While my recent commentary (here and here) demonstrates Australian housing is in a bubble, I have not explained where this situation has come from.
Asset markets, in this case, property, are the subject of speculation based upon the delusional premise that past price rises will continue indefinitely into the future, with no chance that a downturn will occur. The dream of creating and realising capital gains has prompted ever more Australians to participate in the property market as either first home buyers or investors (speculators).
Incomes rise too slowly and savings are too low to inflate a bubble into the stratosphere. Another ingredient is needed: mortgage debt.
Property is not bought for the rental income stream it provides because this is insufficient to finance the debt used to purchase property at inflated prices during a bubble. As prices are bid up, owner-occupiers and investors take on ever-increasing amounts of mortgage debt, supplied by banks and other financiers. This creates an upwards spiral of increasing prices and debt, leading to a housing bubble (aslo known as a pyramid or Ponzi scheme).
Australians have shouldered a mountain of debt, readily supplied by the banking system. Mortgage debt currently stands at $843 billion and $359 billion for owner-occupier and investment properties, respectively, for a combined total of $1.2 trillion or approximately 90% of GDP in 2011. A report by the Bank of International Settlements shows that a ratio of 85% or more becomes damaging to the economy.
The clearest indicators Australia has a housing bubble are the sky-high prices in relation to fundamentals (inflation, wages, GDP) and that the average investment property generates a negative yield.
Since 2000, rental income has not even covered interest charges. No rational individual purchases an asset that generates a net negative yield – but clearly speculators have been pursuing capital gains instead.
It is important to note it is the land component, not the structure (which depreciates), that increases in value during a bubble.
Economist Hyman Minsky was the first to show that asset bubbles were the natural consequence of unregulated financial markets.
His “Financial Instability Hypothesis” explains how this occurs, recognising markets are endogenously (internally) inefficient. The Australian economist Steve Keen is a prominent advocate of this view.
The fault of the government lies not in creating these inefficiencies, but rather amplifying them via social engineering and poor tax structures. But rather than implementing policies that will prevent or diminish the possibility of a housing bubble, the Australian government has done the exact opposite:
First Home Owner’s Grant (FHOG): almost certainly leads the pack in inflating housing prices.
Capital gains tax (CGT): in 1999, the Howard government enacted a 50% tax cut on a property if it was held for at least one year.
Negative gearing: taxpayers subsidise landlords on the premise that it will increase the number of rental properties on the market, allowing part of the loss to be written off.
First Home Saver Account (FHSA): designed to encourage first home owners to accumulate a sizeable deposit through a combination of government contribution and individual savings. Few first home buyers made little use of the program.
Travel write-offs: landlords are allowed to claim tax deductions on travel expenses to their investment properties.
Other exemptions/reductions: owner-occupied housing is exempt from imputed rent, capital gains and land value taxation.
Moral hazard: The big four banks have 80% of the Australian market between them. Each is too big to fail and jail. They have issued debt with impunity, so when the financial system implodes, the government must bail them out.
Residential Mortgage-Backed Securities (RMBS): the government supports non-banking mortgage lenders that would not otherwise lend or at least lend below current levels by purchasing these securities.
Bubble denialism: by claiming there is no bubble – and supporting this assertion with extensive and quite mistaken analysis – the government, along with industry, has maintained the illusion everything is fine, thus deceiving ever more Australians into the property market.
The figures regarding the property market are staggering.
Negative gearing has been criticised, though nobody appears to have figured out how much it costs the Australian taxpayer. By examining the last 16 years of tax office records, I’ve calculated that negative gearing has cost us an aggregate $29.3 billion over this period.
The Senate report on housing affordability aggregates tax exemptions for property owners: $53 billion per year for 2007-08; add another $1 billion per year for the FHOG. This is equivalent to almost one fifth of federal tax revenue in 2008.
If property owners were to pay a land tax equivalent to the annual imputed rent they privately capture, it would replace all of Australia’s 125 inefficient taxes that burden business, labour and consumers. It is widely recognised that land value taxes are the most efficient (little to no deadweight loss).
Land valuer Bryan Kavanagh estimates that publicly generated rent stemming from land is on the order of 32% of GDP in 2005. The non-payment of approximately $300 billion per year is a massive gift to property owners.
ABS statistics show that the value of residential land has risen from $586 billion in 1996 to $2.8 trillion in 2010. This has allowed property owners to privatise trillions in capital gains over the last 15 years.
Given these figures, it comes as no surprise that the government treats property as a sacred cow. So who benefits?
The landed gentry (large property owners), established owners and speculators gain the most. First home buyers, renters, tax-paying businesses and workers are severely disadvantaged by our insane taxation system.
In this vein, business journalist Alan Kohler’s words are priceless:
“Five years ago Treasurer Peter Costello told Australians: ‘Work for a living and we’ll tax you at close to 50 cents in the dollar; speculate and we’ll only take 25 cents. Not only that but, as a special deal – while stocks last – we’ll pay half your speculating costs’.”
In ancient times, the Egyptian Pharaohs would decree “our pyramids must be strengthened and made larger: find more slaves.” In modern times, the Australian corporate state declares: “our housing pyramid must be kept strong: find more Australian debt-slaves.”
Our system, however, has one advantage. Australians willingly enter a lifetime of debt slavery, whereas Egyptian slaves were forced.
As the bubble-predicting economist Michael Hudson has written, amassing paper wealth through speculation does little except to ensure that the public remains on the road to serfdom. The only way out of the ensuing mess is to cut down debts to the ability to pay, as those who can’t, won’t.
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Comments (20)
Dan Sullivan
(logged in via Facebook)
Markets are self-regulating when there is no privilege involved. The land title is a state created privilege, often unrelated to whether the land holder is using the land. Bank lending is also based on privilege, for the banks are guaranteed by the government, lending money they do not have, or, for those who like to be precise, extending credit that is based on the government guarantees rather than on the solvency of the bank.
If the value of land were taxed, those holding only the land they are…
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AnnMarie Brennan
Lecturer of Design Theory (logged in via email @gmail.com)
There are other costs and damages to speculation of housing in Australia which is probably not so easy to quantify, such as the emergence of "investor-grade" apartment housing. These are incredibly small apartments, poorly designed and built, with very little concern to aesthetics or sustainability. And then there is the sprawl without adequate infrastructure services...
Also there is the question of investing in existing housing, with profits gained by merely selling and buying, rather than actually investing other things such as developments in infrastructure, education, and Australian business which may work on advancements in technology, making things, etc. From a both an economic and social point of view, buying and selling property does little to advance the country.
Philip Soos
(Researcher, School of International & Political Studies at Deakin University)
Yes, this is what happens when policy is purposefully designed to enrich the economic parasites (the FIRE sector) rather than investing in productive enterprise and infrastructure.
This is why residential property must have all capital gains taxed away - it must be treated as shelter first and foremost, not an investment asset. There is no real incentive for landlords to maintain the quality of their properties to gain more rental revenue when the capital gains far outweigh rental income by letting the properties rot.
Dan Sullivan
(logged in via Facebook)
One of the doubletalk words in economics is the use of "invest" for "acquire." People who buy up real estate are not actually investing in anything unless they make improvements to that real estate. People who hold urban land out of use are not merely non-investors, but they are preventing others from investing in that land.
Land that is already served with infrastructure is much more valuable than land that requires new infrastructure. The reason people sprawl out into the countryside is that the suburban land is too expensive. The urban land is even more expensive unless it is in a problem neighborhood. Switching from property tax to land value tax would throw much of that unused urban and suburban land on the market, making it uneconomical to build suburbs on rural land.
Philip Soos
(Researcher, School of International & Political Studies at Deakin University)
Yes, its rather Orwellian. The only gains that should accrue to a property is due to improvements. Merely holding onto a property should not be grounds for reward.
Land values taxes have many good effects: replacement of burdensome taxation on labor, business and consumers, has little to no deadweight cost, does not reduce supply, decreases rents, substantially reduces land values, eliminates bureaucratic tax compliance, etc.
Andrew Hack
Business Analyst and Full-Time Law Student UNDA (logged in via email @gmail.com)
I think you would find the speculation would be sufficiently removed if the government programs designed to prop up the bubble were removed. I don't think you need to tax what you subjectively consider 'bad behaviour' into oblivion. If the market deems it an inefficient investment then the losses will be punishment enough.
There is no equilibrium as there will always be bad investments. The market will take of that. The market is trying to take care of that in the form of recessions which is essentially the liquidation of the malinvestment. Government programs are trying to prevent that from happening.
I believe people should be free to make their own decisions even if those decisions are bad. I don't believe any one man or small group of central planners have the wisdom to steer economies by tinkering with things. It is this idea that is fundamentally flawed.
Dan Sullivan
(logged in via Facebook)
I share the libertarian ideology, but not all the neolibertarian assumptions. There were severe real estate bubbles before there were any of the programs you mention. Prior to the "neolibertarian shift" (led by Rothbard, Rand and von Mises), almost all libertarians recognized that the grant of a land title without a reciprocal payment of rent to either the community or the landless was a fundamental violation of libertarian principles, and an interference with the market.
Some libertarians (notably Benjamin Tucker) argued that land tenure should be conditioned upon occupancy and use. Most, however, proposed rental payments on land, and no any other privileges granted by the state. Again, where there is no privilege, no force and no fraud, there is no need to interfere with the market.
Thomas Kline
(logged in via Facebook)
As well as NIMBYism, several other trends related to household income, household formation, and ease of credit, worked together to excessively and unsustainably force up Australian house prices to unfair levels as shown on the charts below......
http://www.australianpropertyportal.com/Gallery
These factors are combined with unchecked commodification of shelter for the population, caused by misguided governments who omit to regulate house prices, while unfairly allowing over-leveraged bidders to…
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Philip Soos
(Researcher, School of International & Political Studies at Deakin University)
Well Australians are going to learn the hard way eventually... Can't escape Judgement Day.
Gavin R. Putland
(logged in via Twitter)
Greetings, Philip.
Of all the bad policies that you mention, the one that does the most damage is probably the discounting of capital gains for tax purposes, because the after-tax effect is to magnify (relative to current income) the capital gains that negatively-geared investors are chasing. The mechanism is summarized by the graph at http://blog.lvrg.org.au/2011/11/financial-stability-contour-map.html ; discounting of capital gains moves us to the right, towards the unstable region of the graph.
Notice however that I have an unusual understanding of the bubble-burst cycle, even for one who admits that we have a problem. According to my analysis, the problem is not that people borrow more than properties are worth, but rather that the tax system causes properties to be "worth" more than people can afford to borrow.
(Disclosure: I have met Mr Soos but not yet had the opportunity to discuss the graph with him.)
Philip Soos
(Researcher, School of International & Political Studies at Deakin University)
The tax system appears to act as an amplification mechanism - by itself it can't raise prices to current levels but when combined with loose credit standards, it acts as a springboard to catapult prices upwards.
Andrew Hack
Business Analyst and Full-Time Law Student UNDA (logged in via email @gmail.com)
Do you think RBA interest rates are at the correct rate?
And do you think the RBA plays any part in inflating the housing bubble?
Dan Sullivan
(logged in via Facebook)
There is no correct rate, because the RBA should not lend money at all. Rather, the Australian Treasury should spend any new money into circulation via deficit spending. The deficit spending debt is phoney. If you have a $20 bill in your pocket, it represents $20 worth of debt, but all the government will give you for that $20 bill is another $20 bill.
If the Australian spent the money into circulation (not by increased spending, but by decreased taxes), it would create no genuine debt, and Australian citizens would then have money with which to pay their own debts. There would be very little debt, public or private, if monetary policy did not favor money lending.
Of course, land speculation would continue, in a limited way, unless taxes on land value exceeded the prospect of asset gains on land.
Andrew Hack
Business Analyst and Full-Time Law Student UNDA (logged in via email @gmail.com)
I have serious concerns with with this proposition. By not restricting the government to adhere to budgetary limitations they will just print out all the money they want to spend. This will lead to rampant inflation and ultimately the demise of the Australian dollar in the same fashion as Zimbabwe.
Dan Sullivan
(logged in via Facebook)
There is a great deal of irrational mythology about money. Suppose Zimbabweian dollars at leased claimed to be backed by gold. Would anyone living there actually have the nerve to demand gold from Mugabe?
Genuine republics actually have had a very good record in terms of issuing money with little or no inflation - a much better record than banks have had. The US Continental was hyperinflated, not by US extravagance, but by massive British counterfeiting as a wartime tactic. The same thing was true…
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Philip Soos
(Researcher, School of International & Political Studies at Deakin University)
The RBA plays a huge role in inflating the bubble. Bubble denialism, supporting the commercial lenders, manipulating inflation measures by removing land values and mortgage interest costs, and acts as the propaganda loudspeaker for the financial sector. It is certainly one of the villains, much like the Fed under Greenspan was strongly responsible for allowing the US housing bubble to continue.
Andrew Hack
Business Analyst and Full-Time Law Student UNDA (logged in via email @gmail.com)
Sounds good. Refreshing to hear the blame being put where it belongs for once (as opposed to just 'greedy bankers' or 'capitalism'.
But do you think the RBA should be removed or just leadership replaced?
Philip Soos
(Researcher, School of International & Political Studies at Deakin University)
Actually I blame three villains: markets for having mis-allocated tremendous amounts of credit into a Ponzi scheme, governments for amplifying this process rather than containing it, and economists for (1) advocating a nonsensical market-based theory (neo-classical economics) that has no relation to the real world and (2) ignoring the major issue of rent.
Once appropriate regulation is in place to prevent credit from being used to finance Ponzi schemes, which requires (1) prevention of excessive credit creation and (2) taxing away the rent that accrues to land, the RBA can be eliminated and let the market determine the interest rate.
Andrew Hack
Business Analyst and Full-Time Law Student UNDA (logged in via email @gmail.com)
I like this article but I have one issue with it:
"asset bubbles were the natural consequence of unregulated financial markets"
I take it you don't accept the notion of free markets being self-regulating?
I agree with your views there that government intervention is the culprit for causing the malinvestment. But do you just mean that this is due to the government implementing the wrong schemes so that if the government intervened differently, it would be more beneficial?
I'm more of the opinion that government intervention in any way, shape or form leads to inefficiencies and malinvestment.
Philip Soos
(Researcher, School of International & Political Studies at Deakin University)
The idea that markets are self-regulating is one of the myths derived from static equilibrium economic theory. Markets do not function as the textbooks would have us believe.
Government policy can help to mitigate market inefficiencies and failures or it can exacerbate the problem. In this regards, the Australian governments (federal, state) have overwhelmingly implemented the latter.
Many market distortions should be eliminated, e.g. FHOG, NG, FHSA, privatization of publicly-generated rent, etc. Some interventions should be kept, such as the Commonwealth Rent Assistance (CRA) scheme and public housing.
Can't really devise a blanket rule here.