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Do we need a recession to stop the house price bubble?
Topic Started: 30 Jul 2014, 02:36 PM (4,156 Views)
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http://www.businessspectator.com.au/article/2014/7/30/australian-news/how-heal-housing-market

How to heal the housing market

Five years after the GFC, many nations appear to be lurching head first into yet another housing crisis. In response, increased macroprudential regulation has become the policy du jour, proudly advocated by the International Monetary Fund and widely adopted around the world.

The Reserve Bank of New Zealand only last year decided to limit the proportion of bank loans with a loan-to-valuation (LVR) of more than 80 per cent, to 10 per cent of new lending. Similarly, the Bank of England announced in June that it would restrict the proportion of loans that are 4.5 times the borrower’s income to 15 per cent of new lending. Lenders are also required to assess a borrower’s capacity to absorb a 3 per cent interest rate hike in the first three years of the loan.

In the Australian context, I don’t think there should be much doubt that we will follow the same path. While the RBA has offered mixed rhetoric on the issue, such reservations aren’t shared by the head of the Commonwealth Treasury, Dr Martin Parkinson, who only last week advocated a role for increased regulation though macroprudential policies.

Suspicion should be raised, however, when what were previously well accepted principles are so easily cast aside.

Deregulation was embraced for many reasons: efficiency, productivity, equity. Regulation simply wasn’t working, and the GFC was a modern case in point: a perfect example of bureaucratic bungling and its disastrous consequences. Against that backdrop, the move to re-regulate now isn’t so much an evolution of thought, but rather an intellectual corrosion.

Remember that the US housing crisis was not result of insufficient regulation. Instead the crisis was caused by a combination of a housing glut, excessively low interest rates and a generous system of exemptions from existing regulatory oversight.

Subprime mortgage corporations come to mind here, as do actions taken by Freddie Mac and Fannie Mae, both of which contributed to the explosion in alternative lending such as subprime and Alt-A loans. Outright fraud in the rating of many mortgage products associated with subprime lending exacerbated the problem, as did the ease with which households could default.

High LVRs themselves did not cause the US housing recession or the global financial crisis. Indeed LVRs overall remained quite constant. Little changed from what was ‘normal’ in the lead-up. That loan-to value ratios subsequently spiked during the US housing recession was a simple reflection of the ensuing house price slump, which in turn was exacerbated by the ease at which mortgage holders could default.

Against that backdrop, moves to re-regulate must be viewed as a draconian intrusion of bureaucrats into the free market. The Reserve Bank of New Zealand’s actions highlight this perfectly. At the time loan-to value restrictions were put in place, it was not clear that there were any policy grounds for lifting the regulatory burden. Lending growth was (and is) quite modest.

Consequently, the decision simply deprives some citizens, who may have otherwise been able to service their debt happily without incidence, of a home. They have been denied access to credit for no good reason -- a deprivation based purely on the arbitrary assessment of a bureaucrat with absolutely no regard to personal circumstances. In a free-market capitalist democracy, this is not acceptable.

Such decisions can even act against the national interest. Consider that the decision to restrict credit growth could hamper the provision of adequate housing stock. House prices are surging for a reason; something that bureaucrats don’t seem to be able to get their heads around. There is a price signal trying to give policymakers a message that there is policy failure in some other area. In this case, the provision of affordable housing for the citizenry. Hiding behind increased regulation is the wrong way to address it. It can't address it.

So what remains? House prices are surging and history shows that it is probably desirable to moderate this in some way. Increased regulation (not no regulation) is clearly not the right answer.

Moreover, as I outlined in my piece (Stop blaming investors for the housing shortage, July 16) attacking investors is not the correct approach either. Investors did not cause this housing crisis. That they have sought take advantage of this ultra-low rate environment to purchase an asset in tight supply is not a crime; it is shrewd investment. The housing affordability crisis, rapidly rising prices -- all of that is due mainly to insufficient housing stock, a lack of infrastructure and excessively low interest rates -- basically a failure of government policy. One of the unfortunate consequences of this global move or discussion of macroprudential controls is that it distracts from the real causes not only of the financial crisis, but also Australia’s current housing crisis.

The best way to fix this current dilemma is quite simple. Build more houses and associated infrastructure, enforce existing regulations and keep interest rates appropriately calibrated.


From Paul Bloxham.
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So far, the plan is working. As mining activity slows, other sectors are picking up, albeit modestly, and rising housing prices are part of the story. Australia’s rebalancing act is underway. To drive this, the RBA has held its cash rate at its lowest level in history for almost a year. Rising house prices and low interest rates are driving an upswing in housing construction, which is also part of the plan.

At this stage, the upswing looks like a regular housing price cycle. National housing prices have risen by 16% since their trough two years ago. This followed an 8% decline in the previous two years, so part of the rise is just catch-up. Although housing prices have outpaced income growth in the past two years, they have grown in line with incomes over the past five years. As long as interest rates remain low, we expect the housing boom to continue, with housing price growth of around 10% forecast for 2014 as a whole.

This is where the story gets trickier. Although monetary policy has, so far, done what it is supposed to do, the central bank needs to be wary of creating a build-up of excessive risks along the way. And, while we remain of the view that Australia does not currently have a housing bubble, it seems likely that if the current housing market trends were to persist for too long, there would be a risk of inflating one. Signs of exuberance are most acute in Sydney, where housing prices are already rising at twice the pace of elsewhere and the investor share of market has reached record new highs in recent months. The RBA will need to be wary of not falling into the trap of leaving interest rates ‘too low, for too long’ and driving excessive risk taking in the housing market.

For policy, Australia’s still booming housing market is a key factor that underpins our view that the RBA is unlikely to deliver further cash rate cuts. Indeed, we expect rates will need to rise to rein in the housing market and secure financial stability. We still see rates needing to rise earlier than the market is currently pricing in, with a hike expected as early as H1 2015.
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Barista
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A recession will be particularly painful. In a nation that hasn't had one for 23 years it is going to be seriously painful. I’ve seen what other nations have gone through since 2008 and don't think your average person in Australia has the faintest idea what is in store. In a nation carrying the private debt that Australia is, going anywhere near a recession is going to be nothing short of a disaster.

Even more pertinently, going anywhere near a recession with the AUD either where it is, or god forbid, higher than where it is, is just magnifying the disaster that awaits us. For mine the simple fact of the matter is that the globally exposed (and I mean really globally exposed, as in competes and engages with the rest of the world, not just loads parts of our world onto a boat and sends it to another world and forgets all about it) is going to be the biggest single requirement Australia has at the point it goes anywhere near a recession. For mine that means manufacturing, technology and services. To get any boost to Australia’s standing vis technology manufacturing or services the AUD needs to come a long way down.

For mine the investment in manufacturing and technology may come as Australia signals that it is looking to create a lower AUD, but wont make a move until that signal is given, and sure as hell wont even think about it while everyone from the government and RBA to the man on the street is mulling over whether it goes higher. Australia needs that investment. Services will generally only come when the AUD is already down – services generally being a lot more transportable.

But on the other side the view that Australia needs a recession (a crash) is plausible (IMO) for a lot of people, and for very good reason. The reason it is plausible is that Australia has monumentally stuffed up a mining investment boom. It has made sure that the upside of that has essentially gone into boosting debt (which was already to high levels) and boosting house prices, and has been accompanied by the continued selling off of national assets to support a CAD. The upside has gone to those with access (or preparedness to take on) the debt and/or to those who have the assets already (eg the boomers). But the downside (and there has been one, despite Australia’s view of its circumstances) has been largely borne the globally exposed side of the economy, and those with reduced or secondary access to debt (access to it after others have bid up the asset prices). For anyone in this position there has been virtually no boom, or no boom unaccompanied by considerable risk (for most a debt risk).

So for these people, who may not actually have any experience of a ‘boom’ then there is a vastly diminished sense of threat about the prospect of recession, and if (and I am one) you think that there is need for a vast economic reset in this nation, and that the only way the urgency of how desperately it is needed in the minds of some people (eg me) can be replicated politically, is by means of a crash, then there is often a sense of ‘bring it on’.

That sort of brings me to three points.

The first is that Australia needs exporters/globally exposed businesses (that employ people, encourage skills, innovation etc) and will need them more as we move forward, and even more so should we find ourselves (as I believe we will at some point) in recession.

The second is that for a very large section of Australian society the benefits of the 23 years of economic growth haven’t been particularly well understood or felt, and indeed it could be argued not particularly tangible.

From there those two points need to be seen against the backdrop of the status quo (in an economic policy and macro sense) is essentially deteriorating, and offers very little scope for an improved economic performance moving forward. So for mine there is a sense of inevitability about significant economic restructuring being forced upon us at some point. But at the same time for most people at the moment (and Australia’s body politic), the present is generally seen as something close to the best of all likely immediate outcomes, with major policy moves potentially having significant negative effects for large chunks of the economy too – for a whole host of vested interest reasons [the punters are in debt to their eyeballs]. So there is a sense of inevitability about the need for major economic policy change (which may or not involve a recession or crash) while at the same time the body politic and many people would expect the current regime to use every tool at its disposal to fend off any deterioration to the current status quo being experienced by the punterariat (which would fit with the AUD being allowed to remain where it is or drift higher).

Look at the completely inadequacy – if not stupidity – of many of the economic policy settings we have/had. Australian economic policy should be about providing benefits to all Australians, ensuring that all Australians are in a position to benefit from the Australian economy, ensuring that Australian economic resources are used to support this, and ensuring that Australia has a productive economic future. Generally they push market based responses (and I think rightly so) and note that it is essentially non market based policy settings that have Australia is an economic straightjacket. If I was to have a royal commission of my choice tomorrow I would want one on the processes and decision makers who decided that Australia’s external facing sectors should be crushed to fit in a mining boom, and that it would be good policy to funnel significant aspects of that into real estate without looking at the longer term implications of that.

But ultimately they are pushing an Australian economy where exporters (beyond resources) and the globally exposed sectors of the Australian economy are encouraged with policy settings which support them, and where real estate costs are considerably lower. I agree with them, or what I think is their broad position, that over the longer term these positions are not contradictory or in competition. From here it is all about how we get there.
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van
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They should restrict loans to those who already own property. Restricting loans to people who do not have a lot assets and allowing those who do just widens the gap of the people who own property and those who do not.

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peter fraser
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markets take corrections in their stride, but a long deep recession will hit home ownership harder than most here will understand and it will guarantee a housing bubble that is bigger than any of us have ever seen.

A deep recession would suit me fine, but it would hurt people I know and family members a lot.
Any expressed market opinion is my own and is not to be taken as financial advice
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Dr Watson
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Australia had a (per capita) recession in 2009 and house prices continued to march higher.
The trouble with the world is that the stupid are cocksure and the intelligent are full of doubt — Bertrand Russell
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peter fraser
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Dr Watson
30 Jul 2014, 03:12 PM
Australia had a (per capita) recession in 2009 and house prices continued to march higher.
They have to go higher, less people are buying in a recession so the undersupply increases. In addition the only ones who do buy are those with the cash or the assets, and that's the existing property owners, so the ownership becomes even more concentrated in fewer hands.

So we get a short term gain for the wealthy and a long term loss for the poor, under the current high population increase environment.
Any expressed market opinion is my own and is not to be taken as financial advice
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Barista
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I think we are going to do the double.

First, we wipe out the globally exposed sectors a tad more with a final surge in the AUD.

Second we get the hog wild speculative frenzy in exisiting real estate, absolutely humming with the old vinegar stroke vibe by cutting rates again.

Third, we have the blow off to end all blow offs which has Australian banks sitting on a lot of mortgages (funded short from global wholesale markets) which migrate to the Non Performing Loan side of the financial report.

Fourth we get the government, eyeing off the need to backstop banks in a more meaningful sense than verbage, finding itself having to explain to the Australian public that they will need to tighten their belts further.

The long mooted combination of retrenching public and financial sectors, clouds the sentiment bubble in the consumer and retail worlds a tad more. It doesn't do much more for anyone thinking of investing in Australian productive capacity.

Then we get the moment where someone somewhere thinks that the economy going into the pike position may not be the best environment to be hanging onto real estate that hasn't actually ever been a worthwhile investment (and maybe even with a government so stretched it is making noises about restricting the Negative Gear in some way).

Global buyers of Australia’s resources commodities twig to the idea that those arrogant game players who smashed the contract negotiation system might conceivably be taken to the cleaners if they hold off on an order or two until the AUD has the chance to really dive face first into the merde.

To a chorus of analysts chanting sell sell sell, the body of the Australian economy is laid before the RBA with a casual ‘would you care to look through this’ and the high priest of Australian economic mismanagement finds himself in the position of needing to consider lifting rates into the face of an economy going deep south.

and on and on and on...

It wont be a grind, it will be a long series of knees to the economic nuts of this land.

But don't forget, there has never ever been anywhere on the planet a better time to buy real estate.
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b_b
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Dr Watson
30 Jul 2014, 03:12 PM
Australia had a (per capita) recession in 2009 and house prices continued to march higher.
Shhh

Don't ruin the dream....
(S – I) + (T - G) + (M - X) = 0
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Don't Buy Now
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Bulls underestimate the inversion of incentives in a falling market!

If buyers think prices will fall, they will stand aside!

Here’s the real cause of the malaise – not mining or capex or construction, but the dead hand of rent-seekers working tirelessly to engineer a free ride!

When the market starts returning the awesome price gapping seen in Japan, Europe, USA, buyers then require a period of stability, which their restraint makes impossible as activity declines!

All those overseas lenders will renew loans for shorter and shorter times then abruptly want their money back in synchronicity, failing which they will settle for deeply-discounted assets!

This is what the bond market is about, not collecting a dribble of interest!

I have no problem people buying when it makes sense, even in a falling market!

If rents and repayments approximate and family need presses, they should buy!

In this scenario, people are not speculating, they are hedging the economic rent created by their very existence, a rational response!

We foresee dramatic and astonishingly expensive moves by government to sustain the status quo in bailing out banks, LMIs and investors!

Never mind these intermediaries’ problems are caused by borrower difficulties and the economy would be better served by solving borrower problems!

Don't Buy Now!
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It’s all complete and utter bollocks!

Our banks are mortgaged to the eyeballs and beyond.

Our banks are still world leaders in the total percent of Real Estate Loans vs Total Loans, last count over the 65% mark.

Everybody knows we are over leveraged to property and a decent shudder though our property markets will have the government, the RBA and the Banks all collectively crapping themselves at the same time.

The stink will envelope the planet and future investors will be scared off by the smell of decaying and rotting real estate values.

In other words while many countries in the world have been through their ‘slap upside the head moments’ we Aussies still have that lunatic grin and saliva dribbling from both corners of our mouths.

We have yet to discover a proper level of sanity.
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