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20 Jan 2020

Australian Property Price Boom Since 2005, but Former RBA Governor Ian Macfarlane Can’t Foresee a Crash Coming

Australian Property Price Boom Since 2005, but Former RBA Governor Ian Macfarlane Can’t Foresee a Crash Coming

In his statement explaining the Reserve Bank’s decision on the rate cut, the former RBA governor Ian Macfarlane had expected the global downturn following the dotcom bust to worsen and Australia to feel the consequence.

"The dampening impact on other parts of the economy of global events will become increasingly clear during 2002, at a time when the housing upswing will begin to moderate," he had forecast.

On the opposite, the US economy posted strong growth in early 2002 and the rest of the world was being dragged along with it. Moreover, the moderation in house prices that Mr Macfarlane predicted didn't eventuate.

By May 2002, economist John Maynard Keynes questioned Mr Macfarlane, "when the facts change, I change my mind. What do you do, sir?"

"The strong rises in house prices seen over recent years have also been associated with a rapid expansion in household debt, a process that carries longer-term risks if households become seriously over-extended," he wrote then, justifying the rapid about-face on rates.

"To persist with a strongly expansionary policy setting would risk amplifying inflation pressures and, over time, could fuel other imbalances such as the current overheating in the housing market, potentially jeopardising the economy's continued expansion."

Reserve Bank tapped the brakes on housing bubble #1

In a recent interview with Joseph Walker for his Jolly Swagman podcast, Mr Macfarlane said he was "very happy with the result" regarding his decision.

"I don't know whether we did it, but certainly house prices stopped rising … certainly, that's what we were trying to achieve and it was a gentle landing, they didn't collapse," he said.

Gentle is somewhat of an understatement. In fact, the average house prices had risen for another two years and then remained broadly steady for a few years until the rate cuts and first-home buyers boost in the wake of 2008's global financial crisis stoked them again.

But, the first-home buyers might not agree on that as the damage had already been done.

During Mr Macfarlane's tenure, average capital city house prices rose 120 percent and went from being just above four times annual incomes to nearly seven. Mr Macfarlane claims part of this surge was inevitable when taming inflation.

"We finally got inflation down and were able to bring interest rates down, and when interest rates came down people could afford to service bigger mortgages," he explained.

Bigger mortgages, of course, mean people have more money to spend on houses, pushing up prices.

Capital gains tax cut sparked 'crazy' property speculation

But that had already happened in the 1990s, so how can the boom in house prices at the turn of the millennium be explained?

"On top of that we had something that was really harmful, which was pure speculative activity, particularly through the negatively geared acquisition of second, third, fourth, fifth properties," Mr Macfarlane continued.

"I'm particularly talking about a period around the turn of the century, from 2000, particularly 2002, 2003, when it was at its peak. It was starting to get pretty crazy then and it was starting to get pretty close to a bubble."

While this isn’t mentioned in the interview, the only possible explanation is the major policy shift has triggered such a stampede into speculative property investment — that is the Howard-Costello government's decision in 1999 to effectively halve capital gains tax (CGT) overnight.

This 50 percent CGT discount gave higher earners a strong incentive to convert current income from salaries, profits and investments into future capital gains that would be much more lightly taxed. The obvious way to do this was through borrowing money to buy an investment property, deducting the interest bill against your current earnings and pocketing the profits from selling while only paying tax on half of them.

To show the shift in the property market after the CGT discount, the number of taxpayers reporting a rental loss jumped from 631,435 in 1999-2000 to more than a million in 2005-06, while the number of landlords reporting a profit decreased from 532,472 to less than half a million. Effectively, this meant Howard and Costello cleaned up the mess that the Reserve Bank made of the property market with the only tool the RBA has — the blunt one of interest rate rises.

Luckily, America's rapid recovery from the dotcom bust and China's epic growth in the early-2000s, with the Australian mining boom that triggered, meant the RBA could do this and check further property price gains without sinking the broader economy.

Reserve Bank generated property bubble #2

The following property price bounce was sparked by dramatic interest rate cuts — the cash rate more than halved from 7.25 percent to 3 percent in just eight months from September 2008 to April 2009 — and the Rudd government's first-home buyer boost during the global financial crisis.

But it was momentary — the government grants were temporary and then-RBA governor Glenn Stevens stuck with his predecessor's playbook and started hiking rates again by October 2009.

However, as the mining boom turned to bust, the Reserve Bank itself turned to residential construction as another source of economic growth. With no major changes in government housing policies, it's obvious that the property price boom that ran from 2012 to 2017 was largely down to the RBA's rate cuts, from 4.75 down to 1.5 percent.

Mr Macfarlane commented, was it "so exclusively dominated by speculative investment purchases". But he added it "definitely did seem bubble-like".

One of the reasons it wasn't as dominated by speculative investors was intervention by the regulators.

The banking supervisor APRA, in consultation with the Council of Financial Regulators (which includes the RBA), started putting the brakes on investor lending in late-2014, probably trying to avoid a repeat of what happened in the early 2000s. Even so, house prices across Australia's capitals soared by two-thirds, dominated by increases in Sydney and Melbourne.

That prompted APRA to limit other forms of risky loans, such as interest-only mortgages, while ASIC and the banking royal commission focused further scrutiny on lax lending standards. By the end of 2017, the boom ran out of finance and out of momentum.

Although prices fell around 15 percent in Sydney and 11 percent in Melbourne, they were still more than 80 percent higher than when Mr Macfarlane left the RBA.

Once again Reserve Bank introduced rate cuts — this time in conjunction with APRA loosening its lending restrictions and the re-election of a Coalition Government promising the continuity of investor tax breaks — that turned home prices back upwards.

While that might spell relief for property owners, developers, banks and real estate agents, Mr Macfarlane isn’t certain it’s doing any good for the economy longer term.

"It probably would've been better to have had a bigger correction, although over the short-term that would have hurt a bit."

Where to now?

Does the former Reserve Bank head think it will be third time unlucky for Australia after avoiding two property crashes after bubbles?

"Do I see the risk of a collapse in house prices? No, I don't," he told the Jolly Swagman podcast.

"I think that those huge long-term structural factors are so powerful, the desire for people to compete with each other to buy houses or apartments in places where there are good jobs, which means big cities, people coming from other parts of the world to do it, people coming from the country to do it, people are already here doing it.

"I think a fundamental shift in the relative price of housing has occurred over the last 30 or 40 years, I don't think it's ever going to go back to where it was."

But does that mean anyone who can should rush out to buy investment properties? Mr Macfarlane thinks not.

"I don't think it can continue to go up as fast as it has over that period," he predicts.

"I think we've reached the limit of the household sector's capacity to service mortgages."

After leaving the Reserve Bank as governor, Mr Macfarlane believes most property investors would have been better off putting their money elsewhere.

"If you're lucky enough to buy right at the bottom and sell at the top, yes, you will make money. But that's only a minority of people who do that," he said.

"The majority, I think, either make not much more money than they would've in the bank or, in many cases, they lose money."

For the few who do succeed at making money out of rising property values, he had this message.

"You're making yourself richer at the expense of your children."

And, like the consumption of non-renewable resources or pollution the earth, that kind of intergenerational theft undoubtedly isn't sustainable.

Source: ABC News