The Wiki Man

The engagement-ring theory of property bubbles

We buy houses like we buy diamonds. That’s why they’re so stupidly expensive

29 March 2014

9:00 AM

29 March 2014

9:00 AM

Google ‘the bread market’ and you get 135,000 hits, mostly from specialist food industry websites. Google ‘the property market’, however, and you get over 180 million. ‘The financial markets’ nets you 282 million.

Seen like this, it’s unsurprising that capitalism has a reputational problem. The likelihood that the word ‘market’ is attached to any area of commercial activity is in direct proportion to the degree to which that category is seriously messed up.

The idea that all ‘markets’ are effectively the same is perhaps one of the stupidest economic errors of the past 50 years. For a start, asset markets are not like other markets. As John Kay explains, writing in the FT, ‘A semantic confusion leads us to use the word market to describe both the process which puts food on our table and the activity of gambling in credit default swaps. That confusion has enabled people to claim the virtues of the former for the latter.’

Let’s consider one decidedly weird market: diamonds. In order for a chap to show the seriousness of his intentions, he has to demonstrate some costly form of up-front commitment to his fiancée: he therefore spends a large amount of money on an allotrope of carbon for her to wear on her hand.


Diamonds are what’s called a Veblen good. Their value lies in their being widely known to be expensive. And much of this value was created out of thin air by an advertising campaign, ‘A diamond is forever’, written by Frances Gerety (part-inspiration for Peggy Olson in the series Mad Men) at the agency N.W. Ayer. One of the greatest slogans of the campaign simply read: ‘How else can a month’s salary last a lifetime?’

That is pretty damned clever/evil. A social norm is created that you are deficient husband material if you don’t spend a set proportion of your annual salary on carbon-based jewellery. The buyer therefore asks not ‘What do I need?’ but ‘I need to spend $X,000 — now what can I get?’ We don’t generally do this when we order a pizza. As I have become richer, my pizzas have probably become a bit more elaborate — but I don’t buy pizza based on a fixed proportion of my monthly salary. That would be silly.

But there is one area where behaviour is stranger still: when people buy a house. I would guess the majority of people adopt the following approach. 1) Go to bank. 2) Ask how much they can borrow. 3) Work out what they can spend in total. 4) Buy a house that costs that much.

If someone wrote a slogan for the property market, it would be ‘How else can a lifetime’s salary buy me an extra bedroom?’

Why do we do this? I don’t know. It’s a herding effect, I suppose. But the behaviour creates very dangerous consequences. First of all, it means that the price of property will not reflect any underlying use value — it will simply be a function of how cheap and easy it is to borrow money.

But it also creates a bonanza for banks. Normally there is a limit to what banks can lend — since people have natural limits to their urge to borrow. Few people go to a car dealership and ask ‘What’s the most expensive car I can afford?’ But in the property market, normal limits to borrowing don’t seem to apply. Hence the Ponzi scheme we see now.

So if property prices are too high, the fault does not lie only with the Russians and Chinese. In some peculiar psychological way it lies with ourselves. Germans, who have what I call a ‘Protestant Consumption Ethic’, don’t seem to exhibit the same behaviour.

Got something to add? Join the discussion and comment below.

Rory Sutherland is vice-chairman of Ogilvy Group UK.

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Show comments
  • Ahobz

    Argh..you stopped just when it became interesting.

    • rorysutherland

      …to be continued!

      • Ahobz

        Excellent, thank you.

        • rorysutherland

          The best commentary on this comes in Michael Lewis’s book Boomerang. Explaining why German Landesbanks were the most insane lenders to Southern Europe and the US, he suggested that German banks were forced to lend their money abroad since it was impossible to get Germans to borrow money for unnecessary things.

          By contrast, Barcelona seemed happy to borrow almost a billion Euros to build a new (and entirely unnecessary) new airport terminal simply because Madrid had just built a fancy new airport and they felt a bit left out.

  • transponder

    Rory: Not all of us behave the same. My ring — which I cannot wear because I’m too lazy/cheap to correct the radical de-sizing done by the hubby’s irrational grandmother — was my grandmother’s. It’s a nice single diamond and I’m told it lacks inclusions or some such (grandfather-in-law was a jeweller). But any way you slice it, it’s second hand.

    I prefer these sorts of diamonds, on water.

    • rorysutherland

      The behaviour largely created by advertising was the use of diamonds as the central stone in engagement rings: this was a comparative rarity beforehand.

      My wife too has a used ring.

      You cannot quite blame banks, since no-one forced people individually to bid up the prices of each others homes (Germany seems partly immune from this, and in any case renting there is more common) however a collective herding effect combined with FOMO (fear of missing out) makes the effect almost inevitable. You might also add that the effect was exacerbated by the fact that other consumer goods – cars, televisions, white goods, holidays etc – had become relatively cheaper, leaving nowhere else for people’s borrowing power to go.

      • transponder

        Fair points. Though it seems to me that cars are still an extraordinary expense for most people — a ‘big-ticket item’. Holidays also: even our summer rental in a quiet/sleepy part of America represents our biggest outlay in any given non-car-buying year. And then there are labour costs: the cost of getting a plumber/painter/gardener/landscaper/roofer/tree-remover round to your property — that sure hasn’t gone down.

        You mention Germany. Houston, Texas is another pocket where house prices remained stable even during the boom and bust — though they did drop a bit, precisely at the moment when I had to sell, of course. (Never mind: I moved to fabulous Florida.) The reason is rather negative, however: property taxes are so high relative to other parts of the country (and in absolute terms, as a proportion of most middle-class incomes) that no one wants house prices to rise much since the yearly ouch would go up to match. And the annoying thing is that the bulk of the taxes, which go to public schools rather than infrastructure, are there to fatten the pensions and salaries of often useless administrators (America’s education level is declining not rising). It’s hard enough to pay up for a good cause. It makes you want to get out of town when it’s a bad one!

  • davidshort10

    RS is always a treat to read but I do wonder if he writes as a hobby on a big pension from advertising. The Spectator, particularly under the stewardship of a Scottish lackey in the pay of Scottish owners, does not pay well, I would think.

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