Who’s to blame for Australia’s property bubble?

By Leith van Onselen

Some of you would have seen the RBA’s testimony on Friday to the biannual House of Representatives Economics Committee, in which the Bank denied being primarily responsible for inflating Australian housing values:

…the first two of those questions [from students] focused on how they might hope to buy into a housing market that has become very expensive.

Mr Stevens acknowledged the problem, but denied that low interest rates were the biggest culprit for recent surges in home prices in some locations, particularly in Sydney.

“The biggest enemy for first home buyers is rising house values as the other 97 per cent of the population bids up those prices,” he answered.

“The answer doesn’t really lie with us though, we can’t change that much at all, the answer to those problems in my view lies in more innovative and more flexible use of the land that we have.”

The RBA’s deputy governor Philip Lowe said improved transport infrastructure is the key to that.

“As a society, one of the things we could do is invest more effectively in transportation to increase the supply of well-located land to put downward pressure on land prices and make housing more affordable,” he added.

For what it is worth, my view is that the RBA has played only a bit part in pushing Australian housing to unaffordable levels, with policy failure by Australia’s federal and state governments the main culprits.

Take the federal government, which has maintained a tax system that has made investment into housing a relatively attractive proposition via a combination of high tax rates on savings, as well as generous tax concessions like negative gearing and capital gains tax discounts, the latter of which was halved in 1999. As a result, demand for housing is much higher than it otherwise would be, resulting in too much of the nation’s capital being tied-up in housing, chocking-off productive areas of the economy in the process.

Anyone questioning this proposition only needs to examine the proportion of loans taken up by investors, which has surged over the past 20-plus years, in line with Australian house values (see next chart).

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Or the overall explosion of property investment, most of which is negatively geared:

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Of course, the Howard Government’s relaxing of rules around superannuation funds leveraging into property, the massive ramp-up in immigration, as well as the Rudd Government’s opening the sluice gates to foreign investors have also played major roles in raising demand for housing, which combined with easier credit via “financial innovation” put a rocket under Australian home values.

Nor can Australia’s state and territory governments escape blame. It is they who systematically tightened land-use and urban planning from the late-1990s, and implemented a range charges on new development. Together, these supply-side constraints have impeded the market’s ability to supply affordable housing and significantly dampened the supply response, despite rocketing prices and strong population growth (see below charts).

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On this point, the 1990s experience is instructive. Despite the hangover from the early-1990s recession, this period represented one of the biggest dwelling construction booms in the nation’s history when measured in population-adjusted terms, dwarfing the current construction “boom”, which has been largely confined to shoebox apartments (see next chart).

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Over the past 15 years, Australian house values have closely tracked the growth in finance commitments. That is, as demand has risen, so too have prices (see next chart).

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By contrast, throughout the 1990s, when construction rates were high, there was minimal correlation between finance commitments and house price growth, as the extra demand manifested in more homes being built rather than price increases. It also meant that home values returned to long-run norms after the bubble of the 1980s – something that should also have happened after the 2004 bubble, had the supply-side of the market been working effectively.

Put simply, it is government policy at both the state and federal level, and on both the demand and supply sides, that are the primary cause of Australia’s housing malaise.

Perhaps the biggest mistake of the RBA is that it has acted both as cheerleader and apologist for the housing market, continually neglecting housing market risks and arguing explicitly against the notion that Australian housing is overvalued or a bubble. In turn, this has provided Australia’s policy makers with cover to ignore the problem, and on occasions celebrate rising values for the wealth effect that it bestows on home owners.

More recently, APRA has been equally negligent, ignoring the unprecedented speculator frenzy taking place in Sydney and to a lesser extent Melbourne, which have driven Australian housing values and mortgage debt to unprecedented heights, and risks blowing-up the economy as it launches off the mining cliff, the local car industry shutters, and/or the next global crisis hits.

In short, there is plenty of blame to go around when it comes to Australia’s unaffordable housing. And finding a solution requires authorities to first acknowledge that the problem exists. This has occurred in New Zealand, where the central government and RBNZ are working to free-up supply and choke-off speculative demand, but unfortunately has yet to happen in Australia.

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