Next year is shaping up as an annus horribilus for whoever wins the federal election, but one of the big nasties likely to turn voters against whoever’s in the Lodge is being overlooked – house prices, and the wealth effect that flows from living inside an appreciating asset.
Prices are leaping ahead again, causing much excitement. However to understand what could, and in my view is likely, to go wrong, requires a bit of history.
First, a hands-up moment. In October of this year a bunch of housing-market bears, including yours truly, who walked 230 kilometres from Parliament House to the top of Mount Kosciusco with economist Steve Keen, will be proved wrong.
Wrong, that is, to expect Keen to win his bet against another economist, Rory Robertson, that Australian house prices would fall more than 20 per cent, peak to trough, by October 2013.
That was the bet, and though Robertson disputed the terms of the bet in 2010 (explained fully here, KEEN’S DEBT MARCH: Rory’s repudiation, April 19, 2010), he will no doubt be pleased in October to see that he won nonetheless. Keen 'lost the bet' three years prematurely, and walked the walk, as required.
How can we be sure, five months out, that the bet is lost? Because between now and October there is virtually no chance that home-buyers will be refused the amounts of credit they need to keep prices up in most capital city markets. The Reserve Bank cash rate remains at 3 per cent, and pundits are tipping one more rate cut in this easing cycle.
House prices are not a key consideration in the Reserve Bank rates decisions – the board is always careful to insist it maintains a narrow focus on inflation, not asset prices. Nonetheless, it’s string of cuts since 2011 have clearly buoyed house prices.
In the past 18 months, many thought Keen’s prediction was coming true. Australian Bureau of Statistics nominal house price data shows large peak-to-trough falls between the time of the Kosciusco walk and the end of 2012.
Prices are now recovering, especially in Sydney (4.2 per cent year-on-year compared to 1.7 per cent for the nation), but the falls were:
Sydney -3.7
Melbourne -6.9
Brisbane -7.3
Adelaide -5.6
Perth -7.4
Hobart -10.1
Only Hobart appears to be still falling, with all other state capitals enjoying significant rises. Keen has argued that it is a “sucker’s rally”, and has provided alarming evidence for this claim. In particular, the composition of buyers bidding up prices has changed dramatically.
As Keen wrote two weeks ago: “The revival in mortgage debt growth since 2012 has been more than 100 per cent due to additional speculation: the decline in owner-occupier borrowing from $40 billion per annum at the start of 2012 to $32 billion per annum now has been more than outweighed by the increase in speculative mortgages from $11.5 billion per annum to $21.8 billion today (House prices shoot towards a ceiling, April 15).”
Investors are rushing back to market with the old noughties-era zeal – get in now before the real capital gains kick in.
But as Philip Soos explained in great detail in February, this mentality overlooks fundamentals that have changed beyond recognition since the heady days of the late noughties, when TV programs on every channel taught the nation how to renovate and flip properties, stoking feverish asset inflation (The irregular ratio spooking property, February 1).
The relationship between house prices and rental yields was stretched during that period. So too were the oft-quoted house-price-to-income ratios of owner occupiers.
Some good arguments were made during those years as to why this was not a bubble, but a one-off adjustment in a structurally changed market.
For instance, the houses being bought and sold were much more luxuriously appointed inside, due to a long-standing fashion for renovation.
Another argument was that workforce participation had increased – a couple, both working, could pay more for a home than a single-income household and hence prices were bid up.
But these trends, even if fully accepted as the cause of the asset inflation, have their limits. Deloitte Access Economics suggested last month that workforce participation may have peaked, for all time, in 2010 at 65.9 per cent. That part of the structural change is over. And we really can’t add many more bathrooms.
Where this comes back to haunt next year’s prime minister is in the relationship between fiscal policy, the high dollar, consumer confidence and interest rates.
There is a good chance, as Robert Gottliebsen writes today (Miners are blind to China’s new reality, April 26), that “the situation in China is more serious than is generally understood in Australia”. Indeed, more serious that Prime Minister Julia Gillard was willing to let on in her Business Spectator interview last week.
China weakness is one important factor in keeping the dollar high. Capital inflows to fund the final stage of the mining construction boom are contingent on China’s growth, and multi-billion dollar projects, like the Browse Basin LNG project, can vanish from the ‘investment pipeline’ overnight.
There is, therefore, a very real risk of a correction in the dollar mid-2014 as less capital is pumped into Australia. This is not the only factor – safe haven investors in government bonds are another large capital movement – but it is the most volatile.
As explained on Thursday, the 40 per cent of the components of the consumer price index classed as ‘tradable’ would, if the dollar fell even to 90 cents, jump in price – TVs, fridges, clothes, footware – even the foreign cars Australians now prefer to poor old Holdens and Fords. From a possible deflationary scenario, the Reserve Bank would have a large imported inflation problem.
As consumer confidence was hit by rising prices, the Reserve Bank may have to lift rates a little from their record lows. Those two factors together would change the equation for investors wanting to borrow large sums of money, at low rates, to chase capital gains in the residential property market.
The big difference between a stalling of house price growth in 2014 and five years earlier, is that in 2009 Kevin Rudd still had pots of cash, and seemingly unlimited borrowing capacity, to bail the market out with generous rounds of First Home Owner Grants (or First Home Vendor Grants, as Keen calls them).
Neither Prime Minister Tony Abbott nor Prime Minister Gillard will have access to the same kinds of cash Kevin Rudd had. The batteries on the defibrilator that state and federal governments have used to shock the housing market back to life so many times, have run flat.
Global events will, of course, play a big role. But the political fallout from a stalling of the current ‘recovery’ in house prices will be large.
Private investors have no right to expect the public purse to underwrite their risk, but then it's just something we all got used to. When Canberra fails to provide a safety net, there'll be hell to pay.