Carney’s Prairie Planning Solution Won’t Prevent Housing Bubbles

Mark Carney’s appearance before the Treasury Select Committee this week, and especially his Guardian interview today. clearly shows what is one his mind.

The right way to do policy – to protect against the boom and bust cycles – is to act early in a graduated, proportionate way and that reduces the probability of having to act in a bigger way later.”

He said that Britain was building half as many homes a year as Canada despite having a population twice as large, and added: “It is widely acknowledged that there is a very large supply-side issue here.

“I fully recognise that Canada is the second-biggest country in the world. It’s easy to build housing as it’s easy to find places [to build]. But it does give you a sense of the issues around the constraints on supply and the movements in prices you see as well. They all reinforce that sense that there is a supply issue. And there’s nothing the Bank of England can do to change that.”

Well Canada has 35 million population,  England 53 million.  Canada builds (annualised seasonally adjusted) around 196,000 units a year, in England we build around 106,000.  So clearly the message from Carney to Osborne is there is nothing more I can do so you need to undertake measures to increase housebuilding, and top of Osborne’s list is liberalise planning.  He has already had two rounds of this.  Round one the NPPF, round two liberalising changes of use.

Late in 2012 Carney took measures to cool the Canadian housing market which by some measures is the most overvalued in the world.  He clearly is using the same measures designed to achieve a ‘soft landing’. So far this has been successful in Canada, the property has cooled without crashing, though with declining inventories it is still high risk territory.

The fact that the Canadian market is experiencing a housing bubble despite a much more elastic housing market and planning system suggests that planning alone is not the cause of housing bubbles.  Although it is easy to sprawl or go tall in most Canadian cities Toronto and Vancouver have housing markets which are probably the most overheated in the world.  Vancouver for example has a shelter cost to income ratio of over 89% the worst in the world.

Throughout history we have seen housing bubbles explode to devastating economic effect in countries with no or weak planning systems (Melbourne 1870 for example).  So planning by itself is not the cause of bubbles.   Cities are constrained by geography such as the Sea or the fact that central locations are intrinsically in short supply and that supply cannot be increase (there is only one central Toronto).  This is essentially Homer Hoyt’s theory of housing bubbles.  The popping of housing bubbles always occurs first in the most overpriced markets and national statistics can conceal this. Rather a plentiful supply of housing has two consequences.

1) It lengthens the upside of a housing boom.  So countries which have plentiful supply ride that wave longer, in the same way that countries that take measures to extend credit (such as Australia) can extend booms.  But this does not prevent them eventually bursting, and because of the prolonged growth they may burst more spectacularly

2) Low housing affordability makes economies extremely sensitive to rises in interest rates.  Carney

“Think about the mortgage you are taking on, the debts you are taking on,” Carney said when asked what his message was to those aspiring to get on the housing ladder. “You are taking at least a 25-year mortgage, maybe a 30-year mortgage.

Here we have a problem comparing Canada and England in terms of housing affordability.  For England has terrible statistics.  If one looks at house price to earnings ratios England does not look too bad compared to Canada.  However this is comparing a flow (income) to a stock (house price).  Canada on the other hand uses shelter-cost-to-income ratio, flow of housing payments compared to flow of income.  The importance of the difference comes when we consider the sensitivity of the economy to a rise in interest rates.  House prices to incomes ratios (which should be median house prices compared to median incomes) don’t show the increase in housing service costs when interest rates rise.  Then the shelter-cost-to-income ratio shoots up and the most levered households with the most precarious incomes can default, flooding the market with repossessed properties and causing debt-deflation.  Much of the crisis in England’s housing supply situation has been concealed by very low interest rates increasing housing affordability despite low supply.

Another problem of comparison is that many in Canad to maintain affordability have been forced out to further and further remote locations, with lower incomes and higher transport costs, transport costs subsidized through the short term fall in oil prices caused by shale.

All of this illustrates that an extreme neo-liberal response to planning will not prevent housing bubbles of their bursting.  The best way of avoiding a housing bubble is to build public housing at low rents for those who would otherwise take out highly leveraged loans (sub prime) or fuel a buy to let bubble in those seeking to supply for generation rent.