Australia has a new high-profile property spruiker. But it’s not a real estate agent or buyer’s advocate or even mortgage broker — no, Australia’s latest high-profile property bull is (worryingly) the deputy governor of the Reserve Bank, Ric Battellino.
Last week Battellino (who has never actually worked outside of the Reserve Bank since graduating from university in 1973) defended Australia’s ever-growing property bubble, telling the National Housing Conference in Melbourne last week that:
… Australians seem to spend less of their income on non-housing consumption then is the case for US households, with a significant part of the difference explained by lower health costs in Australia. Australian households therefore have greater capacity to service housing loans.
While the US spends a greater proportion of income on health costs, (according to the Productivity Commission, in 2005, Australians spent about 8.5% of GDP on health, compared with 15% in the US) that doesn’t actually explain the difference in housing costs. The median cost of a US property is about$US180,000 or 3.5 times median income, compared with $A405,000 in Australia or 7.6 times median income. Battellino is therefore suggesting that because Australians spend a couple of thousand less annually each on health, they are able to spend hundreds of thousands more on property.
Moreover, in global terms, Australia ranks right on the OECD average for health spending, however, Australia’s housing remains expensive compared with other developed nations. For instance, Australia actually spends more on health costs than the UK, however, in Australia property prices are about 7.6 times income, compared with approximately 5.3 times income in Britain. The health-care argument appears to be a convenient furphy.
Battellino continued:
It is certainly the case that the ratio of house prices to income in Australia is higher now than it was 20 years ago. However, this is explained by the fact that the fall in inflation has allowed nominal interest rates to cycle around a lower average level now … that is, lower interest rates have allowed households to take to bigger home loans, without increasing home loan payments.
Inadvertently, Battellino appeared to answer his own question: Why is Australian residential property resembling an asset bubble? The answer is simple — massive increases in debt. While Battellino argued that the increased leverage is vindicated by lower interest rates, his premise appears based on the optimistic assumption that interest rates (and inflation) will remain indefinitely low. Given the recent tendencies of the US and UK to undertake quantitative easing (which increases the money supply), it would be foolish to declare inflation (especially in the medium to long-term) dead.
Further, the use of debt has created a housing price mirage — property appears more valuable, but that is simply because banks have been willing to lend buyers more money — not because rental amounts have increased drastically or Australian’s are far wealthier. For example, the large banks are all willing to lend purchasers up to 90% of the value of a property. In Melbourne, RP Data reports that median prices have increased from $350,000 in 2005 to about $500,000 now. In simple terms that means in 2005, banks were willing to lend the median property buyer $315,000. However, with property prices increasing those very same banks are willing to lend to the very same hypothetical buyer an amount of $450,000 for the same property. Has the intrinsic value of Melbourne property increased in value by 43% in four years? Unlikely, given BIS Shrapnel reported yesterday that rents have increased by an average of just 3.5% annually in recent years.
To put it is in perspective, since 2005, GDP has increased by about 10% (total). In theory, property appreciation should very roughly track increases in GDP (or inflation but the two have been relatively similar in recent years) — if that had happened, Melbourne median property prices would be about $350,000. However, currently, property prices bear little resemblance to the value of their rental yield — instead, their value is largely determined by how much banks are willing to lend to buyers (coupled with external demand factors such as the first home-owner’s grant).
Leaving aside the issue of whether Battellino’s principles are correct (and there are certainly valid arguments to the contrary), it is arguable that a role of the central bank is to act to prevent a asset bubbles from occurring. In other words, ensuring that an asset class doesn’t deviate dramatically from its intrinsic value (which is the present value of all future cash flows). Recent turmoil in Dubai (where property prices have fallen by 50%) and in the United States (which is down by more than 30%) has indicated that asset bubbles can lead to a dramatic misallocation of wealth — instead of capital being invested in income-producing assets, it is used for speculation. When prices eventually return to intrinsic levels, not only does that capital evaporate, but the economy’s productive capacity is substantially diminished.
Had Alan Greenspan and the US Federal Reserve not maintained a low interest rate regime after the dot.com crash in the early 2000s, the US would most likely not have experienced such a violent residential property boom. The bubble and subsequent bust in 2008 led to a dramatic slump in GDP and total unemployment exceeding 16%.
Australian properties offer terribly low yields, with returns coming from the “bigger idiot theory” — the principle that in the coming years to someone will pay an even higher price for an asset already divorced from its intrinsic value. But this isn’t a concern for our central bankers. It’s probably time someone told the Reserve Bank that the first step for any (debt) addict is to admit that they have problem.
Hear, hear. I have long suspected the RBA’s primary concern is to create conditions that keep the big banks’ profits gushing. Shame RBA, shame. It’s outrageous that house prices are so high. It’s the biggest rort in Australian history. They want us all to be in debt up to our eyeballs for life and paying a huge swath of our paycheques to the banks each week. It would ruin the banks’ businesses if house prices were such that people could pay off their mortgages within a few years. Paul Keating used to say that money tied up in housing was unproductive – and it is. Imagine the wealth people could build if they were able to stop paying interest by age 35 or so, and start investing that money instead into income-producing investments. Imagine the social capital we would have if families could again live on one normal income while they were raising children. Parents could be home with kids rather than putting them into substandard daycare at very young ages. Volunteering work could be hugely revitalised. Pollution would drop with fewer commuters. BUT with fewer people working and paying tax, the government would have to hugely rein in its spending. Thus the Govt is happy for the RBA to keep driving this whole Ponzi scheme ever upwards and bugger the human misery of lifelong debt. Not to mention the huge numbers of homeless who are spat out by the system and its outrageous house prices. As long as the banks are pumping profits and the Govt is raking in tax, that’s all that matters.
Widow, I’m not sure if the whole RBA has such a consensus. Earlier this year Glen Stevens warned of a possibility of a bubble developing, in his careful decorous way. Reading between the lines, he meant that the existing bubble was growing alarmingly big.
The housing bubble is a lot worse than just unproductive. It’s a transfer of wealth from the future to the present, similar to borrowing but disguised as tangible assets.
Battellino is also quoted in today’s SMH saying Australian houses are bigger than those of other countries like USA and UK, justifying the higher prices.
He sounds more and more like an apologist for property scalpers. He disingenuously ignores the possibility that the increasing size of new homes is a result of the land-scalping bubble. Land prices increasingly put inner urban homes out of reach for all but the richest buyers. The richer the buyers, the bigger the houses they want to build. Poor people don’t get a look in, while those of middle income are pushed further to the outskirts where blocks are bigger and building is cheaper.
James, when I hear Stevens justifying interest rate rises by “warning” of a developing bubble, methinks he is just trying to put a do-gooder cloak on a motivation which is more to do with boosting the amount of interest we all pay the banks. Hell, if we had the 2 per cent and less rates they have in the UK and US, people might actually start paying off large slabs of their principal debt, and we can’t have that.
I’ll admit I have no idea of how official rates bear on cost of money to banks – but I do know after the rises of the past three months we are all now paying much more in interest each month. And I would have thought as we move through the GFC that money would be more easily available to banks and possibly not as expensive to them as it was three months ago. OK I know the banks and the govt want to raise more funds on-shore in future, and domestic deposit rates have been rising. But I think the proportion of funds raised from local deposits is less than half of any bank’s loan book.
People used to talk about looking at fundamentals, and some economist somewhere should be able to work out some what housing should cost, based on fundamentals.
The massive failure in the system is in lack of urban and transport planning that makes inner and middle ring suburbs so much more in demand than outlying suburbs, bottlenecks in supply of land (we have quite a lot of it in Australia) meaning that construction of new houses is not keeping up with population growth, and massive government charges and regulation that makes building houses so expensive.
Oh, and then there’s capital gains tax (massive tax discounts for property investors). Have a look at the blowout in property prices since Costello introduced that rort.) Swannee is too scared to touch CGT, and of course the Libs won’t – in the unlikely event that they ever get back into power. It was the perfect recipe for dividing society into the haves and have-nots. Now, because there are so many have-nots, we are dependent on having all those private rental properties to house all the people who will never have a hope of owning homes.
It has been widely misreported that Keating removed negative gearing (around 1987 ?). In fact, he ruled that rental property losses could only be written off against income from that property, not against all other income as well. It seems perfectly reasonable really, but because it was widely misunderstood and reported as meaning that investors could not tax deduct interest costs at all, he was forced into a backdown.
And back to the RBA. I’m sure they like to think they are the masters of the universe, tweaking interest rates here and there. But in fact this is a very blunt tool. With a third of the population owning their homes outright, probably many of them older with some super or savings in cash deposits, when interest rates go up, these people probably cheer and go out and hit the shops.
Mrs Twankey, you’re right. On fundamentals – “some economist somewhere should be able to work out some what housing should cost, based on fundamentals” – Adam Schwab has done so in the article here:
“To put it is in perspective, since 2005, GDP has increased by about 10% (total). In theory, property appreciation should very roughly track increases in GDP (or inflation but the two have been relatively similar in recent years) — if that had happened, Melbourne median property prices would be about $350,000. However, currently, property prices bear little resemblance to the value of their rental yield — instead, their value is largely determined by how much banks are willing to lend to buyers (coupled with external demand factors such as the first home-owner’s grant).”
On the housing bottleneck, public transport is part of it, but there are also deliberate policies Rudd has put in place solely for the purpose of boosting the speculative property market: increasing the FHOG (which contrary to its original stated intention, was never designed to “offset the effects of the GST”), removing limits on foreign investment in Australian housing, and so on. Adam has written about most of them in various articles. Any of these measures, taken in isolation, might be seen as misguided policies which had a side effect on home prices. Taken together, there is no question that pushing house prices as high as possible has been a top priority for the Rudd government, as it was for the Howard government. These policies have been spectacularly, and tragically, successful
Yes James, I agree. Many ingredients have contributed to the housing price disaster, and the FHOG is another. Yes, and true, true, rental yields, as Adam points out, are a key fundamental that should be giving us some guidance on how far out of whack the market is.