RBA Governor Philip Lowe spoke at the Economic Society of Australia (QLD) Business Lunch. Of note is the data which shows one third of households with a mortgage have little or no interest rate buffer, and that the Reserve Bank does not have a target for the debt-to-income ratio or the ratio of nationwide housing prices to income.
This afternoon I would like to talk about household debt and housing prices.
This is a familiar topic and one that has attracted a lot of attention over recent times. It is understandable why this is so. The cost of housing and how we finance it matters to us all. We all need somewhere to live and for many people, their home is their largest single asset. Real estate is also the major form of collateral for bank lending. The levels of debt and housing prices also affect the resilience of our economy to future shocks. Beyond these economic effects, high levels of debt and housing prices have broader effects on the communities in which we live. The high cost of housing is a real issue for many Australians and can have serious side-effects. High levels of debt and high housing costs can also reinforce the existing distribution of wealth in our society, making social and geographic mobility more difficult. So it is understandable why Australians are so interested in these issues.
At the Reserve Bank, we too have been focused on these issues in the context of our monetary policy and financial stability responsibilities. Our work has been in three broad areas. First, understanding the aggregate trends and their causes. Second, understanding how debt is distributed across the community. And third, understanding how the level of debt and housing prices affect the way the economy operates and its resilience to future shocks.
This afternoon, I would like to make some observations in each of these three areas.
Aggregate Trends
This first chart provides a good summary of the aggregate picture (Graph 1). It shows the ratios of nationwide housing prices and household debt to household income. Housing prices and debt both rose a lot from the mid 1990s to the early 2000s. The ratios then moved sideways for the better part of a decade – in some years they were up and in others they were down. Then, in the past few years, these ratios have been rising again. Both are now at record highs.
Graph 1
Although the debt-to-income ratio has increased over recent times, the ratio of debt to the value of the housing stock has not risen. This reflects the large increase in housing prices and the growth in the number of homes. Over recent times, there has also been a substantial increase in the value of households’ financial assets, with the result that the ratio of household wealth to income is at a record high (Graph 2). So both the value of our assets and the value of our liabilities have increased relative to our incomes.
Graph 2
Turning now to why the ratios of housing prices and debt to income have risen over time. A central factor is that financial liberalisation and the lower nominal interest rates that came with the lower inflation of the 1990s increased people’s ability to borrow. These developments meant that Australians could take out larger and more flexible loans. By and large, we took advantage of this new ability, as we sought to buy the housing we desired.
We could, of course, have used the benefit of lower nominal interest rates in the 1990s and the increased ability to borrow for other purposes. But instead we chose to borrow more for housing and this pushed up the average price of housing given the constraints on the supply side. The supply of well-located housing and land in our cities has been constrained by a combination of zoning issues, geography and inadequate transport. Another related factor was that our population was growing at a reasonable pace. Adding to the picture, Australians consume more land per dwelling than is possible in many other countries, although this is changing, and many of us have chosen to live in a few large coastal cities. Increased ability to borrow, more demand and constrained supply meant higher prices.
So we saw marked increases in the ratios of housing prices and debt to household incomes up until the early 2000s. At the time, there was much discussion as to whether these higher ratios were sustainable. As things turned out, the higher ratios have been sustained for quite a while. This largely reflects the choices we have made as a society regarding where and how we live (and how much at least some of us are prepared to spend to do so), urban planning and transport, and the nature of our financial system. It is these choices that have underpinned the high level of housing prices. So the changes that we have seen in these ratios are largely structural.
Recently, the ratios of housing prices and debt to household income have been increasing again. Lower interest rates both in real and nominal terms – this time, largely reflecting global developments – have again played some role. But there have also been other important factors at work over recent times.
One of these is the slow growth in household income. During the 2000s, aggregate household income increased at an average rate of over 7 per cent (Graph 3). In contrast, over the past four years growth has averaged less than half of this, at about 3 per cent. Slower growth in incomes will push up the debt-to-income ratio unless growth in debt also slows. This partly explains what has happened over recent years.
Graph 3
A second factor is that some of our cities have become major global cities. Reflecting this, in some markets there has been strong demand by overseas investors.
A third factor has been stronger population growth. Population growth picked up during the mining investment boom and, although it subsequently slowed, it is still around ½ percentage point faster than it was before the boom (Graph 4). For some time the rate of home-building did not respond to the faster population growth; indeed, the response took the better part of a decade. The rate of home-building has now responded and we are currently adding to the housing stock at a rate not seen for more than two decades. Over time, this will make a difference.
Graph 4
It is Melbourne and Sydney where population growth has been the fastest over recent times. Not surprisingly, it is these two cities where the price gains have been largest, and these price gains have helped induce more supply. Indeed, Victoria and New South Wales account for all of the recent upward movement in the national housing price-to-income ratio (Graph 5). In the other states, the ratio of housing prices to income is below previous peaks. So there is not a single story across the country. This is despite us having a common monetary policy for the country as a whole. Factors other than the level of interest rates are clearly at work.
Graph 5
In summary then, the supply-demand dynamics have been pushing aggregate housing prices in our largest cities higher relative to our incomes. With interest rates as low as they have been, and prices rising, many people have found it attractive to borrow money to invest in an asset whose price is increasing. The result has been strong growth in borrowing by investors, with investors accounting for 30 to 40 per cent of new loans.
This borrowing is not the underlying cause of the higher housing prices. But the borrowing has added to the upward pressure on prices caused by the underlying supply-demand dynamics. It has acted as a financial amplifier in some cities, adding to the already upward pressure on prices. The borrowing by investors is also obviously contributing to the rise in the aggregate debt-to-income ratio. Just like in the early 2000s, there is again a discussion as to whether these increases will continue and whether they are sustainable.
The Distribution of Debt
I would now like to turn to the distribution of housing debt across households. This is important, as it is not the ‘average’ household that gets into trouble. At the Reserve Bank we have devoted considerable resources to understanding this distribution. One important source of household-level information is the survey of Household Income and Labour Dynamics in Australia (HILDA).
If we look across the income distribution, it is clear that the rise in the debt-to-income ratio has been most pronounced for higher-income households (Graph 6). This is different from what occurred in the United States in the run-up to the subprime crisis, when many lower-income households borrowed a lot of money.
Graph 6
It is also possible to look at how the debt-to-income ratio has changed across the age distribution. This ratio has risen for households of all ages, except the very youngest, who tend to have low levels of debt (Graph 7). Borrowers of all ages have taken out larger mortgages relative to their incomes and they are taking longer to pay them off. Older households are also more likely than before to have an investment property with a mortgage and it has become more common to have a mortgage at the time of retirement.
Graph 7
We also look at the share of households with a debt-to-income ratio above specific thresholds. In 2002, around 12 per cent of households had debt that was over three times their income (Graph 8). By 2014, this figure had increased to 20 per cent of households. There has also been an increase, although not as pronounced, in the share of households with even higher debt-to-income ratios.
Graph 8
Another dataset that provides insight into distributional issues is one maintained by the Reserve Bank on loans that have been securitised. This indicates that around two-thirds of housing borrowers are at least one month ahead of their scheduled repayments and half of borrowers are six months or more ahead (Graph 9). This is good news. But a substantial number of borrowers have only small buffers if things go wrong.
Graph 9
At the overall level, though, nationwide indicators of household financial stress remain contained. This is not surprising with many borrowers materially ahead on their mortgage repayments, interest rates being low and the unemployment rate being broadly steady over recent years. At the same time, though, the household-level data show that there has been a fairly broad-based increase in indebtedness across the population and the number of highly indebted households has increased.
Impact on Economy and Policy Considerations
I would now like to turn to the third element of our work: the implications of all this for the way the economy operates and its resilience.
It is now commonplace to say that housing prices and debt levels matter because of financial stability. What people typically have in mind is that a severe correction in property prices when balance sheets are highly leveraged could make for instability in the banking system, damaging the economy. So the traditional financial stability concern is that the banks get in trouble and this causes trouble for the overall economy.
This is not what lies behind the Reserve Bank’s recent focus on household debt and housing prices in Australia. The Australian banks are resilient and they are soundly capitalised. A significant correction in the property market would, no doubt, affect their profitability. But the stress tests that have been done under APRA’s eye confirm that the banks are resilient to large movements in the price of residential property.
Instead, the issue we have focused on is the possibility of future sharp cuts in household spending because of stretched balance sheets. Given the high levels of debt and housing prices, relative to incomes, it is likely that some households respond to a future shock to income or housing prices by deciding that they have borrowed too much. This could prompt a sharp contraction in their spending, as they try to get their balance sheets back into better shape. An otherwise manageable downturn could be turned into something more serious. So the financial stability question is: to what extent does the higher level of household debt make us less resilient to future shocks?
Answering this question with precision is difficult. History does not provide a particularly good guide, given that housing prices and debt relative to income are at levels that we have not seen before, and the distribution of debt across the population is changing.
Given this, one of the research priorities at the Reserve Bank has been to use individual household data to understand better how the level of indebtedness affects household spending. The results indicate that the higher is indebtedness, the greater is the sensitivity of spending to shocks to income. This is regardless of whether we measure indebtedness by the debt-to-income ratio or the share of income spent on servicing the debt. If this result were to translate to the aggregate level, it would mean that higher levels of debt increase the sensitivity of future consumer spending to certain shocks.
The higher debt levels also appear to have affected how higher housing prices influence household spending. For some years, households used the increasing equity in their homes to finance extra spending. Today, the reaction seems different. This is evident in the estimates of housing equity injection (Graph 10). In earlier periods of rising housing prices, the household sector was withdrawing equity from their housing to finance spending. Today, households are much less inclined to do this. Many of us feel that we have enough debt and don’t want to increase consumption using borrowed money. Many also worry about the impact of higher housing prices on the future cost of housing for their children. As I have spoken about previously, higher housing prices are a two-edged sword. They deliver capital gains for the current owners, but increase the cost of future housing services, including for our children.
Graph 10
This change in attitude is also affecting how spending responds to lower interest rates. With less appetite to incur more debt for current consumption, this part of the monetary transmission mechanism looks to be weaker than it once was. There is, however, likely to be an asymmetry here. When the interest rate cycle turns and rates begin to rise, the higher debt levels are likely to make spending more responsive to interest rates than was the case in the past. This is something that we will need to take into account.
In terms of resilience, my overall assessment is that the recent increase in household debt relative to our incomes has made the economy less resilient to future shocks. Given this assessment, the Reserve Bank has strongly supported the prudential measures undertaken by APRA. Double-digit growth in debt owed by investors at a time of weak income growth cannot be strengthening the resilience of our economy. Nor can a high concentration of interest-only loans.
I want to point out that APRA’s measures are not targeted at high housing prices. The international evidence is that these types of measures cannot sustainably address pressures on housing prices originating from the underlying supply-demand balance. But they can provide some breathing space while the underlying issues are addressed. In doing so, they can help lessen the financial amplification of the cycle that I spoke about before. Reducing this amplification while a better balance is established between supply and demand in the housing market can help with the resilience of our economy.
There are some reasons to expect that a better balance between supply and demand will be established over time.
One is the increased rate of home-building. As we are seeing here in Brisbane and some parts of Melbourne, increased supply does affect prices. This increase in supply is also affecting rents, which are increasing very slowly in most markets.
A second reason is the increased investment in some cities, including in Sydney, on transport. Over time, this will increase the supply of well-located residential land, and this will help as well.
And a third reason is that at some point, interest rates in Australia will increase. To be clear, this is not a signal about the near-term outlook for interest rates in Australia but rather a reminder that over time we could expect interest rates to rise, not least because of global developments. Over recent years, the low interest rates in Australia have helped the economy adjust to the winding down of the mining investment boom. They have helped support employment and demand through a significant adjustment in the Australian economy. We should not, though, expect interest rates always to be this low.
It remains to be seen how the various influences on housing prices play out. Other policies, including tax and zoning policies, also have an effect. But increased supply and better transport could be expected to help address the ongoing rises in housing prices relative to incomes. These changes and some normalisation of interest rates over time might also reduce the incentive to borrow to invest in an asset whose price is rising strongly. To the extent that, over time, a better balance is established, we will be better off not incurring too much debt, and having housing prices go too high, while this is occurring.
I want to make it clear that the Reserve Bank does not have a target for the debt-to-income ratio or the ratio of nationwide housing prices to income.
As I spoke about earlier, there are good reasons why these ratios move over time. My judgement, though, is that, in the current environment, the resilience of our economy would be enhanced by an extended period in which housing prices and debt outstanding increased no faster than our incomes. Again, this is not a target or a policy objective of the Reserve Bank, but rather a general observation about how we build resilience.
Many of you will be aware that these issues have figured in the deliberations of the Reserve Bank Board for some time. This is entirely consistent with our flexible medium-term inflation targeting framework. With a medium-term target, it is appropriate that we pay attention to the resilience of our economy to future shocks. In the current environment of low income growth, faster growth in household debt is unlikely to help that resilience.
We have also been watching the labour market closely. The unemployment rate has moved up a little over recent months and wage growth remains subdued. Encouragingly, employment growth has been a bit stronger of late and the forward-looking indicators suggest ongoing growth in employment. We will want to see a continuation of these trends if the overall growth in the economy is to pick up as we expect. Stronger growth in incomes would of course also help people deal with the high levels of debt and housing prices. Overall, our latest forecast is for economic growth to pick up gradually and average around 3 per cent or so over the next few years.
To conclude, I hope these remarks help provide some insight into the Reserve Bank’s thinking about housing prices and household debt. As household balance sheets have changed, so too has the way that the economy works. Both from an individual and an economy-wide perspective, we need to pay attention to how the higher level of debt affects our resilience to future shocks.
A senior property data expert has warned Australians not to fall for “propaganda” claiming the Sydney and Melbourne housing markets have already cooled.
Even Treasurer Scott Morrison cited CoreLogic’s numbers on Friday to argue the housing market needed a “scalpel, not Labor’s chainsaw”.
“The concern here is that we’ve actually had the Treasurer refer to the index, basically to imply that he doesn’t really need to do that much more on affordability,” Mr Christopher told The New Daily.
“It couldn’t be further from the truth. Our opinion is that the market continues to boom and APRA [Australian Prudential Regulation Authority] will likely have to step into the market later this year.
“This is being used as propaganda, as an excuse for people to hold back from taking real action in the market.”
Unlike CoreLogic, SQM Research calculated that asking prices for houses rose over the last month by 1.1 per cent in Melbourne and 2.2 per cent in Sydney, coupled with steadily falling property listings and strong auction clearance rates around 80 per cent.
Falling listings were probably a sign that vendors were “holding back” because they expected prices to rise even higher, Mr Christopher said.
This is in stark contrast to CoreLogic, which estimated that Sydney’s dwelling values fell 0.04 per cent last month, while Melbourne grew by just 0.5 per cent. According to its index, combined price growth in the capital cities was the slowest month-on-month since December 2015.
CoreLogic is the most widely cited property pricer, at least among journalists, because it reports dwelling values daily and weekly. Its data formed the basis of most headlines reporting a ‘slowdown’ or ‘peak’.
However, CoreLogic’s own research director, Tim Lawless, urged “caution” last week about over-interpreting the company’s April numbers. He told The New Daily “potentially there is some seasonality creeping into these numbers”, as the index is generally moderated in April and May.
The Reserve Bank dumped CoreLogic as a data source last year over concerns about its methodology.
Mr Christopher said while the data continued to paint a picture of a booming market, he did not rule out a “slowdown” later in 2017, especially if regulator APRA cracks down further on bank lending.
By “real action” on affordability, he meant a temporary cut to immigration; incentives for migrants to move to regional areas; and the replacement of state-imposed stamp duties with a federal land tax.
Dr Stephen Koukoulas, an economist, warned that calling the end of the boom now would be “extremely premature and arguably a bit hazardous”.
He admitted he had been caught out “badly” in years past by making too much of month-to-month CoreLogic fluctuations, and urged others not to repeat the mistake.
“If we get another month of zero, well, the story builds. But so far I don’t think we’ve seen enough concrete evidence to say definitively this is the end of the boom,” Dr Koukoulas told The New Daily.
He also warned that vested interests could use CoreLogic’s numbers for their own ends.
However, the economist agreed the markets would eventually cool, perhaps as early as the second half of 2017.
“Look, it is going to cool, it is going to slow down, because it can’t keep going at that pace. There’s the APRA changes, many rate hikes by the banks, an oversupply in Brisbane apartments and Perth’s still looking dreadful,” Dr Koukoulas said.
“But to say there will be minus signs and a genuine ‘bust’, ‘correction’ or ‘slump’, that’s not going to happen. Or at least, I’d want to be see more evidence.”
An ideal scenario would be for price growth to stagnate at zero per cent in Sydney and Melbourne for the next five years while wages grow by 2 or 3 per cent (up from the current 1.2 per cent), he said.
“There is a problem in house prices in Sydney and Melbourne – there’s no question, I don’t think. Saving a deposit is difficult, even though once you’ve got the deposit you’re okay.”
Sydney home values remained unchanged in April, adding to a string of a data that points to a slowdown in property prices in the Australia’s largest city.
The April results mark the weakest monthly change in dwelling values in Sydney since December 2015 had a 1.2% fall, data from research firm CoreLogic showed today.
Apartment values fell 1.2% in Sydney last month. Melbourne values inched up 0.5%, while the increase across all capital cities was a mere 0.1%, the slowest pace in 15 months, the data showed.
The latest figures add to tentative signs of easing in Sydney, where prices have more than doubled since January 2009, prompting the Reserve Bank of Australia to voice concerns of financial stability risks and the banking regulator to tighten lending norms.
While the weekend’s new figures will be released later today, auction clearance rates in Sydney slipped last week, while growth in investor home loans, the primary drivers of the market, climbed at the slowest pace in six months.
This table shows the changes in dwelling values
“The softer results should also be viewed against a backdrop of an ever evolving regulatory landscape s which is firmly aimed at slowing investment and interest-only mortgage lending,” Tim Lawless, head of research at CoreLogic said. “The higher cost of debt, as well as stricter lending and servicing criteria, has likely dented investment demand over recent months.”
And this one points to the housing boom in Sydney and Melbourne
The Australian Prudential Regulation Authority last month directed banks to limit the flow of new interest-only lending to 30% of total new residential mortgage lending, as well as placing strict internal limits on the volume of interest-only lending loan-to-value ratios. It also urged banks to to restrain lending growth in higher risk segments and apply prudent buffers in assessing loan eligibility.
The 30% limit on interest-only loans, which are favoured by investors, compares to about 40% of all new mortgages now, a level that APRA said was quite high by international and historical standards.
While tighter lending can dent demand in Sydney, where more than half the new mortgage demand is from investors, CoreLogic cautioned against calling a peak after just a month of “soft results.”
“April, in particular, coincides with seasonal factors including Easter, school holidays and ANZAC day long weekend,” Lawless said.
Any measures in the federal budget aimed at housing affordability will have little impact on getting more people owning their own homes, according to latest budget monitor report from Deloitte Access Economics.
The concept of home and all that it means will come into focus at the federal budget next week with treasurer Scott Morrison indicating he will take action to increase home ownership.
The key questions are why housing has become so expensive and what can be done to get young people back into the market, especially in Sydney and Melbourne where prices have skyrocketed.
Nationally, house prices have risen 12.9% over the last year, with hot spot Sydney jumping almost 20%, according to the latest numbers.
Deloitte Access Economics blames record low interest rates.
“Affordability is through the floor because interest rates are through the floor,” according to the budget monitor report, led by respected budget forecaster Chris Richardson.
Deloitte Access Economics says politicians are increasingly pretending “they” can do something about it.
“Housing affordability is stunningly important … today’s housing prices are dangerously dumb, especially so in Sydney,” says Deloitte Access Economics.
Among the measures the federal government could announce in the 2017 budget are cutting the capital gains tax discount and supporting capital raising for social housing.
“But the likely impact of any of these on affordability would require a microscope to observe,” says Deloitte.
“Yes, there’s good policy there and much that we’d support,” says Deloitte.
“But affordability is rotten because interest rates have never been lower.”
Deloitte says each percentage point increase in interest rates would strip some 7% off average housing prices.
Here’s how mortgage rates have fallen over the last three decades:
Source: Deloitte Access Economics
“If politicians, state and federal, are leaving punters with the impression that they can solve housing affordability, then they’re leading us down the garden path,” says the budget monitor report.
“And that’s unfortunate, because the electorate is already incredibly disappointed in the ability of politicians to deliver anything.”
Shane Oliver, head of investment strategy and chief economist at AMP Capital, notes that the government is now playing down what it can deliver on housing affordability.
“Maybe a few fiddles to encourage downsizing but since the big issue is supply and that is a state issue there is not really much it can do,” he says.
The federal government may be poised to unveil a special savings account and tax breaks for first home buyers in next week’s budget, despite government ministers refusing to confirm leaked reports in the media at the weekend.
With the housing affordability crisis close to the top of voter concerns, the federal Treasurer last week appeared to change focus from the housing sector to infrastructure, but those hoping to get into the housing market will be encouraged to hear the issue may be tackled, if in limited form only.
Reports suggested that Treasurer Scott Morrison’s upcoming budget would feature a provision allowing aspiring first home buyers to salary sacrifice in order to raise their needed deposits.
If that is true, it will be a case of back to the future, as a similar measure was introduced during Kevin Rudd’s first turn as prime minister before being scrapped by the Abbott government.
While Resources Minister Matt Canavan would not deal in specifics during a Sky News interview on Sunday, he stressed that home ownership would be a key theme of the upcoming budget.
“We are focused on making sure Australians can afford a home,” he said. “It is a fundamental principal.”
Under the Labor scheme, First Home Saver Accounts saw the government make co-contributions of up to $1020 (or 17 per cent) on the first $6000 that account holders deposited each year.
While there were tax concessions associated with the accounts, there were also restrictions around access to the funds, including that they were only to be used towards payment for first homes.
That scheme proved to be something of a disappointment. While Labor treasurer Wayne Swan predicted as many as 750,000 accounts would be established, only 46,000 had been opened when his successor, Abbott-era treasurer Joe Hockey, wound it up six years later in 2014.
And there was no shortage of critics, including the consumer group CHOICE, which complained in a submission to Treasury that it provided disproportionate assistance to high-income earners while doing little to help those who genuinely needed it.
“We are unaware of any evidence to suggest that sufficient savings are more difficult to achieve for higher-income earners,” CHOICE noted sarcastically.
Another criticism came from Treasury itself, which warned that the scheme as initially conceived would be complex to administer while not benefitting those on low incomes.
If the Turnbull government is indeed planning to revive home-saver accounts or something similar, the one near-certainty is that government contributions and associated tax breaks will need to be far more substantial if they are to have a positive impact than under Labor, when house prices were substantially less.
Despite First Home Saver Accounts being in effect for six years, Labor frontbencher Mark Butler insisted on Sunday that they had not had time to work – and, if something similar were to be re-introduced, it wouldn’t do much good anyway.
“The critical message is this,” he told the ABC’s Insiders, “you cannot deal with housing affordability in Australia without dealing with negative gearing.”
Greens senator Sarah Hanson-Young also rejected the notion that salary sacrificing would have a major effect.
“We have to bring the pressure down, not just give people more money to go straight into the hands of property investors.”
There’s been quite a bit of speculation over whether Australia has a property market bubble – where house prices are over-inflated compared to a benchmark – and when it might burst. According to housing experts, there’s at least four scenarios where this could happen.
Australia could see a property bubble burst due to:
Lending tightening, interest rate hikes and mortgage stress
Underemployment and unemployment creating a slow deflation
Government intervention failure and market repair
Global crisis
These four scenarios focus on different tension points in Australia’s and the global economy. One scenario focuses on the balance of actions between regulators like APRA and the Reserve Bank, combined with household mortgage stress. Another envisions the affect that unemployment might have in certain areas.
Some of the factors we may see play out, such as the federal and state government trying to intervene to “fix” problems in the market, as happens in one scenario. But other factors may be out of the government’s control, for example, where a global crisis pushes up risk premiums.
All of these scenarios highlight just how complicated and interrelated the steps that lead to a property bubble burst could be.
Lending tightening, interest rate hikes and mortgage stress
Associate Professor Harry Scheule, UTS Business School
Following increases in interest rates in the US and Europe, as those markets recover, the Australian dollar begins to decline – forcing the Reserve Bank of Australia (RBA) to increase interest rates.
Higher interest rates lead to higher monthly repayments, as most of Australia’s home loans are adjustable. Interest only loans are the most exposed. Higher interest rates also lead to more mortgage delinquencies.
The banks tighten bank lending standards in response to the increase in delinquencies. This further constrains interest-only borrowers seeking to refinance after the end of the interest-only terms. This means more mortgage stress, as many had expected to roll over the interest-only period indefinitely, but now they are forced to make principal repayments next to interest payments.
The cycle between delinquencies and tightening bank lending standards continues and as a result there’s a noticeable drop in loan supply and a fall in house prices.
Underemployment and unemployment create a slow deflation
Danika Wright, Lecturer in Finance, University of Sydney
Unemployment and underemployment – workers who want to work more but can’t – increase. As the apartment development boom dies down, and without a mining boom to replace it, construction industry workers are at high risk.
Households with a lot of mortgage debt are forced to limit their spending, particularly on discretionary items. This in turn affects companies that employ retail workers, reducing hours and employment.
Employment opportunities are a major component of house price amenity, in part because demand for housing is pushed higher by inbound work-related migration. So, as there are less jobs nearby, the amenity value of some areas decreases.
The amount of people at risk of defaulting on their mortgage increases in areas where there is a loss of employment or reduced income. In 2008, arguably the last time Sydney house prices went through a correction, the incidence of mortgage defaults and property price declines was geographically localised.
Borrowers who have the least amount of equity in their homes (typically the least wealthy, younger and newer entrants to housing market) are the hardest hit by falling property values. They are more likely to end up “underwater” – that is, owing more than the property is now worth – and face the prospect of a distressed sale. This in turn contributes to the downward spiral in house prices.
Australia has tighter lending criteria than regulators enforced before the global financial crisis in the United States. But concerns by regulators, including APRA, over current lending practices and potentially fraudulent activities raise questions over the real quality of mortgages and the ability of borrowers to repay them.
Government intervention failure and market repair
Professors of Economics, Jason Potts and Sinclair Davidson, RMIT
A combination of low interest rates and low growth in new housing stock drive up Australian housing prices, a situation compounded by poor policy choices by state and federal governments and high demand from foreign residential property investors.
As a result housing is misallocated in the Australian market, across demographic and especially age groups. This produces demographic pressures, as millennials delay leaving home, delay starting families. This leads to political pressure on governments – increases the urge to intervene.
The federal government intervenes, blaming the secondary drivers (particularly the non-voting group: foreign investors). They increase restrictions on foreign investment in residential housing stock.
The federal government also lobbies APRA to increase rules on financial products, while promoting a scheme to subsidise and promote first home ownership.
Because none of these previous measures from the federal government affect the primary drivers of the misallocation of housing, domestic interest rates don’t change, and state governments do not act to release new stock. As a result housing prices continue to grow.
Increasingly alarmed that house prices continue to rise, the federal government starts to panic, threatening ever further regulation and starts to blame the financial system. This triggers the RBA to finally act, raising interest rates.
As interest rates rise, this causes mortgage stress, resulting in default among investors with high amounts of debt, pushing these properties onto the market. These distressed sales finally cause prices to fall.
Global crisis
Timo Henckel, Research Associate, Centre for Applied Macroeconomic Analysis, ANU
International crisis (whether it be political, military, economic) leads to an increase in global risk premiums.
Borrowing costs for Australian banks rise because of this and supply of global capital falls, pushing up mortgage rates in Australia.
The most vulnerable mortgagees can no longer afford their mortgages and are forced to sell their homes.
House prices fall which, coupled with rising interest rates, adds further distress to households’ balance sheets, leading to more selling of houses and so on.
Authors: Jenni Henderson, Editor, Business and Economy, The Conversation; Wes Mountain, Deputy Multimedia Editor, The Conversation
Interviewed: Danika Wright, Lecturer in Finance, University of Sydney; Harry Scheule, Associate Professor, Finance, UTS Business School, University of Technology Sydney; Jason Potts, Professor of Economics, RMIT University; Sinclair Davidson, Professor of Institutional Economics, RMIT University; Timo Henckel, Lecturer, Research School of Economics, and Research Associate, Centre for Applied Macroeconomic Analysis, Australian National University.
Experts have warned against predicting that property prices have peaked just yet.
A flurry of headlines this week generated by UBS analysts, Australian Financial Review columnists and others all warned that Sydney and possible Melbourne prices had peaked and we should brace for a correction.
Most were based on slower price growth in Sydney dwelling values and slight reductions in auction clearance rates compiled by CoreLogic, a property data firm.
However, CoreLogic director of research Tim Lawless cautioned against reading into the results (especially dwelling values, which are yet to be officially released for April) because April and May are generally weaker periods.
“Potentially there is some seasonality creeping into these numbers and that’s one of the reasons why I would probably suggest caution calling the peak right now before we see a few more months and see if the trend actually develops,” Mr Lawless told The New Daily.
“When we look at, say, a year ago or any sort of seasonality in the marketplace, yeah, we do generally see some easing in our reading around April and May.”
A further complication is that CoreLogic adjusted how it calculated dwelling values in May 2016 to account for seasonality. The result, according to Mr Lawless, is that “technically speaking, there are some challenges and complexities making a year-to-year comparison”, although he said the adjustments were “quite minor” and values could still be compared.
The change sparked a scandal last year, with the Reserve Bank ditching the company as its preferred data source after claiming it had overstated dwelling values in April and May.
Despite this, CoreLogic remains the most widely cited property data source because it reports dwelling values daily. But the most authoritative is the Australian Bureau Statistics, which has measured similar quarter-on-quarter falls in the past, especially between the December and June quarters. And yet, the trend has been ever upwards.
IFM chief economist Dr Alex Joiner agreed we shouldn’t jump to conclusions based on the latest statistics.
“I wouldn’t suggest that anyone looks at any month-to-month data in Australia and makes firm conclusions from it,” Dr Joiner told The New Daily.
“People might want to rush to call the top, but the trends are for gradually decelerating growth, and I think that’s about right.”
But if this is not the peak, the market is “very much approaching it” because the Reserve Bank and the banks are likely to lift interest rates even as wage growth stays low, Dr Joiner said.
“When that actually decelerates price growth, whether it’s this month or later in the year, I don’t know. But we’re certainly eeking out the very last stages of price growth in the property market.”
CoreLogic has revealed the property market has been largely flat during the month of April, ahead of the release of its end-of-month numbers on Monday.
CoreLogic’s hedonic home value index for Australia’s top five property markets held virtually steady in the first 27 days of the month, indicating that the current cycle could be moving through its peak.
Sydney prices recorded a “subtle” decline, according to CoreLogic, a dramatic though welcome turnaround from the blistering 18.8 per cent increase recorded in March. The five-city aggregate also recorded an exceptionally strong result in March, rising 12.9 per cent despite a 4.7 per cent decline in Perth prices.
Leeanne Pilkington, deputy president of the Real Estate Institute of New South Wales, says the April decline in Sydney prices was only very slight, and will vary from suburb to suburb.
“None of my agents are telling me they’re worried about prices going down,” she said.
However, Pilkington said her agents are saying there a lower numbers at open houses, which means there could be less competition in the market between buyers.
“We’ve seen that [trend] with the lower clearance rate last week,” she said. Pilkington said clearance rates above 80 per cent were not sustainable, and that a modest decline in clearance rates would actually be desirable.
“We really want some stability in the market,” she said.
Pilkington said April was a holiday month, containing both Easter and ANZAC day, so the numbers for the month may not reflect the true state of the market. Auction clearance rates over the weekend will provide clearer guidance, she said.
Tim Lawless, head of research Asia Pacific with CoreLogic, attributes the flat overall result to recent regulatory changes which have led to higher mortgage rates and weaker investment demand, causing a “dampening” effect on the property market.
If you need some evidence that the echo-bubble in housing is global, take a look at this chart of Sweden’s housing bubble.
A funny thing often occurs after a mania-fueled asset bubble pops: an echo-bubble inflates a few years later, as monetary authorities and all the institutions that depend on rising asset valuations go all-in to reflate the crushed asset class.
Take a quick look at the Case-Shiller Home Price Index charts for San Francisco, Seattle and Portland, OR. Each now exceeds its previous Housing Bubble #1 peak:
Is an asset bubble merely in the eye of the beholder? This is what the multitudes of monetary authorities (central banks, realty industry analysts, etc.) are claiming: there’s no bubble here, just a “normal market” in action.
This self-serving justification–a bubble isn’t a bubble because we need soaring asset prices–ignores the tell-tale characteristics of bubbles. Even a cursory glance at these charts reveals various characteristics of bubbles: a steep, sustained lift-off, a defined peak, a sharp decline that retraces much or all of the bubble’s rise, and a symmetrical duration of the time needed to inflate and deflate the bubble extremes.
It seems housing bubbles take about 5 to 6 years to reach their bubble peaks, and about half that time to retrace much or all of the gains.
Bubbles have a habit of overshooting on the downside when they finally burst. The Federal Reserve acted quickly in 2009-10 to re-inflate the housing bubble by lowering interest rates to near-zero and buying over $1 trillion of mortgage-backed securities.
When bubbles are followed by echo-bubbles, the bursting of the second bubble tends to signal the end of the speculative cycle in that asset class. There is no fundamental reason why housing could not round-trip to levels below the 2011 post-bubble #1 trough.
Consider the fundamentals of China’s remarkable housing bubble. The consensus view is: sure, China’s housing prices could fall modestly, but since Chinese households buy homes with cash or large down payments, this decline won’t trigger a banking crisis like America’s housing bubble did in 2008.
The problem isn’t a banking crisis; it’s a loss of household wealth, the reversal of the wealth effect and the decimation of local government budgets and the construction sector.
China is uniquely dependent on housing and real estate development. This makes it uniquely vulnerable to any slowdown in construction and sales of new housing.
About 15% of China’s GDP is housing-related. This is extraordinarily high. In the 2003-08 housing bubble, housing’s share of U.S. GDP barely cracked 5%.
Of even greater concern, local governments in China depend on land development sales for roughly 2/3 of their revenues. (These are not fee simple sales of land, but the sale of leasehold rights, as all land in China is owned by the state.)
There is no substitute source of revenue waiting in the wings should land sales and housing development grind to a halt. Local governments will lose a majority of their operating revenues, and there is no other source they can tap to replace this lost revenue.
Since China authorized private ownership of housing in the late 1990s, homeowners in China have only experienced rising prices and thus rising household wealth. The end of that “rising tide raises all ships” gravy train will dramatically alter China’s household wealth and local government income.If you need some evidence that the echo-bubble in housing is global, take a look at this chart of Sweden’s housing bubble. Oops, did I say bubble? I meant “normal market in action.”
Who is prepared for the inevitable bursting of the echo bubble in housing?Certainly not those who cling to the fantasy that there is no bubble in housing.
Australian house price growth will slow to 7 per cent in 2017 before it collapses to between zero and 3 per cent in 2018, predicts UBS.
In a new housing outlook report, UBS said it is “calling the top” for Australian residential housing activity despite a surprise rebound in February approvals to 228,000.
While the “historical trigger” for a housing downturn is missing (namely, RBA interest rate hikes), mortgage rates are rising and home buyer sentiment is at a near record low, said UBS.
“Hence, we are ‘calling the top’, but stick to our forecasts for commencements to ‘correct but not collapse’ to 200,000 in 2017 and 180,000 in 2018,” said the report.
House prices are rising four times faster than incomes, noted UBS, which is unsustainable and suggests that growth has peaked.
“We see a moderation to [approximately] 7 per cent in 2017 and 0-3 per cent in 2018, amid record supply and poor affordability, with the new buyer mortgage repayment share of income spiking to a decade high,” said UBS.
The report also pointed to the March 2017 Rider Levett Bucknall residential crane count, which has more than tripled since 2013 to a record 548, but is now flat year-on-year.
Housing affordability has gone from “bad to even worse”, said UBS, with the house price to income ratio soaring to a record 6.5.
“With record low rates, repayments haven’t yet reached historical tipping points where prices fell, but would if mortgage rates rose by only [approximately] 100 basis points,” said the report.
The gross rental yield for two-bedroom unit has fallen to a record-low of less than 4 per cent, said UBS, which is now below mortgage rates of 4.25-4.50 per cent.
UBS also pointed to Australia’s household debt to GDP ratio of 123 per cent, which is one of the highest in the world.
