The RBA in their latest edition of The Bulletin has included an article examining the factors driving long-run trends in Australian housing price growth over the past three decades. They look at factors like supply, inflation and population growth.
However the glaring omission in our view is the direct impact easier credit and capital ratios have had on bank lending. Without the credit boom we could not have had a house price boom. Whilst they do point out that price to income ratios are high (but more static), we think this is a function of income growth, and is directly connected with the current level at which banks are willing to lend.
During the 1980s, housing prices grew broadly in line with general price inflation in the economy. The period from the 1990s until the mid 2000s saw relatively strong housing price growth associated with a significant increase in the debt-to-income ratio of Australian households. Since the mid 2000s, strong population growth has played an increasing role in explaining housing price growth.
Over the past 30 years, Australian housing prices have increased on average by 7¼ per cent per year, and over the inflation-targeting period by around 7 per cent per year However, these averages mask three distinct phases:
- During the 1980s, annual housing price inflation was high, at nearly 10 per cent on average, but so too was general price inflation. In real terms, housing price inflation during the 1980s was relatively low, at 1.4 per cent per annum compared with 4.5 per cent during the period from 1990 to the mid 2000s, and 2.5 per cent over the past decade.
- The 1990s until the mid 2000s were marked by quite high housing price inflation, of 7.2 per cent per annum, on average, in nominal terms.
- Annual nominal housing price inflation over the past decade was lower than either of these periods, at a little over 5 per cent on average.
They note that housing price growth, has outstripped the rate of inflation in other prices in the economy including inflation in the cost of new dwellings. They posit a range of drivers, for example population growth….
Price to income and household debt to income ratios have never been higher than they are now. Part of this is explained by freeing up the financial system, so finance was easier to get. The increased access to credit by Australian households over this period can be seen in the steady increase of the ratio of household debt to income. A similar trend is observed in the dwelling price-to-income ratio. While deregulation and disinflation were largely complete by the mid 1990s, the adjustment of the economy to the new steady state took well over a decade. These adjustments appear to have largely run their course, with the household debt-to-income ratio fluctuating around 150 per cent over the past decade.
Finally supply did not keep up with demand. When compared with the range of underlying demand estimates, completions suggest that, over much of the past decade, the supply side has been slow, or unable, to respond to the significant increases in underlying demand (based on estimates of underlying average household size, rather than actual household size). More recently, the gap between underlying demand for and supply of new dwellings in Australia looks to have become smaller. Much of the aggregate gap was accounted for by developments in New South Wales. Underlying demand-supply gaps in Queensland and Western Australia also look to have contributed to the aggregate gap, although the estimates of underlying demand on a state level are subject to even larger uncertainty than those at the national level.
They conclude that during the 1980s, housing price inflation broadly followed general price inflation in the economy, which was relatively high and
volatile. Following the financial deregulation of the mid 1980s and disinflation of the early 1990s, cheaper and easier access to finance underpinned a secular increase in households’ debt-to-income ratio that was closely associated with high housing price inflation from the early 1990s until the mid 2000s. The past decade saw a stabilisation of debt-to-income levels, but also a prolonged period of strong population growth – underpinned by high immigration – and smaller household sizes that led to increases in underlying demand exceeding the supply of new dwellings.Looking ahead, they say it seems unlikely that there will be a return to the rather extreme conditions of the earlier episode when significant increases in household debt supported high housing price growth. Nonetheless, protracted periods of changes in population growth that are not met by adjustments in dwelling supply could lead to periods of sizeable changes in housing price growth. One important factor for housing price growth is the ability of the supply of new dwellings to respond to changes in demand. The significance of this is made clear by the recent increases in
higher-density housing and lower growth of those prices relative to prices of detached houses, whose supply has been less responsive.
We think the generous capital adequacy ratios and the banks fixation to lend on property however is the root cause. We think they should have looked harder at credit supply, and capital ratios in the context of bank profitability.
