Via the ABC’s Michael Janda:
Hindsight is 20/20, so they say, but some big calls do seem to stand the test of time.
One of those is the Reserve Bank’s decision to start raising interest rates in May 2002, having cut them only five months previously.
In his statement explaining that rate cut, then-RBA governor Ian Macfarlane had expected the global downturn following the dotcom bust to worsen and Australia to feel the fallout.
“The dampening impact on other parts of the economy of global events will become increasingly clear during 2002, at a time when the housing upswing will begin to moderate,” he had predicted.
But that didn’t happen. In fact, the US economy posted strong growth in early 2002 and the rest of the world was being dragged along with it.
Moreover, the moderation in house prices that Mr Macfarlane forecast didn’t eventuate.
By May 2002, Mr Macfarlane seemed to be following the famous adage generally attributed to economist John Maynard Keynes, “when the facts change, I change my mind. What do you do, sir?”
“The strong rises in house prices seen over recent years have also been associated with a rapid expansion in household debt, a process that carries longer-term risks if households become seriously over-extended,” he wrote then, justifying the rapid about-face on rates.
“To persist with a strongly expansionary policy setting would risk amplifying inflation pressures and, over time, could fuel other imbalances such as the current overheating in the housing market, potentially jeopardising the economy’s continued expansion.”
Reserve Bank tapped the brakes on housing bubble #1
Looking back on that decision in a recent interview with Joseph Walker for his Jolly Swagman podcast, Mr Macfarlane said he was “very happy with the result”.
Gentle is something of an understatement. On average, house prices kept rising for another two years and then remained broadly steady for a few years until the rate cuts and first-home buyers boost in the wake of 2008’s global financial crisis stoked them again.
But, for first-home buyers the damage had already been done.
During Mr Macfarlane’s tenure as central bank boss, average capital city house prices rose 120 per cent and went from being just above four times annual incomes to nearly seven.
Mr Macfarlane argues part of this surge was the inevitable consequence of taming inflation.
“We finally got inflation down and were able to bring interest rates down, and when interest rates came down people could afford to service bigger mortgages,” he explained.
Bigger mortgages, of course, mean people have more money to spend on houses, pushing up prices.
Capital gains tax cut sparked ‘crazy’ property speculation
But that had already happened in the 1990s, so what explained the pop in house prices at the turn of the millennium?
“On top of that we had something that was really harmful, which was pure speculative activity, particularly through negatively geared acquisition of second, third, fourth, fifth properties,” Mr Macfarlane continued.
“I’m particularly talking about a period around the turn of the century, from 2000, particularly 2002, 2003, when it was at its peak.
The interview doesn’t really dive into it, but there’s only one major policy shift that could have triggered such a stampede into speculative property investment — that is the Howard-Costello government’s decision in 1999 to effectively halve capital gains tax (CGT) overnight.
(Albeit, probably exacerbated by its goods and services tax, which pushed up the cost of building new homes relative to buying existing properties).
This 50 per cent CGT discount gave higher earners a strong incentive to convert current income from salaries, profits and investments into future capital gains that would be much more lightly taxed.
The obvious way to do this was through borrowing money to buy an investment property, deducting the interest bill against your current earnings and (if properties prices kept going up) pocketing the profits from selling while only paying tax on half of them.
To give a sense of the change in the property market after the CGT discount, the number of taxpayers reporting a rental loss jumped from 631,435 in 1999-2000 to more than a million in 2005-06, while the number of landlords reporting a profit actually fell from 532,472 to less than half a million.
Effectively, this meant Howard and Costello left Mr Macfarlane’s Reserve Bank to clean up the mess it made of the property market with the only tool the RBA has — the blunt one of interest rate rises.
Luckily, America’s rapid recovery from the dotcom bust and China’s epic growth in the early-2000s, with the Australian mining boom that triggered, meant the RBA could do this and check further property price gains without sinking the broader economy.
Reserve Bank generated property bubble #2
The next property price bounce was sparked by dramatic interest rate cuts — the cash rate more than halved from 7.25 per cent to 3 per cent in just eight months from September 2008 to April 2009 — and the Rudd government’s first-home buyer boost during the global financial crisis.
But it was fleeting — the government grants were temporary and then-RBA governor Glenn Stevens stuck with his predecessor’s playbook and started hiking rates again by October 2009 as it became clear the worst of the global crisis had passed.
However, as the mining boom turned to bust and desperate for another source of economic growth, the Reserve Bank itself turned to residential construction as saviour.
With no major changes in government housing policies, it’s abundantly clear that the property price boom that ran from 2012 to 2017 was largely down to the RBA’s rate cuts, from 4.75 down to 1.5 per cent.
It wasn’t as big as the early 2000s boom nor, Mr Macfarlane said, was it “so exclusively dominated by speculative investment purchases”.
But he added it “definitely did seem bubble-like”.
Swapping houses for holes
One of the reasons it wasn’t as dominated by speculative investors was intervention by the regulators.
The banking supervisor APRA, in consultation with the Council of Financial Regulators (which includes the RBA), started putting the brakes on investor lending in late-2014, probably trying to avoid a repeat of the early 2000s “craziness”.
Nonetheless, house prices across Australia’s capitals jumped by two-thirds, dominated by increases in Sydney and Melbourne.
That prompted APRA to limit other forms of risky loans, such as interest-only mortgages, while ASIC and the banking royal commission focused further scrutiny on lax lending standards.
By the end of 2017, the boom ran out of finance and out of momentum.
Prices fell around 15 per cent in Sydney and 11 per cent in Melbourne, but were still more than 80 per cent higher than when Mr Macfarlane left the RBA.
Once again it was Reserve Bank rate cuts — this time in conjunction with APRA loosening its lending restrictions and the re-election of a Coalition Government promising the continuity of investor tax breaks — that turned home prices back upwards.
While that might spell relief for property owners, developers, banks and real estate agents, Mr Macfarlane isn’t sure it’s a good thing for the economy longer term.
Where to now?
Having now seemingly twice avoided property crashes after bubbles, does the former Reserve Bank head think it will be third time unlucky for Australia?
“Do I see the risk of a collapse in house prices? No, I don’t,” he told the Jolly Swagman podcast.
“I think that those huge long-term structural factors are so powerful, the desire for people to compete with each other to buy houses or apartments in places where there are good jobs, which means big cities, people coming from other parts of the world to do it, people coming from the country to do it, people are already here doing it.
“I think a fundamental shift in the relative price of housing has occurred over the last 30 or 40 years, I don’t think it’s ever going to go back to where it was.”
But does that mean anyone who can should rush out to buy investment properties? Mr Macfarlane thinks not.
“I don’t think it can continue to go up as fast as it has over that period,” he forecast.
After leaving the Reserve Bank’s top job, Mr Macfarlane crunched the numbers and believes most property investors would have been better off putting their money elsewhere.
“If you’re lucky enough to buy right at the bottom and sell at the top, yes, you will make money. But that’s only a minority of people who do that,” he said.
“The majority, I think, either make not much more money than they would’ve in the bank or, in many cases, they lose money.”
For the few who do succeed at making money out of rising property values, he had this message.
“You’re making yourself richer at the expense of your children.”
And, like the use of non-renewable resources or the pollution of a finite Earth, that kind of intergenerational theft clearly isn’t sustainable.
Permanently high plateau anyone? Like so many of these boffins, Macfarlane is more mythmaker than seer or effective regulator. He oversaw the birth, adolescence an early adulthood of the great bubble yet he likes to see himself as hosing it off. Whatever you say, mate.
As for the future, of course it’s going to unwind. What do you think is going to happen when Australia has no rate cuts left, its terms of trade collapse as China goes ex-growth, and fiscal austerity persists anyway?
Australia is going to get cheaper. A lot cheaper. Including houses.
You can argue how it will happen, and over what time frame, but it happening is as certain as anything in economics.
My own view remains that this is a bull trap for house prices. We know that the iron ore market will correct through the next two years on supply side normalistion alone. Add China passing through peak steel and over the next few years, with volumes falling away at a decent clip in the enxt few years and becoming very serious by the mid-2020s.
As that happens the current income crush will turn into elephant sitting on the chest of every Aussie household such that they won’t be able to breath at all.
There’ll be no help from the RBA and the Budget will be slashed across the jugular.
Only the external sector can save us then and to compete everything will need to deflate a long, long way.