When too much housing is bad for our health

ScreenHunter_23 May. 30 09.38

By Leith van Onselen

Over the past 24 hours, I have read a range of articles, both from Australian and abroad, arguing that the obsession with housing “investment” is sacrificing the economy’s potential by diverting too many scarce resources to what is, in the case of pre-existing housing at least, an unproductive investment.

John Carney, writing in Business Insider, encapsulates this view nicely, arguing that overinvestment in housing is thwarting innovation and technological advancement in the US, making it harder to grow living standards:

Let’s face it.

We are in something of an innovation rut…

What’s gone wrong? Much of the lack of innovation can probably be blamed on the malinvestment that resulted from the housing boom. It’s not just that too much funding got directed into housing—too much human capital got directed into housing and finance during the boom.

This is all too obvious on Wall Street these days. Most financial firms, stung by the tech bust and investor fears of tech companies, shrank their operations in this sector while pouring talent and funds into housing related sectors…

The result is that most financial firms lack the in-house expertise to invest in innovative business ventures on any meaningful scale…

What’s more, there was so much money to be made in derivatives and credit—largely arising from the underlying housing boom—that many of the smartest people got drawn into these areas rather than tech innovation. Basically, we got lots of questionable financial innovation instead of technological, medical, or environmental innovation…

In short, we can’t produce what we should be able to because we invested in the abilities to produce what we don’t need…

Is there a way out? Of course.  The bursting of the housing bubble created a great opportunity to set the economy back on course. Unfortunately, our government engaged what amounted to Shock-and-Awe war against the liquidation of past errors, locking up even more capital in the errant bubble businesses.

It’s a view shared by Zachary Karabell, also from the US, who asks whether the economy has become addicted to housing in order to drive growth. From Reuters:

Housing is widely perceived as a key ingredient to a healthy economy, and so the revival in the housing market has been heralded as a positive step for an American system that has been sluggish at best. Similar trends in the United Kingdom and parts of the EU are greeted as positives as well.

But is it? Housing is a key aspect of economic activity in most countries, but that doesn’t mean that we should welcome a return to housing as a perceived pillar of national strength. And we should be very wary of any return to an ethos that sees either home ownership or housing prices as a barometer of individual and collective success. Those attitudes very nearly imploded the modern financial system, and they could imperil it again.

Homes are places where you live. They are not — and should never have been — investment vehicles. Yes, homes may gain in value and augment one’s net worth, but the reason to own a home is that it can be a cost-effective way to obtain a place to live. The minute they are seen as investments, that reality gets perverted, with dangerous consequences…

What was most damaging about the housing boom and bubble of the 1990s and 2000s was that millions of middle-class families bought into the notion that homes should be the repository of their net worth and future wealth. Decisions about buying shifted away from pure calculus of need and acceptable costs and instead were increasingly based on the likelihood (or not) that their homes would increase in value.

It’s an easy path from that belief to outright speculation. The idea that homes are a primary investment is not only what drives real estate bubbles but also drives real estate crashes.

And finally, our own Adam Creighton has written a post today in The Australian arguing that the recent explosion of property investment in Australia is “bonkers”, diverting resources away from more productive activities:

Ordinary people are being priced out of the so-called “great Australian dream” by cashed-up older generations buying for themselves and their children…

Buying a quaint 19th-century terrace in Sydney or Melbourne might impress friends, but it doesn’t add to the nation’s productivity capacity one iota. Individuals invest by studying at university, or investing in a growing business; companies might buy equipment or build factories that enhance their productive capacity and future profitability.

Beyond any capital appreciation, the only tangible return from buying an established dwelling is the right not to have to pay rent – nothing more or less. And rents typically grow in keeping with average household income; they bear no relationship with the skill or effort of the owner as business profits do…

Australians developed an unhealthy obsession with housing in the 1980s which they are yet to shake. In the long run we can’t become more prosperous by buying each other’s houses at ever higher prices, however wealthy individuals might “feel”.

I obviously sympathise strongly with these views. A quick look at the Australian macro data suggests that the Australian economy has become over-invested in housing, with the total value of the housing stock now roughly three times the size of the economy, versus only two times the size of the economy in the mid-1990s and around 1.5 times the economy in the 1960s (see next chart).

ScreenHunter_61 Sep. 20 09.13

Perhaps of more concern from a productivity persepctive is that Australia’s banks have become far less focussed on lending to businesses over the past 20 or so years, instead choosing to fund housing, most of which is pre-existing and therefore not marginally productive (see next chart).

ScreenHunter_62 Sep. 20 09.17

Also concerning is that the huge surge in mortgage lending, which has fuelled rising house prices, has been funded partly via increased offshore borrowings by Australia’s banks, in turn increasing Australia’s dependence on fickle overseas investment markets and heightening liquidity risks during times of international turmoil (see next chart).

ScreenHunter_63 Sep. 20 09.20

The financialisation of Australia’s economy, in part through housing, has also seen the finance and insurance sectors grow at well over double the pace of the rest of the economy since financial deregulation, hitting an equal record 9.9% share of the economy as at June 2013 (see below charts).

ScreenHunter_80 Sep. 04 18.06
ScreenHunter_81 Sep. 04 18.06

Like Frankenstein’s monster, it would appear that the financial sector, which once acted merely as an enabler of the productive economy, is now pulling its master’s strings, and arguably crowding-out more productive sectors in the process.

As noted yesterday, the likely decline in commodity prices and the terms-of-trade over the decade ahead is set to weigh heavily on Australian income growth, requiring a significant lift in productivity if Australia’s living standards are to continue growing at a pace to which we have become accustomed.

Diverting more of the nation’s financial capital and resources into housing, particularly pre-existing homes, is the wrong recipe to achieve such growth in productivity and living standards.

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Unconventional Economist
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  1. Purchasing a house isn’t just about making money but preserving wealth. People have been brainwashed into thinking that housing always goes up so why risk my money in a new venture when I can leverage it 10 to 1 in an asset that has never failed.

    You can spend all the money in the world educating these people but until they get burnt housing will always be the preferred method of building wealth for the average Joe.

    • “preferred method of building wealth for the average Joe”

      And just so people know who the average Joe is, unconventional has kindly included a photograph. It describes a lot about the housing situation in Australia without having to use words.

    • wasabinatorMEMBER

      Unfortunately the savers will be burnt in an attempt to save them well before they even start getting warm.

  2. That’s all absolutely true UE- but how do you turn the ship around when the psychological/cultural momentum is so great?.I mean we even have Kohler on the housing drug now! Exceptional political leadership is one ingredient-but that is not going to be forthcoming-and nor is it coming from the RBA or Treasury both of whom appear to have washed their hands of the issue.Maybe the looming crunch facing the RBA thanks to a rising currency and rising house prices-will force them to pull finger?
    So that leaves MB and a handful of others. Keep up the good fight.

    • Hugh PavletichMEMBER

      Terrymcf … excellent comments.

      You might like to check out the list of articles by Bonnie Cao of Bloomberg on the Chinese property market within the comments stream of Leiths “China Ghost Cities” article here on MB today.

      It does cross ones mind … what happens to Australia is Chinese property goes pear shape ?

      And second … what are the Australian Authorities doing to fizz the local bubble, so Australia is not so vulnerable ?

      Hugh Pavletich

  3. Thanks UE! Great article! Hopefully someone somewhere in a position of influence will note it. The 9.9% share of the economy by the Finance and Insurance sector is actually effectively a TAX on the productive sectors of the economy.
    As per jobs today I wonder what it looks like if you add the PA&S sector to the Finance.

    Unfortunately observing the problem does not help us out of it. Modern economic theory sees no problem. The RBA sees no problem. Politicians see no problem. Most people live in capital cities, particularly isolated in Sydney and Melbourne, and dominate the politics of the nation see no problem.

    The issue now looks too immense and difficult to try to fix. Any attempt to fix this will cause severe dislocation.

    Sorry! The answers lie back in time.

    • From recent blogs here it seems the Macrobusiness position has changed from your original position that Australian house prices must inevitably crash/melt from 2010 levels, to a new moralistic position on why the ongoing house price inflation is bad for society.

      Am I right in thinking the new Macrobusiness position is that the crash/melt (from the 2010 peak) is no longer the most likely scenario, and that a renewed period of house price inflation is now more likely (with perhaps a future crash/melt from a new higher peak?)

      • I definitely can’t speak on their behalf but my interpretation of recent blogs is that, while we may see price inflation in the short term, there is still significant risk in the next few years in the form of commodity prices, falling mining investment and a global liquidity squeeze… which could all lead to higher unemployment.

        I think the key question is, seeing as the RBA is unlikely to raise rates in the face of falling mining investment, would unemployment alone be enough to cause significant price deflation? or is it necessary to have rising interest rates as well? If rising rates are compulsory for deflation, then it may be quite a while before deflation begins.

      • In the short-run, yes. In the longer-term, no. My rough guesstimate previously was that housing values would return to around 2 times GDP within a decade. This view has not changed, although obviously there is a cyclical bounce at the moment.

        I have always taken a moralistic position on why the ongoing house price inflation is bad for society, despite being a home owner. This has never wavered. Hence my interest in the structural factors behind the current situation (e.g. supply-side barriers, negative gearing, etc).

      • @CT I can’t speak for MB and I don’t know if the position has changed. However I think there is a greater realisation of the negative impact of high house prices and a economy driven only by housing.

        As we have seen in the US, holding rates down low only inflates asset prices without actually boosting the economy much.

        Slow melt or otherwise, the question becomes of how do we do more productive things … Why can’t we (as the human race, not just Australians) build more infrastructure? more scientific research? Send men to Mars?

      • “My rough guesstimate previously was that housing values would return to around 2 times GDP within a decade.”
        Thank you for the opinion.

        Imagine what that will do to this economy or look at the mirror-image and imagine what this economy will look like to enforce that!

  4. Note: As a developer I hate hot housing markets. It brings out a lot of builder/developers who pay to much for the land and bet on rising prices to make a return.

    True developers would rather house prices never rise more than inflation. It means we know exactly what our costs will be, how much you should pay for the land and what your realisation would be.

    The only people who benefit from house price increases are existing owners of the land and land bankers. If you want more land available to be developed you need to encourage these people to sell and a land tax would be perfect for that.

    • I sympathise with you Labrynth. A close friend of mine is an expert on eco building. His biggest gripe is that the cost of land is so high that there is nothing left for eco ‘extra’s’. It’s not that people don’t want to consider improving the energy efficiency of their homes, or the sourcing of responsible materials, its just that they are mortaged up to the hilt before the building process even begins!

    • Too true, I spent years in the uk in the mid 80’s as a builder developer being outbid by enthusiastic amateurs that paid over the odds only to be saved by the madly rising market, that is until it all went dreadfully wrong, and the market corrected by 45%.

  5. “What’s gone wrong? Much of the lack of innovation can probably be blamed on the malinvestment that resulted from the housing boom. It’s not just that too much funding got directed into housing—too much human capital got directed into housing and finance during the boom.”

    So here we see the true cost of having all those physics, maths etc, etc Phds going into the financial sector, rather than becoming professional Physicists, Mathmaticians etc, etc.

    “The result is that most financial firms lack the in-house expertise to invest in innovative business ventures on any meaningful scale.”

    Exactly. Our financial institutions have forgotten how to lend money.

    • dumb_non_economistMEMBER


      If the NSW Gov buys back that “in admin” toll road, are the taxpayers going to take it in the neck or are the shareholders going to take a bath on their investment?


    • The new government is going to have a “toll-road-led recovery”

      Well, I can see an excellent opportunity here. Why not build a large circular toll-road. A nice big one circumnavigating Sydney. Only on-ramps – no off-ramps (to maximise revenue).

      We need more simple, well thought out wealth generators like this if we intend to continue being the Lucky Country.

  6. Cheap money has to share a lot of the blame. Eventually this must turn (signs are emerging that this process is underway) and then the whole house of cards comes crashing down.

    Governments that are up to their necks in debt will have to inflate the debt away. Our government will be forced to take on a good deal of the private debt and end up doing the same. The creditor nations will take a huge haircut on their holdings of US bonds. It will make the Depression seem like a Sunday school picnic.

    However, when it will happen is anybody’s guess. Might not be in my lifetime. Can kicking is surprisingly effective in postponing the inevitable.

  7. For every young person who has a dream of starting a company and launching a productive endeavor, there are 10 others who simply dream of “get rich quick by flipping houses”.

    It’s depressing what we have become.

    • “get rich quick by flipping houses”

      Flip them? Heavens no!
      You don’t sell them. You get them revalued then borrow against the equity and leverage into more property. Have you learned nothing from the last 40 years of wealth creation?

    • I would say for every young person who actually starts a company and launching a productive endeavour, there are 10 others who’ve had the dream crushed out of them by the effort of simply trying to save enough to afford to buy a place to live.

      Dreams of making a fortune out of housing remain solely the domain of elderly Australian boomers.

  8. A little over a year ago I was told that the capital investment promises which I was relying upon for my business plans would no longer be honored. Basically the Sydney RE bug had struck and sucked the well dry. I naturally argued that my venture would generate better returns, what else could I do?

    Well guess what a couple of weeks back I meet with the investor group and they took pleasure in pointing out their 30% plus paper profits, in just over 1 year, all backed by solid risk free Sydney RE.

    Dont know how often I was told (endured):
    “what you technical types dont understand is Risk adjusted Returns” 30% return, zero Risk, compare that with even your Best Case manufacturing returns…..and you wonder why we pulled the capital….

    I felt like saying FU and all your speculator friends too, but that would serve little purpose so I suggested they break out their best Champagne and we could all celebrate….it appears that in Australia a good drowning of one’s sorrows is all us technical types deserve.

    • I was at a seminar in Frankfurt last week which was basically looking at ‘bubbles’ in play – How they got there and what they mean – how they play out. The one which got the lengthiest discussion (by a mile) was what they called the ‘English Speaking world’ (US, UK, Ireland, Canada, Australia and New Zealand) and its focus on real estate as a driver of aggregate demand, the tax breaks in play supporting it (and to some extent they have a lot of similarities across the ‘Anglosphere’ although each nation/state has its own peculiarities).

      But the general idea (which was explored extensively) was that from here (2013) pumping up Real Estate in the US and UK (as well as Canada and Australia) is basically about buying time to get other economic drivers in play – it isnt a long term strategy. A couple of the speakers noted it was supporting the few at the expense of the many and would have its own social political implications on that basis, but there would be diminishing return on the strategy (for reasons similar to those put in the article – it is a noose around the economy, stifles innovation etc, embeds debt into the economy, socially regressive etc). People noted that the Irish property collapse has slowed, but the Irish government (and I also spent a night getting tanked in Dublin with a mate in this position) has just started changing laws to put pressure on home owners under water with their loans (a large chunk) and there is a massive property overhang on the market.

      They seemed strongly of the view that in Australia and Canada the bubbles were still there to pop – when I pointed them in the direction of advertising, prices and commentary on RE readily available in Fairfax etc there were guffaws – but there was general expectation that governments would continue to try and pump them. In the end my views tended to drift towards Australia needs to have the bubble as the only way to get the economy on some sort of productive footing in the longer term was that there needed to be the bust. There is no political way around paying off a ransom to those embedded (through tax systems) into rent seeking positions. The slow melt theory I think requires sustained political discipline of the type we don’t have. Unless we get the downturn in real prices the economy become progressively more moribund.

      I was actually with some fund managers who spent time considering how to most effectively short the market. That discussion is likely to be ongoing. But my takeaway (as someone who has thought of buying – but is basically of the view that Australian Real estate is right up there with the worst purchasing opportunities on the planet) was a few beers with a guy who handles staggering sums (across all asset classes) and is basically a walking encyclopaedia of the global financial system. He asked me about Australian real estate (it was the first time I had seen him in a couple of years). I pointed him in the direction of realestate.com.au and his eyebrows lifted as the prices came up, and they went higher when I showed him rents, higher again when I showed him prices of everyday things in Oz, and he lit up a smoke when I showed him the debt/disposable income chart from the last RBA chart pack. He asked if I had bought since coming back, and I told him no. He said to give him a call if ever I was thinking about it. But the question he posed which has stuck with me was ……’even if they get the uptick in house prices, where do they think they go from there? At a certain point it is all one way, and that certain point has to be getting closer every minute’

      • Thanks for a great post. We need more people like your mate talking to our politicians (and to our better halves as well 🙂 )

      • reusachtigeMEMBER

        A great read as usual, but that point has been getting closer for a very long time. Australians are actually innovators … we invented the titanium plated housing bubble!

      • Thanks Gunna…this is a request for thoughts not criticism.

        Australia IS different. It is not Ireland, UK or Netherlands nor even the US (although that might be worth a separate topic) The big difference is our truly amazing seemingly inexhaustible natural resource assets. As long as we are prepared to sell those assets to fund ourselves why can’t current policy go on.

        The RBA is hell bent on blowing up this housing bubble to fill in the apparent gap following mining investment decline. As such it is reducing interest rates as much and as quickly as it can. Given our willingness to sell assets to fund ourselves which gives us ‘street cred’ internationally it looks like Ben has just underwritten our external account. So, without some major unexpected event, there will be plenty of funds available to fund us. Further the result of Ben’s shenanigans this week the RBA is free to set sail towards zero with nominal interest rates. What’s to stop them going there now?
        Inflation doesn’t matter. Everyone has a reason why there will be no inflation. JMO they are completely wrong but even if there is inflation at some point the RBA will ‘look through’ it because they have no choice. If inflation gets going then cost of development and construction accelerate rapidly again driving house process generally upwards in the absence of a serious interest rate increase by the RBA.

        As reported by China Bob this housing bubble looks like a risk free guaranteed bet for as far out as we can see.

      • ff……………ESPECIALLY the better halves. Man! The pressure!
        And…I’ve got no defence. I’ve been wrong for decades!

      • Welcome back, Gunna, I was wondering why you hadn’t been posting lately.

        It’s always interesting to see the reactions of outsiders to our property market, but as one who thought back in 2007 that prices couldn’t get any higher, I was proved completely wrong.

        I tend to agree with flawse that the RBA and the govt are hell-bent on pumping up this bubble, and it’s been bemusing to see an all-out media attack on any thought that this boom could be likened to a bubble. There have been articles lately predicting Sydney’s prices to grow by up to 20% in the next year, but that still wouldn’t be a bubble!

        Gunna, you’re absolutely right that this bubble has to burst, but I know I have completely underestimated the govt’s powers of keeping it and pumping it higher. Interest rates could still go lower, they could create more housing shortages by more immigration and could somehow increase the rate of foreign investment, even though it is unprecedented at the moment. I’m sure there are more things they could dream up.

        The main thing is, we really are different and it will only be in hindsight whenever that is at some distant point in the future when it does all blow up, that we’ll be able to say we’re not different after all.

    • China-Bob,

      I would say to them.

      In the late 90s I worked at an export based industrial company that was making about 10 to 15% return on investment providing solid jobs for people in the community.

      The manager told us that a number of investment fund managers had cornered him and had said to him that they were not keen to invest in the company because they could make twice that by investing in “technology” companies on the share market. We all ended up losing. We couldn’t get the investment we needed to expand/reduce costs and they ended up losing a lot of their money.

      And I put “technology” in brackets because I remember Jack Welch’s explosion at a reporter who asked asked a question which effectively said GE was not a technology company and what he thought of that. Now the new idea of technology is getting people to create apps.

      Thump. Thump. Thump. Thats the sound of me hitting my head against the wall. Again.

    • Just a minor correction willy_nilly, its households with 4 or more bedrooms and not spare bedrooms.

      In any case, that is a staggering number, ~ 1M.

    • 696,000 two people houses with 4 or more spare bedrooms,

      That’s nothing. We have thousands of CPU’s with 99% spare capacity.

      Hell, some desktop PC’s even have 1, 3 or more unused CPU cores!

      What about all the unoccupied laptops at night time?

  9. We shall reap what we sow. Australia has had ample warning from other countries who have already suffered from a popping real estate bubble.

  10. Fantastic comment from Labrynth above. Until the tax system is changed and a broad based land tax is implemented we run the risk of misallocation of resources into speculation in the land market. Ken Henry recommended this in his review but no party will go near it. I attended a breakfast briefing this morning with Peter Anderson from the ACCI and he mentioned that they support tax reform with payroll tax first on the agenda. The bigger issue though is negative gearing which inflates property prices and business / income tax which adds to the cost of running a business and the eventual selling price of the goods and services that they offer.

  11. I was interested in the Bank Lending by Category chart. The big banks think they are different but really they are great big building societies. When they lend to business as recorded in the chart is that lending still mostly secured against property? My experience is that banks wont lend to business unless they have the house/building nailed down!

  12. Great post. Great comments. Taking a business or innovation risk mostly comes after housing and kids educations are sorted – Australia is just shooting itself in the foot.

    And I couldn’t agree more with labyrinth’s point. As someone who recently bought an upgrade house that needs improvement, the 20% more I had to spend fending off specufesters at the end of the auction is just money I don’t have for better building improvements.

    Booms do nothing for quality or legitimate operators – just ask anyone in the insulation business about Rudd’s idiotic scheme.

  13. We don’t need any productivity or innovation we can just continue to print money and as long as Chinese are wiling to sell us their goods for piece of paper, we don’t have to produce stuff and can continue to speculate on housing and stocks.