Leith and I have been debating internally if Australia is on the verge of a psychological break this morning. There is a lot of coverage in the press about the housing bubble, APRA and RBA tightening.
Having thought this through I’ve come to the conclusion that it’s the wrong question to ask. More apposite is what is it that regulators have set about doing and how will sentiment respond to that in due course.
To understand what they’re about, we can turn to a similar historical period. In 2003 the RBA confronted a relatively weak economy following the dot-com bust but a runaway property bubble in Sydney.
To combat it, the then Macfarlane RBA set about popping the bubble without crashing the economy by launching a major jawboning assault on investors combined with a couple of short and sharp rate hikes. They succeeded in doing a lot more damage to sentiment than they did actual monetary tightening which helped mitigate the fallout.
Significantly, this approach was based upon research by a junior governor name Phil Lowe, who had several years earlier penned BIS research arguing that bubbles ought to be dealt with up front, not afterwards, as was the orthodoxy under Alan Greenspan.
Contrast that with today and I think we can see the same methodology being employed by the Council of Financial Regulators. In the past few days we have had ASIC, the RBA and APRA all jawboning their butts off about the bubble, about household debt and about dodgy lending. They have also tightened macroprudential across a anumber of metrics. All three are at it again today. See Wayne Byers this morning:
In the past few days, there has been a great deal of attention given to our recent announcement on additional measures to strengthen one particular part of the financial system: the residential mortgage lending market. These measures build on the steps we have taken over the past two years to bolster loan underwriting practices and moderate investor lending, in an environment that we considered to be one of heightened risk. Those measures had a positive impact (Chart 1), but at the same time the risk environment certainly hasn’t moderated:
- house prices remain high;
- household income growth remains subdued;
- the already high ratio of household debt to income has got higher;
- the already low official cash rate has got lower (although not all of this reduction has flowed to borrowers, particularly investors – Chart 2); and
- competitive pressures haven’t diminished.
It’s important to be clear that our goal in implementing the additional measures we announced on Friday is not to determine house prices. Housing prices are not within the control, nor the mandate, of the prudential regulator. Nor, as the Reserve Bank Governor said last night, can prudential measures address underlying supply-demand issues within the housing market. Rather, our role in the current environment is to promote a higher-than-normal degree of prudence – definitely by lenders and, ideally, also borrowers – in both credit decisions and balance sheet strength. On this occasion, we have focussed on interest-only lending to complement our earlier measures. Although there are perfectly legitimate reasons why individual borrowers might prefer an interest-only loan, in aggregate the level of interest-only lending creates additional vulnerabilities and we came to the view some additional moderation in this area was warranted.
We chose not to lower the investor lending growth benchmark at this point in time, given the need to accommodate the increasing supply of housing in the construction pipeline. However, limitations on the volume of new interest-only lending will impact investors more acutely than owner-occupiers, given that around two-thirds of lending to investors is on an interest-only basis. Furthermore, although the 12-month annual growth rate for investor lending is currently below the 10 per cent benchmark, the run rate in more recent months has been closer to (if not a little above) 10 per cent on an annualised basis. Therefore, even with the benchmark unchanged, lenders are still likely to have to tighten their lending practices and slow lending from that in recent months to ensure they remain comfortably below the desired level.
This latest step is a tactical response to current market conditions – we can and will do more (or less) as conditions evolve. We also developing a more strategic response that recognises that, in the Australian banking system, housing lending risks and capital adequacy are far from independent issues. I’ll come back to that point a bit later.
Note the emphasis on doing more if needed. The same from Phil Lowe last night.
If the analogy holds then more may be needed – it took two hikes in 2003 – but at some point soon regulators are going to break investor psychology. Indeed that is, I believe, their goal. With much of the media now a bald-faced property spruiker the message may take more time to get through this time, and because it’s co-ordinated across regulators it may be a bit more clumsy in execution plus its macroprudential tools not the heavy hand of rate hikes, but they have the power to succeed.
The subsequent 2003 Sydney bust was quite nasty in the mortgage belt though overall it only stalled city-wide prices for a decade. As I’ve noted many times, the bust stalled the “move-up ladder” as outer suburbs prices fell then folks could no use their equity to pay more for more expensive properties closer in.
The market oversupply was then backfilled by immigration and mining boom related income growth for ten years. Credit was no rationed at any point.
Regulators usually trust that “something will come along” so I reckon they are prepared to rerun the 2003 gamble for Sydney and Melbourne. It might work for a while as they bash investors but keep money loose.
However, there are a few key differences his time around versus 2003. Income will remain under pressure as a resumption in falls in the terms of trade arrives, immigration is coming under immense political pressure, the power shock is building, the car industry is shuttering, and the construction boom itself will peter out from year end. Then of course we’re at the end not the start of the global business cycle so we’ll be sailing into an external shock as well before too long.
Get out of property, sell banks.