Chris Joye versus the bubble

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The bubble debate rages on, led by Chris Joye. Late last week he reiterated his concern that we should be “panicking about the future” on Switzer:

And he continued his assault upon the potential for an SMSF blowoff as well over the weekend:

The impact of self-managed super funds on banking and housing markets is bigger than most people realise. My high-level analysis of unmet housing demand in SMSF portfolio ranges from $150 billion to $450 billion. SMSFs could, therefore, radically reshape the housing market in both positive and negative ways.

The government first allowed SMSFs to borrow to buy property in September 2007 and then the global financial crisis hit.

It has also taken several years for banks to build “limited recourse” products tailored to SMSFs. So we are only at the beginning of what is likely to be a long, SMSF-fuelled housing investment boom.

At June this year, SMSFs had $507 billion in assets. The amount invested in housing is tiny: only $17.5 billion, or 3.5 per cent. About $314 billion of SMSF money is spread evenly across cash and equities.

Surveys suggest SMSFs want to commit 30 per cent of their savings to housing, which implies $152 billion for investment.

…A threshold question is whether all this SMSF purchasing power ends up in new housing supply or existing homes. If SMSF capital flows into new supply, it could help solve the problem of how we are going to house 15 million new residents over the next 35 years. If, on the other hand, it flows mostly into buying existing homes, it could fuel very deep imbalances.

This is worth discussing but it also a red herring. SMSF is only the latest in a long line of housing-related tax distortions that have already driven Australian property investors to be the world’s most leveraged. That’s why we already have a bubble. Still, let’s not let it get even bigger!

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Meanwhile, banking consultant Tony Rumble defends more and more:

Back in December 2002, the Australian Prudential Regulatory Authority (APRA) and the Australian Taxation Office stated gearing could “offer superannuation funds benefits that would otherwise not be readily available to them”.

The regulators also confirmed super funds have always been able to borrow if the rest of the assets of the fund aren’t used as security for the loan – the key being to use a “limited recourse” style of borrowing.

So the hysteria whipped up over the last few days, after the Reserve Bank of Australia (RBA) warned about new self-managed superannuation fund (SMSF) money flowing into property, needs to be considered in light of these positive statements and the pro-consumer benefits that this type of finance provides.

Corporate finance scholars have long agreed gearing by investors is a legitimate tool. Modigliani and Miller showed in 1958 how gearing was appropriate, as part of the purchase of assets using a combination of the investor’s own capital (equity) and borrowed finance (debt). The key issue is how to avoid losing your capital when a geared investment sours.

This is another red herring. Superannuates should be able to make or lose their fortunes. But they should not able to blow up the rest of the country in the process via distorted tax incentives.

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Next up, Stockland is out arguing that supply will prevent further distortions:

Stockland chief executive Mark Steinert is confident the housing market will continue to strengthen, but says he is not concerned about a housing bubble, as new housing supply will halt rapid price growth.

Mr Steinert told the ABC’s Inside Business on Sunday the pent-up demand that has pushed prices will eventually ease.

“You are seeing apartments and high density coming in to address that demand in a lot of the capital cities, ­particularly in Sydney, Melbourne and Brisbane,” he said.

Certainly this one goes into the vested interest category but it’s still reasonable everywhere outside of Sydney. David Uren of The Australian picks up that argument:

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THE Reserve Bank is not so worried about the strength of house prices that it would not cut rates further if the labour market deteriorated, but it is unlikely to do so at tomorrow’s board meeting.

Although mortgage rates as low as 5 per cent have brought a pick-up in turnover in the housing market across the nation, there are special circumstances firing Sydney and Perth house prices, while prices across the rest of the country remain subdued.

Even in Sydney and Perth, conditions are a long way from what the RBA would consider “bubble” conditions in which prices are driven by unsustainably leveraged speculation. In Sydney, prices are up 8.2 per cent in the past year, while in Perth they are up 7.9 per cent. In both cases, they are about 4 per cent above previous peaks of three years ago.

This is a far cry from booms of the past. In the early 2000s, the Sydney market surged by 15 per cent to 20 per cent a year for three years, while Perth’s market soared a remarkable 40 per cent in 2006.

Uren’s comparison with past booms is not relevant. The whole reason we are having this debate now is because it was never had during past booms that were allowed to run far too far. More broadly, Uren’s position is the same as mine but it is still very obvious that macroprudential rules are required to guarantee that the Sydney blowoff does not spread. As for the RBA cutting again, Uren is wrong. Unless labour market weakness steepens before year end, which is unlikely in my view, more cuts are off.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.