Political manipulation of money at root of housing crisis

The narrative running through political and media characterisation of the housing market goes like this: ‘ever increasing demand for houses, turbo-charged by foreigners looking for a safe-haven, has been met by limited supply causing prices to rise dramatically.  Fortunately, our politicians and the City are on hand to ensure cheap mortgages are available to help you onto the property ladder to prosperity.‘

Is it not also plausible that the rapid expansion of cheap mortgage credit has been a causal driver of house price inflation rather than a consequence of it?

On the face of it you might expect widening access to ever cheaper money simply means more people can buy houses more cheaply.  But if the number of houses doesn't increase to meet demand then more people with more money chase the same properties and prices rise rapidly. Without an excess of supply, above and beyond demand, there is no downward pressure on prices. That is not to say an increasing population and other demographic changes don’t influence house prices but the impact is limited without an associated increase in mortgage lending. 

Prices are set for entire streets and beyond by the last price paid for one house – a price agreed between a buyer (most probably a willing borrower), a seller and a willing lender. Few people would doubt that a rise in interest rates limits people’s ability to borrow thereby reducing house prices. Yet the material effect of borrowing costs on house prices isn’t widely understood. An abundance of credit steadily ratchets up prices. Valuations that would have seemed insane a few years ago now seem reasonable.  Other than an adequate increase in supply the only factor which can temper demand and limit ever increasing price rises is a restriction in the supply of credit. 

Rising prices are only possible if someone has access to money - either savings or money created through lending.  In our system of money when banks make loans they don’t go to a pot of carefully accrued savings, they create new money, quite literally, at the touch of a button. It is money printing. 97% of money consists of deposits created out of thin air by commercials banks. To enable a house purchase there is a limited cost to a bank.

In the absence of new construction, no new wealth is created.  We still have the same number of houses. Credit enabled price rises reallocate money in the form of 'paper claims' from one pocket to another while the actual, consumable, wealth remains the same. More claims for the property haves and less for the property have-nots, who are left facing ever higher rents and mortgage costs. Given that the City is also taking its cut is a high level of wealth inequality really such a surprise?

The effect on the young is particularly pernicious. A substantial levy will be taken from their future incomes and passed to the banks and others benefiting from rising house prices, largely the older generation. The Conservative’s help to buy programme, established under the guise of helping young people get on the housing ladder, is therefore dishonest.

For politicians, unable to structure economic growth yet believing it to be the means to gain and retain power, housing presents a powerful temptation. It is a conduit for large scale money printing which produces a sense of rising wealth and increased purchasing power for those who own houses. This creates a series of consumption driven knock on effects throughout the wider economy.  It is a policy pursued with zeal by both Labour and Conservative governments.  In this light, their claims to have the long-term interests of the economy at heart seem false.

We are told that interest rates are low to motivate investment in new ventures and grow the real economy. The reality is that house price inflation has ensued with an associated boost in consumption by all those with newly printed money in their pockets. 

The fundamental cause of the 2007 financial crisis was lending by the financial sector for property and consumption, rather than investment. Continued misallocation of credit into housing is more of the same. Extraordinary monetary policy measures – such as quantitative easing - are taken to fill the void which appears when reality rears its head and the bubble collapses. This exacerbates inequality and economic instability.

Hubris underlies the widespread belief that high house prices are an intractable consequence of the UK’s economic success. While high house prices have delivered a short-term boost to consumption and some economic growth it is paid for by the young. 

There is an astonishing lack of public debate about credit driven house prices and the consequences of such a large redistribution of wealth. Little attention is paid to the role of credit, a political and regulatory matter, yet it is at the root of the housing crisis. 

About the authors

Jason Leavey is an independent writer and researcher.

Jan Muench works for a bank in New York. He writes in a personal capacity.