-
Housing The Quiet Decade
Speech given by
Sir Jon Cunliffe, Deputy Governor Financial Stability, Member of the Financial Policy
Committee, Member of the Monetary Policy Committee and Member of the Prudential
Regulation Committee
The Law Society Property Section Convention, London
Thursday 20 May 2021
I'm grateful to Kristina Bluwstein, Rand Fakhoury, Lewis Kirkham, Lisa Panigrahi, Sarah Venables and Matt Waldron for their
assistance in preparing these remarks. I'd also like to thank Richard Donnell, Robert Gardner, Geoff Meen and
Christine Whitehead for sharing some of their insights with me. All view represented here are my own.
1
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One of the many unusual features of the Covid-driven economic contractions in advanced economies has
been the behaviour of housing markets. Housing markets typically slow and house prices fall in severe
economic contractions.
But despite very adverse economic conditions after the initial Covid lockdown shock last spring, housing
markets have been buoyant in many advanced economies and house prices have been rising. House prices
grew by 5.7% on average across advanced economies in 2020, the sharpest increase since 20071.
Of course, what we have experienced over the past 12 months or so has been very different to a 'normal'
business cycle contraction or even to the more extreme contractions that follow financial busts. Economic
developments have been driven by wholly exogenous health developments and governments have provided
massive fiscal support to incomes, employment, the corporate sector and in some cases like the UK, to
housing markets.
It remains striking however, that following some of the sharpest economic contractions in modern history and
amid great uncertainty and indeed, initially fear, about the future, housing markets have been strong.
In the UK, over the 12 months to February, house prices have risen by 9.1%, the highest growth rate since
October 2014. This compares to an average annual growth rate of under 4% in the 10 years prior to the
pandemic. Mortgage approvals have averaged around 85,000 per month and total transactions 111,000 per
month since housing markets opened in June 2020, compared to around 60,000 and 90,000 in the prior
decade, respectively.
The pre-pandemic decade, however, may not be the right comparator. The 10 years following the financial
crisis appear unusual in that over that period house prices grew broadly in line with incomes, having grown at
double the rate of income in the previous twenty to thirty years.
I want to look today at some of the reasons why house prices growth and housing transactions were, in UK
terms, relatively subdued for the 10 years prior to Covid, and at what drives house prices and transactions.
I will go on to look at why, post-pandemic, the market might be very different to the post-GFC period and
some of the broader implications were house prices to resume their pre-GFC trend of rising significantly
above earnings. Finally I will look, at what, if any, implications this might have for policy.
1
Countries included in this calculation are: Australia, Belgium, Canada, Switzerland, Germany, Denmark, Spain, Finland, France,
United Kingdom, Ireland, Israel, Italy, Japan, South Korea, Luxembourg, Netherlands, Norway, New Zealand, Sweden, United States.
The authors acknowledge use of the dataset described in Mack, A., and E. Martínez-García. 2011. "A Cross-Country Quarterly
Database of Real House Prices: A Methodological Note." Globalization and Monetary Policy Institute Working Paper No. 99, Federal
Reserve Bank of Dallas.
2
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The post financial crisis period.
In the 30 years following the liberalisation of the financial sector in the 1980s, outside recessionary periods,
house prices in the UK grew consistently faster than earnings. There were two periods of particularly fast
growth in house prices relative to incomes. The first was in the late 1980s, ahead of the early 1990s bust,
and was driven by that liberalisation. The second was from the late 1990s up until the global financial crisis,
and may have been linked to the Bank of England's independence in 1997 and the consequent reduction in
interest rates as inflation expectations and risk premia fell. The upwards trend over this period generally was
also driven by the secular decline in the long run equilibrium interest rate that we have seen over the past 30
years, and which makes higher levels of debt more sustainable2.
By 2008, household mortgage debt relative to income had risen to 110% from 67% at the beginning of the
decade and roughly four times its level in 1980. The debt service to income ratio remained relatively constant
as the impact of higher levels of mortgage debt relative to income was offset by lower debt servicing costs.
Access to credit was easy and the cost of credit was relatively low. By 2007, the spread on a 2 year fixed
rate 90% Loan-To-Value (LTV) mortgage product over risk-free rates was just 0.4pp. And a large share of
mortgage products advertised were available to relatively riskier borrowers, such as 90%+ LTV or to
borrowers who had recently faced repayment difficulties.
Over this period, the market was very active, with mortgage approvals averaging over 100,000 per month.
In the financial crisis and ensuing recession, house prices dropped and the market effectively froze.
Transactions fell from their peak of 150,000 in December 2006 to their trough of 52,000 in January 2009.
And house prices contracted by over 15% in February 2009, from a peak growth rate of over 10% in June
20073. The housing recovery, as with the UK economic recovery in general, was slow and painful. House
prices, led as usual by London, did not begin to return to their pre-crisis peaks until the end of 2013.
Even after the recovery, however, house price growth did not recover to pre- financial crisis rates. From
2014-2019, average house price growth was 5% and the house price to earnings ratio for the UK as a whole
did not return to its pre-crisis peak until 2017, despite the slow growth in earnings in the UK recovery. In most
areas outside London, the South and East, the ratio is still below its pre-crisis peak.
Activity over this period was subdued relative to the period before the financial crisis. Mortgage approvals
averaged 61,000 per month. The period between home moves became longer; in 1988, households moved
every 10 years on average. 30 years later, in 2017, this extended to every 17 years.
2
See Rachel, L. and Smith, T. (2015) "Secular drivers of the global real interest rate" and Box 6 ("The equilibrium interest rate") in the
August 2018 Bank of England Inflation Report for further discussion of this.
3
Real house price growth peaked at over 20% in 2002 to 2003, but prices were still growing at around 9% in 2007 in real terms. Real
prices started to contract from 2008, with the largest annual fall being 18% in early 2009.
3
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In the years immediately following the financial crisis, households paid down debt. By early 2016 mortgage
debt to income ratio had dropped to 97%. It remained around that level until Covid, due in large part to house
prices growing more in line with earnings.
I should make clear here that London - and to a lesser extent the South and East - was very much an outlier
during this period (Chart 1). For example, in London, house prices increased by 35% and the house price-to-
earnings ratio rose by 200 percentage points. The market in London was probably driven by the sheer
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weight of demand given employment patterns. But investor flows including from abroad and migration
may have also played a role. Nationally, however, the picture over this period is of a less active market more
in line with economic growth and with households staying longer between house moves.
A simple thought experiment illustrates the unusual and quiet nature of the market for the UK as a whole
over this period. In the blue line shows the flow of new mortgage borrowing since 2000. After rising
Chart 2,
through the first half of the decade, new lending drops of dramatically during the financial crisis.
The red line shows what the flow of borrowing would have looked like, if, taking house prices at their outturn
levels, mortgage transactions had levelled off at their financial crisis peak rather than falling back.
Chart 1: House price: earnings Chart 2: Flow of new mortgage borrowing
Quarterly mortgage
House price to earnings ratio
lending (£m)
14
80000
Whole UK
70000
12
South and East
Value of new lending if transactions
60000 remained at pre-crisis levels
10
London
50000
8
40000
6
30000
4
20000
Value of new mortgage lending
2
10000
0 0
97 99 01 03 05 07 09 11 13 15 17 19 99 00 01 03 04 05 07 08 09 11 12 13 15 16 17 19
Quarterly value of new mortgage transactions, excluding pure
remortgaging. Counterfactual assumes that the number of
mortgage approvals remains at its pre-crisis peak, while house
prices and LTVs follow the realised out-turn. This exercise
take into account potential feedback from
therefore doesn't
transactions to house prices.
4
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What lay behind this relatively "quiet" decade for the UK housing market? Housing is a very complex market
with multiple drivers on both the supply and the demand side. There is a great deal of debate in the
academic literature about the drivers of house prices and the role played by credit conditions. These provide
a number of lenses through which to look at the UK housing market over this period.
Housing supply is for obvious reasons an in-elastic market in most countries. New houses take time to
construct and there are multiple frictions, not least planning and other regulations. This will affect whether a
boom in demand for housing is reflected in new building and increased supply, or in upward pressure on
prices.
There is, however, variation between countries. The literature bears out the intuition that that the more
inelastic the market, the greater the impact of demand side factors on price. The UK scores very poorly on
elasticity of housing supply. The IMF estimates that the elasticity of housing supply in the UK is about half
the OECD average4
(Chart 3).
Chart 3: Estimated Long-Run Housing Supply Elasticity
4
(2018), "The Fundamental Drivers of House Prices in Advanced Economies"
Geng
5
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On the demand side, the fundamental drivers of the market are population and income. But credit conditions
and expectations clearly play a role, as do non- credit constrained investors who can arbitrage between the
rental and the owner occupied market. It is difficult to disentangle these factors.
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At a fundamental level demand for housing whether as a renter or as an owner is determined by the
number of households, their incomes, the housing stocks and households' intrinsic preferences. And so in
- - we'd
areas with rapid population and income growth especially in areas where supply cannot adjust
expect to see an increase in both rents and house prices.
Of the 2.2 million increase in the UK's population between 2014 and 2019, 20% was in London and 13% was
in the South East. These areas have seen above average house price growth.
But as well as these fundamental drivers, house prices also depend on expectations and on whether
households are able to obtain and afford the credit that will allow them to get onto the housing ladder.
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There is substantial evidence, both theoretical and empirical that credit conditions both the cost and the
-
availability of credit have played a leading role in driving house prices in the UK and the US. Empirical
cross-country estimates vary, but would suggest that a 1% increase in the policy rate, which would translate
into higher borrowing cost, all else equal, reduces house prices by around 2-11%, with the majority
suggesting a drop between 6-9%.5 The more purchasers are constrained by either the price or the availability
of credit, the larger the impacts of a change in credit conditions on house prices is likely to be.6 Credit
constraints are most likely to affect first time buyers.
Conversely, the greater the proportion of purchasers that are not dependent on credit, the weaker the impact
of credit conditions on prices will be. Such investors can act as arbitragers, selling when
'deep-pocketed'
house prices are high and rental returns therefore low and, conversely, buying when prices are low. There is
some support7 for the existence of such an arbitrage mechanism in the UK8.
Other academic work assigns a greater role to expectations. Expectations are important to house prices as
they influence both consumption choices (as housing is 'service' that people consume) and
investment
5
See e.g. Assenmacher-Wesche and Gerlach (2009), Calza, Monacelli and Stracca (2013), Goodhart and Hofmann (2008), Iacoviello
and Minetti (2008), Jorda, Schularick and Taylor (2015), Sa, Towbin and Wieladek (2011)).
6
See for example Favilukis et al. (2017) which assumes a large share of credit constrained households. A loosening in credit conditions
increases a sufficient proportion of households' demand for homeownership to
generate a rise in house prices. Kaplan et al. (2019) and
Greenwald & Gruber (2019) in contrast assume more 'deep pocketed' investors, so that a change in credit conditions has less effect on
house prices.
7
Empirical evidence on this arbitrage mechanism is somewhat limited, but long-run evidence of rental yields and house prices may
provide some support. In the UK, high rental yield tends to precede house price growth: see Broadbent, 2019 "Debt dynamics".
There is
evidence of buy-to-let investors entering the market when letting out properties is relatively profitable, driving up house prices. As yields
decline, house prices also decline. These dynamics would be consistent with the arbitrage mechanism
8
In equilibrium, rental yields (the ratio of rent to prices) is a function of risk-free rates, depreciation, a risk premium, and real house price
growth. In a market with a sufficiently large share of such deep-pocketed arbitrageurs, it can be argued that the development of house
prices relative to incomes can be largely accounted for by the substantial decline and then flattening out of the real risk-free interest rate
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over this period. Miles and Monro (2019) apply such a framework to demonstrate this. However as I will go on to describe this
relationship does not fully explain house price moves over shorter time periods, which may be affected by credit conditions.
6
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decisions (as housing is also an asset). In this literature, expectations of future income, future interest rates,
and future house prices and can all play a role. There is some evidence that current interest rates and
current house price growth have an important influence on expectations (Charts 4 and 5).
All of these factors were likely at play during the pre-Covid decade.
Chart 4: Momentum in annual asset price growth
1.0
Regression coefficient on lagged asset price
inflation using annual data
0.8
0.65
0.6
0.33
0.4
0.2
0.0
House prices FTSE all share
Sample uses annual data from 1971-2020 for
house prices, from 1977-2020 for FTSE
allshare.
7
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Chart 5 Interest rate expectations track actual
interest rates9
Given the long and painful recovery from the financial crisis and the fall in house prices, expectations of
future income and of future house prices were depressed. Consumer confidence hit an all-time low after the
GFC and remained subdued until 2014. Expectations of future interest rates may also have been low;
however to the extent that the low risk free rate in the period was associated with a recession, this may not
have had an upward effect on price.
One would expect these factors to have waned following the economic expansion beginning in 2013, though
real pay growth did not start to recover until some years later. Brexit uncertainty following the referendum
result in 2016 is likely to have had a further general dampening effect on expectations.
Moreover, as well as changing the expectation of future economic prospects, the financial crisis and the
recession and unemployment may well have increased household risk aversion. Psychological scarring
following crises can cause perceptions of risk to become overstated, and lead households to prioritise
balance sheet repair in response10.
9
"UK house prices and three decades of decline in the real interest rate",
Miles and Monro, risk-free
forthcoming
10 For a more detailed discussion, see Haldane, A. (2011), "Risk off"
8
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To help gauge the role played by these factors, we can consider the historic relationship between house
prices and fundamentals and how this relationship might have evolved in the decade since the crisis11.
The blue line in Chart 6 shows how we might have expected mortgage debt to evolve following the crisis,
based on the historic relationship between mortgage lending and fundamentals such as the housing stock
and incomes.
This shows underlying demand falling in the immediate post-crisis period. This reflects weaker fundamentals.
beliefs are shaped by recent trends -
And to the extent that households' and there is good reason to believe
that is the case - weaker expectations will be captured in weaker demand.
This fall in demand could also reflect credit conditions. In the years immediately following the crisis Bank
Rate remained close to zero, but the interest rate spreads over Bank Rate charged by banks and building
societies, for new mortgages, were high. This meant that interest rates on new mortgage did not fall with
Bank Rate. But, as is shown in Chart 7, from 2013 onwards, mortgage spreads fell and the cost of mortgage
credit dropped to well below pre-GFC level.
11
I have borrowed this thought experiment from Geoff Meen. It makes a number of simplifying assumptions, notably that there would not
be feedback from higher demand into house prices in the counterfactual in which credit is unconstrained. These simplifying assumptions
mean that the analysis and resulting figures should be taken in context.
9
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Chart 6: Mortgage debt: income Chart 7: Price and non-price credit conditions
pp
Cumulated net
8 -600
spread to
percentage
Percentage
OIS balances
140
6 -400
Counterfactual Actual
120
4 -200
100
80
2 0
60
0 200
2007 2010 2013 2016 2019
40
2y75% mortgage spread (lhs)
2y90% mortgage spread (lhs)
20
Availability of secured credit (CCS, rhs)
Credit scoring criteria
0
Maximum LTV
70 75 80 85 90 95 00 05 10 15 20
The blue line represents estimated demand for mortgages and the
resulting impact on aggregate mortgage debt, under the assumption that
there is no shortage of mortgages.
Demand for mortgages is estimated based on factors including
household wealth and incomes, the housing stock and the elements that
contribute to the user cost of housing (including interest rates,
maintenance and depreciation costs, property taxes, and expected
capital gains). It is estimated for the period 1984-2007 when most
borrowers were not credit-constrained.
This forward demand equation is then projected forward based on
realised values for incomes, house prices and the stock, assuming there
are no constraints on credit availability or access to mortgages.
But Chart 6 also shows a gap opening up between expected mortgage demand and the mortgage lending
we've actually seen since, shown in the purple line. This reflects factors including constraints on the
availability of credit, and potentially an increase in uncertainty and risk aversion in the wake of the crisis.
Alongside the increase in spreads immediately post-crisis, a similar pattern appears in non-price credit
terms, which usually move over time in line with price terms as is shown in Chart 7. This includes the
availability of higher loan to value mortgages, which can represent one of the largest credit constraints on
first time buyers, particularly in high cost areas12.
Access to credit was also affected from 2014 by the introduction of the FPC's housing
measures, which
constrained the flow of high loan-to-income (LTI) mortgages and set the level of the stressed interest rate
12
Increased competition in the mortgage market may have played a role in this
10
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affordability test applied to new borrowers13. These were set by the FPC to constrain the future growth of
household indebtedness in aggregate and to limit the number of highly indebted households, given the
evidence that high levels of household indebtedness had amplified the depth and duration of the post-GFC
recession14.
It is unclear what impact these regulatory constraints on credit may have played in house price formation.
The limit on the flow of new, high LTI mortgages was not reached during the period, although there is some
anecdotal evidence that, while the limit did not bite, it did constrain lenders' behaviour due to their own
risk
appetite. However, these limits are likely to have had some impact in some areas, particularly London, where
house prices had grown fastest relative to earnings15.
Finally, the arbitrage mechanism referred to earlier, to the extent that it exists in the UK market, and which
might have resulted in 'deep pocketed investors' putting upward pressure on prices, may itself have been
weakened by changes to the taxation of rental properties and the stamp duty surcharge on second homes.
There will, I am sure, be further academic investigation of the factors that drove this unusual decade in the
UK housing market. My own guess is that expectations, writ large, played a strong role throughout, with the
impact of the financial crisis and slow recovery being strong in the early part of the period and Brexit effects
on expectations being important after 2016.
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Credit constraints both price and availability - may also have played a role for the UK market as a whole in
the post-financial crisis years, but these loosened materially in the second half of the decade without a
marked impact on prices or transactions suggesting that the market was not being held back by credit
constrained purchasers.
London, and to a lesser extent the South East, are clearly outliers in this respect. Given the elevated level of
prices relative to earnings at the start of the decade and the further sharp increase in the middle of the
decade, constraints on the availability of credit, both lender-imposed and regulatory, are likely to have held
back activity. Building a sufficient deposit is one of the biggest constraints facing most first-time buyers. Only
19% of renters across the UK have sufficient savings to afford a 5% deposit on the median first-time property
in their region. In London and the South and East, high house prices relative to earnings mean that potential
first-time buyers have to save even larger deposits in order to be able to afford their mortgages. For regions
buyers'
outside London and the South and East, first-time deposits are typically 48% of their incomes. In
London and across regions in the South and East on average, this is 121% and 80% respectively.
13
Since June 2014, the FPC has recommended a limit of 15% on the proportion of new mortgages extended at or above 4.5 times a
borrower's income. Building on the FCA's rules, the FPC has also recommended that lenders assess whether borrowers could meet
their mortgage payments if their mortgage interest rate switched to the contractual reversion rate and increased by 3 percentage points.
14
The FPC published its most recent review of the housing tools in the December 2019 Financial Stability Report.
15
Tripathy et al, "Macroprudential Policy, Mortgage Cycles and Distributional Effects: Evidence from the UK" show that constrained
banks issued fewer high LTI mortgages after the FPC's policy was introduced. They also find evidence supporting the
macroprudential
benefits of the policy. The local areas with greater exposure to constrained lenders experienced smaller declines in house prices in the
aftermath of the EU referendum in June 2016, when house prices fell across most UK regions.
11
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The distinction between expectations effects and credit constraints matters in another way. To the extent that
demand for housing is simply subdued by dampened household expectations about the future, there is no
'loss' to households. If however, demand for housing is held back by credit constraints, transactions which
are desired are 'lost'. One needs to be careful
however about assuming that relaxation of credit constraints
will lead to all otherwise 'lost' transactions taking place.
The thought experiment I carried out earlier suggested that almost 10 million additional transactions would
have occurred from 2007 to 2020 had transactions remained at their-pre financial crisis level. But this
assumed that house prices remained at the actual levels we saw over the period. In the absence of
increased supply, the evidence suggests that much of the additional demand would have fed into higher
prices, raising indebtedness in the short term but eventually choking off the additional demand.
I want to look at one other aspect of the market over this quiet decade - distributional impact. Distributional
the Bank's statutory primary objectives of price and financial stability. This is not
effects are not a part of
because they do not matter. They certainly do, and access to housing is included in the Government's
economic policy, which the Bank has a secondary objective to support16. It is because these are issues
primarily for elected authorities rather than technocratic ones, and there are more effective tools to address
them.
One cannot ignore that housing booms shift wealth towards existing and generally older homeowners and
can therefore widen intergenerational inequity.
The large increase in house prices in the decade leading up to the financial crisis came with a large
expansion in mortgage debt. Much of the £664bn increase in household mortgage debt over that period
represented borrowing by first time buyers and those moving up the housing ladder to finance an increase in
housing wealth for those further up the ladder. Moreover, an increase in house prices often leads to higher
rents which are predominantly paid as transfers from non-home owners to existing home owners, potentially
even further restricting the ability of prospective first time buyers to put a foot on the housing ladder.
As well as increasing intergenerational inequity, this shift in housing wealth also risks widening inequity
within the younger generation going forwards as housing wealth is passed down within families17. 40% of
FTBs received help with raising their deposit in 2018-2019 relative to 25% in the mid-90s, showing an
increasing reliance on family wealth to purchase the first home18. The 'Bank of Mum and Dad' is already
estimated to be the 10th most important lender in the UK19
16
The FPC's 2021 remit letter can be found here: https://www.bankofengland.co.uk/letter/2021/march/remit-for-the-fpc-2021. The Bank
of England also has a Public Sector Equality Duty under the Equalities Act.
17
It is important to note that the Gini coefficient overall has not risen over this period.
18
Report based on Nationwide data
19
Legal and General calculations
12
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The intergenerational impact of the pre-financial crisis housing boom can also be seen in how the age profile
of first time buyers and homeowners has shifted. Over the 1998-2008 period and immediately following the
financial crisis, the share of young people buying their homes effectively collapsed (Chart 8). From 2014, the
share has stabilised.
Home ownership rates by age cohort
Chart 8:
The price-to-earnings ratio for first time buyers for the UK as a whole shows a similar pattern, rising sharply
from 1998-2008, but then growing at a much more moderate rate after the crisis. London, however, shows a
very different picture a consequence of the sharp rise in house prices from 2012-2017.
The comparison of the pre-Covid decade outside London with the decade that preceded it, is I think a helpful
illustration of the impact, when supply elasticity is low, on inter and perhaps intra generational equity that can
result from a highly active market in which prices consistently grow faster than incomes.
As I highlighted at the outset of this speech, over the past year the UK housing market has returned to pre-
financial crisis levels of activity and rates of price growth.
Public and banking sector support has played a huge part in this. Furlough schemes and interest payment
holidays have limited distressed sales through the Covid crisis, which would otherwise have pushed down on
house prices.
In addition, a combination of pent up demand from the initial lockdown in which the UK housing market was
closed and the substantial tax incentive provided by the stamp duty holiday - which was announced in July
13
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and which will be tapered out over the course of this year has fuelled the strength in demand for housing.
After an initial tightening, credit conditions have dropped back broadly to pre-Covid levels.
One would expect the market to cool down when public support to the economy in general and the housing
market in particular is withdrawn over the course of the year, as is currently planned. Previously, we've seen
transactions spike prior to the end of stamp duty holidays, followed by a brief trough before transactions start
to recover, consistent with a large share of the impact coming through shifts in the timing of transactions,
rather than an aggregate increase in demand.20
But there may also be some reasons to believe that the recent increase in demand for housing, and perhaps
the composition of that demand, which has driven the UK market in recent months reflects some more
persistent drivers and that the market will not fall back to its pre-pandemic decade performance when the tax
incentives have gone. A survey conducted by Nationwide in April found that, amongst homeowners moving
or considering a move as a result of the pandemic, three-quarters of them said they would still be moving or
considering moving even if the stamp duty holiday hadn't been extended. Moreover, the
stamp duty holiday
in Scotland has already come to an end with no material drop-off in demand.
There has been a clear shift in attitudes towards remote working - both by employees and employers - as a
result of the pandemic.
According to the Understanding Society Covid special survey, half of respondents who have been working
from home during the last year report wanting to work from home often or always once social distancing
Decision Maker Panel
measures end, compared to just over one in ten prior to the pandemic. The Bank's
also suggests that employers' expectations have shifted, with the share of firms expecting their employees to
work from home at least one day a week beyond 2022 tripling relative to 2019.
A structural shift in more working from home is likely to lead to preferences for larger homes, with less weight
attached to considerations around commuting times relative to pre-pandemic.
There is also likely to be a regional dimension to any such behavioural shift in the housing market. Remote
working considerations would point to a shift away from urban areas like London and towards suburban
areas and further out. Post pandemic health-related concerns about densely populated metropolitan centres
might also encourage such a shift.
20
Estimates vary as to whether such holidays have any aggregate impact. For example, Best and Kleven (2013) estimated that about a
third of the impact of the 2008-09 holiday was solely due to timing, but th