Why falling house prices aren’t a cure for the UK’s broken economic model

Until the economy’s overdependence on finance is ended, lower prices risk triggering a recession that costs us all. 

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The outlook for the UK housing market, according to a survey released today, is the worst for 20 years. Almost 30 per cent of Royal Institution of Chartered Surveyors members expect house prices to fall over the next three months. House prices in London have been declining all year – a trend that portends falls in other parts of the country.  

This negative outlook follows stress tests by the Bank of England, which suggested that, in the event of a no-deal Brexit, house prices might fall by up to 30 per cent. This was, of course, a worst case scenario – falls of such magnitude are highly unlikely even with the most disorderly Brexit. But the news still added to a pervasive sense of pessimism in the UK housing market.

Some might ask why falling house prices should lead to such doom and gloom. Those of us who have grown up in the shadow of the financial crisis have seen house prices tear away from stagnant wages. Home ownership amongst 25-34 year olds has fallen from 51 per cent in 1989 to 28 per cent today. A sharp fall in prices would make housing significantly more affordable for those who haven’t yet made it onto the ladder.

But non-owners might want to think twice before welcoming a fall in prices. For in the UK, housing is not simply housing. The property market is now so central to the British growth model that changes in prices can have far-reaching effects on the rest of the economy.

Our property-owning democracy was born in the 1980s, when Margaret Thatcher fundamentally reshaped the British housing market in two ways. The first was through Right to Buy – the flagship policy that gave social housing tenants the chance to buy their council homes. The second was the deregulation of commercial banking and the demutualisation of the UK’s building societies, which led to a massive expansion in mortgage lending. Total household debt rose from around 80 per cent of households’ disposable incomes in the 1980s to a historic high of 148 per cent in 2008, with the vast majority comprising mortgage debt.

If the supply of housing remains the same, but more money is being created to purchase it, prices will inevitably rise. As mortgage lending began to diverge from housing supply, prices skyrocketed, increasing at twice the rate of consumer price inflation between 1979 and 2017.

With similar processes underway in the US, this mortgage lending provided the raw material for the financial boom of the Nineties and Noughties. The deregulated financial sector in London exploded, and a professional services cottage industry sprung up around it. The City sucked in capital from the rest of the world, pushing up the UK’s exchange rate and damaging regional manufacturers. And the capital gains accrued by those who were able to buy property before the bubble burst created a wealth effect that stimulated consumer spending.

As we now know, the foundations for this model were profoundly flawed. When the bubble burst, the underlying fragilities of the finance-led growth model were exposed. Today, we live in a property-owning oligopoly in which capital gains for home owners only partially conceal stagnant wages and a faltering economy.

This is the central problem that a house price crash creates for the UK: it undermines the only remaining engine of demand – debt-fuelled consumption. If consumers do not anticipate future increases in their wealth or wages, they are less likely to borrow to finance current spending. In the context of wage stagnation, and without house price inflation, weak growth in the UK may turn into a recession.

None of this is an argument to keep house prices exorbitantly high. As we saw in 2008, house price inflation cannot permanently exceed wage increases. What is required is a fundamental transformation of the way the British economy functions: we must build an economy based on green, sustainable growth, rather than debt-fuelled consumption.

On the one hand, this requires a restoration of workers’ bargaining power to increase wages, and a deep rethink of the commercial banking system, including a write-down of existing consumer debt. On the other hand, it requires the socialisation of wealth and ownership to ensure that a shrinking oligopoly does not monopolise the capital gains created by growth. And all of this must take place in the context of a fundamental rethink of what a healthy economy looks like – finance-led growth that increases indebtedness and damages our environment should not be considered growth at all.

The Labour Party is beginning to come to terms with many of these ideas, though there is still far to go. But whilst we are faced with a government that seems deeply uninterested in dealing with any of these structural economic issues, falling house prices do not spell good news for the British economy.

Grace Blakeley is the New Statesman’s economics commentator and a research fellow at IPPR.