Unaffordable housing: the nanny state fix we need

From The NewDaily.

Incoming NSW premier Gladys Berejiklian and federal Treasurer Scott Morrison have raised expectations they will actually do something about unaffordable housing.

With capital city median house prices cooling but still relentlessly rising there is broad consensus that supply, in the form of more land release and fast-tracked apartment development, will never bring acquisition costs down for young home buyers.

Demand is also relentless through population growth from migration and the natural birth rate. Australia is on track to reach 40 million people by 2055. The Sydney home-unit tsar Harry Triguboff has become Australia’s richest man tracking demand through migration and building blocks of flats to cash in.

Endemically low interest rates have pumped up prices in hotly competitive city real estate markets. The federal government has failed to stop the distorting impact of too-generous negative gearing with aggressive property investors now building substantial multi-dwelling portfolios. We are becoming a nation of landlords.

NSW Opposition leader Luke Foley on Friday produced State Revenue Office figures showing a 61 percent growth in investor-owned property over the past three years.

Premier Berejiklian has said an “average, hard working” person should be able to afford a home in Sydney. But first-home buyer numbers have dropped from 18 per cent in 2011 to 8 per cent of total purchases today.

Hey Barnaby … there are no jobs in Tamworth

Why can’t people abandon their aspiration for a harbour view and move to an eminently affordable house in Tamworth, Deputy Prime Minister Barnaby Joyce asked in his deeply superficial contribution to the national affordability debate.

The answer is that the jobs are in the cities. There are fewer jobs in Tamworth, as there are in all Australian regional towns.

To buy a house you need a job. A worker on $75,000 a year with no dependants or credit card debt can borrow $512,000 for housing on this income. That would buy this income earner a good house in Tamworth, but at current prices, only a studio or one-bedroom apartment over-looking an industrial bin (forget the harbour view) in Sydney. You can add in Melbourne, Brisbane, Adelaide, Perth and Hobart to this calculation with some variations.

Young couples, each in full-time work, can combine their incomes to go deeper into debt to acquire their first home, and many do. But the barriers to entry remain extortionate, leading to the recent ‘smashed avocado’ kerfuffle where a demographer provocateur, Bernard Salt, lamented that millennials now preferred to spend $22 on this delicacy rather than save up for a house deposit.

Young people have given up, staying at home with mum and dad or sharing accommodation indefinitely, well past their student days.

What are legislators for?

Treasurer Scott Morrison has been fact-finding in London to see how the UK has addressed the affordability problem. A package of measures could come in the May federal budget. In spite of dissent from some Liberal MPs, any reform is not expected to include confronting the market distortion of negative gearing.

Premier Berejiklian is gathering insights from the fine policy minds available to her in the NSW government and is expected to announce some lever-pulling soon. First-home buyers’ grants and stamp duty holiday concessions can help to get more young people deposit-ready to buy, but they compete in already hot markets further pushing up prices.

The answer is in legislation. This will be derided as ‘a nanny state’ solution by ideologues and rapacious developers but with the market having so demonstrably failed to deliver the dream of home ownership for ‘average, hard-working people’, now is the time for a state plan. After all, what are legislators for? Do they always have to stand around, thumb in bum and mind in neutral? Why do we pay their salaries and helicopter expenses?

Let us now see if Premier Berejiklian is prepared to enact laws to establish state-wide inclusionary zoning for affordable housing. This has been done in London and New York. This would establish a public land register for affordable and social housing. The Greater Sydney Commission, a NSW planning agency headed by Lucy Turnbull, has already recommended government mandating six district plans for affordable housing for low-income households ranging from $42,300 to $67,600 per year.

The Committee for Sydney, a think tank, has proposed that under-utilised land could be slugged with higher taxes to get private owners to release it from their speculative ‘land banking’ grip. Most affordable housing in London, both freehold and rental, is high density around transport hubs for easier job access.

In the UK there is a social/affordable housing bond market which could be adapted by the Australian equivalent state-owned housing finance corporations to kick start affordable housing development with the not-for-profit and private sectors including investment-hungry superannuation funds.

So the answer to unaffordable housing in Australia? L-A-W … law.

No consolation for home buyers in these inflation figures

From The NewDaily.

Despite Wednesday’s “worryingly” low inflation result, house prices have continued their upward march right where it hurts the most: the overheated capital cities.

Not only does the consumer price index measure things like groceries and petrol, it also measures changes in the price of buying a new home.

In fact, this measure contributes almost a tenth (9 per cent) to the Australian Bureau of Statistics’ theoretical basket of goods and services bought by the average consumer in the eight capitals, making it the single-biggest contributor.

The ABS reported on Wednesday that the overall rate of inflation was 1.5 per cent for 2016, and that the price of buying a new home rose 0.5 per cent in the December quarter.

As seen in the chart below, this continues the national trend of housing price growth, especially in Melbourne. Over 2016, new house prices increased a total of 1.9 per cent, according to the ABS’ inflation measure.

This is despite the recent GDP contraction, disappointing jobless figures, sluggish wage growth, constant predictions of a property market crash, and the fact that Perth is dragging down the average.

And this may not tell the full story.

Martin North, principal at Digital Finance Analytics, said the ABS measure “understates” the true impact of rising housing costs on household budgets.

“The costs of what it really is to live in a place anywhere close to the centre of the major cities, particularly Sydney and Melbourne, is much, much higher than will be stated or imputed in the CPI,” Mr North told The New Daily.

“There is no doubt that everyone is now recognising that house prices relative to incomes – or relative to any other metric you can think of – are way off, they are way too high.”

Another concern: the Reserve Bank’s reaction

Industry Super Australia is predicting the Reserve Bank will be forced to cut the cash rate target by 50 basis points in 2017: 25 points in the first half of the year followed by a further 25 points near the end.

However, this may not benefit the average new borrower or household on a variable rate mortgage, as the big banks are currently lifting borrowing rates despite the fact Australia’s central bank has been in a holding pattern.

“While this 50 basis points might seem very attractive, what it’s more than likely to do is just offset what’s going on in wholesale markets,” Industry Super Australia chief economist Dr Stephen Anthony told The New Daily.

“Therefore, what gets passed on to the consumer may be very little.”

Despite this, Dr Anthony still saw the inflation result as carrying an important warning for mortgage borrowers.

“Whilst it may be a ‘no change’ result for households, the most significant risk to the Australian economy in 2017 is vulnerability at the postcode level,” he said.

“If I am wrong and the Reserve Bank starts raising rates, that combined with developments in wholesale markets probably means that the level of mortgage stress will rise exponentially and that would be a significant risk to dwelling investment and obviously house prices would fall accordingly.”

Finance analyst Mr North said he saw a rate rise in 2017 as both prudent and far more likely than any cuts.

“I personally think rates should be higher than they currently are. We are stoking the housing market way beyond what is sensible,” he said.

“The problem we’ve got is that rates will at some point continue to rise. Most people have already experienced a rise of 15 to 65 basis points over the last little while because of bank repricing. That’s having a significant impact on a number of households – 20 per cent plus are finding it difficult to accommodate any rise.

“So if we take the rates even lower we are seeding a longer-term problem. The simplistic idea of ‘cutting rates and hoping’ is not going to work.”

From the March quarter 2017, the ABS will adjust the way it measures prices changes in new dwellings to ‘more robustly’ reflect the rising popularity of apartments.

Why Housing Affordability Talk Is Just Hot Air

So, suddenly its politically correct to be discussing “housing affordability”. But talk is cheap, as we discussed in a recent video blog.

The problem is the political weight from home owners, banks, and the construction industry are all wedded to ever rising prices. The number of first time buyers are relatively small, so they have little political impact. Numbers count.

In addition, the regulators go out of their way to say all is well. We have questioned their stance on a number of occasions.

States benefit from high stamp duty returns, financial institutions can swell their balance sheets, and existing tax concessions assist investors who have enjoyed amazingly strong capital growth.

Tackling supply-side issues is indeed one factor, but we suspect there will be much talk and little action to address the long-term systemic issues – this is because the majority of households (and so voters)  prefer prices to keep rising. So real political intervention is untenable, unless political leaders stand up. We think this is unlikely.

In addition, we have a diverse set of outcomes across the states, from rabid house price inflation in Sydney, to falling prices in Perth. There can be no-one size fits all solution, so the issues are complex and long term, and beyond the political cycle.

In 2014 in a submission to the Senate Inquiry on Affordable Housing we outlined a road-map to address the issue. Some of the numbers may have changed, and some aspects have been tweaked, but the trajectory remains correct:

  1. We believe that the current long term trends in housing are detrimental to Australians, and this is having a significant negative impact on the economic performance of the country.
  2. We are not in a housing bubble, but we have a chronic problem. This is because the rapid growth in prices in recent years has not kept pace with many households ability to pay, forcing significant numbers into high debt to income ratio’s, the selection of properties in less accessible and less convenient locations and the exclusion of considerable numbers from the market. In total 2.3 million households are not active in the property market at all.
  3. In addition, discretionary spending has been blotted up by higher housing costs. Households are highly leveraged today, and if interest rates were to rise, mortgage stress would become more significant.
  4. Banks have grown their balance sheets in-line with growth in demand – especially supporting high levels of investment loans, and as a result they are not adequately providing reasonable lending services to a considerable number of small and medium enterprises, who could create economic value to the country. This is influenced by the relative capital costs of housing lending versus commercial lending under the Basel rules. Lending ever more loans to households to purchase property does not create real growth, it just inflates prices.
  5. We believe there are significant supply-side issue, with at least 200,000 properties required to meet current and expected demand. A significant proportion of these should be aligned with the needs of the large number of “Want-to-Buy” households, who cannot access the market today. Today 1.2 million households are directly excluded from the market. Many of these are younger, less well-off and in rental property at the moment.
  6. Local government policies and reliance on stamp duties are part of the problem, together with planning restrictions and high development fees and charges, all leading to poor supply of affordable homes. The proportion of high-rise developments is increasing.
  7. Many First Time Buyers are only able to access the market with direct financial assistance from family or friends.  The focus of First Time Buyer incentives being aligned to new-builds is welcome, but we believe that these incentives actually lift prices, and do long term harm.
  8. In addition, we note there is considerable demand from both local and overseas investors, contending with potential First Time buyers.
  9. Ultra-low interest rates are not helping because it is stimulating demand from the investment sector, lifting the size of loans, and negatively impacting affordability. Note that the banks rightly utilize buffers to test for affordability, so low rates do not flow into greater loan availability.
  10. Negative gearing has been one of the most significant incentives for many investors, but it is widely accepted as a costly tax advantage which has pushed up prices, and driven First Time Buyers from the market.
  11. For many, property has ceased to be primarily a place to live, it is rather an investment first and foremost. This is a concerning trend. Self-Managed Super Funds are also accessing investment property, thanks to the attractive tax sheltering which exists today.

DFA recommends the consideration of the following to help address affordability and accessibility of housing in Australia.

  1. Australia should develop a strategic housing plan which guides ongoing development, be it in current centres, or expansion into new towns. Current tactical plans are not sufficient. The plan should specifically address the supply of affordable housing.
  2. Strategies should be devised to increase land supply. State governments should reduce the current high levels of access fees for new development and revise planning criteria and processes. This has the potential to create considerable economic growth.
  3. Overseas investors should not be able to access first-time buyer incentive schemes, and the Foreign Investment Review board rules should be strengthened to reduce the impact of foreign investors on the local market.
  4. The RBA should have a direct multi-segmented housing affordability metric within its measurement framework. Affordability should be targeted at trend average, not rates experienced since the debt explosion of the 2000 onwards.
  5. Macro-prudential policies should be employment to control the growth in lending. In line with the recommendations from the Bank of International Settlement debt to income servicing ratios should be employed as the policy tool of choice.
  6. Negative gearing should be tapered away and removed for new transactions.
  7. Joint equity schemes like the UK’s Help to Buy Scheme  should be considered as a tactical step to assist some of the “Want-to-Buys.”

 

Smashed Housing Aspirations

From The NewDaily.

Australian politicians have sleepwalked into a housing affordability “crisis” because they were hooked on property taxes and votes, a think tank has warned.

Demographia, a global company based in the US, released an annual report this week that ranked Sydney as the second-most expensive city for housing in the world.

It divided Sydney’s median house price ($1.077 million) by its median household income ($88,000) to roughly estimate it would take 12.2 years’ wages to buy a home – better than Hong Kong (18.1 years) but worse than Vancouver (11.8), Auckland (10) and San Jose (9.6).

Using the same measure, Melbourne (9.5 years), Adelaide (6.6), Brisbane (6.2) and Perth (6.1) also made it into the top 20 of the 406 cities on the list.

Wayne Matthew, the Australian spokesman for Demographia, told The New Daily that our politicians are “only just starting to realise” the extent of the problem.

International Housing Affordability Survey

The report’s release coincided with the first press conference of newly appointed NSW Premier Gladys Berejiklian, who pledged on Monday to tackle housing affordability, calling it the “biggest issue people have across the state”.

On the same day, senior figures in the Turnbull government made it known that housing affordability will be an “extraordinarily high” priority in 2017.

Politicians have sleepwalked into the “crisis” because they initially saw no problem with the rapid increases in prices, or were too scared of voter backlash to intervene, Demographia’s Mr Matthew said.

“Initially, the Australian dream seemed to be paying fabulous dividends. People’s property prices were going up and they felt good about that. As prices went up, people were able to leverage the equity in the increased property to buy other properties as investments to rent out,” he said.

“That all looked good and enterprising, however it has now caught up with us, particularly in Sydney.

“There have been too many people benefiting from the investment wave, but the goose that laid the golden egg is becoming a millstone around the necks of young people.

“It’s going to create great chasms in our society, with young people being bitter that they can’t afford the home their parents had and that they can’t realise the same dreams. Australia has always been a country where people have had a right to a roof over their head that they could aspire to own themselves, but that great Australian dream is being smashed.”

There are two distinct sides to the debate over housing reform. There are those who argue for supply-side measures (often conservatives, such as the Liberal Party) and those who argue for demand-side measures (such as Labor, which has promised to reduce negative gearing).

Demographia’s argument, as a conservative think tank, is that land prices are high because of an artificial undersupply imposed by state governments, who fear voter backlash if they free up large plots of land for development or allow more high-rise apartments.

“State governments have been concerned about stepping into the market and offering lower-priced land on the basis that they’re fearful it could affect other property prices where investors are dependent upon equity to maintain a balance in borrowings they’ve undertaken,” Mr Matthew said.

“The reality is, and international experience has shown, that’s not what occurs.”

australian property marketWe need more than just more land, says one expert. Photo: Getty

Dr Ashton De Silva, an economist with expertise in the housing market, agreed that supply is “probably the most important factor”, but said Demographia’s data should be treated with caution.

The measure used by the think tank – median house price divided by median household income – is “problematic” because the way home loans are funded varies widely between countries, Dr De Silva told The New Daily.

“I’m very circumspect about this kind of report. I know that Sydney and Melbourne house prices are very high, and I know this causes a great deal of hardship in the community. However, I’m not sure if the problem is as extreme as they say.”

Professor Tony Dalton, a housing expert at the Australian Housing and Urban Research Institute, said supply is an “important” factor because of the nation’s high rate of immigration, but does not tell the “full story”.

Overly generous tax concessions for landlords, a lack of social housing, and a concentration of “good jobs” in the inner city are also crucial factors, Professor Dalton told The New Daily.

“There are very big differences between house prices in central city areas and the periphery. That’s because of the way we’ve organised and designed our cities. We’ve got all the good jobs, those with greater security and higher income, within a 10 to 12km radius of the central business district.”

To fix the problem, governments shouldn’t focus just on freeing up land. They should also curb negative gearing and capital gains tax concessions and invest more in outer suburb infrastructure and social housing, Professor Dalton said.

“We’ve got first home buyers bidding for properties alongside cashed-up, affluent people who are able to bid for properties for investment purposes.

“Meanwhile, most western developed countries have a social housing system that’s much bigger and more robust than Australia. We are a standout in terms of how little of that sort of housing we provide.”

If you’re serious about affordable Sydney housing, Premier, here’s a must-do list

From The Conversation.

So “fixing housing affordability” in Sydney is one of three top priorities for the new premier of New South Wales, Gladys Berejiklian. It’s good that the state’s new leader recognises this as an intensifying problem that can’t be ignored.

Berejiklian will appreciate the electoral importance of this issue. It’s an especially sensitive topic in western Sydney, which no longer provides Sydney with the large reserve of less-expensive property that it once did. Unless they can draw on family wealth, even middle-income first-home-buyers are now locked out of huge swathes of Sydney – including areas far from the inner city.

But given she came to the top job from the Treasury portfolio, Berejiklian would also be expected to have a clear understanding that the lack of well-located affordable housing is an economic productivity concern as well as a social problem.

One aspect of this, as shown by our recent research, is that central Sydney’s booming hospitality sector is facing growing pressure to find and retain suitable employees. This is because of workers’ limited ability to find affordable housing within a reasonable distance. To work in the inner city they must weigh up other compromises – such as living in shared housing, or paying a very high proportion of income in rent.

Relying on backpacker labour supply isn’t an ideal business strategy. And, as inner Sydney housing affordability deteriorates further, there’s every possibility other CBD industries will see their lower-income labour market thinning out.

The broader issue is the growing stress caused by the continuing focus of employment creation in inner-city areas. This applies especially to the so-called “global arc” stretching from the airport in the south to Macquarie Park in the north.

The mismatch between where affordable housing and jobs are available is a key cause of traffic congestion. Dan Himbrechts/AAP

In the last few years annual job growth here has been running at more than 2%, but only 0.5% in western Sydney. At the same time, housing market pressures mean more and more people needed to fill these new jobs are having to live in outer western Sydney. The resulting traffic congestion is damaging Sydney’s economy.

Nationally, the cost of congestion in 2015 was A$16.5 billion – up by 30% on 2010. Anyone who commutes by car in Sydney will know it is a major part of this problem. Ultimately, some companies may choose to relocate to places where these problems are less severe.

Housing supply is only part of the solution

On the other hand, it must be hoped that Berejiklian will leave behind at Treasury the flawed analysis that fixing Sydney’s housing problems is simply a matter of increasing housing supply.

No-one disputes that, with continued population growth, maximising new house-building must be part of the policy mix. But the idea that this can provide any kind of silver bullet for housing unaffordability is shot dead by the experience of the past few years. Record construction rates have co-existed with unprecedented and ongoing property price hikes.

As premier, Berejiklian should therefore lend support to her ministerial colleague, Rob Stokes, who called it right by arguing recently that Sydney’s housing problems partly result from a market pumped up by excessive tax concessions for landlord investors.

These powers are held at the federal level, not with the states. So Berejiklian can do little more than lobby for such reform.

Adopt the best policies from others

And yet the premier does have important powers of her own that can make a difference.

Recognising that even a moderation of property prices isn’t going to provide relief for tens of thousands of hard-pressed renters, the NSW government must take a leaf out of the book of cities like London and New York by using its planning muscle to ensure the inclusion of affordable rental housing in all major new housing developments.

Under the former premier, Mike Baird, a promising initiative in this arena was the recent proposal by the Greater Sydney Commission to introduce a scheme of this kind. Private housing developments on sites “upzoned” under the planning system should include 5-10% affordable rental housing.

If she is serious about this issue, Berejiklian should back the commission’s move. She can prove her commitment to finding solutions by setting a much higher affordable rental housing target for development on government-owned land. This would ensure that a significant affordable component is locked in for flagship projects such as the Central to Eveleigh and Bays Precinct urban renewal schemes. This is a one-off opportunity that must not be squandered.

The new premier should also recommit to the innovative Social and Affordable Housing Fund (SAHF) created under her predecessor, following his 2015 commitment to a “billion-dollar fund” for affordable housing.

An announcement on the promised second phase of the SAHF has been long-awaited. Perhaps Berejiklian can pledge to underwrite this by dipping into the huge stamp-duty bonanza the government has reaped in recent years.

Above all, NSW needs an overarching housing strategy that encompasses much more than just the social end of the spectrum. Recognising the urgency of the problem, Berejiklian should pledge that her officials will get to work on this right away.

Author: Hal Pawson, Associate Director – City Futures – Urban Policy and Strategy, City Futures Research Centre, Housing Policy and Practice, UNSW Australia

Malcolm Turnbull seizes housing affordability as key to his comeback

From The New Daily.

Malcolm Turnbull has seized on housing affordability as one issue that could help drag his government out of the electoral doldrums, according to sources close to the Prime Minister.

Treasurer Scott Morrison is currently in London with a mission to take a lead from Britain in finding ways to open up the housing market to more potential home buyers and help solve the crisis in Australian cities.

Add to that Mr Turnbull’s decision last week to appoint Victorian MP Michael Sukkar as Assistant Minister to the Treasurer with the task of tackling housing affordability, and it becomes clear the government is taking the issue seriously.

Mr Sukkar insists the housing crisis is an “extraordinarily high” priority for the Prime Minister.

That view was reinforced by another government source, who said the Prime Minister wants to be seen to be acting on the issue.

“Malcolm is genuine in wanting to see something done on housing affordability, but it has also become too much of a hot political topic for us not to be seen to be acting in this space,” the source said.

“We need something to help turn the polls around, and if we can make progress with housing, it could be a win-win situation.

“The problem is being able to achieve something substantial. Kevin Rudd promised the earth on housing when he was in opposition and then found out how hard it was to deliver once he got into government.

“We are under no illusion about how difficult this issue is, but we think something can be achieved.”

Mr Morrison is embarking on a string of briefings in the UK detailing how the Conservative government there opened up access to bank data and changed how that data is created and shared.

The so-called open banking standard will help more startups offer cheaper housing financing products.

Last year, an Australian parliamentary committee recommended banks here be made to, by July 2018, open up access to their customers’ data and thereby make it easier for them to switch financial institutions.

The Treasurer will meet with the Open Data Institute, the Bank of England and the Financial Conduct Authority while in Britain.

He will also meet with his UK counterpart, Chancellor of the Exchequer Philip Hammond.

But while the government seems keen to follow some of the examples the Brits are setting over housing affordability, abolishing negative gearing doesn’t appear to be one of them.

Mr Sukkar has already dismissed changing Australia’s negative gearing regime, while Labor is continuing its pledge to make significant changes to the system.

Shadow assistant treasurer Andrew Leigh said there was more to learn from the UK conservatives about housing affordability than just innovative financing methods.

You’ve got to distinguish between a policy which builds a small number of homes at the bottom end of the market and one which could make a difference right across the wide swath of the market,” Dr Leigh said.

“So sure, we should look at innovative financing solutions but let’s not pretend that that’s going to make it easier for middle Australia to buy a house.

“Here you need to look at something else the Conservatives have been doing over in the UK.

“In the 2015 budget the British Conservatives decided to make changes to negative gearing. The British Conservatives, against a scare campaign in which some of the tabloids said it was going to drive down house prices, saw through significant changes to negative gearing of the kind that Labor has been proposing in Australia.

I’m worried that the Treasurer will come back touting a plan which will really only help a few rather than one that will help many.”

Subdued price growth expected early in 2017 – REA Group

Demand for property on realestate.com.au skyrocketed in 2016, with the REA Group Property Demand Index increasing by 16.2% across the year.  The REA Group Property Demand Index is produced by the REA Group, owner and operator of realestate.com.au.

After peaking in October and November, demand for property dropped slightly to close out 2016, with the index falling 6.6% nationally in December. Victoria saw the largest decline over the month, driven by low levels of demand for both houses and apartments. New South Wales followed closely, suggesting the housing boom may be over, or at the very least slowing quickly, in both Sydney and Melbourne.

Despite December declines, Tasmania, New South Wales and Victoria continue to see the highest levels of demand in Australia with Western Australia and Northern seeing the lowest
While still early into the new year, the easing of demand nationally suggests that the record price rises we saw in Sydney and Melbourne last year are likely to be more subdued as we move further into 2017.

The key drivers of this demand decline are likely due to Australian banks increasing interest rates for buyers independently of the Reserve Bank of Australia in late November and early December and continuing affordability issues across the Eastern seaboard.

Given the RBA has indicated that it may still cut the cash rate further, the banks have sent strong signals that they will respond by not passing cuts onto borrowers and we expect out of cycle interest rate rises by banks to continue. This will be a key issue for borrowers this year, especially first home buyers and investors, with access to cheap money becoming more difficult.

The states which saw the largest declines in demand in December were New South Wales and Victoria. Continued concerns about apartment over supply are starting to cause concern in these markets with demand for apartments dropping by more than 7% in both states.

Western Australia and Northern Territory remain the lowest in-demand markets on realestate.com.au, however Western Australia’s demand index was relatively stable and both states saw an increase in apartment demand. The result suggests that barring any surprising negative economic news or changes to the supply outlook in Western Australia, the bottom of the housing market could be close.

Tasmania continues to see elevated levels of demand and is now the strongest demand market in Australia. Relative affordability is likely a key factor driving interest

Do Central Bankers Know a Bubble When They See One?

From Mises Wire.

Between 2000 and 2008, two of the largest financial bubbles in history — in technology stocks and housing, respectively — suffered spectacular collapses. Opinions vary, but some market commentators believe at the peak of the tech bubble, total stock market capitalization exceeded 180% of US GDP. To put this in perspective, the tech stock bubble was over twice the size of the 1920s stock bubble!1 As large as the bubble in tech stocks was, it was child’s play compared to the housing bubble. When the US housing bubble collapsed, the credit losses were so large the entire worldwide banking system was considered to be in mortal danger.

One of the primary justifications behind the 1913 founding of the Fed was to prevent financial crises. Logic then dictates if a major motivation behind forming a central bank is the prevention of a financial crisis, then a financial crisis that breaks out under the nose of a central bank must be due — at least in part — to mistakes of that bank. The Fed’s mistakes and its subsequent leading role in causing the housing bubble will be seen by reviewing speeches given by Alan Greenspan and Ben Bernanke that praised the housing bubble era Fed. In addition, a review of statements made in the wake of the tech bubble’s collapse will reveal senior Fed officials taking positions diametrically opposed to positions Alan Greenspan claimed formed the basis for the Fed’s policy toward bubbles, namely, allowing bubbles to burst and dealing with the consequences later.

From its March 2000 peak to its October 2002 bottom the NASDAQ declined 80%. Throughout the 1990s no one cheered on the “new economy” more than the “maestro,” Alan Greenspan. After the bubble collapsed, Greenspan recognized a need to explain his and the Fed’s actions while the tech bubble grew. In August 2002 Greenspan gave a speech at the Fed’s conference in Jackson Hole. In this speech, which Jim Grant called “self-exculpating revisionism,”2  Greenspan offered this rationale for the Fed’s actions during the late 1990s:

The struggle to understand developments in the economy and financial markets since the mid-1990s has been particularly challenging for monetary policymakers. … We at the Federal Reserve considered a number of issues related to asset bubbles — that is, surges in prices of assets to unsustainable levels. As events evolved, we recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact — that is, when it’s bursting confirmed its existence.

Less than two years later, in January 2004, Greenspan would congratulate himself on the apparent success of the Fed’s strategy. In doing so he would expose the Fed’s role in creating the far more ruinous housing bubble.

There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble’s consequences rather than the bubble itself has been successful. … As I discuss later, much of the ability of the U.S. economy to absorb these sequences of shocks resulted from notably improved structural flexibility. But highly aggressive monetary ease was doubtless also a significant contributor to stability.3

The “monetary ease” — slashing interest rates — Greenspan was taking credit for here was not helping the economy heal. Instead it was fueling an enormous bubble in housing whose negative consequences can best be described as world-altering.

One month later, in February, Greenspan’s partner in criminal economic ignorance, Ben Bernanke, gave a speech titled, “The Great Moderation.” In this speech Bernanke would, unknowingly, provide further evidence of the Fed’s enormous role in fueling the housing bubble. Bernanke claimed the Fed’s monetary policy was a source of stability and helped to reduce variations in economic output. The irony in giving this speechat this time should not be lost. Bernanke’s speech, like Greenspan’s, betrays a total ignorance of the enormous housing bubble that was only a few weeks from peaking. (Homeownership peaked in April 2004!) With just these two speeches, the criminal incompetence of the Greenspan/Bernanke and the leading causal role the Fed played in the housing bubble are demonstrated.

The Fed’s bubble befuddlement was not limited to a few speeches. For years on end Fed officials would take positions in contradiction to those established by Greenspan in his Jackson Hole, Wyoming, speech. For example, in July 2005 and in his capacity as head of the president’s council of economic advisors, Ben Bernanke was asked on CNBC if there was a housing bubble. He does not answer by saying bubbles can’t be seen until after they burst. Instead he says the following:

Well, I guess I don’t buy your premise. It’s a pretty unlikely possibility. We’ve never had a decline in housing prices on a nationwide basis, so what I think is more likely is house prices will slow, maybe stabilize, might slow consumption spending a bit. I don’t think it will drive the economy from its full employment path.

Later in October 2005, other Fed officials would also contradict Greenspan’s Jackson Hole speech. By then, homeownership had already peaked and the bubble had started to collapse. Amazingly,  two Fed economists investigated if there was a housing bubble. They — erroneously, of course — concluded home prices are high but not out of line.4 Obviously, if Fed officials were investigating to see if a housing bubble existed, then they believed it could be observed without first having to collapse.

Often, the most damning indictments of the bubble-era Fed come from other Fed officials. The most loquacious of these officials is current St. Louis Fed president James Bullard. Among the truths Bullard accidently exposed was the one concerning the obvious nature of the recent stock and housing bubbles. In a September 2013 interview Bullard said, The bubbles we had in the past were gigantic and obvious.5 Later, in a November 2013 interview, he said the housing and tech bubbles were blindingly obvious.”6

Amazingly, Alan Greenspan would eventually completely contradict Greenspan! Here is “Mr. Chairman,” as CNBC lovingly refers to him, discussing the Lehman Brothers failure in October 2013, “We missed the timing badly on September 15th, 2008 [the day Lehman Brothers went bankrupt]. All of us knew there was a bubble.”7 So which is it Mr. Chairman? Can bubbles be “obvious” or something “everyone knew” to exist before they pop — as you indicate here — or do you have to wait until after they pop to confirm their existence as you said in Jackson Hole?

Our brief review here demonstrates both the leading role the Fed played in creating the housing bubble — the January and February 2004 speeches — and the many mutually exclusive positions the Fed took on bubbles. In spite of being exposed in what is either a self-exculpating lie (the claim that bubbles can only be seen after they burst) or a sign of gross incompetence (the failure to see two of the largest financial bubbles in history), no Fed official has ever been asked to explain or rationalize the Fed’s contradictory positions on bubbles. Whether anyone from the Fed is ever forced to do so or not, it is obvious the Fed has much to answer for concerning all the economic hardships their bubble befuddlement has caused.

  • 1. Marc Faber, “The Monetization of the American Economy,” DailyReckoning.com, January 16, 2002 https://dailyreckoning.com/the-monetisation-of-the-american-economy/
  • 2. Jim Grant, Mr. Market Miscalculates (Mt. Jackson, Va.: Axios Press, 2008), pp. 241.
  • 3. “Risk and Uncertainty in Monetary Policy”, Remarks by Chairman Alan Greenspan at the Meetings of the American Economic Association, San Diego, California, January 03, 2004.
  • 4. Jonathan McCarthy and Richard W. Peach, “Is there a Bubble in the Housing Market Now?” Federal Reserve Bank of New York, 2005.
  • 5. Steven C. Johnson, “Fed Need Not Rush to Taper While Inflation is Low,” September 20, 2013, CNBC, http://www.cnbc.com/id/101051526/
  • 6. Matthew J. Belvedere, “Fed’s Bullard: $1-trillion a year QE pace torrid,” CNBC, http://www.cnbc.com/id/101166475
  • 7. Matthew J. Belvedere, “Bubbles and leverage cause crisis: Alan Greenspan,” October 23, 2013 CNBC, http://www.cnbc.com/id/101135835

A double shock for over-indebted households

From The NewDaily.

The OECD has once again warned that rising borrowing costs could wreak havoc on global property markets this year.

Chief economist of the Organisation for Economic Co-operation and Development, Catherine Mann, told the UK’s The Telegraph that property prices had soared in Canada, New Zealand and Sweden in a way “not consistent with a stable real estate market”.

What she didn’t mention is that the OECD’s own research puts Australia in the middle of that pack based on house-price-to-income ratios – making it at least as likely to be affected by the US Federal Reserve-led rise in global interest rates.

In its last economic outlook, the Paris-based think tank rated Sweden at 22 per cent above its long-term price-to-income ratio, Australia 29.4 per cent above, Canada at 30.5 per cent and New Zealand at 31.9 per cent.

In the UK market, where that ratio is only 21.3 per cent, the London market is already cooling rapidly thanks in part to Brexit uncertainty.

Ms Mann said it would be “interesting” to see “who bears the burden – who bears the adjustment cost”.

The Australian story

The same question needs to be asked in Australia, in light of our eye-watering levels of household debt.

There are mixed opinions as to whether the Reserve Bank will cut official rates again this year, but even if it does it will be fighting a tide of rising rates in wholesale funding markets.

Those rates affect a third of our banks’ borrowing costs and are likely to force more out-of-cycle mortgage rate hikes.

Who will bear that pain?

To understand what Catherine Mann, the OECD’s chief economist, means by “adjustment costs”, both asset prices and lending rates have to be taken into account.

That’s because banks lend money based on two main criteria: the income the borrower has to service debt at a given interest rate, and the likelihood of the asset increasing or decreasing in value.

Just before the global financial crisis hit, some Australian lenders were offering mortgages at loan-to-valuation ratios of up to 107 per cent.

balancing your budgetRe-mortgaging to cover extravagant spending is coming to an end. Photo: Getty

They were so confident the market would continue rising, that they were happy for the safety buffer of equity to build up in the months or years after the loan was made.

Likewise, serviceability ratios were stretched to the limit at lenders such as Bankwest, because the mining boom was inflating wage packets relatively quickly.

The GFC changed all that. The lenders that were pushing those ratios too far, such as Bankwest, St George and Rams Home Loans, came close to collapse in 2009 and were snapped up at bargain prices by the bigger banks.

While the worst excesses of the GFC have not been repeated, banks and borrowers have once again become too comfortable with the idea that rising property prices and wages will get overstretched borrowers out of trouble.

Ms Mann is essentially warning us not to get too comfortable, as the era of ultra-low interest rates comes to an end.

Debt as ‘income’

To illustrate the point, I’ll go back to the example of the “completely disorganised” borrower described to me by a lending manager last year.

Catherine Mann“[What’s] interesting in terms of the implications … is who bears the burden,” said Catherine Mann. Photo: Getty

Such borrowers, he said, would bumble along with maxed-out credit cards, a personal loan for their last holiday, a leased car, and a fairly opulent lifestyle overall.

In a rising market, they could, and did, remortgage every few years and use equity in their home to pay for their extravagance.

What’s changed? Well firstly, many Australian households are seeing a big slowdown in the capital growth of their homes.

The latest all-cities average dwelling price from CoreLogic, released on Tuesday, shows a national increase of 10.8 per cent over 12 months.

However, that is overwhelmingly concentrated in Sydney (up 15.5 per cent) and Melbourne (13.7 per cent).

For “disorganised” borrowers living in Perth, where values have actually fallen 4.3 per cent, there’ll be no more remortgaging to pay off their other debts – the era of equity withdrawal is over, for some years at least.

bill shockHigher mortgage costs will make the end of debt-funded spending an even bigger shock. Photo: Getty

The situation is similar in Darwin, where prices rose less than inflation in the past 12 months (0.9 per cent), or Brisbane where prices were just a bit ahead of inflation (3.6 per cent).

If out-of-cycle rate increases start to bite into their budgets, households in many areas are facing a double-whammy – no more debt-financed consumption, plus higher monthly outgoings just to keep a roof over their heads.

As economist Steve Keen has argued for years, household consumption is financed by two things: wages, plus the net change in debt.

We are now going into an era when a growing number of households will have only their wages to spend.

With wage growth at record lows and mortgage rate increases on the medium-term horizon, for the over-indebted that’s going to come as quite a shock.

Channel Nine News Does House Prices and Mortgage Defaults

A segment today from Channel Nine featured the latest data on Sydney residential property, and featured data from the Digital Finance Analytics mortgage default heat mapping, as well as the latest from CoreLogic on Home Prices.