subsidies.
Ask the Americans who have had to fork over more than £133 billion to bail out Fannie and Freddie since 2008 how that “financial-market” transaction has worked out for the government’s own deficits.
In his Budget Speech Wednesday, Osborne proudly said that Britain’s nascent mortgage-guarantee scheme “has not been seen before in this country.”
Sometimes that’s a good thing. Conservative politicians would help keep it that way.