7 March 2012
If growing calls to use quantitative easing to directly stimulate weaker parts of the economy lead to a change in approach by the Bank of England it would leave a tricky question.
That’s the question Sir Mervyn King, the Bank’s Governor, threw back at Treasury Committee member Andy Love last week.
He asked: “Can you give me an example of the asset you think we should be purchasing. I asked the previous Chancellor and got no reply.”
Mr Love gave a jumbled reply. But it was in line with the thrust of the debate so far which has emphasised easing the funding to small and medium-sized enterprises.
But I believe house building offers a more effective way to use QE to meet the aim of boosting broad money and also to target economic growth where it is needed.
However, the problem is that I write about construction and the Construction Products Association represents suppliers to the those who build houses. It’s easy to dismiss our calls as special pleading.
There may be an element of this. But to focus on that would be to miss the point. The case for channelling quantitative easing through house building has great merit, if the approach is well structured.
There remain huge questions over the appropriateness of QE as a monetary tool, but let’s assume the case has been made for the BoE to buy assets to boost the supply of broad money.
The question then becomes what to buy if not gilts?
Boiling down the various exchanges over this issue there appear to be three main tests that should be satisfied.
I believe, correctly structured, a form of housing QE would pass these tests with flying colours.
Before I can come on to tackling those it’s necessary to sketch out what housing QE might mean. I’ll not however go into the huge operational details that would need to be sorted out.
Basically the aim would be for the Government to establish a not-for-profit entity with a strict remit to fund house building. It would be a public interest company.
It would not be a public body. This would not be a vehicle for creating public sector housing, although it might build homes that were purchased by the public sector. It would not be controlled by the Government other than through its initial mandate.
Armed with, say, £50 billion over time it would build homes and associated infrastructure on, mainly, public sector land. The bulk of the assets created would remain in its ownership for a period after the homes were built. There would need to be sales or some homes and part-sales of others to ensure a reasonable balance of tenures for a healthy community. It would probably work alongside private sector developers where appropriate to make sure the communities it was creating were sensibly balanced.
Its two main aims, however, would be to keep the house building supply chain running at a higher rate than today’s pitiful level and to ensure homes are being delivered to the overall stock of homes to meet the widely accepted need.
The scope of the entity could be fairly narrow or pretty far-reaching. So for instance it may be charged with creating new towns. That’s an operational matter.
The key element is that the Bank of England’s stake will eventually be sold off and the money injected into the economy taken out of the system as the asset purchase facility is wound down.
Naturally it would not be for the BoE to create such an entity. That’s a job for Government, albeit in consultation with the Bank. The Bank’s role would be to provide the capital.
Now let’s turn to the three key tests.
Test 1: Is housing a sensible sector for support?
The statistics clearly say yes.
The first point to make is that house building creates a physical asset that generally increases with age.
Residential buildings represent the biggest asset on the nation’s books, standing at about £4,000 billion. It is a highly tradable asset and in the long run retains its value, with new homes normally gaining added value as the communities they create mature. This is illustrated by the reckoning that to rebuild the UK’s housing stock would cost less than half the asset value.
We are building about half the homes we were before the recession and even before the recession the view was that we were not building enough.
There is huge slack in the supply chain, but this will rapidly degrade as the industry rebased itself. The cost to rebuild the supply chain to match
The Government clearly sees a need to build substantially more homes. It launched its Housing Strategy late last year with that intention. The strategy will fail to deliver growth at a pace necessary to retain the supply chain.
An undersupply of homes is seen as a potential cause of unwanted house price inflation.
Pumping QE money through house building would disperse the benefits of increasing liquidity widely within the economy. It would create large numbers of jobs throughout Britain. Construction is regarded as having a high economic multiplier effect, which suggests the money would be put to good use.
Boosting house building though QE would seem to help to correct a market failure and provide significant economic benefits above and beyond those achieved through buying gilts.
There is a further opportunity that it presents. It could be encouraged to provide suitable ready-to-buy rental housing stock for institutional investors.
Test 2: What about subsidy?
It is not as easy as it seems to decide what is subsidy and what is not, given the complexity of regulatory charges, taxes and grants that impact on most industries and particularly the housing industry.
Clearly the housing sector and its supply chain pay taxes, so when we look at subsidy in this context we are not talking about whether the industry is a net contributor to the economy or not.
But if we set the pre-recession levels as the benchmark, the house building sector has received huge subsidies since and continues to do so.
The Government helped fund the purchase of thousands of unsold homes. It provided support through HomeBuy Direct and then FirstBuy. It has cut regulation. It is encouraging the renegotiation of Section 106 deals which have a value of many billions. And the “build-now-pay-later” deal for public land must be regarded as subsidy in this context.
Looked at more broadly the act of reducing interest rates, suggests an economic transfer from those with little interest in housing to those with a great interest in housing.
The case for providing subsidy to ensure house building seems to have already been made.
It should also be noted that many of the subsidies that would operate would do so through the land supply system. The effect of this would be nullified if the concentration of land purchase was in the public sector.
Furthermore if a subsidy were provided to a public interest company, as this company is acting in the public interest, it may be argued that the public is the beneficiary. One might argue that on a subsidy-per-house measure the level of subsidy might reduce using this approach.
Test 3: What’s the risk to taxpayers?
This perhaps is the easiest test for “housing QE” to pass. I have detailed this many times before.
Firstly while house prices fluctuate and there is risk, history suggests that house prices rise in real terms in the long run. Added to this there is a potential “regeneration premium” in building new communities which is realised as they mature.
Long term the value of a house normally greatly exceeds the build cost and the initial land cost. So in the long run housing is a fairly secure asset.
But house building is a risky business. Hence the margins demanded by private house builders. But the risks are complex.
The risk to the public sector should be seen holistically from a Treasury perspective. The Treasury would underwrite the bonds purchased by the BoE.
But it would benefit directly from reduced benefit payments and from increases in taxation generated by the process of building homes.
This can be broadly quantified and I have done the sums elsewhere
Taking very broadbrush indicative costs, let us assume an average market price of £120,000 for the homes built. The cost to build would be about £85,000 (including associated overhead) on a land plot costing £25,000. This would not be a fantastic performance, but let’s play safe.
This provides a £10,000 cushion (surplus after overheads).
But in addition the Treasury would be £20,000 in credit on its account from reduced benefit payments and increased employment tax, according to estimates I have made before. This leaves aside any other tax and benefits gains resulting from multiplier effects through the wider supply chain and within the wider economy.
On this basis the Treasury would have to see the value of the house dropping from £120,000 to £90,000 before it felt a loss.
Furthermore the Treasury would have paid into the public sector £25,000 for land that would, if house prices fell, have significantly less value in the market.
It’s probably fair to say that the price of houses would have to drop by about a third before any real loss was felt by the Treasury.
Such a drop could be insured against. Given the risk is small the cost of that insurance would not be great.
This would mean that the housing market would need to collapse catastrophically for there to be any risk to the Treasury. And if that happened we would probably be waving the economy off to hell in a handcart anyway.
On the basis that these three tests appear to be satisfied, it seems reasonable to press the Government to construct a vehicle whereby QE money can be channelled into house building.
This need not necessarily mean more QE. If the limit of QE is reached then the BoE could sell some gilts and buy bonds in QE Housing – a fitting tribute perhaps to the Queen in this Jubilee year.