Friday 13 August 2010

Hair splitting/What can't speak can't lie

TheFatBigot left a comment on Killer arguments against LVT, not (59):

"... people have fixed budgets, and the more they have to pay in interest, the less they will pay for the purchase price." People do not have fixed budgets, although they might have fixed incomes. How they apportion their income between housing costs and other items is hugely variable. Some are prepared to allocate far more to housing than others.

Sure, different households have different incomes; different households on similar incomes have different preferences (some couples buy a house because they are planning on having children; other couples want to go on holidays and not have children so they buy a flat); a couple's preferences may change over time etc.

But, overall this averages out, and the proportion of net income that first-time buyers are prepared to spend on housing is relatively stable, see chart 3 on page 5 of the recent CML report on 'Affordability and first-time buyers' (pdf). As we'd expect, lower interest rates and higher house prices go hand-in-hand and largely cancel each other out* - i.e. low interest rates do not benefit the purchaser; they benefit the vendor.

a) The only significant spike is between 1989 and 1992, which was only partly a result of the previous property price bubble which peaked in 1989. The bulk of it was because during/after the ERM debacle, interest rates shot up much faster than prices were falling (people correctly anticipated that interest rates would fall again).

b) What is also noticeable about that chart is that the ratio (net of MIRAS) did not increase after MIRAS (a subsidy to home buying) was phased out; in relative terms, the withdrawal of the subsidy was counter-acted by prices paid being lower than they would otherwise have been*. This is exactly what we would expect - all subsidies accrue to the least elastic input (TM Dearieme's Dad), which in most cases is land values. So if we introduced such a thing as 'negative MIRAS' (like VAT on mortgage interest, or Land Value Tax) then this would not affect the overall trend either.

Adam then chimed in with this:

Thank you, FB! And we've seen this in action over my lifetime. Average mortgages now are much higher than before, because people have generally decided to put more of their salaries into housing.

Agreed, the average loan-to-income ratio has increased disproportionately, see Charts 1 and 2 of that pdf (even though monthly expenditure in Chart 3 is fairly flat). There are a number of well rehearsed factors at play here:

a) The fact that we are just coming out of the biggest property price bubble ever; the 1970 - 1999 trend line in Chart 1 is more or less flat, but the 1970 - 2009 trend slopes steeply upwards.

b) Over the past five or ten years, people weren't just paying for the value of the house, they were paying for the hope value of future capital gains.

c) Over the very long term (decades or centuries), land values increase disproportionately to overall GDP growth.

d) In the UK, prices are kept artificially high by the NIMBYs, and because interest rates were kept artificially low after the bubble (now more so than ever).

In any event, I see this trend to 'put more of your salary into housing' as A Bad Thing, seeing as it's the same people in the same houses. The Home-Owner-Ists will say that this is A Good Thing, heck knows why anybody would believe them.

* I don't know if that chart is adjusted for the fact that first-time buyers might have been buying smaller properties during property price bubbles:


Bayard said...

"Average mortgages now are much higher than before, because people have generally decided to put more of their salaries into housing"

Only because the banks let them do so. If the interest rates were higher, the multiple of their salaries that people could borrow would be lower. The proportion of salaries paid in interest has remained pretty constant in the long term (see chart 3).

Mark Wadsworth said...

B "Only because the banks let them do so." is putting it mildly. I would say because the Home-Owner-Ist coalition has pressurised/tempted them into doing so.

Bayard said...

Well, if I could have borrowed more than 2.5 times my salary when I took out a mortgage, back in the mid eighties, I would have done (and I was buying mainly because I couldn't find anywhere decent to rent, not just because I saw it as a good investment). IMHO ridiculously high house prices are a direct result of banks allowing people to borrow more (i.e. low interest rates). I don't think much temptation or pressure was/is required.