Why should financial regulators worry about exorbitant house prices?

A new UNSW Sydney report recommends a Royal Commission and broader RBA remit to address the effect of soaring house prices on productivity, economic instability and inequality

Australia’s property market is a threat to the nation’s economic future with soaring house prices driving inequality and damaging productivity, according to a UNSW report. The Housing: Taming the Elephant in the Economy report, produced by UNSW Sydney’s City Futures Research Centre, was based on the expert opinion of 87 leading Australian economists and other housing market experts on the impacts of housing system outcomes on Australia’s economy.

The report noted that Australians, with record debt to income ratios, have $2.1 trillion in outstanding home loans. But at the same time, since the mid-1990s, housing prices have consistently outstripped income growth, the national home-ownership rate has fallen by 4 per cent and the ownership rate for under 35s has collapsed, building in structural problems for future decades.

Report lead author, UNSW City Futures Research Centre Honorary Professor Duncan Maclennan, said the current housing system is dysfunctional at all levels and is especially failing increasing numbers of young people. “Australia’s approach to housing policy has fuelled income and wealth inequality and created significant economic instability. This is becoming a huge drag on productivity, and warping Australia’s capital investment patterns,” Prof. Maclennan said.

“The scale and complexity of the problem demands [in particular] that a Royal Commission be established to investigate how to defuse the time bomb and create a more effective and equitable market for all Australians.”

The recent explosion in house prices, in particular, brings a fresh and troubling dynamic for younger Australians who are being locked out of the market in growing numbers, Prof. Maclennan said.

“In responding to housing economics evidence, Australian housing policy actions seem to perfectly meet Einstein’s test of madness: in repeating the same actions and expecting different results. Now, emerging from potentially the worst recession of the last 100 years, we already have a new housing boom rippling across the nation,” the report said.

“Of even more concern, the RBA, almost flying in the face of advice from other central banks, has remained sanguine on rising house prices and argued they are good for growth. This view has no validity if the longer-term evolution of the economy and the housing market is the concern,” the report said.

APRA needs to step in and step up

The relevant regulatory powers currently reside with APRA, and Anthony Asher, Adjunct Associate Professor in the School of Risk and Actuarial Studies at UNSW Business School believes that APRA can use its ability to change capital requirements for banks and be more directly prescriptive in limiting loans.

Read more: To fix Australia’s housing affordability crisis, negative gearing must go

A/Prof. Asher said there are a number of important and often overlooked considerations in the well-publicised debate about whether those without housing should be able to access their superannuation savings to buy a home.

“One argument against this access is that the increase in demand will drive prices higher. Less well known is that about one quarter of the lump sums paid by superannuation funds at retirement are used to repay mortgages,” said A/Prof. Asher.

“One reason is that banks willingly give 30-year mortgages to older borrowers, even to those in their sixties. (I know, I was given two mortgages last year to be repaid finally before my 96th birthday.) To my knowledge this is never mentioned in debates around house prices even though it is likely to push prices higher. I have also never seen this linked to the perverse incentives created by the exemption of the home from the asset test for the Age Pension.”

The numbers appear to be significant, according to A/Prof. Asher, who cited APRA statistics that suggest about $15 billion is taken from Superannuation lump sums each year (although other estimates are on the smaller side). On the banking side, he said calculations from ABS statistics suggest that a quarter of new loans are to those who already own a dwelling and are between 45 and 65.

“They are taking smaller loans than younger people, but rough calculations suggest that loans to this age group would be up to $70 billion each year. If these loans had, instead, to be repaid by the age of 65, the amount borrowed could be smaller by as much as $30 billion. This could perhaps mean a 10 per cent reduction in loans made each year,” he said.

Excessive lending to older borrowers is economically unreasonable in that it contributes to financial instability, A/Prof. Asher explained. “One needs to accept that banks are only capable on making 30-year loans and funding them by short term deposits and savings because the government is prepared to intervene in liquidity crises. The 2008 crisis brought this home, and we still have the guarantee of $250,000 on deposits to remember it,” he said.

Read more: The home stretch: accessing home value to fund long-term care

Debt, financing and fairness

A/Prof. Asher said the theories of economist Hyman Minsky perhaps offer the most insight on this question. Minsky distinguished between normal finance, which is repaid by instalments of capital and interest, and speculative finance, where the borrower can only afford the interest. “He also added Ponzi finance, where the borrower could not even afford the interest, but we are not there yet – I hope,” said A/Prof. Asher.

Minsky’s theory was that in times of financial stability, banks became tempted to drift into speculative finance, and this leads to financial crises. On this theory, regulators should require individual borrowers (owners and investors) to repay their debt before they are likely stop working. “Investment properties might still have some debt outstanding but should be cash flow positive. To be clear, it is not speculation that is so much of a problem, as speculation with other people’s money,” A/Prof. Asher noted. Because this is the case, he said regulators have a responsibility to put limits on long-term borrowing.

“It can be argued that higher house and unit prices appear to be good for the economy because owners are likely to spend some of the increase in the short run. But where does the money come from? Ultimately from the pockets of those who will eventually buy the dwellings from them. And the buyers’ spending on other things will be crimped for their entire lifetimes,” said A/Prof. Asher.

“And this clearly is what makes it unfair to younger generations – young children and their parents currently living in cramped conditions.” The ABS estimates that more than 300,000 families with children need another bedroom, while 1,200,000 couples with no children at home have three or more spare bedrooms. “Every small push to undo the perverse rules and incentives that lead to this unequal distribution would be worthwhile,” said A/Prof. Asher.

Even though APRA has argued that it is “not our job”, A/Prof. Asher points out that it regulates both banks and superannuation funds. “There is no need for new legislation for APRA to act. Its mandate includes financial stability but also enforcing the sole purpose test for superannuation funds. It is clear that 95-year-olds cannot repay mortgages unless they are using their super. On both counts, it can intervene – and should do so immediately.”

Anthony Asher is an Adjunct Associate Professor in the School of Risk and Actuarial Studies at UNSW Business School. His research is focused on the development of appropriate retirement income products, including product design, investment, regulation and personal financial advice.