Understanding the Affordability Crisis

Affordability was the political and economic issue of 2019. The riots and uprisings in Hong Kong, Chile, France and other countries have been at least partly driven by the fear among many that a middle-class lifestyle is moving out of reach. In Canada, the recent federal election saw all major parties focusing on the issue, with the Conservative Party even highlighting it in their slogan “It’s time for you to get ahead.” While we all can agree that there is a crisis of affordability, where is it centered and what are its causes?

View post to subscribe to site newsletter.

To answer the first question, while higher taxes are also a problem, the core of the crisis is clearly housing. To illustrate the crisis using an example I know well, in 2000 I bought a home (which needed some work) in an inner suburb of Montreal for $155 000. My teacher’s salary, at $48 000 per year, was just under 1/3 of the home’s price.

This past summer I checked and learned that same semi-detached house now costs $560 000. Meanwhile, the current salary of a Montreal schoolteacher with the same level of experience I had in 2000 is $60 000, which is not even 1/9th of the cost of the house. Clearly, there is no way a teacher today could afford to buy the house I bought 20 years ago.

However, teachers and other public servants like policemen and firefighters need to live in large cities. To allow them to do so, their salaries have had to rise. In order to pay their salaries, taxes have risen. Nevertheless, as we can see from the example above, public sector workers like teachers are still falling behind. Workers and entrepreneurs in the private sector facing the double whammy of higher housing and premises costs (whether to buy or rent) and higher taxes and fees have clearly fared even worse.

As higher taxes are largely, then, a consequence of higher home prices, understanding the tendencies in human nature and the recent changes in bank lending practices driving up home prices becomes vital.

Looking at human nature first, housing is what economists call a positional good. Where we live and in what sort of house is an important indicator of status. As we are a status-conscious species, it follows that most people will do (or borrow) whatever it takes to live in the ‘right’ sort of house in a desirable neighborhood. As the number of people wanting to purchase such homes is greater than the number available for purchase, such homes will go to those willing and able to pay more than others, pushing up prices.

In the past, however, conservative bank lending practices nonetheless managed to keep a lid on home prices. Prospective buyers/borrowers were routinely frustrated by lending officers constrained by strict rules. Up until the 1990s, purchasers needed to put down at least 10% as a down payment, with 20% being the customary amount. Further, loan repayments could only be amortized over 20 years. Finally, mortgages would only be approved if the monthly payments comprised no more than 25% of pre-tax household income.

Over the years, though, these rules have been loosened. It is now customary for first-time homebuyers to put down just 5%, thanks to Canada Mortgage and Housing Corporation (CMHC) mortgage insurance. As well, amortization periods are now up to 25 years (down from a period in 2006 where they could be up to 40 years in length). Finally, monthly debt payments may now consume up to 40% of household income.

Predictably, these looser lending standards have led to a vast increase in borrowing to purchase property. Unfortunately, while the individual home buyer may feel that greater access to credit makes desirable homes more attainable, because everyone has such access it merely serves to push up prices. And so, we have the current affordability crisis (turbocharged, one might add, by almost 20 years of extraordinarily low interest rates courtesy of the world’s central banks and, in Canada and other desirable nations, record levels of immigration).

However, just as war is good for the arms merchants selling weapons, so too has the battle for desirable homes been good for the banks issuing mortgage loans.

Banks love mortgage loans. As noted by economists like Dr. Michael Hudson and Richard Werner, over 80% of all bank lending is for property, because it has zero cost and almost zero risk. It has zero cost because when you take out a mortgage, the bank simply creates the money you are borrowing out of thin air with a few strokes on the computer keyboard (as admitted by the Bank of England’s Andrew Haldane in 2014). It has almost zero risk for two reasons. First, while businesses regularly go bankrupt and default on their loans, people will move heaven and earth in order to make their mortgage payments to keep their homes. Second, even if over-stretched households do begin defaulting on their mortgages, it is a relatively simple matter for the banks to stem the tide by loosening standards further and offering them yet more credit.

However, while extending more credit may work in the short run, in the long run the continued expansion of mortgage lending causes a greater share of household and national income to flow to the banks in the form of mortgage interest payments and a lesser share to flow to the businesses and workers producing and selling goods and services. Here we come to the heart of the matter: the affordability crisis is the inevitable consequence of the banks taking advantage of their ability to lend without cost to saddle households with odious debts. As the payments to service these debts are now squeezing enough wealth out of the productive economy to significantly depress spending, employment and income, it is time for action.

Any meaningful solution to the affordability crisis will obviously need to address the banks directly, which is something I will explore in a subsequent article. As Lord Acton put it so memorably, “The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks.”

Disclaimer: This is a republishing of Bryce McBride’s personal work.

Leave a Reply