Interest rates are not the ‘overwhelming cause’ of the housing crisis

Ian Mulheirn, an analyst who argues that there is no shortage of homes, has written a new post citing a recent estimate that if we had doubled the responsiveness of our housing production – to still below the underwhelming levels of Canada, Japan and Denmark – prices would only be about 9% lower than they are today.

There are three reasons why that does nothing to rebut arguments for building more homes.

First, all the 9% estimate tells us is that double nearly nothing is still not very much. As the paper he cites explains: “[doubling] the stock elasticity of UK housing supply […] would be consistent with (but still short of) the underlying flow elasticities of Canada, Japan and Denmark (yet remains considerably smaller than the US)”. And yet economists across the US are screaming for better housing supply.

It also raises the question of where you would build those homes. Some parts of the UK – sadly with few good jobs, and perhaps with fewer wealthy residents to get upset about every inconvenience from nearby construction — are much better at building homes than, say, Oxford or London.

Mulheirn’s own estimates of the effect on prices of building more homes tell us that if we build enough, prices would not rise. They also let us estimate how many homes we would need to build. And this graph from the housing analyst Neal Hudson shows that in the past, we have often grown the housing stock much faster than we do today.

Mulheirn has never given any plausible reason why we couldn’t get back to historic rates of growth in the housing stock. Certainly technology is far more advanced than it was during the previous booms in the 1820s or 1930s. In the 1920s, cars cost the same as a house. New homes in parts of the US are vastly cheaper than here. The only thing missing is a better planning system that can get more homes built where they are most desperately needed – within reach of good job opportunities.

Mulheirn also has “a” and “the” mixed up. Of course interest rates have been “a” cause of rapid house price growth, but not “the overwhelming cause”, as he claims : lack of supply has been a cause too. Cities like Atlanta and Houston that build plenty of homes have not seen a substantial increase in house prices above the cost of building them.

The gap between the price of homes and the cost of building new homes is critical, because it illustrates the ‘wedge’ created by poor planning resulting in needlessly low supply. In much of the South East, the wedge accounts for over half of the price of a home. That wedge does not occur in places with healthy supply. Mulheirn does not address the evidence of this wedge.

Second, he argues that building more would just result in more empty homes. But all of the evidence points to the contrary: absent a dysfunctional planning system, high prices in places within reach of good opportunities, where people most want to live, would cause most new building to happen in those areas. Something like half of the family homes in London are occupied by unrelated people sharing. Why on earth would all the new homes stay empty, when the London vacancy rate is lower than many other cities in the UK and elsewhere, and lower than it has been in decades past, there is a long line of people keen to live on their own, and when the homes we already build are not all empty?

Third, Mulheirn points out that the original Bank of England paper’s finding that prices could have risen by about half as much under conditions present in a selection of other OECD countries is largely driven by smaller reductions in government bond yields in those countries, not by differences in supply elasticities.  But it is unrealistic to assume that more building would have left UK bond yields unchanged. Under a better supply scenario, where housebuilding increased significantly, competition for financing for the capital-intensive task of building homes would drive market interest rates higher.

The strongest part of Mulheirn’s article is where he notes the risks to first time buyers if interest rates were to rise. That is a major reason why economists argue for a much healthier supply of homes over the long term. Studies show that will mitigate or prevent house price increases, and substantially reduce the boom-and-bust cycle that he purports to worry about. Houses should be priced more like furniture. Build well, and they may hold their value. An exceptional work, well cared for, may even go up in price. But it is unjust and unhealthy for the prices of basic necessities to rise far above the cost of providing them.

This article first appeared in CapX.