Why Can't You Afford a Home? by Josh Ryan-Collins

Author:Josh Ryan-Collins
Language: eng
Format: epub
ISBN: 9781509523252
Publisher: Wiley
Published: 2018-11-26T00:00:00+00:00

4

How and Why Economic Policy Went Astray

4.1 How rising house prices can keep the economy afloat

One reason regulators and policy makers didn’t pay enough attention to increasing house prices and mortgage debt relative to incomes in the lead-up to the GFC was that economic growth was generally stable over the period. Financial liberalization meant that those lucky enough to enjoy rising house prices in the 1990s and 2000s were able to increase their consumption, at least for a period. This is significant because consumption makes up around two-thirds of national income in most advanced economies.

This house price–consumption effect works through two channels: a deposit channel and a home equity channel. Higher loan-to-value and loan-to-income ratios on mortgages meant that households needed to save less for a deposit on their homes, meaning they could increase their consumption in the present. Meanwhile, home equity withdrawal enabled households to monetize gains in previously illiquid housing wealth. Between 1989 and 2014, fourteen out of twenty European economies gained formal access to housing equity withdrawal.1

In particular in countries with more liberalized mortgage finance, there is clear evidence of a positive relationship between house prices and consumption.2 Figure 4.1 shows the remarkable growth of home equity withdrawal in the United States in the 2000s running up to the financial crisis. Home equity lines of credit increased from 1% to over 4% of GDP over this period. There are similar dynamics in the UK and Australia. As a result, the stagnation in real wages and productivity experienced in many advanced economies in the 1990s and 2000s thus did not feed through to economic growth, which was being propped up by housing-financed consumption.

The build-up of mortgage debt also smoothed the business cycle by enabling consumption even when wages and productivity were stagnating. But it encouraged excessive leverage in both the banking and household sectors that eventually resulted in fragilities that led to financial collapse.3 The smoothing of the cycle enabled by mortgage lending was simply disguising the build-up of much larger, longer and more dangerous ‘credit’ or ‘financial cycles’ that macroeconomics had neglected for much of the post-war period.

Figure 4.1. US home equity withdrawal, 1990–2017 Source: US Federal Reserve.

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