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
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.”
Drama is right: “Osborne bets the
house on helping HALF A MILLION families buy new homes with astonishing £130bn
pledge to bankroll mortgages,” the Daily
Mail screamed after the Budget speech.
“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
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
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
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
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
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
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
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.