The ballooning of housing prices has continued to garner considerable media attention. As is commonplace in the economics profession, this tends to get attributed to a simple question of “supply and demand”, which, in addition to being a bit of a cop-out, fails to adequately explain why demand for homes has increased to the extent that it has. As more and more young people, especially in English-speaking countries such as the US, UK, and Australia, renounce their dreams of homeownership, I began wondering how, historically, we had ended up here.
The Growth of Real Estate
The staggering rise in housing prices over the past 2 decades, with the exception of a brief dip following the 2008 financial crisis, did not just “naturally” appear. In the decades following World War II, housing was relatively affordable for workers. This was due to a combination of new construction projects, sustained wage increases, and favorable policies, at least for those from certain backgrounds, such as government-backed mortgages at low-interest, fixed rates with little to no down payments.
Beginning in the 1980s, however, Western economies began to transition away from manufacturing and towards services in a process referred to as “deindustrialization”, which would later have important implications for housing. Some have argued that increased productivity in manufacturing made parts of the industry obsolete, reducing the total number of jobs available. However, it was deregulation in the global economy that would allow corporations to move their production facilities offshore, or to simply import goods that they had previously made.
In the decades following World War II, housing was relatively affordable for workers.
This was spurred on by the incentives offered by rapidly developing economies, such as cheap labor and lax environmental regulations, much of which was made possible through authoritarian governments, as in the case of China. The export-led growth strategy followed by Asian countries in particular — known as Tiger economies — coincided with the removal of trade barriers in much of the West, not to mention the curtailing of power of many national trade unions.
In any case, as imports increased and foreign outsourcing was ramped up, Western countries whose economies and main source of employment had previously been based around manufacturing had to find alternative means of maintaining GDP. And so we enter into the era of the service-based economy, with finance and real estate being front and center.
Financial Deregulation
While the general economic transition towards services was one part of the equation, changing governmental policies, such as reduced public spending and the deregulation of the banking sector, were another. For example, prior to the 1980s, interest rate ceilings were imposed on deposit accounts in banks in the United States. Savings and loans associations or thrifts, which were specialized in home loans, were allowed to offer slightly higher interest rates to depositors, helping many of the latter to secure mortgages.
The beginning of the 1980s, however, saw the removal of these interest rate ceilings on deposit accounts, as well as the increased commercialization of thrifts. Many thrifts would ultimately collapse from competition from other financial institutions, thus ending their provision of affordable mortgages.
The phaseout of the Glass-Steagall Act by the end of the 1990s then dissolved the separation between commercial and investment banks, allowing the two institutions to jointly engage in lending, insurance and financial services. Spurred on by these reforms in the context of the Thatcher-Reagan era, other Western countries, and later developing countries under pressure from the International Monetary Fund, would enact similar legislation.
The phaseout of the Glass-Steagall Act allowed banking institutions to engage in lending, insurance and financial services.
The Commodity Futures Modernization Act of 2000 in the US then deregulated financial derivatives (whose value is derived from an underlying asset, hence the term derivative). This paved the way to — you guessed it — the 2008 financial crisis.
The recently deregulated global economy also played a role. As the US continued to import from countries such as China, liquidity was injected into the financial system by exporters buying by US debt. This period also coincided with reductions in the interest rate set by the Federal Reserve — the Central Bank of the United States — which further extended the line of available credit.
The Creation of a Crisis
American banks thus had more funds to play around with, as well as the freedom to do so, than ever before. So, they turned towards an industry that had long been seen as infallible, especially in the context of a declining manufacturing sector in which they might have invested in prior years. Everyone needs homes, right? This period also represents an increase in the “financialization” of the economy, as opposed to the growth of the “real economy”.
The end of the 20th century thus appears to be the beginning of an important shift in attitudes towards housing. Whereas housing had previously been seen as a necessity for workers, a kind of insurance that provided financial stability but not necessarily any excess profit, it now became a commodity, a financial tool with which investors could amass wealth. Many of us know how the rest of the story goes. US banks came up with mortgage-backed securities (MBS), which were essentially “groupings” of various home loans that could be bought and sold as assets. The holder of an MBS would receive occasional payments based on the underlying interest paid by the mortgage-holders.
This period also represents an increase in the “financialization” of the economy, as opposed to the growth of the “real economy”.
Of course, at some point, banks ran out of “responsible” loanees with strong credit scores to whom they could give out mortgages, so they turned towards low-income borrowers. Providing what are known as “subprime mortgages”, these banks enticed high-risk loanees with low-interest rates that would reset within a couple of years. Note that, although working families appeared to once again have access to affordable mortgages, this was illusory. What really took place was a kind of predatory lending, as compared to the years prior to the 1980s, in which families could actually afford to pay off their mortgages as a result of government policies and institutions such as thrifts.
As demand for housing increased, home prices did too. This allowed homeowners, using their homes as collateral, to borrow against the increased value of their homes in a context of seemingly endless credit. This often meant more mortgages, which meant more MBSs, which benefitted investors and loanees alike. MBSs would later be exported beyond American banks to deregulated finance in European cities and others around the world.
House prices cannot increase indefinitely, however, and by 2006, a number of high-risk borrowers had begun defaulting on their loans, bursting the housing bubble and provoking a global economic crisis. Despite the immediate economic downturn, which was followed by bank bailout after bank bailout, this would provide the conditions for a complete reshaping of the housing sector, as I explain here.