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It is generally agreed that the crises of the mid-2000s were triggered, in part, by the failures of financial innovation in the housing economy. In relation to the securitisation of mortgages, and the growth of markets for collateralised debt obligations and credit default swaps, this may well be true. However, this chapter argues that, in other ways, notably in relation to house price volatility and the management of housing equity, key element of the crisis were less a legacy of innovation than a product of conservatism.

Whatever measure of affordability is used house prices and rents play a central role and Chapter 3 is concerned with what causes these two variables to change over time and vary across different parts of the country. Although increases in house prices have been particularly strong in the UK by international standards, other countries are also discussed. In fact, house price trends and volatility can be explained by a fairly small number of variables – and their influence has been remarkably consistent over the last fifty years. The problem has been rather that house prices are very sensitive to changes in incomes, interest rates and credit conditions and these vary greatly over time. Therefore, modest changes in macroeconomic conditions have disproportionate effects on housing. UK empirical work on market rents is less well-developed than for house prices, but the chapter considers the reasons why rents appear to have risen at a slower rate than house prices.

This chapter describes the foreclosure crisis of the 1930s. Borrower defaults were rooted in the double trigger of reduced incomes and lower house prices, as well as the fragile structure of contracts discussed in the previous chapter. The result was a self-reinforcing cycle of foreclosures and weaker house prices. As lenders’ financial positions weakened, the flow of new credit fell to historic lows. By March 1933, the housing and mortgage markets in the U.S. were in a downward spiral with no end in sight.

Chapter 6 discusses new house building and the changing structure of the industry. Current housing policy is heavily concerned with ways of increasing supply and, in terms of analysis, the responsiveness of construction to changes in house prices is one of the key parameters. If the response is strong, then increases in demand are primarily met by an increase in supply. If the response is weak then demand increases lead to worsening affordability. The response appears to be particularly weak in the UK by international standards. However, the chapter also demonstrates, through simulations, the extent to which it is feasible to improve affordability by increases in house building. To have a significant impact, increases have to be large and sustained, on a scale that has rarely been achieved in the UK in the past.

The HOLC provided significant relief to individual borrowers and lenders, and also pursued a more general public mission. HOLC officials were determined to stabilize mortgage and housing markets by interrupting the cycle of foreclosures and price declines that caused a downward spiral in the early 1930s. This chapter describes the findings of an econometric analysis of HOLC activity in local housing markets. The evidence shows that on average the HOLC prevented declines in house prices and home ownership outside the nation’s largest cities between 1930 and 1940, but did not affect construction in those markets. The authors identify these effects by using the location of HOLC offices as a source of randomness affecting the allocation of refinance activity. The effect of the HOLC on markets in larger cities is still an open question.