Why can’t you afford a home? There are simple answers to this question that have proven politically very popular: not enough homes, too many immigrants, overly zealous planning laws. Some of these issues are relevant. But there are more fundamental forces at work. The demand for landed property has become excessive and speculative. Banking systems in modern capitalist economies no longer engage in the activity our textbooks say they do. They have become primarily real estate lenders, creating credit and money that flows into an existing and fixed supply of land. This pushes up house prices, creating ever more demand for mortgage credit and higher profits for banks.
Through these profits, the banking system – and other financial institutions which buy mortgage-backed securities issued by banks – capitalizes the land rents from rising prices that their own lending helps to generate. This housing–finance feedback cycle has come to dominate late capitalist economies, squeezing consumer demand and productive investment, just as the classical economists feared when most land was used for agriculture. Yet few policy makers or economists appear to recognize this.
Land and money are two of the most neglected concepts in economic theory. Land is immobile, irreproducible and appreciates in value over time due to collective investment – none of these features apply to capital goods. Yet modern economics and national accounts treat them as one and the same. Banks create new money and credit when they lend and their lending decisions can support production and economic growth – or pump up land and house prices. A lightly regulated, profit-orientated banking system will naturally drift towards mortgage credit and away from business lending. This dynamic needs to be viewed as an iron-law, not some short-term aspect of the ‘business cycle’. A ‘free market’ in land and credit will not optimize social welfare: it will lead to increasing economic rents, unaffordability, inequality, debt and, ultimately, financial crisis.
The difficulty is in how to intervene in a way that is politically acceptable and economically manageable. For many years the gradual expansion of mortgage credit supported increasing levels of home ownership across Western democracies, complementing rising growth and productivity. But the 1930s–1970s period was also one when mortgage credit was controlled, limited to specialist financial institutions separated from the wider financial system. At the same time, the transport revolution freed up land and enabled the creation of suburbs that brought down the cost of housing and spread wealth. Housing finance and home ownership were just one part of a broader Keynesian economic model whose primary driver was capital investment by the state, the banking system and firms.
By the 1970s, this model was under pressure. Faced with mounting public debts and difficult distributional choices, Anglo-Saxon governments liberalized mortgage finance to further spread home ownership even as growth and incomes began to falter. For a long period, rising house prices combined with liberalized finance appeared to happily be sustaining consumption and stable economic growth. Mortgage finance went global, with securitization and related financial innovations enabling mortgage debt to be packaged up and distributed across the world.
But this ‘Great Moderation’ was an illusion. The smoothing of the business cycle enabled by mortgage lending was disguising an unsustainable increase in house prices and household debt relative to incomes. The collapse of the sub-prime mortgage market in the US sent Western capitalism into its worst crisis since the Great Depression, so ingrained had the housing–finance feedback cycle become in our economic architecture.
‘Residential capitalism’ is no longer a sustainable path for modern economies. Deep systemic reforms will be required to break free of the housing–finance feedback cycle. But we are not starting from scratch. A number of economically successful advanced economies have found ways of keeping house prices at more manageable levels relative to incomes. Key to this has been maintaining tight control over mortgage credit creation. Countries with more flexible mortgage markets, high levels of securitization, variable interest rates and high levels of equity withdrawal tend to have high and more volatile house prices. The more liberalized the financial system, the stronger the feedback between house prices, consumption and the wider economy.
Complementing tighter regulations should be the creation or expansion of state investment banks and stakeholder banks able to provide long-term, highrisk capital to support innovation and provide the next generation of infrastructure needed to support the transition to a low-carbon economy. The huge demand subsidies that governments have showered on home ownership would be better employed stimulating capital investment and innovation in more productive sectors of the economy, which have suffered under austerity policies.
The public sector must also take a much more interventionist role in shaping the land market and ensuring it creates public value, not just short-term capital gains or rentier incomes for speculative domestic and international investors. Retaining public control over land and the usage of land appears key. It is remarkable that house price-to-income ratios have been moving in the opposite direction in Western democracies and mature East Asian economies such as Korea, Japan and Singapore. But in these latter economies, land and the economic rents from rising land values are socialized to a much greater extent.
If large-scale land nationalization is not politically feasible in Western democracies, then perhaps we need to accept that the dream of the ‘home-owning democracy’ must now be abandoned and consider the idea of more balanced tenure mixes. Western European countries such as Germany, Austria and Switzerland have not experienced the rapid house price increases of the majority of the West, but all have home ownership levels at or below 50% and enjoy generous provision of rental and social housing. Anglo-Saxon economies should follow suit and end the favourable fiscal treatment of home ownership over other tenures. Private renting, public and cooperative housing systems must be properly funded. Taxation systems in general need to move away from labour and on to land rents.
And our political leaders must be brave enough to stand up to vested interests and make the case for housing returning to be primarily a source of shelter, not a financial asset. A new narrative focused on secure, affordable housing for all citizens as a right must be established, as opposed to housing as a means of securing financial wealth. As home ownership moves out of the reach of more and more young and poorer households, this process should become easier. But the key will be to find a way of de-linking our financial system and wider economy from where we live without causing financial havoc. Governments should be taking steps now to direct finance towards more productive ends, not least the creation of housing and transport infrastructure that would boost economic growth and consumption but ease pressure on our cities. A gradual, managed house price deflation is required with demand coming from investment and production, not off the back of rising asset prices. Then we can begin to break free of the housing–finance feedback cycle.