How about we become solution focused? Maybe even think a little outside the paradigm. MacroBusiness has been full of very well researched articles over the last month with data to burn. Accompanied by more often than not, very well thought through commentary and interpretations. It’s been hard to keep on top of the many topics and arguments but I’ve noticed something missing. What are we going to do about all this stuff that’s causing great concern?
It’s like a break up with a partner where the one that is the last to find out searches for answers. What did they do wrong? How did this happen? Who’s to blame? Searching for answers in the past. But just maybe no one’s to blame, no one’s a bitch and things just need to change.
The issue here is that if we stay focused on what went wrong in the past to find a solution, we can miss some simple obvious solutions for the future.
Delusional Economics in Who’s Responsible did an excellent analysis of the situation we face but I found myself in strong disagreement with the conclusions on responsibility and the point to it. The thought of the atypical delusional preacher blaming the rape victim for wearing provocative clothing came to mind. There were no solutions offered by commentators to which I also agreed. I believe that gives me a responsibility to come up with my analysis of who’s responsible and what’s a viable solution? I’ll also try and do that with only words and hopefully ones we can all understand.
In my post the Bubble Formula, I gave an overview of a detailed formula that I’ve been working on that determines house prices and therefore shows how house price bubbles form. The first part of that formula determines that there is a maximum median house price (“MMHP”) at any point in time. The major driver for the MMHP is the lending policy of the banks or at least the lowest common denominator until its recycled as that bank either runs out of money or risk appetite. The more aggressive and indeed competitive the lending policy, the higher the MMHP. This fact in itself should not normally create an issue or a bubble but in Australia for quite some time availability of credit and loose risk policy has allowed the MMHP to rise to systemic risk levels.
In my post Big profits, huge risk I explain how mortgage hypothecation and rehypothecation allows the banks to raise funds for mortgages at very cheap rates by using the increasing asset prices to reduce capital or recycle it into new mortgages. Secondly and more recently pointed out yet again by Moody’s is that Australian banks, notably the 4 majors, have both explicit and implicit government guarantees which have allowed them to raise significant funds for housing in both local and international markets. So the availability of credit is the major driver of the MMHP.
The other principle driver of MMHP is direct government subsidy ie FHOG. The effect of FHOGs has been covered by many commentators both the direct effect and the geared effect. I only need to make the point that FHOG is a key driver of MMHP.
So who’s responsible? Well for creating the MMHP under which a bubble can form, the only parties that can be responsible are the banks, the federal government and the federal government’s support of the banks. No borrower or anyone else in sight here.
However, as my Bubble Formula shows that’s not the end of the story when it comes to determining actual price. The actual median house price or AMHP is determined by the effect of demand or ED on the MMHP. A number of factors which I’ve outlined effect demand including buyer delusions but I’d like to just focus on what I consider to be the main driver of ED. Specifically what drives the ED to fill the gap between what is a reasonably affordable AMHP and the MMHP? It should come as no surprise that the main instigator in this part of the equation is state and local governments who in their search for ever increasing revenues fill the gap. How? As Australia does not have a housing shortage, this perhaps would seem difficult. State government policy (and local) by not actually limiting available land in total but manipulating land releases to all but eliminate proper competition maximizes demand and price for new land on a consistent basis. As state governments revenues are highly dependent on land values why would you not do it this way, especially since the banks and the federal government oblige with their policies to maximize the MMHP. To put the final nail in the “Who’s responsible” coffin, local governments come to the party by maximizing charges and conditions to rip as much as the developer and buyer/borrower can pay in the price of the land. Revenue raising by local authorities allowed for in the system created by both federal and state levels of government.
All this revenue raising by stripping house buyers and mortgagors bare is given legitimacy by the mantra of housing as the great Aussie Dream and an asset for retirement and government policy designed to delude the masses that revenue and taxes gouged by banks and governments is actually going to build a reliable valuable asset and therefore is not a cost. This is a fraudulent argument at best. The mantra is reinforced by depicting renters as irresponsible and rent as dead money. What’s interest?
As far as I’m concerned the whole real estate industry, property investors, first home buyers and the selfish baby boomers are just along for the opportunistic ride. Being given confidence by the powers they rely on. They’re not responsible. That privilege goes to our leaders in every level of government and the home lending business. These are the people with the ability to say, no, stop, many borrowers will get burnt and the country will suffer. But nobody in a position to do so has said no. Now they’ve put us in the situation that the mortgage bubble is about to be deflated with pain for everyone.
Deflating the housing bubble is not what will hurt the most. It’s the mortgage bubble that will bite very hard. Debt is real, the value of a house is not. At least, until you sell to the next punter and the cash is in hand. As a country we’ll have to recapitalize our banks and repay offshore and local debt. Is the mining boom mark 2 going to do that? Good luck on that one! We are going to pay and it will come out of all our superannuation. No matter how it’s dressed up. Get used to it. This is not a solution it’s a consequence.
Ok so what are my solutions. Let’s better risk manage our future and have a solution for keeping the MMHP at reasonably affordable levels, so and how do we not let the ED get out of control? We have to deal with our TBTF banks which flaunt lending policy knowing that its taxpayer risk due to both explicit and implicit guarantees. How do we remove the effect of the guarantees? This is an international issue which we have little debate about in Australia. Please see this piece from Reuters where the issues for the G20 and the Financial Stability Board are concisely outlined. My solution for managing TBTF or SIFI banks is neither unique nor complicated. We must regulate now that these institutions must carry very high levels of capital to counter any risk to the taxpayer and incentive to socialize bank losses. There needs to be no other solution to ensuring that the MMHP is maintained at reasonably affordable levels. Whilst the SIFIs will be open to competition to non-SIFIs, by definition this will not lead to creating systemic risk or an unaffordable MMHP. The only caveat I’ll add is the definitions of capital and risk weighted assets needs clarity and transparency, as our friends the banksters are very adept at playing games with those two concepts.
Having dealt with the SIFI banks, what about the off balance sheet market that most believe caused the GFC? Whilst I don’t believe that securitization is the spawn of the devil, changes are required. Whilst figuratively shooting the rating agencies sounds like a good idea, I don’t believe that would work. But responsibility must be shifted to those who manage our and other people’s money. How is this done? By simply requiring the onus to be on money managers to do their own risk assessment and require those that borrow under structured or securitized arrangements to have complete transparency on a monthly basis of service provider and seller responsibilities and all the assets/mortgages/loans that are being funded. Again nothing new here as there are regulations in both the US and Europe currently being implemented to provide just those requirements. Its just that I strongly believe those requirements is all that is required to ensure risk based pricing and rating agency accountability in the securitization markets.
My next solution is not about changing tax laws as I just can’t reconcile either increasing taxes or denying legitimate deductions even when it relates to housing investment or ownership. I simply suggest that strengthening and increasing tenant rights will significantly reduce the attractiveness of housing as an investment whether as a landlord or occupier. I have made this suggestion before but I’m putting this in more context of an overall systemic solution. Rather housing would rebecome just an asset which may or may not increase in value. Tenants should receive long term tenure as a matter of right, say, 5 years breakable by the tenant only. Tenants should also receive rights for rental rebates on completing designated improvements. These two simple initiatives would almost eliminate incentives for short term investor capital gains and the uncertainty surrounding renting. Government dogma on home ownership and investment purely in the name of revenue raising will lose a lot of clout with these tenancy rights in place.
So there you have it. Take away the ability and incentive for our SIFI banks to create systemically risky high MMHPs. Remove the ability of governments to rob house buyers and mortgagors from basing revenue receipts on house and land values by removing the credibility of the dogma of the need for home ownership and the weakness of renting. What you have left is a country and housing system that will not contain systemic risk or the ability to make many of us very unhappy.