Why Are Houses So Expensive?
As a young solicitor in Auckland in the early 1960s, I handled the conveyancing for young couples who were buying their first home. It was one of the more satisfying parts of my work.
At that time, a deposit of just L50 ($100) would purchase, for a total price of L850 ($1700), what was called a deferred licence on a quarter-acre section. It was then possible to borrow the total cost of building a new house through a 100% mortgage either with the State Advances Corporation at 3% interest or with a non profit-making building society with which the young couple had been saving and of which they were members and co-owners.
These arrangements promoted what was then virtually the highest rate of home ownership in the developed world. Many young families were enabled to bring up their children in the secure environment provided by ownership of their own homes. It is hard to know why that was possible 50 years ago but is said to be beyond our reach today.
The damage done by the shortage of affordable housing today does not need emphasis. Young families with children are growing up in conditions that threaten their health, handicap their education prospects and destroy their life chances. The benefits to those who already own their homes of the rapid, unearned and untaxed growth in the value of their housing equity, by contrast, represent a huge transfer of wealth from the poor to the well-off. We cannot be surprised that New Zealand today is disfigured by growing inequality.
The contrast between 1960 and today in terms of housing affordability is the result of a fundamental shift in policy. In 1960, decent housing for all was seen as a social responsibility to be discharged by the community through its government or through cooperative arrangements. Today, confidence is reposed in the market to achieve this same outcome.
The evidence as to which is the better approach is surely conclusive; the market has – in this respect at least – failed. But, says the government, that is not the fault of the “free market” (which ideology asserts is infallible), but rather the consequence of “rigidities” which stop the market from operating as it should.
The argument is the same as that used to explain why the market has produced an historically high rate of unemployment. The reason for this, we are told, is that “labour market rigidities” preclude a low enough price of labour to clear the market.
In the case of unemployment, in other words, the fault is said to lie with the trade unions, notwithstanding their “small influence” – described by the Prime Minister as a principal reason (together with a tax gift of $67 million) for Warner Bros deigning to come here to make The Hobbits.
In the case of affordable housing, the villains are supposedly the local authorities. Again, the government – and “free-market” theory – cannot, it seems, be blamed. In both cases, not only does the government deny responsibility but they have conveniently found a scapegoat in those who do not share their political view.
Abandoning the effective planning of land usage, however, so that developers were free to go wherever and do whatever they liked, might stimulate a short burst in property development and building activity, but is unlikely to bring down the cost of housing in the long term. Much more likely would be a surge in the profits made by both property developers and banks – both significant elements in pushing up the cost of housing.
The very term “property development” gives the game away. The development value of land, which is almost entirely produced by the wider community’s success in building new communities and local economies, has been siphoned off into private pockets.
An even more significant factor has been the increasing role of the banks in financing house purchase. With the replacement of mutually owned building societies by profit-making banks, the whole nature of lending for house purchase has changed. The banks make most of their money from lending on mortgage. Its appeal is that it is risk-free lending, with houses providing real and immoveable assets as security. It is in the banks’ interests to go on lending ever more; they thereby apply in effect a huge pair of bellows to the housing market.
The huge increase in the money supply caused by inflated bank lending for non-productive housing, moreover, seriously skews the whole economy. It diverts investment away from productive investment and into housing and creates an asset inflation problem which we choose – unbelievably – to address by raising interest rates so that productive investment becomes even less attractive and housing yet more expensive.
It is encouraging to note the first glimmers of recognition of this issue in the Reserve Bank’s contemplation of “macro-prudential” measures to restrain bank lending; but their emphasis is still on the health of the banks’ balance sheets rather than on the distortion of the macro-economy. And, as on so many issues, the government’s loyalties seem to lie with its big business and corporate backers, rather than with families and children in need.
Bryan Gould
29 January 2013
This article was published in the NZ Herald on 31 January
Why Housing Isn’t Affordable
As a young solicitor in Auckland in the early 1960s, I handled the conveyancing for a number of young couples who were buying their first home. It was one of the more satisfying parts of my work.
At that time, a deposit of just L50 ($100) would purchase, for a total price of L850 ($1700), what was called a deferred licence on a quarter-acre section. It was then possible to borrow the total cost of building a new house on the section through a low-interest 100% mortgage with the State Advances Corporation or the non profit-making building society with which the young couple had been saving and of which they were members and co-owners.
These arrangements promoted what was then virtually the highest rate of home ownership in the developed world. Many young families were enabled to bring up their children in the secure environment provided by ownership of their own homes. But I suppose we must have been doing something wrong, because that system was changed for what was supposedly something better.
We know that the changes have achieved their purpose because of the huge fortunes made out of the housing sector by property developers over recent decades and the even greater profits from lending on mortgage made by our Australian banks and repatriated to Australia. In that respect, the changed policies have been a roaring success.
What a pity, though, that the impact on the availability of affordable housing was not so positive. By the time I returned to New Zealand in 1994, home ownership had passed beyond the reach of many young families; and housing is even less affordable today, with the result that home ownership rates have slumped and we are rapidly approaching a housing crisis.
The government is of course concerned. It would like to do something to help, as witness their response this week to the recommendations of the Productivity Commission on the subject. True to form, however, they look everywhere for solutions rather than where the real responsibility lies.
The government prefers to avert its gaze from what has really happened to create the housing crisis. The fortunes made from property development by some of our most successful business leaders have come from somewhere – and that “somewhere” is an important element in the hugely inflated prices now being asked and paid for houses. The very term “property development” gives the game away. The development value of property, which is almost entirely produced by the wider community’s success in building new communities and local economies, has been siphoned off into private pockets.
An even more significant factor has been the increasing role of the banks in financing house purchase. With the replacement of mutually owned building societies by profit-making banks, the whole nature of lending for house purchase has changed. The banks make most of their money from lending on mortgage. Its appeal is that it is risk-free lending, with houses providing real and immoveable assets as security. It is in the banks’ interests to go on lending ever more, whatever the consequences for individual borrowers or for the housing market or for the economy as a whole.
The banks have in effect applied a huge pair of bellows to the housing market and have accordingly inflated house prices to their current – and, for many, unaffordable – levels. They are about to start all over again, as the Auckland market already demonstrates. The increased prices being paid by house purchasers will in effect disappear westwards across the Tasman as bank profits. If we want an explanation of the huge rise in housing prices, that is where we should look first.
It is hard to exaggerate the price we pay for these excesses. Not only have we generated a quite unnecessary housing crisis, but we have also created a powerful mechanism for creating ever-widening inequality, as the untaxed capital gains as a result of house price inflation mean that wealth is in effect transferred to those who own homes and away from those who cannot afford them.
The huge increase in the money supply caused by inflated bank lending for non-productive housing purposes, moreover, seriously skews the whole economy. It diverts resources from productive investment and creates an inflation problem which we choose – unbelievably – to address by raising interest rates so that productive investment becomes even less attractive and bank profits grow even larger.
The government’s response to all of this? More of the same. Their “remedy” is to remove remaining restrictions on property developers – even to the extent of displacing families from their homes to allow private “redevelopment” to occur – and to bypass elected authorities so that the community interest or environmental concern can no longer inhibit the drive for profit. And they set their face against any change in the monetary policy that conveniently overlooks the damaging role played by excessive bank lending.
As on so many issues, the government’s loyalties seem to lie with its big business and corporate backers. As we assess the government’s plans, let us remember that families without decent homes, and children being brought up in unsafe and unhealthy conditions, need and deserve more than crocodile tears.
Bryan Gould
29 October 2012
The Beginning of the End of the Road
Let’s hear it, for once, for our politicians. It’s not every country that has a Finance Minister with the good sense to recognise a policy dead-end when he sees one and with the courage to try to do something about it.
The mere prospect of a discussion about a mortgage interest levy is enough to send some people into a panic attack. Those who are ready to consider more complex solutions to difficult problems will always be easy targets for the self-interested and short-sighted. But most thoughtful people will accept that an informed debate about possible alternatives to current orthodoxy is long overdue.
Spare a thought, for example, for Alan Bollard and the plight in which the Reserve Bank governor finds himself. He is like a doctor who prescribes a drug to treat a fever, only to find that the treatment is less and less effective in controlling the fever, but more and more damaging to the patient’s overall health. What is he to do? Does he continue with the drug, and risk long-term damage to the patient, or does he seek a different and more effective treatment?
Most commentators now expect that a commitment to monetarist orthodoxy will require an early hike in interest rates. This can only be regarded as a counsel of despair. The outcome of such a step is all too predictable – an inflow of “hot money” producing a further rise in an already over-valued dollar, a further loss of productive capacity, a further (and unsustainable) worsening of our current account, and the certainty that the day of reckoning, when it comes, will be terrible.
Yet, for as long as current orthodoxy remains dominant, he has no other option. The across-the-board raising of interest rates is his only weapon, even though it is increasingly ineffective and increasingly damaging.
We do not need to look far for the reasons. Much is made of the high proportion of New Zealanders with fixed-rate mortgages who are therefore insulated against the immediate effects of rate rises. I believe, however, that the problems are more deep-seated than this.
The New Zealand economy is now, as most commentators recognise, and as a consequence of decades of monetarist orthodoxy, seriously out of balance. The reality (and when not actual, the prospect) of an overvalued currency has meant increasingly a low-productivity, low-profit productive sector. The housing sector, by contrast, has been buoyant and a much more attractive prospect for investment. That has produced its own momentum. The higher house prices go, the more convinced people are that housing is the best investment, and the buoyant demand pushes house prices higher again.
In this scenario, interest rate rises are not only unhelpful to the counter-inflationary battle. They threaten to make matters worse. They raise the costs of building and buying houses, but so buoyant is the housing market that that cost increase is painlessly absorbed into the price structure, and provides a further fillip to rising prices.
If Alan Bollard is to bring that process under control, he will have to raise interest rates to dizzying levels, sufficient to stop economic activity dead in its tracks. The price for relying on across-the-board interest rate hikes in order to control inflation is, in other words, a further and debilitating blow to the health of our overall economy.
Those who are already squealing at the (still remote) prospect of new measures like a mortgage rate levy should recognise, in other words, that the alternative to new thinking is not “do nothing”. The only other option is a general rise in interest rates, which will still raise mortgage payments for home-owners, but will also threaten economic activity on the grand scale. Those who fear for their homes will have to look to their jobs as a well.
It is very much to the credit of Michael Cullen and Alan Bollard that they have had the intellectual and political fortitude to think the hitherto unthinkable. New Zealand is probably the first advanced country in the world to have first committed itself to monetarist orthodoxy, then tested it virtually to destruction, recognised its limitations, and then dared to contemplate better ways of doing things.
No one is saying that monetary policy should be abandoned as a counter-inflationary instrument. But the old simple certainties – that controlling the money supply through regulating its price was an effective and painless way of controlling inflation – have now been fatally undermined. A mortgage interest rate levy may or may not prove to be useful, but selective measures and fiscal policy will surely now play a larger role. A new era has begun.
Bryan Gould
9 February 2007