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Out-of-control house prices requires a different approach

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In purely economic terms, the upcoming Federal election is extremely unusual. The shut down of the Australian economy for almost two years because of health measures really has no precedent in our history. Only war can produce that type of shock. 

The Federal government’s financial response was as extreme as the state of emergency measures, including a sharp increase in Australian government debt. It remains to be seen, however, if the government gets much credit for injecting so much free money into the economy. It is unlikely. When Labor prime minister Kevin Rudd did something similar during the financial crisis of 2007-08 with his so called ‘cash splash’ he got little recognition for acting fast and keeping Australia, uniquely in the developed world, out of recession. 

The economic focus is instead likely to be on two types of inflation: asset inflation (especially rising house prices) and consumer price inflation. For most of this century the Australian economy has been a battleground between those two forces, with asset inflation winning easily. 

For about two decades CPI inflation has been quiescent, allowing the Reserve Bank to bring in steadily lower interest rates. There were many reasons for this, one of which was the efficiency of cross-border supply chains. In the aftermath of the pandemic those supply chains have started to come apart and it is not clear if they will return in the same form.

Thus the game came to an end when the country recorded the largest quarterly and annual increase in inflation since 2000. The CPI rose 2.1 per cent in the March quarter and came in at 5.1 per cent annually. The Reserve Bank has responded by increasing interest rates by 0.25 per cent, the first jump in over 11 years. 

 

'Australian households are amongst the most indebted in the world. In the third quarter of 2021, Australia’s household debt-to-GDP ratio was 119 per cent.' 

 

For those with large mortgages, a return to interest rate levels more like the historical average is a chilling prospect. The current rate of 0.35 per cent is still very low but it is likely to be heading higher, as indicated by the fact that the Australian 10 year bond rate has hit 3.56 per cent. Last August it was only 1.06 per cent.

Australian households are amongst the most indebted in the world. In the third quarter of 2021, Australia’s household debt-to-GDP ratio was 119 per cent, second only to Switzerland’s 131 per cent. The ratio of housing debt to household income is over 140.5 per cent and residential housing is worth almost five times the stock market and five times the nation’s annual economy.

That indebtedness is heavily skewed to younger generations. Only about a third of the population has a mortgage (a third rent and a third own their homes). So the most indebted are younger people who had to buy when prices had already soared. They have had little or no experience of the risks of higher interest rates and many have borrowed at six times their income. If rates rise sharply they are at risk of default.

Labor is proposing a Help to Buy scheme, in which it will take up to 40 per cent equity in a house for those who qualify. This idiosyncratic project will probably only reinforce the high prices that are making housing unaffordable for young people; it will not solve the core problem and could easily have unintended consequences. It is probably a good thing that it will be capped at 10,000 homes a year, which is only about 1.7 per cent of the total turnover in houses. 

The political parties and regulators have largely ignored asset inflation and the distortions it has caused for two reasons. One is that Australian banks, which have $2 trillion in housing loans, have enormous political influence and going against them is risky, especially as the economy depends on their being healthy. 

 

'The politicians, instead of using sops like the First Home Owner Grant, which are either ineffective or counterproductive, could have changed the tax system to make it less attractive for investors to gamble on house prices – otherwise known as negative gearing.' 

 

The second problem is that economists have difficulty measuring asset inflation. Consumer price inflation is easy to calculate because the products are constantly being transacted but asset prices can rise with few, or even no, transactions taking place. A house, for instance, can be worth more even if it is not being sold.

Faced with that measurement problem economists have tended to throw up their hands. They resort to circular arguments, such as claiming that assets are justifiably worth whatever people are prepared to pay for them so the price therefore must be fair and not inflated. QED.

It is a leadership betrayal. Just because something is hard to measure does not mean it does not exist. It just means a different approach is required like, I don’t know, using common sense. Any fool can see that house prices are out of control, just not the fools in Canberra. 

The Reserve Bank could have addressed the problem when setting interest rates but it did not. The politicians, instead of using sops like the First Home Owner Grant, which are either ineffective or counterproductive, could have changed the tax system to make it less attractive for investors to gamble on house prices – otherwise known as negative gearing. 

At the very least there could have been an effort to educate younger people about the dangers, and how to assess and manage risk. None of that has been done, and it will not be sensibly addressed during this election campaign. There are almost certainly some hard lessons to come.

 

 

 


 

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

Main image: An auction outside  a residential property  Strathfield in Sydney, Australia. (Lisa Maree Williams / Getty Images) 

Topic tags: David James, Election, Economy, Economics, Inflation, Housing, Debt

 

 

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Existing comments

Bravo once more David! I put you in the same class as Satyajit Das, another genuinely wise and insightful economist. Many in your profession work for banks or other similar institutions and cannot speak out as freely and openly as you. To a non-economist like myself it appears negative gearing has created a house of cards, which could tumble down upon us at any time in the near future. All politicians are silent on this and loathe to take any real remedial action because of the powerful interests, including lobby groups, involved.


Edward Fido | 16 May 2022  

A quick look at your Council rate notice is enough to demonstrate that the problem of ‘house prices’ has little to do with the cost of building and lots to do with the value we place on land. Land value, in turn, has less to do with cost of land production (subdivision, servicing, etc) than with its potential to make tax-free or lightly taxed capital gains. The values we place on land, and therefore the 'cost' of housing, would be much reduced if we removed, or at least reduced, the potential to make these capital gains. There are several ways to achieve this: one would be through 100% tax on all capital gains in land value, another would be an annual tax equivalent to 100% of the annual rental value of the land in stark contrast too the inflationary effects of subsidies to purchase. Such taxes would remove the incentive to own land for any other reason than its immediate usefulness. Not an easy policy to implement in full immediately, but with bipartisan support it could phased in over decades.


Ginger Meggs | 16 May 2022  

I have the luxury of making a comment after the liberal pre-election announcement to allow home buyers to access their superannuation to buy a home... which is a variation on the labour party "Help" theme but primarily to give Paul Keating a nail in the coffin of the sanctity of super for retirement (and heart attack). It does differentiate the parties that liberals appear to have less faith in the buyer's competence and places the risk back with their own finances. The difficulty I see is the judicious application of how a "home" is in the importance of the the legal fraternity; a judge might send you to the wall financially but rarely wants to take away the perceived most major asset of a family home... now if we start interfering with the acquisition process where a retirement investment fund is used for buying that changes the game. It's not irregular for financial settlements to redistribute superannuation funds; it might put a new slant on a family home being little more than another investment asset up for grabs in property or damages settlement cases.


ray | 17 May 2022  

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>>> In Australia the housing market has been described as extraordinarily resilient defying many predictions that the pandemic would cause a price collapse but the opposite has occurred which raises the questions of how and why this happened. In short, the answer was through the direct involvement of the federal government who in co-operation with the Australian Prudential Regulation Authority (APRA) , the banks allowed more than 493,000 mortgages to be deferred, with over 118,000 mortgages still deferred according to the latest data. Without this action most would have defaulted on payments triggering repossession by the banks and a housing price collapse. The Morrison government also committed to $507 billion in stimulus policies, encompassing the JobKeeper program and JobSeeker supplement, among others, something that went entirely against their own conservative ideas but was essential in order to keep home buyers viable.
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>>> At the same time the Reserve Bank (RBA) committed to up to $200 billion in near free (0.10 per cent interest) funding for the banks at a time when bank funding costs were spiking due to rising risks in financial markets. To put these measures into perspective the entire Rudd-Gillard Global Financial Crisis era stimulus package was only $51 billion and spread over four years yet it caused great alarm and derision from the then opposition. To be fair many of the Morrison governments actions could be put down to the need for extreme actions in extremely difficult times and there have been criticisms that the spending did not go far enough or long enough. This is borne out by a survey from the small business Australia group who found that 415,000 small businesses were on the brink of collapse, including some house construction firms driven into bankruptcy by the rise in timber prices.
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>>> Even well before the pandemic the housing industry received support that, like negative gearing, CGT, first home buyer grants and high immigration was designed to keep prices increasing. This has been a considerable advantage to the wealthiest 60% of home owners especially the 18% who are landlords, and has been the main driver of wealth inequality with the top 20% some 90 times wealthier than the lowest 20%. Almost half of our politicians are landlords, their full property ownership is impossible to determine because many properties can be concealed through trusts, companies or self-managed super funds or even owned by their spouse. Such a situation is alarming since these are the people making decisions on policies that will influence house prices. As an example, Tim Wilson MP owns 5 investment properties and holds the position of chair of the house economic committee where he argued that first home buyers should be allowed to dip into their super to pay for house deposits.
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>>> While we could dismiss these actions as self-interest it does not explain the failure of successive governments to reign in the rate of corruption that runs rampant through all levels of government and industry following a housing boom. The Pandora papers have revealed that Australia has huge gaps in its financial integrity which has allowed it to become the
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>>> go-to destination for dirty money which ends up in real estate. The current anti-money laundering and counterterrorism financing laws do not require real estate agents, accounts or lawyers to report suspicious transactions even though this has long been pushed by a G7 task force on financial action. It is so blatant that Australia has been listed by the US State Department as a “primary jurisdiction of concern” when it comes to money laundering while the UN office on Drugs and Crime warned that Australia is part of organized crime networks involved in among other things wildlife and forestry crime estimated to be worth US$ 19.5 billion annually. Illegal timber harvesting threatens many of our near neighbors and Government figures put our illegal timber imports at about 10% of our total sawn timber but it is almost impossible to trace the source of wooden products like furniture.
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>>> Organizations that most benefited from the housing boom have been involved in corruption for as long as the boom and this includes our big banks and financial institutions like AMP along with developers and the real estate industry. However, it is the housing market that provides the save haven for dirty money which comes from a variety of sources including casino's, gambling superannuation providers and even football clubs. In Australia some $65-$75billion goes through pokies each year and according to Andrew Wilkie Mp up to 95% of registered clubs do not adhere to AML/counter terrorism laws. Even when criminal acts have been exposed the penalties are hardly likely to discourage future transgressions, the CBA was fined $700m and Westpac $1.3b all of which essentially came from shareholders dividends while the CEO of Westpac was given a $2.7 million redundancy.


DON owers | 10 July 2022