May 19, 2014
If you were worried about the Dublin property market entering bubble territory, then the government’s plans unveiled during the week, makes that bubble more, not less likely.
The Construction 2020 document is long on aspirations and short on detail. There is lots of talk about task forces, reviews, strategic groups and consultation groups, but in terms of initiatives, there’s nothing. The government says it wants to achieve 60,000 jobs in the construction sector. No one can argue against that. There are tens of thousands of construction workers on the dole and anything which can give these men a chance to work again is laudable.
The other objective is to get the construction sector cranking up to build as many houses as are necessary, so that we don’t find ourselves permanently faced with today’s dilemma where young couples are being priced out of a rapidly rising market by older ‘cash buyers’.
The government has decided to help first-time buyers with a ‘help-to-buy’ scheme, the likes of which was introduced in Britain two years ago. This will involve the state underwriting some of the mortgage so that if the banks get into difficulty in the years ahead with defaults or a massive price crash, the state will pay out. The state is calculating this will help first-time buyers get access to funds because it will coax the banks to lend.
The state is dealing with the housing problem as if the solution is to be found in economics – or classical economics, at least – but this is not the case. The housing market in Ireland is driven by deep psychological urges on the part of most Irish people which renders the old-fashioned laws of supply and demand not just obsolete, but dangerously inaccurate.
Traditional economics says that when the price of something goes up, as is happening now in Dublin housing, buyers will get put off by high prices and will stay out of the market. In contrast, sellers will respond to high prices by seizing the opportunity to sell. In addition, builders will respond to higher prices by building more.
This is actually not what happens. The opposite happens.
People who want to buy respond to higher prices by panicking and wanting to buy more now – not less – because they are worried about prices rising even higher. This means that when the price goes up, demand doesn’t fall, it rises. This is the first mistake of applying economic solutions.
The second mistake is the behaviour of sellers. Traditional economics says sellers will respond to higher prices by selling to take advantage of today’s prices, but this doesn’t happen either. Sellers see house prices rising and think that if prices keep rising, they would be mad to sell now, so they wait to avail of yet higher prices and profits next year.
So, instead of supply increasing when prices rise, supply actually falls as sellers wait. Thus the laws of economics are turned on their heads. In terms of new supply, yes it comes on stream, but only slowly. It takes a long time for an entire sector to grind up a few gears. In contrast, psychology changes instantly.
Finally, one last aspect which impacts on the movement of house prices is herd behaviour.
The government is focusing on the travails of the individual buyer with its ‘help-to-buy’ scheme, rather than thinking of the collective. What is good for the individual isn’t always good for the collective.
In housing, everything I do impacts on you, and everything you do impacts on me, even if you have no idea that that is the case. So if I bid over the odds, it throws down the gauntlet for you to do likewise.
Think of it a bit like a football match. Imagine you are watching a game and everyone is sitting down. So we can see the pitch. Then the guy in front of you stands up and doesn’t sit back down. You have to stand up. But that forces the guy behind you to stand up too, and pretty soon most of the stadium is standing up uncomfortably when we should have all been sitting down.
The economy works in the same way. Every actions prompts a reaction, and soon each price increase prompts another one, and prices go out of control. This is exactly what happened in Britain in response to its ‘help-to-buy’ scheme.
Look at the chart. Remember the ‘help-to-buy’ was supposed to make houses more affordable and look what happened.
In Britain, there have been two phases of ‘help-to-buy’. You can see that the reaction to both has been more money chasing the market upwards and prices are now sky-rocketing. This is much more pronounced in London.
If we go down this route, the dynamic of the London market will repeat itself in Dublin. Like London, Dublin houses prices will pull away from the rest of the country as they are doing now. South Dublin will turn into Ireland’s Knightsbridge or Kensington, while the rest of the country will lag way behind.
This will make the already wealthy of south Dublin wealthier, and make the young generation, who are simply looking for a place to live, ever more indebted.
We need to break the link between banks, credit and houses and to do this we need to give less credit to the housing market – not more – while encouraging new builds to start soon.
The best way to do this would be to force the banks to lend, not against the collateral, which is today’s house price, but against the average house price for the last 20 years. At a stroke, we would eliminate the situation where rises in house prices facilitate more credit and drive prices yet higher. Without this lending dynamic, house prices couldn’t rise.
Also, the state could implement a ‘use it or lose it’ approach to planning, whereby a developer who owns residential land has to build within three years, or the land reverts to industrial zoning. That would increase supply overnight.
These are practical measures which could be introduced tomorrow, and would stop house prices spiralling and increase new home building rapidly.
If we don’t do something like this we are on the same road we were on between 2000 and 2006, and we all know where that road led us.
David McWilliams writes daily on international economics and finance at www.globalmacro360.com