Building A House of Cards: Examining the pitfalls of housing policy

Even homeowners admit that homes cause a lot of problems. They are frequently too small or too large, too cold or too warm. Heating is expensive, pipes are decaying, windows are not air-tight, the stairs are dirty, the neighbours are noisy, the jobs are too far away, et cetera, et cetera. For such reasons most people would like to obtain nicer, newer, more convenient and in many other respects better places to live.500-201
As buying residential property requires quite a fortune, wishes often remain just that. People who are not homeowners have even less choice: usually they either rent or buy any type of dwelling and improve it step by step over a long period of time.
It is a common belief that the state should provide special aid programmes to help low-income homebuyers. The forms of such aid may vary, but their essence is always the same -subsidising. The state may subsidise bank loans for homes or pay loan insurance premiums. Subsidising may take the form of VAT concessions that are provided for construction of dwellings as well as income tax favours for the owners of residential property. The state may also subsidise homebuyers by fixing them housing loans.
Housing Policy vs Social Aid
At present, the Lithuanian government supports certain categories of homebuyers by covering a share of interest on bank loans. However, even such subsidised loans have failed to boost demand. The reason for this is that people who satisfy the criteria for state aid (these are in essence social criteria) do not meet loan application criteria used by banks. In other words, those who should receive assistance from the point of view of bureaucrats are not sufficiently reliable from the point of view of bankers.
Residential property is a special purchase: once it is bought, other expenditures automatically go up. Bills for heating and other utilities must be paid, and investments into the home must be made (this is not an issue for tenants). This means that housing subsidies increase the likelihood of pressure on municipal budgets to provide other types of benefits, such as heating or electricity concessions, compensations for other utilities, payments for repair work, and the like. These forms of support are ineffective and unfair in social terms.
For these reasons, there should be a clear dividing line between policies that facilitate home-buying and social support. Low-income housing supply achieves neither goal [1]. People in poverty need money. They need money to pay for bread and electricity, for books and rent. No one but the individual himself knows how to use it to best serve his needs. That’s why state support for the destitute should not be tied to any concrete expenditures, such as compensations for heating, transport concessions, soft loans for homes, and others. Instead, a certain amount of money should be paid directly to a socially supported person. This is a sphere of social policy, or poverty prevention, that should not be linked directly with homebuying.
With reference to housing policy, it makes sense to talk about that category of people who are willing and can afford to buy homes but do not do so because of unfavourable conditions of crediting.
About Bad Banks
Some people think that it is impossible to receive a loan for housing because the requirements raised by banks are too strict. The state, they say, should force banks to reduce interest rates, to extend the repayment period or otherwise facilitate the terms of crediting. Such people should be reminded that a loan is a product that has its price – interest. Regulation of interest rates is tantamount to price regulation, which is widely recognized as a drag on economic relationships and is gradually disappearing from our life [2]. If banks extended loans at an interest rate that wouldn’t pay them, it would be disastrous for the banks as well as their depositors. Surely, in a country that not long ago survived a banking crisis there is no need to explain that problems in the banking sector can be a greater economic and social calamity than all housing problems combined.
Let us look at why interest rates are so high, while the loan repayment period is relatively short. The existence of more attractive investment opportunities and a lack of long-term credit resources are two main reasons for this. The existence of more profitable investment opportunities means that the economy is growing and people can earn more income and use it, for instance, to buy homes. Sad as it is, the bulk of such “profitable projects” comprises government borrowing (T-bills) and deposit auctions conducted by the Bank of Lithuania. Banks choose to invest in government securities because there is essentially no risk, the interest is high, and the work that goes into making such investments is minimal. Deposit auctions of the Bank of Lithuania are aimed to employ “free” money in possession of commercial banks. Here, the interest is not high, but the business is safe and requires minimal work. Little wonder banks have no incentives to look for new projects they could invest in safely, profitably, and quickly. So when an individual wants to take out a loan of 100,000 litas from a bank, he competes with the state that borrows hundreds of millions of litas. It is obvious that people would have greater opportunities if the state stepped aside.
A lack of long-term credit resources is another important factor that curtails the supply of housing loans. Commercial banks in Lithuania derive credit resources from local sources. Neither individuals nor enterprises are willing to lend for longer periods of time yet, so local banks find it quite difficult to balance credit flows. This results in increased interest rates on loans. The supply of long-term credit resources increases as the domestic banking market receives foreign capital flows and more favourable credit lines. However, these processes are evolving gradually, along with the stabilisation of the political and macroeconomic climate in Lithuania.
Private pension funds would be solid investors in long-term securities and other assets. They would also contribute significantly to the development of the entire capital market.
In order to create conditions for small businesses and private individuals to compete for the existing credit resources, the state should cease borrowing, or at least reduce the level of borrowing. It is equally important to provide favourable conditions for the operation of pension funds and other institutional investors, as well as for increased competition in the banking sector.
How the State Builds a House of Cards
Currently, the Lithuanian government is contemplating other possible ways to help homebuyers. Among them are loan insurance, tax breaks, compensation for rent, etc. Again, what are the factors that hamper the development of housing?
People cannot afford to buy homes because earnings are too low. From a different angle, we can say that high prices of dwellings and/or expensive loans are the reasons. So, first, what should be done to increase people’s earnings? Second, how can the prices of dwellings be reduced? Third, how can crediting conditions be improved?
All solutions that have been used or proposed so far to address the last two problems have leaned on the state budget. To help low-income homebuyers, the authorities choose to cover their insurance premiums with public funds and by doing to secure better crediting conditions from a bank, or to cover a certain share of interest on loans or to cut taxes charged on construction activities. However, neither of these measures cracks the main problem – the problem of enhancing people’s opportunities to earn more. And neither of them creates conditions for a natural reduction in the prices of housing and interest on loans through increased competition, greater productivity, new technologies, and other economic stimuli.
Quite the opposite, state subsidies hamper the development in the banking sector and in the construction industry, as they artificially boost demand. This gives rise to many ungrounded expectations. Banks divert resources from other projects, while entrepreneurs rush into starting construction companies. As these processes are brought about by the state and with public funds, their results depend on the amount of the money that is available. True, expanding construction activities create new jobs and bolster budget revenues. However, jobs and tax returns shrink in other areas accordingly, because the amount of credit resources remains the same, with the money being only redistributed in favour of the construction industry.
Even if the country’s economy and people’s income did not shrink and subsidising policies remained stable, the demand for residential property would diminish over time. The prices of housing would fall as a result, injuring all market participants related to the building industry: creditors, insurers, builders, and owners of real estate. Swings and turns are common and natural in every business activity. But when one sector is artificially stimulated, a downturn is much sharper and can occur very suddenly, e.g., when state aid is slashed. The only consolation is that even if a state housing programme like this were adopted under the current budget constraints, this house of cards would not be very large and so the effects of the crisis would not go very far.
In conclusion, housing subsidies can be beneficial to certain groups of people for a short period of time. However, they reduce the general welfare in the long run.
Stimulating Housing Development
For housing to develop, people should have conditions to become richer. To create such conditions, it is necessary to pursue economic policies that are conducive to private business activity as well as to cut taxes and to reduce bureaucracies. The sooner such conditions are created, the more rapidly the economy and people’s income will grow.
This is instrumental for the improvement of state finances and the situation on the capital market, an important factor affecting the acquisition of residential property. Reducing regulations and taxes, privatising state property on the stock exchange, restricting government borrowing as well as reforming pension and healthcare systems would create conditions for the growth of securities and insurance markets, increased competition in the banking sector, and the rise of pension and investment funds. An improved business climate would facilitate the construction industry, too. It is equally important to remove tariff and non-tariff barriers to the import of building materials, to abolish the road tax, which is calculated as a percentage of companies’ turnover, and to simplify employment regulations. This will lead to a decrease in the prices of building materials, construction work, transportation, and, as a result, in the prices of housing itself.
In addition, utility service providers should be privatised. Municipal enterprises are inefficient and expensive, and the people can do nothing to change the situation. This lowers the prices of housing, stimulates negligent attitudes to the maintenance of dwellings, and discourages investment in residential property.
To sum up, today’s housing problems, just like many other pressing concerns, are neither exceptional nor accidental. They are a result of the old defects in the economic policy: a heavy tax burden, costly and unwieldy tax administration, a multitude of controlling and punitive government agencies, a crumbling, unviable social insurance system, protectionist policies, corruption, and so on.820-421
Only after these problems have been addressed shall we be able to take delight in our homes, instead of being intoxicated with sweet promises of state aid.
[1] The same situation exists with transport concessions for severely disabled people: formally, they can use transport concession, but in reality they don’t need them.
[2] Admittedlly, many prices (e.g., electricity, transportation, health care, etc.) are still regulated. All areas that are subject to price controls are underdeveloped, plagued by ineffective production and providing ample opportunity for corrupt practices and abuse of power.