The trouble with the Great Bubble Debate is that the words ‘unaffordable’ and ‘bubble’ are being used interchangeably.
They are connected, of course, but are not synonyms. One implies permanence; the other is temporary by definition. Those who believe we have a housing affordability crisis will be hoping it’s a bubble, because that would mean the problem won’t last long.
Is it a bubble?
Well, you can prove anything with statistics. These two charts prove it is NOT a bubble:
Sydney, it can be seen, is just part of the way through catching up with the rest of the country after a long period of underperformance.
And there’s this one:
The national house price to income ratio has not moved materially in 10 years, although the Sydney ratio is definitely starting to get out of line (currently about 5.5 times annual household income).
And here are two graphs that prove it IS a bubble:
Here’s the national house price to income ratio on a different time scale - back to 1990. It looks extraordinarily stretched.
And this chart proves it is a bubble driven by investor demand provoked, in turn, by negative gearing and foreign money:
But all that aside, the Secretary to the Treasury says it is ‘unequivocally’ a bubble in Sydney, and the Governor of the Reserve Bank says some of what’s happening is crazy, so it must be a crazy bubble. The ‘Yes’ team has won the debate; the ‘No’ team is slumped in defeat.
So it follows houses shouldn’t be unaffordable for long.
When bubbles burst, the people who borrowed too much against the inflated asset tend to go broke, which is their own silly fault and no great loss. The problem is that lenders also get into trouble, as in 2008 in America, when houses suddenly became much more affordable. Recession ensued. Will that happen here when the bubble bursts, if it is a bubble?
Hard to tell, but the banks and bank regulators don’t seem to think so, although they would say that, wouldn’t they.
As for the timing of the bubble burst, I remember a number of people, including John Spalvins, warning in 1986 that the sharemarket was a bubble heading for trouble. They turned out to be right … 18 months later in October 1987, that is, at which point the All Ordinaries index had doubled from where it was when the bubble warnings started up.
Bubbles and booms usually last longer than you think, or as JM Keynes put it: “markets can remain irrational longer than you can remain solvent.”
In that context, and with the inherent uncertainty of knowing whether a boom has crossed over into a bubble, the comments of Treasury Secretary John Fraser and RBA Governor Glenn Stevens can be seen as jawboning -- trying to talk the heat out of the market.
But, unlike with the money and foreign exchange markets, there is no instant gratification with such things in real estate: we won’t know for a while whether they’ve succeeded.
It’s worth noting that a housing boom was actually the RBA’s plan in 2011 when it began cutting the cash rate from the peak of 4.75 per cent to 2 per cent -- it just worked a bit too well and got away from them.
The intention was to rebalance the economy away from the mining sector through housing construction and the wealth effect of a rise in house prices.
As Glenn Stevens acknowledged this week, “there isn’t much cause from research … to expect a direct impact on business investment (of lower interest rates)”.
Nor were the rate cuts going to drive an increase in consumer spending. Stevens added: “Their debt burden, while being well serviced and with low arrears rates, is already high.”
So it had to be housing. And don’t forget that when the first rate cut was announced, in November 2011, this graph was published in the Statement on Monetary Policy:
That was a real concern for the macro economy given the importance of real estate values to consumer sentiment and domestic final demand.
Here’s what that chart looks like now, four years on:
So -- great success all round.
Unhappily, the economy has continued to trend downwards, as Glenn Stevens bemoaned this week, so while the plan worked, it didn’t work.
Meanwhile, the cutting of interest rates by more than half has created a housing affordability crisis, according to many credible, if somewhat emotional, witnesses.
In a way this has been a separate debate to the bubble one, tinged as it is with emotional social welfare issues.
In my view, as I have written a number of times, it is much clearer that housing has become too expensive for the national good -- socially and economically. That’s a different question to whether house prices are in a bubble.
Australia’s cost base is too high, which is largely a function of dwelling costs -- prices and therefore rent.
The simplest solution to this problem would be that if it is, indeed, a bubble that it will soon burst, bringing prices down again.
If that doesn't happen, then a strategy is needed to increase supply or reduce demand. Cancelling the tax deductibility of interest would do it, but that seems unlikely, and there are already earnest efforts to crack down on foreign investment in existing houses which don’t seem too effective just yet.
You could also limit supply by cutting back on immigration, but that seems even less likely than ending negative gearing.
So all roads lead to creating more housing supply, something pet shop galahs are squawking about, along with Joe Hockey. That’s all about infrastructure and planning, and instead of talking about it in press conferences, the Government needs to talk about it in a national summit on housing supply.
As the Senate Economics References Committee recommended in its report in May on housing affordability: (there should be) “a national long term affordability housing plan that recognises affordable housing, including affordable rental housing, as a mainstream and national policy objective and places affordable housing at the forefront of government policy across Australia.”
Unless, of course, it’s a bubble, in which case it won’t long before houses become more affordable all on their own.