The Australian housing market continues to astound, with clearance rates above 80% in Melbourne and median prices nearing $500,000 nationally. However, the prime causes (government meddling in the property market) of the rapidly inflating bubble have become so obvious that even the mainstream media is finally catching on. Recently, Mark Russell writing in the Sunday Age noted that “the paradox of the first-home-owner’s grant is that it makes housing less affordable for the people supposed to benefit”.

Crikey readers will have known that for a while — in fact, since October 28, when the FHOB grant was boosted and this column noted that:

The most obvious problem with the grant is that it doesn’t actually benefit home buyers. Most recipients of the grant will be purchasing lower-end properties, probably in competition with each other.

Giving them extra money will have the effect of “bidding up” the property up by the value of the grant. It is inflation in its purest form. That’s not to say no one benefits from the grant. Those selling their property will receive an extra $14,000. Moreover, by increasing the grant to $21,000 for new properties the government is in effect transferring cash from taxpayers to property developers. (Unsurprisingly, property developers have rushed to applaud Rudd’s move.)

While the media has caught on, still not everyone agrees — unsurprisingly, federal Labor politicians still support the boosted housing stimulus. Labor minister Tanya Plibersek told The Age in August that “the government was pleased with the success of the first home buyers’ grant because ‘a strong housing market is critical for underpinning confidence and supporting jobs in the Australian economy’.”

Aside from the obvious point, that an asset bubble, in any sector, will never be sustainable forever, and leads to inevitable widespread misallocation of savings, Plibersek’s comments are completely wrong on a common-sense basis. High property prices actually prevent developers from undertaking projects due to prohibitively high cost of land preventing developers from earning a reasonable risk-adjusted return. That means less commercial and residential development and less jobs.

However, it is not merely the artificial government stimulus that has spurred the bubble — the major factors underlying the recent price recovery have been a combination of short supply and lax lending policies.

While many believe that banks have tightened lending criteria in recent months, the reality is the Big Four banks are still happy to lend to home buyers on a loan-to-valuation ratio of 95% (with the exception of ANZ, which has marginally tightened to 90%). A loan-to-valuation ratio is another way of stating how much equity the bank requires a purchaser to contribute — for example, an LVR of 95% means that the buyer only requires 5% of the purchase price as a deposit. Therefore, for a young couple who is able to save a mere $30,000 (and can combine that with a $21,000 home-owners grant), earning $75,000 each (not that much more than average weekly wages) would be able to purchase a property for more than $1 million.

The banks, of course, have their own vested interest in maintaining the flow of finance to maintain house prices. If house prices slump, the value of collateral held by the banks will crash, placing their existence in serious doubt. That is because the value of banks’ capital is usually a small fraction of their assets. The inherent riskiness of banks’ operations has been borne out in the United States — since Lehman collapsed one year ago, 109 US banks have folded. (The longer banks can keep the housing boom flowing, the more short-term performance bonuses are paid to senior management. By the time the problems materialise, the cash bonuses have long been paid.)

It is no coincidence that those with the most to lose from a pricking of the housing bubble — the federal government and large banks — have been most instrumental in ensuring property prices remain high. There is also a clear link between the size of the bubble and its duration — the bigger the bubble, the longer it takes to pop. If and when that happens, it will not be pretty.