Why the Housing Crisis Is Happening

Most of the West is facing a housing crisis right now. Again. Property and rent prices have been skyrocketing for many years now and the response to the pandemic has only accelerated the surge. Commentators, activists, and politicians have, unsurprisingly, all been trying to seize the ‘opportunity’ to push for their own pet causes and policies. In this mess, the question of the actual cause of the crisis has remained largely unanswered; or it has been explained only partially. Most analyses on the topic have glossed over the economic elephant in the room  —  the staggering amount of ‘money-printing’ by central banks over the last two years and the predictable dire consequences this has resulted in. Let us look at how that happens.

Any price is a result of two contributing factors  —  supply and demand. To explain what is going on with a price that changes dramatically, we need to figure out whether there has been a drastic change in supply, demand, or both. 

Starting with the former, the situation is more or less straightforward (and consequently, this is the aspect of the housing crisis that is often correctly examined by analysts). The supply of housing can suddenly drop if there is some kind of severe natural disaster that destroys a large number of buildings  —  or a bomb that can do the same. Obviously, this has not happened in the West recently. Besides dropping, however, the housing supply can be prevented from rising, which is exactly what is happening. Across the West, restrictive zoning, drawn-out bureaucratic processes, and endless building regulations have caused the building of homes to be slowed down to a trickle in many places. As long as the demand side of the equation does not act up, this might not seem like such a serious issue. However, a restricted supply like this is a time bomb. Once there is an uptick in demand, problems start being apparent immediately, as the price will start shooting up.

This is how we get to the other, and the more interesting, side of the picture  —  the demand for housing. First things first: it is pointless to separate housing prices into property and rent and treat them separately. These are interconnected markets in which the prices of mortgages and of rents are substitutes of one another and tend to equal out in the long term (i.e. if there is an imbalance, people flock to the more profitable alternative, pushing the price upwards and restoring the balance). This means that the housing crisis cannot be explained by the claim that more people want to live in their own homes rather than rented ones or any similar argument. Besides, all prices have been rising fast, not just one or the other.

Demand for housing can, of course, increase for multiple ‘natural’ reasons. For example, if many people are moving away from a certain city or area or moving into another, this will affect the local demand. The same is the case with emigration and immigration. However, again, this does not apply in the current situation, where housing prices are steeply increasing virtually everywhere, not in just selected places where there is a large influx of new inhabitants. By contrast, a factor that would produce this effect is a cultural shift towards smaller household units. For example, whereas in the past, young people or even young families would often live with their parents, now they tend to prefer living separately. In the UK, the average household included 3 people in 1970, but only 2.3 in 2015. This subtle shift can have significant effects on the housing market if the change is fast enough and the housing supply flexibility is hampered by law. However, this is a long-term trend. Though it can contribute somewhat to the rise in housing prices over several decades, it cannot explain the much more significant surge of the past few years.

By elimination, therefore, we have arrived at the most overlooked and the most misunderstood aspect of the housing crisis  —  the key role that monetary policy plays in it. As I have written about elsewhere, central banks across the West have been extremely busy over the past two years expanding their balance sheets, i.e., creating new money out of nothing and buying assets with it, thereby increasing the total amount of money in circulation. The sheer amount of money created in 2020 is staggering. Even if one does not understand what is going on behind the scenes in economics, if a money supply measurement produces an almost hockey-stick graph like this, it is a clear and unambiguous sign that something very dramatic is happening.

What all this ‘money-printing’ produces is, of course, price inflation. It might not happen right away and it certainly does not happen uniformly across all products and services. But it is unequivocal that many, if not most, prices have been rising at an alarming pace over the past year or so. Seemingly every day there are new reports of predicted price inflation numbers being adjusted upwards. Some central bankers and politicians tried to claim for a time that such price inflation was only ‘transitory’, but most of them have given that up by now. Serious price inflation is here and it is more likely to get way worse rather than any better.

When new money is being added to an economy, prices do not just rise in unison. With additional income available to the financially connected, the newly created money is likely to be used as an investment. The prices of assets like stocks or corporate bonds are therefore likely to be inflated significantly at first. Whenever the ‘stock market is up’ nowadays, it is probably more likely to be due to some kind of recent money printing rather than the quality or success of the businesses represented by the stocks.

This is where we finally encounter the housing market again. Property is often the second arena where newly created money leaves its mark. Just like with stocks, everyone wants to jump on the gravy train in time, which produces a herd effect, creating a bubble. Although the definitions vary somewhat, a bubble is best understood as a rise in a price caused by mass buying of the asset in the hopes of selling it later for a return  —  i.e., not for it to be used as intended but as an investment. A prerequisite of the creation of a bubble is an abundance of money that can be invested somewhere. Under normal circumstances, investment into X needs a corresponding divestment from Y. But when a lot of new money is created, people suddenly have free casino tickets that they can spend however they wish — without any effect on their spending or investments elsewhere.

A bubble can be inflated anywhere, but there are more and less likely candidates. Housing is close to the top because people (correctly) perceive it as a market that is unlikely ever to deflate again (and if so, then only temporarily). Therefore, it is a ‘good’ investment. And this is where our missing piece of the puzzle lies: the increased general demand for housing that is driving the prices sky-high is caused by the soaring demand for housing qua investment. 

With cash savings being eroded away at a considerable rate, with savings accounts and bonds having such a tiny yield that it is typically nowhere near close to covering inflation, and with the movement of stocks often being decided not by corporate fundamentals but by arbitrary political and regulatory decisions, it is no wonder that putting money into real estate has become the go-to option for an investment that is quite safe and quite profitable at the same time. It remains to be seen whether people investing in this way will have made the same mistakes they did before 2008 when the inevitable correction comes in the future. Just like then, people who will be able to keep their investment throughout the crisis will eventually come out of it on top, and the people forced to sell will incur sometimes massive losses.

By and large, the housing crisis has been created and continues to be fueled by central banks’ inflationary policies. When they engage in rapid ‘money-printing’, the result is a flight away from cash and low-yielding investments and a frantic search for a more reliable store of value. Real estate supply being as restricted by law as it is in most places, housing prices consequently skyrocket. As explained above, there are other factors that can contribute a little to the crisis too, but they pale in comparison to the overwhelming effect that central banks’ policies have. As usual, the problem lies where markets are not allowed to operate freely and where the industry (the production of money and currency) is concentrated in a central-planning bureau.