Even before David Cameron announced that the new Help to Buy scheme was to come in three months early, debate over whether it was a good thing was polarised. On the one hand, it has been proclaimed as “very dangerous”. On the other, the Conservatives have been painting it as a way of easing affordability for hard-working families. Which is it?
There is no doubt that some people who would otherwise be unable to take out a mortgage, will now be able to, with only a 5% deposit, and a hefty Government guarantee. But the root cause of the housing affordability problem is high house prices. And rising prices – as in any market – are caused by high demand and low supply. The state standing behind the risk of lending to those with smaller deposits simply eases access to mortgages, further increasing demand. Unless we get an increase in supply at the same time, there is only one way prices can go.
There are reasons to be sceptical that supply of housing will expand enough to stop house prices rising further. A look at the chart below shows that when banks increase lending for house purchases, prices tend to follow soon after. A study by FTI Consulting for Shelter finds that new supply increases very sluggishly in response to higher demand and higher prices. In contrast, developers react very quickly to falling house prices. So, over time, there tends to be systematic under-supply. The previous incarnations of Help to Buy and New Buy were explicitly linked to new builds only, and so had the benefit of explicitly incentivising more building. The new scheme being introduced will apply to any home under £600,000.
Chart: Annual growth in house prices and mortgage approvals compared
If it follows the same pattern as historically, the consequence of the new Help to Buy scheme will simply mean higher prices, further exacerbating the problem that the policy is supposed to solve. And if Government continues the scheme, it will potentially leave it on the hook for ever larger amounts of debt, something that it has tended to be keen to avoid. To make sure this doesn’t happen, the Government will have to push through the less politically palatable policy of encouraging more building.
George Osborne said last week that he has asked the Bank of England to keep a watch on the state of housing market and nip any boom in the bud. Going on what’s happened in the past, it looks like this is exactly what the Bank will have to do.