Are they all insane?

After 5 years of an absurdly overheated residential property market, especially in Sydney and Melbourne, it’s hardly surprising that housing affordability rates are at record lows:

First home buyers in Sydney are being forced to fork out a record 40.6 per cent of average incomes to pay for a typical mortgage, as spiralling home prices make gaining a foothold in the city’s booming property market more difficult than ever.

Home loans ate up more average household income in the three months to June than in late 1989, when interest rates reached 17 per cent, a Commonwealth Bank-Housing Industry Association report shows.

You might expect that a supposedly pro-market forces federal government like that of John Howard would take a leaf out of former Labor Treasurer Paul Keating’s book and explain to Australians that a price correction is simply unavoidable. If more and more people can’t afford to buy a home, the market just isn’t going to keep going up. It isn’t rocket science. The longer it’s postponed the more violent the correction will be. Is Peter Costello dampening unrealistic expectations like Keating did with his “banana republic” remarks all those years ago? Not on your nelly. Instead he’s throwing petrol on the fire, urged on by his Labor counterpart Loopy Latham:

The Federal Government has called on state and territory governments to cut stamp duty to ease the crisis in housing affordability.

A recent report shows housing affordability has slipped to its lowest level in 13 years.

Federal Treasurer Peter Costello argues while interest rates have fallen and prices have soared, state and territory governments have not reduced stamp duty to help first homebuyers.

“I make this point, you buy a house today and you pay what’s called stamp duty. It’s just a stamp that goes on a piece of paper,” he said.

“That’s what it is, except it can cost you I think in Sydney it’ll cost you $16,000 for that stamp.”

Mr Costello has foreshadowed an inquiry into housing affordability.

Shadow Treasurer Mark Latham says it is a national crisis.

He is putting the onus on the Howard Government to do more and introduce tax incentives.

“What we need is some incentives by the Federal Government to help people to save, put aside the money for a home deposit, build up a savings record and literally get their foot in the door,” he said.

Predictably, housing industry spokespeople are also in full-on “rent-seeking” mode, chorusing increasingly insistent demands for governments state and federal to chuck more taxpayers’ money at the housing market to keep the real estate gravy train on the rails. Moreover, we haven’t heard as much as a peep out of the Greens or Democrats on the issue. That’s hardly surprising either: none of them would recognise a sensible policy if they fell over one.

Putting on my political realist hat, I can understand Costello not “doing a Keating” and warning people about the inevitability of a housing price shakeout to restore affordability. It would be tagged as Costello’s “housing crash we had to have” gaffe in about 5 seconds flat. But that doesn’t mean he should be out there urging the States to exacerbate the situation by cutting stamp duty, or contemplating federal assistance schemes that can only make the inevitable crash worse. He should be just keeping his mouth shut while Reserve Bank Governor Ian McFarlane continues trying to dampen housing demand and engineer a “soft landing”.

The infuriating thing about Costello’s cynical fuelling of the housing industry’s “rent-seeking” campaign is that his government’s policies were largely responsible for creating the housing bubble in the first place. CGT changes that strongly encouraged speculative short-term property investment, and an over-generous first homebuyers’ assistance scheme, combined with a prolonged general economic boom over the last 5 years to produce an extraordinary surge in housing prices in south-eastern Australian capital cities (Sydney, Melbourne, Brisbane). Now Costello is urging further government intervention to push housing prices to still more absurdly unsustainable levels

These policies will inevitably lead to an extremely painful property market shake-out in the near to medium term. It’s worth remembering that Japan’s current 10 year recession was caused in part by a property price bubble also engendered by expedient, short-sighted, electorally-driven government policies. However, even before the bubble bursts, Australia’s economy is being damaged. Investment capital is being attracted away from potential productive uses to fuel an orgy of totally unproductive residential property investments. Even more obviously, the Reserve Bank is being prevented from lowering interest rates as a direct result of the overheated housing market. That in turn is a prime factor in the surging Aussie dollar exchange rate, which has made our exports much less competitive and contributed significantly (along with the drought and generally slow world economy) to a worryingly large trade deficit.

Yet no-one, as far as I can see, is protesting against these ridiculous government policies. It’s a classic Emperor’s New Clothes scenario. Are they all insane?

About Ken Parish

Ken Parish is a legal academic, with research areas in public law (constitutional and administrative law), civil procedure and teaching & learning theory and practice. He has been a legal academic for almost 20 years. Before that he ran a legal practice in Darwin for 15 years and was a Member of the NT Legislative Assembly for almost 4 years in the early 1990s.
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Scott Wickstein
2022 years ago

No, I don’t think they are insane but they are caught by the paradox that is known as electoral common sense.

Fancy suggesting to the public that the GCT be increased or that negative gearing be abolished? You could take 5% off your primary vote.

mark
2022 years ago

Sounds to me (like I’ve said before, I’m no economist, and finances aren’t my strong spot… a little too much like maths, really) like Costello’s telling people they can have their cake and eat it, too. Yeah, prices are too high because of the bubble. But don’t worry, the prices can come down without affecting profits and without requiring a burst — *if* the states can pull their greedy mitts outta your finances!

And what’s with Latham? The government needs to give people incentives to save their money, get a good credit rating (is that the phrase), and so on? /Why/? Why can’t people do that themselves? Lefty or not, even I realise the govt can’t hold everyone’s hand all of the time.

Mork
Mork
2022 years ago

Ken – great post. I find it astonishing that just three years after the tech bubble burst that I can have a conversation with otherwise intelligent sydneysiders and they’ll try to convince me that the normal laws of supply and demand don’t apply to the housing market, and that there has been a shift in market fundamentals that justifies historically high valuations.

Bit I guess that one of the necessary ingredients for a bubble is widespread self-delusion.

My conviction that a crash is on the way was sealed a few weeks ago when the Sunday Telegraph ran a front page story on the previous day’s auctions, complete with photos of celebrating purchasers and cheering auction crowds. When speculation becomes a spectator sport, you know a hard rain’s gona fall.

Homer Paxton
Homer Paxton
2022 years ago

Ken,
Politicians are just like the rest of us. They love a bubble and never think it will burst.We are afterall greedy people.

Just look at the reaction Al Greesnspan got when he talked about itrrational exburance. Republicans thought it was unpatriotic!

It will be the same here if the Big Mac tries to cool the bubble down.

I would put rates up to cool it down but I doubt that will happen.

The Usurer
2022 years ago

Insane? No, I think BOTH Scott and Mark are right. I am in agreement with Gerry Jackson about the Coalition, that they DO tend to be more ignorant about economics than Labor (not that Labor or any other party has anything to crow about, mind you). In accordance with this, they are probably going by economic quackery that suggests it is safe to engage in a vote buying exercise by prolonging the boom. This adds more fuel for though to the speculation about an early election I saw on ABC the other day.

Ken:
(a) The coalition is NOT ‘pro-free-market.’ I don’t expect you’ll agree, but really they are just utilitarians whose socialist premises are watered down by old-money elitism. Were they really free market types they’d be laying the boot into the RBA far more than the ABC, for example. I hold the coalition in contempt, but I hold them to be the least of numerous evils. They do the right thing, occasionally, but always for the wrong reasons and in a manner that stuffs up eventually. At least the damage is not quite as bad were other parties to take the helm.

(b) I wouldn’t automatically blame what few real partial-deregulations and disincentive-removals there have been. Speculation, irrespective of the term focus, never of itself creates artificial booms. This is the same thing as blaming Soros et al for the collapse of the Thai baht. Shooting a messenger who makes a mint from conveying the message is still shooting the messenger and doesn’t address the real issue. Here is the REAL issue:

The amount of money circulating around the Australian economy has increased by almost $60 BILLION in just the last eleven months, up from $473b at end of June last year. As the RBA itself plainly notes (http://www.rba.gov.au/Statistics/financial_aggregates.html), that’s an increase of over 11% in 11 months. By contrast, in the six months before that there was a net decrease of about $3b, and in the six months before that a $25b increase. Do you really still want to blame the Coalition’s fiscal policy rather than the RBA’s monetary policy!?

(c) Your complaint about credit being attracted away from industry as a result of coalition policy loses the plot on at least two counts. To begin with, there is a definite reason why the inflation-fueled credit boom goes towards real estate before it goes to industry, and it isn’t CGT rule changes. Australia is signatory to the Basel Accord on capital adequacy, and though I’ve heard (I’ve not confirmed it) that APRA tweaks it slightly, the standard favours housing (‘RRE’) by saying that a bank has to have considerably capital on hand per dollar of industrial credit than it does per dollar of housing credit. That means with a (more or less) fixed amount of capital, banks are legally constrained such that they get more net benefit from housing loans than from business loans. This standard has been in operation since 1988, long before the coalition came to power.

Second, there is simply no way to tell real productive uses for credit from inflation-fueled sales performance. At least with the bulk of the money going to real estate there is less chance of a major industrial boom-bust cycle being generated as credit manipulation is wont to do. Property speculation is more about the land than it is the building, and unlike machinery land doesn’t go obsolete. The adequacy regulation *is* based on something real, and as I said before my objection to the regulation is not primarily on the basis of content. In the same vein, CGT rule changes are not the cause either, but that their removal makes it even less likely that the inflation will badly contaminate the industrial sector before the inflation comes to a halt. I pointed out the other day that US congresscritter Ron Paul was right – housing booms are excluded from orthodox inflation measures, and hence the 2.7% claim is as dodgy as hell.

I object to this boom as much as you do (if for different reasons), but I am cluey enough to thank the heavens for the small mercies I can identify, and am not as quick to shoot the messenger as you.

JJM

woodsy
woodsy
2022 years ago

As is the case with most paradoxes (what is the plural of paradox?) you must view the situation from both sides. OTOH you have existing owners who want the market to soar so that they can wring out the max capital gain, and because their is no CGT on prime place of residence (PPR), where else can you get massive profits without any tax ? OTOH, it’s only the poor first home owners who are complaining about unaffordability, and perhaps many of them should be renting anyway. Which brings me to the subject of negative gearing real estate.

As I said here

For most people the appeal of real estate is not a rationally considered option based on economics, it stems from the simple fact that they can touch their investment. Amateur investors seem to be always wary of pieces of paper, certificates and share scrip. The reassuring physical presence of a property is enough to catch many people off guard. Rather than assessing an investment based on how much cash it will produce compared to how much it costs, your average punter prefers to base a decision on what it sounds like when you whack it with a stick.

It’s because the average person doesn’t understand the economics of an investment in real estate, because the CGT tax system is skewed to reward mindless investment and because negative gearing is the most widely (ab)used method of artificially reducing income tax, that it is way past time for a review of, firstly, regulation of real estate markets, secondly no CGT on PPR and, lastly, gradually removing the tax benefits of negative gearing.

It won’t be pretty but it’s got to be done.

Homern Paxton
Homern Paxton
2022 years ago

I am reminded of the fact when treasurers/finance ministers start talking about ending Government debt and doing away with bond markets a recession eventuates and if by a miracle a large budget deficit arrives.

This is like building the largest building in the world which almost always guarantees a depression!

I can’t see it but one never knows howver with the current account now well over 6% of GDP who knows

The Usurer
2022 years ago

Bah, my trackback pings failed :/

You folx might find this of interest (particularly Ken and Woodsy) – http://usurer.ubersportingpundit.com/archives/002188.html

JJM

woodsy
woodsy
2022 years ago

I read John McVey’s post on this subject, in particular; These demand-based sentiments he identifies are rather omnipresent, and while tax incentives and changes thereto can act as triggers they already presume the existence of some other cyclical mechanism for these sentiments to work upon. The real source is the cycle in the supply of credit, not its demand. To get engineeringly technical, the boom is forced oscillation, not natural oscillation. The RBA’s monetary and credit cycles are doing the forcing, not the omnipresent greed of the investor. and suggest that he’s suffering from some sort of ‘world domination by the central banks’ conspiracy.

Remember when all the farmers borrowed in foreign currencies ? “The banks forced us to borrow too much” they screamed – after exchange rates went through the roof. It’ll be the same WHEN, not if, interest rates rise – it was all the RBA’s fault for making it so easy to borrow (or to put it in John’s words; expanding money supply).

Nobody twists the real estate speculators arm up their back and says “you’ve got to borrow more than you can afford, to buy that ridiculously overvalued property”. So to lay the blame for the current boom at the feet of the RBA is overlooking the element of speculative fever being exhibited by retail investors.

The Usurer
2022 years ago

You missed the point. No, borrowers are not arm-twisted, and I don’t have much sympathy for them for irrational behaviour, but the point was why has their desire for credit actually been met en masse? How can speculators continue to borrow and borrow and borrow without this having great upward pressure on interest rates? I don’t mean ‘oh dear this is getting a little out of hand’ pressure but ‘my god we’ll have to raise rates to attract more funds!’ pressure. Where are the banks et al suddenly getting all this money to throw around?

How on earth can you suggest that the recent injection of $60 billion in extra money (and in turn credit, whose regulatory bias is expressly set in favour of residential real estate) has little or nothing to do with the speculatory boom? Come on Woodsy, the amount of money has increased by 11% yet the price of goods, other than established housing, has only increased by 2.7%. Variation in velocity doesn’t stretch THAT far. You figure it out.

I never said the RBA was the sole cause, only the chief cause of the cyclicality, and I openly stated that your comments on speculation fever and a preference for tactile investments played a part. A lesser point, one I didn’t say, is that I am opposed to measures that will shield irrational borrowers from the consequences of their own actions. There is only one real way for them to learn, and that’s the hard way. The RBA is not to blame for the irrationality, but it is to blame for feeding it and encouraging it to grow.

Nor, btw, am I advocating a central bankers’ world conspiracy, BIS conferences etc nowithstanding. I’ve elsewhere stated quite the opposite, that each is motivated by the neo-mercantilist notion of export-led booms fueled by currency devaluation – I likened it to the wheelchair race scene from Days of Thunder. Central banks are in the midst of a fever of their own.

JJM

Paul Watson
2022 years ago
Patrick
2022 years ago

The Ursurer wrote:
I hold the coalition in contempt, but I hold them to be the least of numerous evils. They do the right thing, occasionally, but always for the wrong reasons and in a manner that stuffs up eventually. At least the damage is not quite as bad were other parties to take the helm.

At last, a coherent statement of my own politics.