Boom Bust: House Prices, Banking and the Depression of 2010by Fred Harrison
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In the two and a half years since the first edition appeared (April 2005), events have unfolded as predicted. Then the consensus among forecasters was that the boom in house prices would cool to an annual 2 or 3% rise over the following years. In fact, in keeping with the ‘winner’s curse’ phase of the cycle described by the author, prices rose by more than 10% per annum in Britain. Harrison’s first book, The Power in the Land, predicted the early 1990s recession. Boom Bust, warned that investing in property is not always a safe bet, because the housing market is subject to a sharp downturn at the end of a remarkably regular 18-year cycle. The crash of 2007/8 occurred exactly as predicted. His forecast was based on a careful study of the evidence from property markets in many countries over the last 200 years. Gordon Brown’s claim, last made in his 2007 Budget speech, that ‘we will never return to the old boom and bust’ has been proved false. The reason for the instability, Harrison explains, is not the housing market itself but the land market on which all buildings stand. Land is in fixed supply ‘ as Mark Twain noted: ‘They’re not making any more of it’. Therefore, as the demand for land for new homes and offices rises with population growth and economic expansion, market forces, which normally increase supply to reduce prices, have the reverse effect: prices rise. This encourages speculation, with banks lending more against escalating asset values and reinforcing the upward spiral. Under existing government policies, the only way land prices can be brought back to affordable levels is a slump, undermining the banking system and causing widespread unemployment and repossessions. This is exactly what happened in America with the collapse of the sub-prime mortgage market. The run on Northern Rock showed the UK economy is not immune. The author reveals that the government’s monetary policy only has a marginal impact on land speculation, but as the Bank of England raises interest rates to curb house price inflation, the main victim is the first-time buyer and the productive economy, especially small businesses. The only way to neutralise the boom bust cycle in the housing market is through a reform of taxation, he claims. ‘This book is an important contribution to an overdue debate.’ Martin Ricketts, Chairman of the Academic Advisory Council of the Institute of Economic Affairs and Professor of Economic Organisation, University of Buckingham. Endorsing the thrust of Harrison’s argument, Prof. Ricketts goes on to acknowledge ‘that insufficient attention has been given by policymakers to the rent of land as socially the most efficient source of public revenue’, and that that will ‘have important practical consequences … for the stability of the economic system’. Economic stability is the objective of Gordon Brown and most governments around the world. Harrison explains how this may be achieved.
"There are some fascinating insights into cycles, property and rents." Economic Affairs
"Harrison's book is a formidable challenge to the apologists of the status quo." American Journal of Economics and Sociology
"Fascinating insights into cycles, property and rents." Institute of Economic Affairs
"[Harrison] does make a case for the existence of an 18-year business cycle, which he links to speculation in the property market." Financial Times
"For anyone seeking to understand the vagaries of the housing market, this is a fascinating read." Sunday Telegraph
"The essence of its argument is that the majority of current property prices reflect land value rather than building costs." Professional Investor
"There are some fascinating insights into cycles, property and rents." John Calverley, chief economist, American Express Bank
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House Prices, Banking and the Depression of 2010
By Fred Harrison
Shepheard-Walwyn (Publishers) LtdCopyright © 2005 Fred Harrison
All rights reserved.
Britain's Housing and the Business Cycle
§1 A Budget for Boom Bust
MARCH 17, 2004, 12.30pm: the dispatch box of the House of Commons. Gordon Brown rose from the green bench occupied by ministers of Her Majesty's Government. This was his eighth budget, and the last day on which he could announce a remedy for the looming boom bust. Would he vindicate his claim to be the prudent Chancellor of the Exchequer who had balanced the nation's books and steered Britain around the recession of 2001? Or would he fail the test that he had set for himself as head of the Treasury? The contents of Brown's speech would determine Britain's economic fate for a decade. He had left it to the last minute. By my calculations, he had three years in which to introduce legislation and implement a pre-emptive strike against the violent beasts that lurk inside the capitalist economy – the booms and busts.
Twice before, in 1909 and 1931, Brown's predecessors had legislated changes to taxes that laid the foundations for sustained growth. But the reforms were expunged from the law books because of the implacable opposition of the peers of the realm. This time, it could be different. Tony Blair's government had a majority in the Commons of 159 MPs. And he had dismantled the blood-line buttresses that protected the privileges of the House of Lords. All that the government now needed was for Gordon Brown to act as a tough-minded chancellor to reform public finances in a way that would finally shift real power to the people.
The chancellor knew where to look for the vulnerable points in the economy. A year earlier, he correctly identified the issue that defeated his predecessors. They had strained to deliver full employment, but were repeatedly thwarted by activity in the housing market. When Brown stepped into the Treasury building in Parliament Street, at the bottom of Whitehall, in 1997, he was determined not to suffer that ignominy. He asked his civil servants to analyse and learn from the business cycles that terminated in recessions. He revealed their findings in his budget speech on April 9, 2003. Brown compared Britain's record with countries like France and Germany, and drew this conclusion:
Most stop-go problems that Britain has suffered in the last 50 years have been led or influenced by the more highly cyclical and often more volatile nature of our housing market.
Politically, this diagnosis helped Brown to defer a decision on an awkward problem. He used the housing cycle as a reason to delay the announcement on whether Britain should abandon sterling in favour of the European Union's currency, the euro. Britain needed to synchronise itself into the continent's housing markets, which were less prone to violent price swings. Then Britain could contemplate locking herself into Europe's monetary system. But the decision to use the housing market to stall on the euro exposed the void in Brown's policies. Now, he would have to explain how he would prevent the next housing boom bust. With prices at the beginning of the decade rising at annual rates of 20% or more, the housing market was 'overheated'. What could be done to prevent similar price rises at the end of the decade, prices that would initiate a wild spending spree and the downturn in the years from 2008 into the trough of 2010? To search for solutions and buy more time, Brown commissioned reports from two eminent economists on the financing and supply of residential property. The results of those enquiries were in his hands when he stood up to address the House of Commons on March 17, 2004.
The parliamentary sketch writers in the Press Gallery were preoccupied by the sub-text of the budget speech. Gordon Brown was pitching for the top job in government. He wanted to move into No. 10 Downing Street lock, stock and barrel. He already lived in the small apartment above No. 10, by agreement with Tony Blair. But he also wanted to occupy the Prime Minister's office. Practically everything that he had done during the seven years of his chancellorship was weighed in terms of whether they would affect his prospects of becoming Premier. Brown's political future was bound up with the health of the economy.
His first task was to establish – and advertise – his credentials as the master craftsman of economic management. Since 1945, he told the law-makers who packed the Commons, Britain had repeatedly lapsed into recession, moving from boom to bust.
But I can report that since 1997 Britain has sustained growth not just through one economic cycle but through two economic cycles, without suffering the old British disease of stop go – with overall growth since 2000 almost twice that of Europe and higher even than that of the United States.
The Presbyterian Scotsman was not averse to singing his own praises. He was triumphant as he pronounced his willingness to confront the 'tough decisions' head-on. As a result, he had entered the history books as the architect of a strategy that would deliver prosperity uninterrupted by the downturns that had caused misery for millions in the past.
But there was more to come. Gordon Brown's achievements were even more awesome.
Having asked the Treasury to investigate in greater historical detail, I can now report that Britain is enjoying its longest period of sustained economic growth for more than 200 years ... the longest period of sustained growth since the beginning of the Industrial Revolution.
Here was a claim of historic significance. Earlier generations of economists and finance ministers had struggled to find the secret of sustainable growth. The formula had eluded them. And then along came Gordon Brown, the heir apparent to the New Labour throne, and the magical formula was pulled out of the red ministerial briefcase.
It was all an illusion. Gordon Brown had not introduced the reforms that could neutralise the propensity of the economy to surge to the peaks that terminate in a valley of tears. Having failed to set in place the preventive measures, the Brown boom bust of 2005-10 would go down in the history books as yet another dismal failure in the quest for sustainable growth.
But that outcome was not on the minds of the journalists who gathered to hear the chancellor. Most of them were willing to declare him a competent master of the art of economic management. The challenge for Brown was to maintain that illusion. How would he perform his sleight of hand? The eagle-eyed politicians on the benches of Her Majesty's Opposition failed to spot the crafty juggling that lulled the nation into thinking that it was in safe hands. The financiers in the City of London also failed to realise that Brown's micro-management techniques had fostered the formative stages of the most traumatic phase in the business cycle.
To expose the interior flaws in the policy edifice that he constructed with meticulous care, we will apply Brown's own tests.
A government that permits volatility in house prices is locked into the stop/go cycle.
Two hundred years of historical evidence affords the evidence for exposing the fatal weaknesses in the foundations of capitalism.
We will push the evidence even further back, and scrutinise Brown's stewardship by examining 400 years of economic history. In doing so, we will reveal that Gordon Brown, by his acts and omissions, allowed the gnawing virus at the base of the industrial economy to flourish. He failed to stop people from speculating in the capital gains that could be captured in the housing market. The downturn in economic activity that would follow from this frenzied activity would drive large swathes of the middle classes into financial crises on an unprecedented scale.
This happened twice within living memory. Two Tory chancellors, Anthony Barber in 1970 and Nigel Lawson in 1983, also thought they could defeat the logic of the business cycle. In fact, they entered the Treasury as hostages to a historical process which – if it was not neutralised – would irrevocably associate their names with severe economic volatility (Table 1.1). In each of the post-World War II housing boom busts, house prices became so unaffordable that they had to plummet – dragging the rest of the economy down with them.
The drop in the real value of houses in the mid-'70s was camouflaged. Superficially, the problems began when the Heath government decided to liberalise the financial system in the Competition and Credit Control reforms of September 1971. Record level wage settlements funded by a pliable credit-creating system meant that mortgages and other loans could be eroded away by roaring inflation. But disguising the drop in the real value of people's homes did nothing to moderate the pain felt by those working people who, having struggled to buy their homes, were thrown onto the dole queues.
This ought not to have happened in the 1980s. Margaret Thatcher and her finance ministers were hard-line monetarists. They would not countenance Anthony Barber's profligate pump-priming policies. And yet, they did preside over a classic housing-fuelled consumer boom. Nigel Lawson took the blame. He did, after all, have sufficient time in the Treasury to propose remedial measures. This time, however, the freefall outcome was not so well disguised by inflation: as prices crashed, the homes of hundreds of thousands of families were repossessed because they could not afford to maintain mortgage payments. John Muellbauer, an economist at Nuffield College, Oxford, was one of the few who tried to sound the alarm bells. The house price/ consumer debt nexus could be read in the statistical record, but there was something more specific about the nature of the problem that he felt ought to be highlighted.
Land speculation plays its part too; as prices rise, some land is held back in the hope of being able to sell at a higher price later. After the peak, land prices fall sharply as owners try to sell while prices are still high. The 1971-73 boom followed by the 1974-76 slump was a classic instance of instability.
The third postwar boom bust will be irrevocably associated with the presiding New Labour chancellor, Gordon Brown. In the reported agreement he had with Tony Blair, in return for not competing for the leadership of the Labour Party he would be responsible for domestic policies when and if they came to power. Whatever the truth about that deal, Brown did, indeed, through his control of the public purse, preside over the domestic political agenda. One result was the boom in house prices which priced low-income first-time buyers out of the market in 2002. They were replaced by middle income speculators who invested in buy-to-let apartments. When the property market paused in late 2004 they, in turn, were replaced by relatively rich buyers of property. Thus began the elevation of the ratio of house prices to earnings towards new records. Symbolically leading the rush upwards was Tony Blair and his wife Cherie. When they bought a house in Bayswater in September 2004 for £3.6m, City Editor Robert Peston calculated that 'they are borrowing about six times their combined income'. Others would emulate the Blair family's willingness to go deep into debt to the point where, when the collapse came, many of them would be bankrupt.
This outcome could have been avoided. Gordon Brown, if he did not wish to join the list of failed chancellors, had a maximum of seven years in which to implement the remedies that could reshape the housing market. In opposition, he methodically planned the party's economic strategy to the finest detail. Nothing could be left to chance if Labour wanted to return to power. At the election in 1997, the voters decided to give the Blair team its chance. And Gordon Brown's first act on arriving at the Treasury was to announce the independence of the Bank of England. There would be no political tampering with the money supply. In future, interest rates would be set by a Monetary Policy Committee (MPC) composed of eminent economists. Brown set the target inflation rate: 2.5%. The central bank just had to keep inflation at, or close to, this level, and expansions of the money supply of the kind that fuelled the Barber and Lawson booms would be consigned to history.
But that 2.5% target – which had to be met 'at all times' – was defined by Gordon Brown to exclude mortgage interest payments on houses. The official definition of inflation included the depreciation of the bricks and mortar but ignored the appreciation in the value of land beneath the buildings. Here was a puzzle. House prices, which determine the size of people's mortgage debt, are not independent of inflation. Stephen Nickell, a professor at the London School of Economics who served as a member of the MPC, explained the connection.
House prices in Britain are currently  rising extremely rapidly. This house price boom has had, and is having, an impact on monetary policy and interest rates because house prices impact directly on consumption and aggregate demand, and hence on future inflation prospects.
If the Bank of England had been legally obliged to include all the information on house prices in the target rate of inflation, it would have been confronted with a terrible dilemma. For as Nickell stressed: 'Setting interest rates to control house prices could easily push both inflation and the economy off course'. Thus, the Bank warned the public that, when it set interest rates, it was not targeting house prices. Following its decisions at one monthly meeting, it declared that 'it would be important for the Committee to make clear that this did not imply that it was targeting house price inflation, or any other asset price'.
Gordon Brown failed to deal with two realities when he established his monetary policy.
House prices have a life of their own. They are ignored by governments at their peril.
If the Bank of England was not directly responsible for curbing volatile house prices, responsibility reverted to the Treasury. The chancellor would have to use fiscal tools to orchestrate stability.
Despite relinquishing authority over monetary policy to the Bank of England, the responsibility for prices in the housing market did remain firmly in Brown's hands. But he did not adopt the remedial tools that could have delivered a sustainable supply of homes at prices that people could afford. His last chance to take decisive action was the budget of 2004, for it would take three years to erect the ramparts against the boom that was due to peak in 2008. He failed to act. That left the business cycle on-course for its termination and the drop into the trough in 2010. But there was one curious detour along the way: a little hitch in the business cycle that we need to unravel.
§2 Mystery of the Missing Recession
HOW DID Britain avoid the 2001 recession that ensnared other countries? Recessions followed after each of the post-war periods when real house prices rose above the level of real household disposable income – in 1972, 1979 and 1987.
Britain's manufacturers did suffer a recession. Total output of the economy rose by over 5% from the end of 2000 to the end of 2003, but manufacturers had a different story to tell. They suffered a fall in output of over 5% in that period. The 6.7% rate of return on their capital (2001) was the lowest since the trough of the recession nine years earlier, in 1992. How did Gordon Brown guide Britain through the global turbulence of these years to avoid the embarrassment of a formal recession for the whole economy? His achievement provided him with a political narrative which he put to good use. One week before his 2004 budget he told the New Labour Party faithful at their spring conference:
When I present my budget next week the first, the central and most important theme ... will [be] for hard working families, to lock in economic stability ... not just for a year or two, not just for an economic cycle. Our aim should be to lock in stability for a generation ... we will take no risks with inflation.
Inflation, that is, excluding a large slice of the costs that people incur when they buy their homes. According to the official definition of inflation, the one on which the Bank of England had to focus, Britain had enjoyed stable prices. But so, indeed, had the rest of the world. Japan's prices declined for a decade. Germany also appeared close to deflation. In other countries, inflation was moderate as retailers slashed prices to attract customers and producers competed for shares in the increasingly cut-throat global markets.
Excerpted from Boom Bust by Fred Harrison. Copyright © 2005 Fred Harrison. Excerpted by permission of Shepheard-Walwyn (Publishers) Ltd.
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Meet the Author
Fred Harrison is Executive Director for the Land Research Trust. He studied economics at Oxford, first at Ruskin College and then at University College, where he read Philosophy, Politics and Economics. His MSc is from the University of London. He cut short a career as an investigative journalist in Fleet Street and embarked on a 10-year sojourn in Russia, following the collapse of communism, acting as an advisor to a number of Russian academic and political bodies, including the Duma (parliament), in order to help the Russian people avoid the economics favoured by rent-seekers.
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