Bursting the bubble: the math behind the housing crisis solution

I said bursting the bubble would be easier than it looks, it looks like it is
It's a bird, no it's a plane, no it's the price

It’s a bird, no it’s a plane, no it’s the price

In the last post I promised a more rigorous mathematical analysis of my housing market solution for the UK. After some serious Excel number crunching (what better proof of my economics geekiness that I find this an enjoyable exercise in my free time), I have come up with the following model which can be tweaked to demonstrate how certain scenarios can play out. Now, as I mentioned in my previous post, this solution is highly theoretical and in fact, my assumptions may prove to be unworkable in practice. However, I think that despite its simplicity, the fundamental logic behind the model is sound, not least because it demonstrates just how easy the fix would be and by extension, just how the present housing crisis is a political construction with no other objective than to make a certain home-owning class wealthy(er) at the expense of the taxpayer.

The model is an attempt to calculate how many houses can be built per year up to 2030 depending on certain criteria, such as the percentage of GDP that the government can spend on housing, the extra revenues from increasing the top rates of council taxes, and the savings obtained through a reduction of housing benefits (yes, I know, this has now been scrapped in favor of a universal credit, but a proportion of this will still be dedicated to housing so it’s still a de facto cost). The theory behind this all is in the previous post. Additionally, the share of private construction relative to GDP can also be tweaked, as can the estimated cost of a single house which I have put as £125,000 as a baseline for 2012 and adjusted on the basis of consumer inflation up to 2013 (and pre-dated as well so we can crudely estimate the share of GDP spent on housebuilding). On this basis, I have developed a pair of potential scenarios to show how the solution would work out in practice.

Scenario 1: Building 250,000 houses a year

Under this scenario, the government would be committed to building 250,000 houses a year regardless of its cost as a share of GDP. This assumes that council tax revenues rise immediately by 10%; that the cost of housing benefit is gradually eased as a share of GDP by one quarter by 2030 and the excess used to finance new builds, and that private construction gradually rises to 1% of GDP (more or less the average of the past decade or so). The initial cost under this scenario would be roughly 1% of GDP in 2014, falling to under 0.5% by 2022. By 2028 the threshold could be reachedentirely through the increase in private builds as well as the excess revenues from the council tax and housing benefit measures, meaning the government would not need to spend on new builds directly anymore.

Under a slightly tweaked scenario in which private construction remained flat as a share of GDP, the government would hit the 0.5% of GDP threshold a bit later, in 2024. However, even by 2030, it would be spending 0.23% of GDP on public new builds. If additionally the housing subsidy were only reduced by 10% by 2030, then the 0.5% of GDP threshold would be reached around 2028, and the government would still be spending 0.43% of GDP on new builds by 2030 to hit the 250,000 mark. In any case, if spending 1% of GDP on new builds seems excessive to you, just consider that the fiscal sinkhole known as the housing benefit alone costs about 1.4%. Seems like a bargain.

Scenario 1 results

Scenario 1 results with 10% reduction of housing benefits

Scenario 2: Spending 0.25% of GDP from 2014 onward

Ok, let’s assume that the government is somewhat of a cheapskate and in times of austerity feels that ramping up spending on new builds to 1% of GDP is too much. Let’s say that it would only want to spend 0.25% of GDP on new builds, a paltry amount. Using the same assumptions of the first scenario, we have it that the target of 250,000 homes could be reached by 2025, rising to an impressive 314,000 plus by 2030. Even better: if it was committed to 0.5% of GDP, it would hit the mark by 2022 and be building 356,200 by 2030. Unfortunately, under a worst case scenario of private new builds staying flat as a share of GDP, and housing benefit only reduced by 10% by 2030, we would still be a bit off track from reaching the target as only 220,000 new builds would be constructed in 2030.

Scenario 2 results

Scenario 2 results under optimal conditions

It’s a bargain!

The caveat remains that the assumptions underlying this model may be too simplistic and that reality may prove it difficult to achieve. However, in no case do the assumptions fail to pass the test of history: it has all done before. Housing subsidy, for example, was just £3.8 in 1987, equivalent to just 0.9% of GDP (a number lower than even my optimistic baseline). Likewise the share of private spending on new builds averaged 2.2% of GDP in the 1980s and 1.4% in the 1990s, so 1% is hardly outrageous. Even the 0.25% of GDP of public new builds under the second scenario is well below the 0.4% average in the 1980s when the economy wasn’t exactly booming either.

In any case, it is painfully evident that the housing bubble is not only unavoidable, but that it carries a relatively easy fix, one that politicians are loathe to admit much less implement. A shock-therapy style fix, like the first scenario, would be ideal but even a more gradual adjustment as pictured in the second scenario is preferable to inaction. But nowhere is it evident that the Tories have any intention of brining housing costs to a more affordable level, even in a way that would be gradual enough to not affect the wealth of homeowners (as I described in the previous post as part of the structural rule). Instead, we have policies like Help to Buy that purposely confuses the sickness and the cure: it’s not that people can’t buy houses because they can’t credit, it’s because they’re too fucking expensive! And they’re too fucking expensive because they’re not building enough!

Don’t need a PhD to figure that one out, Sherlock.

Want to fiddle with the model? Download the Excel file here.

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