Australian Treasury sounds the property alarm

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By Leith van Onselen

After spending years telling us that Australian housing was not a bubble and Australia’s world-beating housing debt was “not a situation for concern”, Australian Treasury officials have warned the Morrison Government that Australia’s household debt will become unmanageable if unemployment rises. From The AFR:

“A large increase in unemployment would quickly see an increase in loan defaults, which leads banks to slow the flow of credit to the economy”…

“The situation would likely be compounded by weaker consumption as other households make efforts to repair their balance sheets”, the brief, dated November 5 and signed by Macroeconomic modelling and policy division principal adviser John Swieringa said…

Treasury has also warned the Government that negatively geared investors could start dumping properties, exacerbating the bust. From The Australian:

“Where around two-thirds of housing investors are negatively geared, these investments are implicitly predicated on expectations of capital gain in the future”…

“Should these expectations be reconsidered in light of the recent declines in prices or increased difficulty in rolling over financing, such as under the interest-only mortgages preferred by housing investors, investor sales may put additional downward pressure on prices.”

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The sad reality is that in addition to draining the budget of much needed revenue and eroding housing affordability, Australia’s combination of negative gearing and the capital gains tax (CGT) discount have raised financial stability risks.

A key financial stability concern is that investors – where the decision to purchase property is based on weighing-up and considering alternative investment returns – are always more likely to be fickle and cut-and-run as soon as conditions change, or more profitable opportunities are presented elsewhere. This places Australian housing on a more fragile footing than if demand was driven primarily by owner-occupiers, who tend to buy into housing for the longer-term.

Expecting ongoing strong capital growth in the face of declining yield also suggests a very strong belief in the “greater fool theory”, and was always going to be unsustainable.

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What was a positive feedback loop that caused dwelling prices to rise could just as easily cause prices to fall. That is, as investors realise that Australian housing is ex-growth, there is little incentive to invest in what is a loss-making endeavour. This could prompt a negative flow of investors into the market, further depressing prices in the process.

By encouraging speculative investment, negative Gearing and the capital gains tax discount raised the risk of a boom and bust in house prices, which now appears to be coming to fruition.

While the timing may not be ideal, Labor’s reforms to negative gearing and the CGT discount are vital as they represent a structural change that would boost the economy over the longer-term by shifting the allocation of capital away from unproductive uses, like house price speculation, towards more productive uses, like genuine business investment.

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In addition to boosting productivity, Labor’s policy should also improve long-term financial stability by preventing future boom/bust property cycles from developing.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.