Economic doom looms in Oz's game of homes

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The Australian property market is finally showing some signs of running out of steam, which is approximately a decade later than more sane commentators had anticipated. It is now considered to be the world's longest bull market — 55 years.

For sale sign in front of houseResidential property is by far Australia's largest asset class. It is valued at $7.3 trillion, according to Bloomberg. To give some idea of how large that is, Australia's GDP is about $1.6 trillion, the stock market is worth about $1.6 trillion and Australia's pool of superannuation funds is just over $2 trillion.

The problem with such financial distortions is that they are not just an economic problem, they have serious social and political consequences. When such distortions are unwound, it inevitably hits those who are more vulnerable. The worst part is that banks, which almost always have heavily contributed to the problem, are protected at the expense of the wider society — as was seen in the 'bailout' of Greece, which was in reality a bailout of German and French banks at the expense of ordinary Greeks.

The reasons for the boom in property are well known: an overly generous system of negative gearing and the 50 per cent cut in capital gains tax. This has encouraged a generation of Australian savers, egged on by banks eager to boost their profits, to punt on property as their way of becoming wealthy in the medium to long term. Investors, rather than owner occupiers, are making about half the purchases of property, which is pushing the young, especially first home buyers, out of the market and creating a financially divided society.

From an economic perspective the strategy is as ridiculous as it is popular. Negative gearing only functions when investors make a loss. So a substantial slice of that $7 trillion is deliberately going into loss making ventures. In a country where it is notoriously difficult to get investment capital for enterprises that are looking to make a profit — albeit it with some attendant risk — trillions are going into investments that are deliberately designed to go out backwards. Nothing can possibly go wrong with that.

The hope, of course, is that those losses will be offset by the capital gains made when the property is ultimately sold. But if investors start to see prices falling, they will quickly realise that such gains are far from a certainty. That could easily lead to a massive sell off. Unlike owner-occupiers, investors do not have an emotional attachment to the property because it is not their dwelling. They will abandon the asset class very quickly if they think it will make them losses.

There is a much bigger problem, from any common sense economic perspective. The housing investment boom is really a land investment boom. It is not the houses that people are valuing aggressively; it is the land. This is, by definition, unproductive. Land produces nothing in itself. A property bubble just sucks up capital that could be more productively used elsewhere (although of course the banks do well out of it). The metaphor of the finance parasites killing the economic host seems apt.


"Even if interest rates stay the same, the party is almost certainly over. Keynes' truism, that markets can stay irrational 'longer than you can remain solvent', has rarely been so apt."


Worse, over 80 per cent of business loans are secured against property, meaning that the productive activities that creates the most employment are shackled to an asset class that produces nothing. It is a recipe for an unproductive economy, and one of the few economic truisms that does withstand scrutiny is that being productive is a good way to make an economy resilient, able to withstand economic cycles. It is also a way to make a society fairer.

It is not difficult to imagine a scenario where the game of musical chairs in Australia will come to a shuddering end, imperilling the banks and dragging the economy into a deep recession. As we saw in the GFC in America and Europe, government money will be thrown at the banks to rescue them at the expense of ordinary citizens.

Australia would then experience a version of the 2007-2008 global financial crisis. It was largely spared the effect of that crisis a decade ago because of the Rudd government's cash splash — which was superbly timed to keep the economy going in the crucial Christmas spending period in 2008 — low levels of government debt courtesy of Coalition Treasurer Peter Costello's fiscal discipline, and extreme good fortune in the form of rising demand for resources from China.

Australia's households are now the second most indebted in the world behind Switzerland: debt stands at 120 per cent of GDP (Canada's household debt is about 100 per cent of GDP, the United Kingdom about 90 per cent and the United States about 80 peer cent).

If there is any rise in interest rates, those indebted households will be in severe trouble. But even if they stay the same, the party is almost certainly over. Keynes' truism, that markets can stay irrational 'longer than you can remain solvent', has rarely been so apt. The Australian property market ceased to make sense on its financial fundamentals some time ago.

At some point, and probably soon, the game will come to an end. The best that can be hoped for is that the decline will be comparatively slow, giving the banks and the rest of the economy time to adjust. Otherwise, the damage to the social fabric will be considerable. And we will all be bailing out the banks.



David JamesDavid James is the managing editor of He has a PhD in English Literature and is author of the musical comedy The Bard Bites Back, which is about Shakespeare's ghost.

Topic tags: David James, property, negative gearing, investment, home ownership



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Here's the scenario. You are 30 years of age in a steady if unspectacular job; your partner the same. You think of starting a family. First you must buy a house so you join the merry-go-round of mortgage brokers and banks and auctions. Every time you bid, there is someone on a phone who put in a bigger bid. It is sold to someone who is not even there and who wants it as a tax deduction/dodge. Week after week the same as you move farther and farther from your work. Negative gearing wins time after time. And you think to yourself: if the whole thing - housing, banks, finance - collapsed, would it be such a bad thing? You console yourself that people are having babies now in their forties.
Frank | 13 December 2017


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