Photo: Google via The Telegraph
The decline of U.S. housing market has a compelling narrative. Lenders convinced borrowers to live beyond their means, financial institutions packaged borrowers’ debt as a high-grade investment vehicle, and rating agencies went along with the charade – until the house of cards came crashing down.However, understanding the effects of the crisis on other countries is a pretty nuanced task.
The Bank of England’s Ben Broadbent, External Member of the Monetary Policy Committee, spoke at Lancaster University on Monday to explain the nation’s construction market – specifically, how it experienced a bust without a preceding boom.
As you can see in the charts below, although home prices increased, the UK’s bust was considerably more than its boom – which itself was devoid of real construction growth:
Photo: Bank of England
These charts also demonstrate that U.K. construction fared much worse than many of its European counterparts.
Broadbent cites three reasons for the poor performance of U.K. construction leading up to and after the recession.
The first explanation is that although the physical stock of housing increased only marginally, a housing bubble was created in the U.K. through loans to commercial real estate companies, as demonstrated in the chart below:
Photo: Bank of England
As Broadbent explains, this reallocation of financial resources wasn’t riskless:
…the debt and the cash ended up with different people. So even if it wasn’t adding much to physical capacity, increased leverage was adding to the economy’s vulnerability to economic shocks.
Broadbent also claims the crisis was exacerbated in the U.K. because banks were a ‘net importer’ of the financial crisis, as 75% of bank losses were due to overseas assets. As a result, Broadbent notes, “these foreign losses added to the contraction in domestic credit supply.”
Finally, leading up to the housing crisis, low productivity growth in construction caused prices to rise more than physical capacity. In other words, the value of commercial properties grew more at a faster rate than the stock of housing. Productivity growth was poor in light of building costs that, over the past decade, have increased much faster than inflation.
As Broadbent writes:
In cash terms, and relative to the general rate of inflation at the time, growth in the 2004-2008 period was almost as strong as it had been 20 years earlier and peaked at a slightly higher level. But growth in real investment was much slower. And, despite higher nominal spending (as a share of national income) the peak number of housing completions was lower.
In short, real output in construction did not mirror the nominal rise in home prices. There just wasn’t that much actual construction occurring in the run-up to the financial crisis.
As such, Broadbent has effectively demonstrated that not all housing crises are created equal – and reinforced how adverse effects of the U.S. housing crisis echoed throughout the world.