The housing conundrum

Almost four years on from the onset of the financial crisis, the US housing market remains deeply depressed, as The Independent reported this week:

The ailing US housing market passed a grim milestone in the first quarter of this year, posting a further deterioration that means the fall in house prices is now greater than that suffered during the Great Depression.

The brief recovery in prices in 2009, spurred by government aid to first-time buyers, has now been entirely snuffed out, and the average American home now costs 33 per cent less than it did at the peak of the housing bubble in 2007. The peak-to-trough fall in house prices in the 1930s Depression was 31 per cent – and prices took 19 years to recover after that downturn.

There are calls from all sides for the Fed to start raising interest rates from the "emergency" levels adopted in response to the crisis, and to refrain from any more quantitative easing. Realistically, though, what prospect is there of that, when the housing market, the key to so many Americans' wealth, is so chronically weak?

Here in the UK, the housing market is also making life difficult for policy makers, though the problem is more nuanced than in the US. House prices fell in the immediate aftermath of the financial crisis, but by nothing like as much as in the US. Moreover, the decline has already been reversed in London and the South-East of England, but prices in other parts of the country remain depressed. The media never tire of warning the Bank of England that any attempt to raise interest rates would cripple the large proportion of UK homeowners with floating rate mortgages, pushing the economy back into recession. As a result, while inflation heads towards 5%, the Bank continues to sit on its hands, praying that the relentless price pressures will prove transitory.

Surprisingly, the relative resilience of UK house prices, at least compared to the US (and Spain and Ireland) is not a sign of a healthy market. There is widespread concern that the market remains closed to new buyers, who find it difficult to raise the much larger down-payments that lenders, once eager to provide 95% of the cost of a property, are now demanding. Stories about a new "Generation Rent" fill the tabloids, and in a country as property-obsessed as the UK, there could be no greater stigma.

The real problem, one that the tabloids and the media generally will only whisper for fear of causing their readers in the shires to expire over their cornflakes, is that house prices in the UK are still too high. Years of exuberant lending pushed prices to unprecedented levels. Now that the banks have returned to more prudent lending criteria, the affordability of homes at the bottom end of the market is historically low.

What to do? Middle England (and Wales and Scotland) would rebel if any steps were taken to bring prices down. So a way has to be found to get new buyers onto the housing ladder (or treadmill, if you prefer). The latest proposal is that homebuilders should contribute to a fund to help young adults to meet the downpayments that lenders are now demanding. You probably don't need a PhD in economics (which is just as well, since I don't have one) to figure out that the homebuilders will simply raise their prices in order to meet the costs of this downpayment fund, so the proposal will fail to improve the overall affordability of housing in a sustainable way. It will also tend to bias first-time buyers toward new-build rather than existing homes. This may suit the building trades, but will distort the market, seriously hurting homeowners thinking of moving up from their starter homes.

There is no easy answer here. There never will be, as long as Brits insist on seeing housing as a failsafe investment, and no government has the courage to tell them they're deluding themselves.