Key Points:

Helen Clark and many others see affordable housing as one of the big political issues of 2008.

Unfortunately her thinking about the issue errs in two main respects. She sees the problem as one of a lack of supply of houses, and she equates "affordable housing" with "affordable property ownership".

Housing - meaning a place to live - is a basic necessity of life. It is a legitimate role of government to intervene where necessary to ensure that everyone can have a safe and healthy place to live.

The market in housing, as a place to live, is the rental market. Equity in residential property, however, is a financial asset, like shares and bonds. It is not a responsibility of government to make it possible for everyone to acquire risk-laden financial assets.

Further, the argument that there are social benefits in having a very high proportion of a country's residents living in homes that they own is often assumed but rarely examined. Indeed, living in new housing subdivisions may actually have substantial disadvantages (see "Dead end streets" in The Aucklander, February 6).

Can we realistically argue that communities in relatively new mortgage-belt suburbs such as Henderson Heights or Flat Bush have stronger social cohesion than Mt Albert or Grey Lynn, where substantial numbers of rental homes are interspersed with owner-occupied dwellings?

The fundamentals of the housing market are simple. The normal market-clearing price of a house and section is a function of its rental value.

For example, if landlords require a 5 per cent return on their asset, then the capital value of the asset will be approximately 20 times the rental value. If the supply of housing is relatively fixed (as we are told it is) then changes to the rental value of housing are determined mainly by changes in the demand for places to live.

Changes in the demand for housing are determined by the rates of population growth and income growth. And by other demographic factors such as the rate of divorce and the propensity for adult children to leave home.

Rental values of housing in Auckland increased substantially in the five years to 2003. But since then rental values have not increased much. There has in fact been very little growth in the demand for places to live in Auckland since 2003.

There is no housing crisis. On the supply side, the value of residential property as a financial asset is influenced by returns on other assets. Thus, if interest rates increase, the capital values of the housing stock fall, because landlords can now get much better returns on bonds than on property.

If landlords now require a 10 per cent return instead of a 5 per cent return, then the fundamental market values of houses falls from 20 times to 10 times the rental value.

There is a housing investment crisis in that the fundamental market values of the housing stock have fallen sharply in recent years. Nevertheless, actual (as opposed to fundamental) market values continued to rise until 2007, in a process sometimes described as a "rational bubble".

Hence we have a crisis in that owners of real estate refuse to sell their properties unless the buyer pays a bubble price that is well above what the property is really worth. The housing market, like the labour market, is flexible upwards but sticky downwards.

The housing market is unable to adjust to its equilibrium (ie fundamental) market value. Rather, there are low sales volumes as vendors hold out for unrealistic prices.

Under these disequilibrium conditions rental values will stay low, and low income households should have little difficulty finding somewhere to live. Under no social circumstances should government be subsidising low income households into home ownership at the bubble prices vendors continue to ask.

In 2008, either the housing bubble will burst as vendors are forced to substantially reduce their prices, or economic growth or inflation will lead to a growth in rental values.

The latter (growth or inflation) scenario is typical of New Zealand's economic past. The former (burst bubble) scenario is more likely, however, in 2008-10.

Further, a policy to add new public housing to an already oversupplied housing market will add to the likelihood of a dramatic correction to housing prices.

The outlook for economic growth is very weak. An overstretched labour market, an overvalued exchange rate, and interest rates that deter business investment in labour-saving technology all conspire to keep New Zealand's economic growth rate below that of our trading partners.

* Keith Rankin teaches economics at Unitec.