And it’s not even necessarily their best one.
Normally, I try to keep my blogs to 500-1,000 words – the sort of length one could read in under five minutes. But this one – at almost 4,000 words – got away from me a little … enjoy!
THE CURRENT SITUATION
The Australian Council of Financial Regulators (the Reserve Bank of Australia (RBA), the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC) and the Treasury) have recently started making big moves to reign in Australia’s eastern states property markets. But there are concerns that it might be too late.
Australia’s property markets are looking very much like a bubble – nationally, prices are accelerating at 12.9% per annum (the fastest rate since 2010), led by Sydney (18.9%) with an average dwelling price of $805,000, Melbourne (15.9%), Canberra and Hobart (both over 10%).
Lenders and mortgage brokers have been naughty, increasingly offering interest-only loans – loans where, for the first five or so years, you only pay interest on the loan without paying down any of the principle – to borrowers who are less and less able to afford them. Specifically, interest-only loans re-accelerated to 37.5% of lenders’ new residential mortgage lending in the last quarter of 2016, up from just 20% three years ago. That is high by both national and international standards. And in a $1.65 trillion mortgage market, that risk can have a widespread impact if realised.
The appeal of interest-only loans is their ability to reduce the borrower’s annual servicing costs and provide greater flexibility in their cash flows/ principle repayments via an almost uniquely Australian arrangement – mortgage offset accounts. But in order to be properly beneficial, these offset accounts need to be properly utilised. If they are not, and the principle is paid too slowly, the loan will take longer (and cost more in the end) to pay off. Consequently, investors need to be quite savvy (and ideally already quite wealthy) for interest-only loans to not cause problems for them – more savvy (and wealthy) than a lot of people who have been granted such loans recently.
This is very reminiscent of the US sub-prime mortgage boom that triggered the GFC – people being lent significant sums of money that they could only afford to pay back if property prices continued growing strongly. Comparisons have even been made to Australia’s great 1890s property collapse, which was deeper and more prolonged even than the Great Depression, rendering about half of Australia’s banks insolvent. And now – as it was then – even a small shock to the economy, or slight increase in interest rates, could result in a wave of defaults from these heavily-indebted investors and households, and consequent widespread economic turmoil. Even just the fear of such turmoil can result in a self-fulfilling prophecy if enough investors/ households start acting in response to the downside scenario.
WHAT’S BEING DONE TO HELP?
Here is a timeline of the measures the Australian Council of Financial Regulators have undertaken before and in response to Australia’s supposed property market bubble:
·
Just before the GFC, APRA
allowed the Big Four banks, and Macquarie to calculate their own risk
weightings for mortgages (the amount of capital they would have to hold as a
buffer), which substantially reduced their capital requirements.
·
In 2015, in light of concerns that banks weren’t
being disciplined enough regarding their capital buffers, APRA ordered a 25%
floor under the risk weightings for residential mortgages (up from a 16%
average at the time) which resulted in banks needing to raise an additional $20
billion of capital. They also imposed a 10% growth rate cap on investor loans. But
these measures failed to reign in the system – banks remained highly leveraged.
This isn’t shocking I suppose, given that 10% is still a $60 billion injection
of new demand every year. But neither is it cause for alarm because, given the fragility
of the market, undershooting on these measures is preferable to overshooting
and risking crashing the market ourselves.
·
On Friday 31st March 2017, APRA instructed
lenders to limit their interest-free loans to 30% of their new residential
mortgage lending and remain “comfortably below” the 10% growth rate cap on
investor loans that was imposed (but clearly not adhered to) in early 2015.
This includes bank and non-bank financial institutions, which is important,
given the significance of the latter in the US sub-prime mortgage crisis.
·
APRA is also targeting banks that conduct overly-generous
borrower-serviceability assessments (another characteristic of pre-sub-prime
crisis lending behaviour), assuming that borrowers can live more frugally than
reasonable. Specifically, lenders should ensure that borrowers have more than a
$200-a-month buffer after expenses and mortgage repayments if things go wrong.
·
ASIC announced a probe where it will use its
compulsory information-gathering powers to gather data that will tell them more
about the interest-only lending activities of large and small banks, mutual
banks and non-bank lenders.
·
ASIC’s 2015 investigation found that up to 30%
of mortgages lent had not properly considered the borrowers’ circumstances and
their ability to repay. Furthermore, they reported in March that brokers were
being rewarded with commissions based on their volume of loans, not their
quality – consequently, ASIC (and APRA) recommended these incentives be changed
to encourage more responsible lending.
·
ASIC has also instructed eight major lenders
(including three out of the Big Four banks) to compensate borrowers for their
poor lending practices, and is even taking Westpac to court for supposed
breaches of the National Consumer Credit Protection Act.
The new measures imposed so far by APRA have been ‘tactical’,
rather than structural, which means APRA, beyond potentially reducing the 30%
limit on interest-only loans even further, has the capacity to do more (i.e. a
second leg to the strengthening of capital requirements) if required as
conditions evolve, including the very real possibility that the risk-weighting floor
will be raised to 30% (by some accounts, as high as 50% for investor loans).
This will require lenders to raise another $12-15 billion in capital between
them, making them (in APRA Chairman Wayne Byres’ own words) “unquestionably
strong” and able to access credit markets in any possible crisis. And it
remains cheap for lenders to raise more capital in current conditions. Indeed,
rising profit levels may allow them to raise this additional capital naturally,
without the need for a capital raising.
As can be seen, these new measures can be targeted solely at the areas of the housing market with particularly high risk characteristics (investor and interest-only mortgages) – the areas we want to slow down, not the whole economy. And due to the consequent higher cost of lending to these areas, banks would happily protect their returns by either lending less to these areas, or charging investors in these areas higher interest rates/ reduced discounts (or both) – consequently slowing down the area. And politicians are less likely to criticise such a move, given their increasing appreciation of the dangers of an unchecked property bubble.
Will these lenders cooperate? Recall my fevered conspiracy theory that the Commonwealth Bank of Australia wants to usurp the RBA’s authority and may therefore, not cooperate? More realistically though, banks may argue that their residential lending practices have actually been an attempt to help the RBA transition the Australian economy away from its dependence on the mining and resources sector in the face of the significant decline in associated investment and weak demand for business loans. Lenders may not appreciate being punished for this. Nor will they be happy to ignore their incentives to keep their lending standards low and maintain market shares – especially given the tendency of mortgage brokers to direct customers straight to the cheapest and least onerous borrowing conditions, and for public outrage every time the banks increase interest rates independently of the RBA.
SHOULDN’T THE RBA JUST INCREASE INTEREST RATES?
Now here's the big point of contention. There are many (including Judith Sloan, Economist at The Australian newspaper) who believe that the current property market bubble is actually the fault of the RBA for dropping interest rates (specifically its own cash rate) so low, and for so long, thereby spurring the property market to these dizzy heights.
But the RBA's cash rate is a crude tool for controlling property markets. It is designed to control inflation rates and unemployment in the real economy. In normal times, a booming property market would be associated with a booming real economy. Therefore, increasing the cash rate would be the right decision, because the real economy requires it too.
But if the real economy is moving in a different direction to the financial economy, the cash rate still needs to focus on the real economy. That is why the cash rate is so low in Australia – real inflation (or ‘core’ inflation, as the RBA calls it) is below the RBA’s target, unemployment is too high, and employment and wage growth are too low (and softening further[1]). Using a higher cash rate to combat a property bubble will further hinder the real economy, including consumption spending which accounts for about 60% of the economy. Furthermore, the property bubble may require a significant increase in the cash rate to deflate.
This was somewhat the situation during the sub-prime market boom leading up to the GFC. A massive cash rate increase would have been required to disincentivise those property investments. Even then-Federal Reserve Chairman Alan Greenspan’s era of low cash rates was a result of a low inflation rate. No doubt he further incentivised the sub-prime boom but he would have had to increase the cash rate monumentally to slow the sub-prime market – that’s how profitable it was (until it wasn’t). Using the cash rate to ‘lean against the wind’ of asset markets is not advisable, especially when the real economy (specifically, real inflation and employment) is sluggish.
And this is also the current situation in Australia – the RBA is stuck between wanting to stimulate the lagging real economy with a low cash rate, and not wanting to over-stimulate the booming property markets. Another way to put it – the RBA is stuck between wanting to reign in the property market but not wanting to add burden to already-debt-laden-and-static-income households. That is why they are opting for a low cash rate and the measures listed above.
But it’s okay because the cash rate is not the only tool at the RBA’s disposal. The above-listed actions are what is referred to as ‘macro-prudential regulation and oversight’ – a powerful tool of the RBA (and ASIC and APRA) in addition to its control over interest rates. This is what the US was lacking during the lead-up to the GFC – macroprudential regulation and oversight, not an effective cash rate policy (which is designed to tackle real inflation not necessarily financial/ property market inflation). And this is why these Australian bodies are stepping in with this tool to reign in property markets directly instead of using the RBA's cash rate. This is because increasing the cash rate for the purposes of cooling the property market will hinder the already-struggling real economy and not necessarily even effectively reign in the property market.
Also keep in mind that we don’t want to reign in house prices too much – if house prices actually fall, this will have flow-on impacts on household wealth and the broader economy. With investor loans accounting for over half of property lending and interest-only loans at 40%, falling house prices may trigger investors into selling, sparking a property crash. It’s a delicate balance to maintain – don’t let the market continue on its current path, otherwise it may crash, but don’t slow it too much, otherwise it might crash.
But it does reinforce the need for macro-prudential measures, which target specific trouble areas of the housing market, rather than the cash rate which affects the broader economy, potentially doing undesired damage. Furthermore, disruption can be minimised if banks have sufficient time to meet these new requirements, which APRA has assured they will.
So to suggest that the RBA should have raised its cash rate sooner, or not lowered it to this level in the first place, is ill-advised.
MORE AVENUES TO SUCCESS
Furthermore, while a contributing factor, interest rates aren’t the only (or even the most significant) cause of the property market bubble. As Philip Lowe, Governor of the RBA, says:
As can be seen, these new measures can be targeted solely at the areas of the housing market with particularly high risk characteristics (investor and interest-only mortgages) – the areas we want to slow down, not the whole economy. And due to the consequent higher cost of lending to these areas, banks would happily protect their returns by either lending less to these areas, or charging investors in these areas higher interest rates/ reduced discounts (or both) – consequently slowing down the area. And politicians are less likely to criticise such a move, given their increasing appreciation of the dangers of an unchecked property bubble.
Will these lenders cooperate? Recall my fevered conspiracy theory that the Commonwealth Bank of Australia wants to usurp the RBA’s authority and may therefore, not cooperate? More realistically though, banks may argue that their residential lending practices have actually been an attempt to help the RBA transition the Australian economy away from its dependence on the mining and resources sector in the face of the significant decline in associated investment and weak demand for business loans. Lenders may not appreciate being punished for this. Nor will they be happy to ignore their incentives to keep their lending standards low and maintain market shares – especially given the tendency of mortgage brokers to direct customers straight to the cheapest and least onerous borrowing conditions, and for public outrage every time the banks increase interest rates independently of the RBA.
SHOULDN’T THE RBA JUST INCREASE INTEREST RATES?
Now here's the big point of contention. There are many (including Judith Sloan, Economist at The Australian newspaper) who believe that the current property market bubble is actually the fault of the RBA for dropping interest rates (specifically its own cash rate) so low, and for so long, thereby spurring the property market to these dizzy heights.
But the RBA's cash rate is a crude tool for controlling property markets. It is designed to control inflation rates and unemployment in the real economy. In normal times, a booming property market would be associated with a booming real economy. Therefore, increasing the cash rate would be the right decision, because the real economy requires it too.
But if the real economy is moving in a different direction to the financial economy, the cash rate still needs to focus on the real economy. That is why the cash rate is so low in Australia – real inflation (or ‘core’ inflation, as the RBA calls it) is below the RBA’s target, unemployment is too high, and employment and wage growth are too low (and softening further[1]). Using a higher cash rate to combat a property bubble will further hinder the real economy, including consumption spending which accounts for about 60% of the economy. Furthermore, the property bubble may require a significant increase in the cash rate to deflate.
This was somewhat the situation during the sub-prime market boom leading up to the GFC. A massive cash rate increase would have been required to disincentivise those property investments. Even then-Federal Reserve Chairman Alan Greenspan’s era of low cash rates was a result of a low inflation rate. No doubt he further incentivised the sub-prime boom but he would have had to increase the cash rate monumentally to slow the sub-prime market – that’s how profitable it was (until it wasn’t). Using the cash rate to ‘lean against the wind’ of asset markets is not advisable, especially when the real economy (specifically, real inflation and employment) is sluggish.
And this is also the current situation in Australia – the RBA is stuck between wanting to stimulate the lagging real economy with a low cash rate, and not wanting to over-stimulate the booming property markets. Another way to put it – the RBA is stuck between wanting to reign in the property market but not wanting to add burden to already-debt-laden-and-static-income households. That is why they are opting for a low cash rate and the measures listed above.
But it’s okay because the cash rate is not the only tool at the RBA’s disposal. The above-listed actions are what is referred to as ‘macro-prudential regulation and oversight’ – a powerful tool of the RBA (and ASIC and APRA) in addition to its control over interest rates. This is what the US was lacking during the lead-up to the GFC – macroprudential regulation and oversight, not an effective cash rate policy (which is designed to tackle real inflation not necessarily financial/ property market inflation). And this is why these Australian bodies are stepping in with this tool to reign in property markets directly instead of using the RBA's cash rate. This is because increasing the cash rate for the purposes of cooling the property market will hinder the already-struggling real economy and not necessarily even effectively reign in the property market.
Also keep in mind that we don’t want to reign in house prices too much – if house prices actually fall, this will have flow-on impacts on household wealth and the broader economy. With investor loans accounting for over half of property lending and interest-only loans at 40%, falling house prices may trigger investors into selling, sparking a property crash. It’s a delicate balance to maintain – don’t let the market continue on its current path, otherwise it may crash, but don’t slow it too much, otherwise it might crash.
But it does reinforce the need for macro-prudential measures, which target specific trouble areas of the housing market, rather than the cash rate which affects the broader economy, potentially doing undesired damage. Furthermore, disruption can be minimised if banks have sufficient time to meet these new requirements, which APRA has assured they will.
So to suggest that the RBA should have raised its cash rate sooner, or not lowered it to this level in the first place, is ill-advised.
MORE AVENUES TO SUCCESS
Furthermore, while a contributing factor, interest rates aren’t the only (or even the most significant) cause of the property market bubble. As Philip Lowe, Governor of the RBA, says:
“The
availability of credit is undoubtedly a factor that can amplify demand, but it
is not the root cause”.
To suggest solely (or even primarily) interest rates are to
blame overlooks the fact that in Perth and Darwin, house values fell 4.7% last
year, and Adelaide and Brisbane grew only modestly at 3.5%. All these cities
are subject to the same low interest rates, and yet they’re having a vastly
different impact on house prices depending on the city. This implies something
much more significant is driving property prices to different extents in
different cities.
And that is … supply.
Long term success requires the supply of housing in these pressure areas to increase. Macro-prudential regulation and oversight can lessen financial risks and the housing market’s impact on the broader economy, but it is merely a temporary solution – even the RBA admits that it won’t address this underlying supply-demand mismatch. This is something over which the RBA and APRA have little control – or even responsibility. But not the government.
One avenue therefore, is government planning to open up new areas for residential development, as well as investment in public transport infrastructure. As inner urban areas fill up, public transport links to outer areas quite literally create new well-located land for housing.
And that is … supply.
Long term success requires the supply of housing in these pressure areas to increase. Macro-prudential regulation and oversight can lessen financial risks and the housing market’s impact on the broader economy, but it is merely a temporary solution – even the RBA admits that it won’t address this underlying supply-demand mismatch. This is something over which the RBA and APRA have little control – or even responsibility. But not the government.
One avenue therefore, is government planning to open up new areas for residential development, as well as investment in public transport infrastructure. As inner urban areas fill up, public transport links to outer areas quite literally create new well-located land for housing.
“Nothing
increases the supply of well-located land like good transport links”, Philip
Lowe.
This planning and investment has not kept up with the strong
population growth since the turn of the century (around 190,000 new permanent migrants
each year), consequently driving this property price growth. Creating this
additional supply will go a long way to addressing house prices (and consequent
household debt) currently out-pacing wages and incomes.
Fiscal stimulus is another avenue. Accelerating household wage and income growth will better allow households to pay down their debt levels. Currently, property prices and debt levels are growing faster than wages and income – last year, household debt increased 6.5%, while wage growth is the lowest in some decades (household incomes grew just 3%). Household debt is now at around 125% of GDP and 189% of disposable income (the latter from around 160% for much of the 2000s, and just 60% 25 years ago). This makes Australian households the fourth most indebted in the OECD behind Denmark, The Netherlands and Norway.
A solution here is government fiscal policy – investments in infrastructure (including public transport above) to drive real economic activity and wages and incomes, allowing households to pay down debt faster, so the RBA can lift its cash rate faster, further easing any pressures on property markets.
The government still has a great capacity to borrow – our AAA credit rating and strong economic record means that demand for government bonds continues to be greater than the supply from Treasury – so Treasury could easily issue more if they wanted to spend more money. And even though interest rates are rising globally, the cost of financing government debt continues to fall as the debt is rolled over (from 5.2% to 3.5% over the last five years), i.e. higher interest rates on government debt will continue for some time to still be lower than the rates at which that debt was initially borrowed, with new borrowings such as an $800 million 10-year bond issued recently, paying just 2.75%. Furthermore, a larger share of our government’s debt is being sourced domestically, reducing our exposure to rising international interest rates.
And remember, in Australia gross government debt as a percentage of GDP is only 41% (net debt is only 20%) – low by international standards and much lower than household debt. If the government budget is like a household budget (it’s not, but for argument’s sake, let’s use the common political talking point), surely the government should be willing to incur a little more debt to help bring actual household budgets back into the black – or at least in line with their own debt levels.
And any consequent government debt incurred can be paid down with the economic proceeds (and consequent tax revenue) of these investments themselves – but this will require convincing the government to spend more money, which is not easy right now (before the GFC, I never thought it would be hard to convince a government to spend more money).
Furthermore, the government can do more to address income inequality. One possible reason that a booming property market in Sydney and Melbourne is not translating into stronger general economic performance elsewhere is that income inequality has resulted in only a small section of the economy having the means to invest in and profit from asset markets. Lower socio-economic individuals tend not to have significant stock portfolios or (even indirect) property investments. Consequently, they can’t benefit from a booming eastern states property market. But if, through its infrastructure investments and redistribution efforts, the government were to better support the lower end of the socio-economic spectrum, giving them more capacity to invest in asset markets on the other side of the country, this would better share the eastern states boom across the economy, and the two-speed economy would start returning to a one-speed economy. Consequently, interest rates could recover faster before the property markets ever get out of control.
WA in particular needs a boost. The end of the mining and resources boom has brought high unemployment and underemployment, and flat wages and house price growth, with almost 3% of mortgage-holders over 30 days in arrears – the highest in the country, 60% higher than last year, and growing. Geraldton, Port Hedland and Karratha specifically have over 6.5% of mortgages delinquent – more than double the previous year. And while nationally this rate of mortgage-holders over 30 days in arrears has increased, it is still just 1.5% (up from 1.2% last year) – so while mortgage stress is appearing across the country, even in the stronger states of NSW and Victoria, the argument for fiscal support is especially strong in the west.
Fourthly – and more widely published – the government could adjust negative gearing and capital gains tax discounts on residential investment, and limit (or ban) the ability of superannuation funds to borrow. Such regulations (or lack thereof) have over-stimulated investor activity (by, for example, making housing tax-deductible – 50% deductible in the case of capital gains – for investors but not owner-occupiers), driving property prices up and rents down, as well as encouraging owner-occupiers to take on interest-only mortgages due to financial constraints. It’s as though politicians have actively sought to make property a more attractive investment. Unfortunately, the Australian government doesn’t seem eager to deal with these issues, preferring to leave it to the regulators.
RESULTS SO FAR AND CONCLUDING REMARKS
For the RBA to use its cash rate to reign in property markets, they are essentially admitting they have no confidence in the government to do its job, i.e. to invest in infrastructure, improve supply, utilise fiscal policy, reduce inequality, reform the tax system. And the fact is, the RBA actually wants to lower the cash rate further to stimulate the real economy, but are holding back over fear of reigniting property markets. So they’re effectively already partially admitting this failure of government. And they are clearly more worried at the moment about the risks of a lower cash rate to the overheated property market than the benefits to the real economy. They’re not stupid[2] – they know the likely risks of keeping the cash rate too low for too long, but they have to weigh that against the almost definite risks to the real economy of lifting the rate too soon.
But they’re not willing to concede the government’s total failure yet. The RBA is not willing to almost definitely hurt the real economy in exchange for possibly cooling the property markets.
And macro-prudential measures already seem to be working at least a little. Lenders have already started increasing their interest rates independently of the RBA, especially rates paid by investors (less so for owner-occupiers). Since December 2014, when APRA first raised concerns about the housing market, the RBA has dropped the cash rate by a further 1%, and banks followed by dropping owner-occupier rates by 0.63% – but rates on interest-only loans have risen by 0.1% (and by an estimated 0.25-0.35% if the above 30% risk-weighting floor is imposed, while leaving owner-occupiers steady), showing the ability of macro-prudential measures to target specific areas of the economy. Many may view these actions by the banks – raising interest rates independently of the RBA – with suspicion. But remember, this is precisely what we want them to do – help slow down the risky sections of the market, rather than the market as a whole. New apartment sales in Melbourne have also slowed in response to these measures. And time will tell how compliant the financial sector is regarding the 10% cap on investor lending, the 30% cap on new interest-only lending, loan-to-valuation ratios and credit checks.
If enough progress is not made, then the RBA may re-consider increasing their cash rate – but only as a second-best alternative in the face of a failure of government policy, regulation and oversight, and financial sector recalcitrance, not a failure of the RBA's cash rate policy.
I have confidence in the RBA’s ability to resolve this situation – even if our perfect 20-20 hindsight suggests they should have acted sooner and more strongly. But they are using the right tools for the situation.
I’m willing to accept that these regulatory bodies have dropped the ball regarding reigning in these property markets. I’m even willing to concede that a long period of a low cash rate has contributed to this boom. But I take issue with the commonly-spouted idea that the RBA should never have left the cash rate so low for so long – that these property markets could have been reigned in if only the RBA raised the cash rate sooner.
Remember – the cash rate for the real economy; regulation, oversight and supply for property markets.
Fiscal stimulus is another avenue. Accelerating household wage and income growth will better allow households to pay down their debt levels. Currently, property prices and debt levels are growing faster than wages and income – last year, household debt increased 6.5%, while wage growth is the lowest in some decades (household incomes grew just 3%). Household debt is now at around 125% of GDP and 189% of disposable income (the latter from around 160% for much of the 2000s, and just 60% 25 years ago). This makes Australian households the fourth most indebted in the OECD behind Denmark, The Netherlands and Norway.
A solution here is government fiscal policy – investments in infrastructure (including public transport above) to drive real economic activity and wages and incomes, allowing households to pay down debt faster, so the RBA can lift its cash rate faster, further easing any pressures on property markets.
The government still has a great capacity to borrow – our AAA credit rating and strong economic record means that demand for government bonds continues to be greater than the supply from Treasury – so Treasury could easily issue more if they wanted to spend more money. And even though interest rates are rising globally, the cost of financing government debt continues to fall as the debt is rolled over (from 5.2% to 3.5% over the last five years), i.e. higher interest rates on government debt will continue for some time to still be lower than the rates at which that debt was initially borrowed, with new borrowings such as an $800 million 10-year bond issued recently, paying just 2.75%. Furthermore, a larger share of our government’s debt is being sourced domestically, reducing our exposure to rising international interest rates.
And remember, in Australia gross government debt as a percentage of GDP is only 41% (net debt is only 20%) – low by international standards and much lower than household debt. If the government budget is like a household budget (it’s not, but for argument’s sake, let’s use the common political talking point), surely the government should be willing to incur a little more debt to help bring actual household budgets back into the black – or at least in line with their own debt levels.
And any consequent government debt incurred can be paid down with the economic proceeds (and consequent tax revenue) of these investments themselves – but this will require convincing the government to spend more money, which is not easy right now (before the GFC, I never thought it would be hard to convince a government to spend more money).
Furthermore, the government can do more to address income inequality. One possible reason that a booming property market in Sydney and Melbourne is not translating into stronger general economic performance elsewhere is that income inequality has resulted in only a small section of the economy having the means to invest in and profit from asset markets. Lower socio-economic individuals tend not to have significant stock portfolios or (even indirect) property investments. Consequently, they can’t benefit from a booming eastern states property market. But if, through its infrastructure investments and redistribution efforts, the government were to better support the lower end of the socio-economic spectrum, giving them more capacity to invest in asset markets on the other side of the country, this would better share the eastern states boom across the economy, and the two-speed economy would start returning to a one-speed economy. Consequently, interest rates could recover faster before the property markets ever get out of control.
WA in particular needs a boost. The end of the mining and resources boom has brought high unemployment and underemployment, and flat wages and house price growth, with almost 3% of mortgage-holders over 30 days in arrears – the highest in the country, 60% higher than last year, and growing. Geraldton, Port Hedland and Karratha specifically have over 6.5% of mortgages delinquent – more than double the previous year. And while nationally this rate of mortgage-holders over 30 days in arrears has increased, it is still just 1.5% (up from 1.2% last year) – so while mortgage stress is appearing across the country, even in the stronger states of NSW and Victoria, the argument for fiscal support is especially strong in the west.
Fourthly – and more widely published – the government could adjust negative gearing and capital gains tax discounts on residential investment, and limit (or ban) the ability of superannuation funds to borrow. Such regulations (or lack thereof) have over-stimulated investor activity (by, for example, making housing tax-deductible – 50% deductible in the case of capital gains – for investors but not owner-occupiers), driving property prices up and rents down, as well as encouraging owner-occupiers to take on interest-only mortgages due to financial constraints. It’s as though politicians have actively sought to make property a more attractive investment. Unfortunately, the Australian government doesn’t seem eager to deal with these issues, preferring to leave it to the regulators.
RESULTS SO FAR AND CONCLUDING REMARKS
For the RBA to use its cash rate to reign in property markets, they are essentially admitting they have no confidence in the government to do its job, i.e. to invest in infrastructure, improve supply, utilise fiscal policy, reduce inequality, reform the tax system. And the fact is, the RBA actually wants to lower the cash rate further to stimulate the real economy, but are holding back over fear of reigniting property markets. So they’re effectively already partially admitting this failure of government. And they are clearly more worried at the moment about the risks of a lower cash rate to the overheated property market than the benefits to the real economy. They’re not stupid[2] – they know the likely risks of keeping the cash rate too low for too long, but they have to weigh that against the almost definite risks to the real economy of lifting the rate too soon.
But they’re not willing to concede the government’s total failure yet. The RBA is not willing to almost definitely hurt the real economy in exchange for possibly cooling the property markets.
And macro-prudential measures already seem to be working at least a little. Lenders have already started increasing their interest rates independently of the RBA, especially rates paid by investors (less so for owner-occupiers). Since December 2014, when APRA first raised concerns about the housing market, the RBA has dropped the cash rate by a further 1%, and banks followed by dropping owner-occupier rates by 0.63% – but rates on interest-only loans have risen by 0.1% (and by an estimated 0.25-0.35% if the above 30% risk-weighting floor is imposed, while leaving owner-occupiers steady), showing the ability of macro-prudential measures to target specific areas of the economy. Many may view these actions by the banks – raising interest rates independently of the RBA – with suspicion. But remember, this is precisely what we want them to do – help slow down the risky sections of the market, rather than the market as a whole. New apartment sales in Melbourne have also slowed in response to these measures. And time will tell how compliant the financial sector is regarding the 10% cap on investor lending, the 30% cap on new interest-only lending, loan-to-valuation ratios and credit checks.
If enough progress is not made, then the RBA may re-consider increasing their cash rate – but only as a second-best alternative in the face of a failure of government policy, regulation and oversight, and financial sector recalcitrance, not a failure of the RBA's cash rate policy.
I have confidence in the RBA’s ability to resolve this situation – even if our perfect 20-20 hindsight suggests they should have acted sooner and more strongly. But they are using the right tools for the situation.
I’m willing to accept that these regulatory bodies have dropped the ball regarding reigning in these property markets. I’m even willing to concede that a long period of a low cash rate has contributed to this boom. But I take issue with the commonly-spouted idea that the RBA should never have left the cash rate so low for so long – that these property markets could have been reigned in if only the RBA raised the cash rate sooner.
Remember – the cash rate for the real economy; regulation, oversight and supply for property markets.
[1] Unemployment
has trended upwards in the last few months. Cyclone Debbie will also complicate
matters, hitting coal exports in the March quarter, along with the fall in
commodity export values in January and February. These, as well as threats of a
Donald Trump trade war, will subtract from economic growth, furthering the
RBA’s incentive to keep the cash rate low. But over the medium term, global
recovery and higher commodity prices are expected to drive Australia’s economy.
[2] Although
you may think they’re just corrupt – a conclusion I prefer not to jump to just
yet.
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