Into the (money) sink

Sinking more and more money into houses may be bad for the economy

A sink is not only something that we wash dishes in but also something that can absorb substances from the surroundings as a carbon sink does. While containing many of the first type of sinks, houses may also end up being like the second type in terms of soaking up money from the economy. Rising prices for property mean that many people must put aside more and more funds to buy a home. Without the need for such savings, the money would typically have been spent and flowed through the economy. More funds going into bricks and mortar maybe thus damaging the economy outside the walls of our homes.

Owning our own home is a desire for many people who thus must save up money for a deposit and then spend years paying off the mortgage. Property has also become a form of investment for many who buy houses to let and thus earn an income. But the demand for places to live (or rent out) has not kept up with availability in many locations (typically large cities), resulting in rising house prices (and the cost of renting). In economic theory, higher prices are supposed to spur an increase in supply but rising housing valuations have had the opposite result – more buyers rather than more availability of housing.

On top of the many problems caused by the booming property market, higher house prices could potentially weaken the economy through excessive amounts of money being tied up in residential property. The removal of such funds from the economy could be seen as a form of forced savings above the level that would be optimal. The issue with excess saving already appears elsewhere in economic theory, Keynes arguing that people would prefer to hold onto money during times of economic hardship. Such hoarding of cash would thus have an adverse effect on the economy as less funds would be spent, and higher prices for real estate could be having the same effect.

In both cases, the effect feeds off itself. Saving and not spending during a recession means taking money out of the economy, thus further exacerbating the problem. In a similar manner, a boom in house prices will prompt even more money to be drawn into property due to expectations of further gains. Yet, when seen as an investment, buying housing compares poorly in many ways to other forms of putting money away. Financial assets such as stocks and bonds have similar returns but also the benefit of much greater flexibility in terms of how much to invest as well as easy access to getting your money back when needed. Money invested in financial assets can thus be put away as savings mount up and can easily conform to the needs of the investor.

As well as money away being stashed away, a large lump sum investment in a home also tends to lock people down to a specific location which may limit their work options. Studies have shown that people tend to move less in search of work compared to in the past and the growing investment required to own property is seen as one possible explanation for this. Changing homes is also difficult due to the high transaction costs of both buying and selling property in terms of taxes and fees for real estate agents. The result is often that people can be stuck with property that does not suit their situation, either as a residence or as an investment.

Money flows out of the property market with the sale of houses but any gains for the seller often prove elusive due to the need to secure a new residence amid inflated house prices. Even if the benefits from a higher sale price are not sunk back into property, a rising housing market tends to shift money from people more likely to spend to those who tend to stockpile. This trend is due to the more well-off being the ones who own property and thus benefiting from rising house prices but who are more likely to put any cash windfall into other investments rather than spending the funds.

While those on low incomes suffer as rent rise in line with higher house prices, the middle class could possibly be seen as the main victims. Those with moderate earnings have the financial capacity to invest in buying their own home but tend to have little money left over. Being in such a position involves sacrificing spending to fund the house purchase but also greater risk if something goes wrong. The middle class is already on the backfoot, struggling most in the job market amid changes wrought by automation and globalization. The plight of the middle class matters beyond their own circumstances due to their role as an economic and political stabilizing force in most capitalist democracies.

Property prices are not likely to fall away anytime soon but the broader impact should be recognized in order to better manage the economy. In particular, monetary policy has been relied on for the past few decades to keep the economy ticking over but the end result of this has been prolonged periods of historically low interest rates. Such cheap credit has helped to buoy the property market as well as lift asset prices across the board, hence exacerbating the trends mentioned above. If more money going into housing is actually taking funds away from consumer spending, this would explain the need for more and more proactive monetary policy to keep the economy growing.

One possible remedy to this is a shift back toward more use of fiscal policy which is a trend that is already underway. Even more benefits could be gained if government money was to be used to build more houses which would provide both an increase in supply of residential properties (and hence temper price rises) but also provide incomes for people to buy homes (or spend as they wish). Another potential policy is to promote working from home as a means to lessen the need for people to buy housing in big and already overcrowded cities. More money for government could be raised from the people that have benefited from the housing market to help out with those that have been left behind. Without some drastic changes, we might continue to throw money into the proverbial sink.