The Housing Crisis We Had to Have

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"The Housing affordability crisis in the United States is in the process of being fixed." This was the dry observation of ANZ Chief Economist Saul Eslake at a recent housing conference in Sydney.

As just about everyone now knows, that’s come at a considerable cost to America. Sub-prime mortgages, which until recently very few people had heard of, now make headlines daily. The world’s largest economy is either in recession or is a hair’s breadth away. Eslake’s argument is that it would take something similar here to solve a crisis where one million Australian households find themselves in housing stress.

The Federal Government is hoping he’s wrong. Housing, refreshingly, is back front and centre in the public policy agenda and it’s not difficult to understand why. Sydney and other major capitals are in the eye of the storm. The issue, not just for home buyers but increasingly renters, is beginning to have a wide impact.

Where I live, in inner City Sydney, this has become a common sight: walking home the other day I noticed about 70 people standing on the pavement outside a bleak block of flats. They were waiting, most with pre-filled application in hand, to see a two bedroom flat. If some reports are to be believed, we’re not too far away from a situation where rental tenancy applications are accompanied by brown paper bags stuffed with cash. This has happened to people I know, who were beat out in their application by someone who attached free movie tickets along with their cash deposit. Real estate agents now rival Wollongong city councillors in their proximity to power.

The vacancy rate for rental accommodation in Sydney is 0.8 per cent. In real terms that means Sydney is full. The figure hovers just above the 1 per cent mark nationally. Increasingly, desperate renters are bidding up prices or offering to pay rent in advance. They’re the ones who are lucky enough to have the spare cash. As the crisis escalates, it’s hard to see how the number of homeless people, currently around 100,000 will not grow significantly as we weather the storm.

Young people seeking to buy a house for the first time are also out in the cold. Going back to Eslake’s argument, we can make some historical parallels between the last time Labor was in power and what’s happening now.

Firstly, there are some worrying similarities today with what Australia looked like just before "the recession we had to have". In 1989, Australia’s current account deficit was in bad shape, rising inflation was capturing headlines and tax cuts were proposed. Those are the similarities, but in housing there are differences – it’s now much worse.

Currently about 9.5 per cent of household income is consumed by mortgage interest repayments. Under the Hawke/Keating government the highest that figure reached was 6.1 per cent in September 1989. The average housing mortgage repayment to income ratio for typical first home loans has increased from 17.9 per cent in 1996 to 30.7 per cent now. Housing affordability as measured by the HIA-Commonwealth Bank Affordability Index, is down 40 per cent from 167.5 in 1996 to 97.8 today.

Put another way, it used to be that the house you were buying was worth about three times your yearly income. Today it’s likely to be more than seven times what you earn. On averege, the gap between income and house prices has more than doubled.

So it’s clear the problem is large and growing. The Federal Government is doing just about all it can do – seeking to increase the supply of housing after years of policy paralysis. The Howard Government preferred to play with demand. It failed spectacularly. The first home owners’ grant coupled with other cynical and self-serving policies such as adjustments to capital gains and negative gearing, were simply capitalised into housing prices, pushing them up sharply.

An obvious solution is seeking to push prices down, but housing is where most Australians park most of their wealth. Implement policy seeking to draw prices down and there would be a coup. It’s a policy no government with even a passing interest in winning elections would ever contemplate – the supply side of the equation is about all that is left.

The Government has announced a program to encourage large scale private investment to build low-cost rental housing stock. Through a combination of tax incentives and some direct Government spending, the aim is to add some 100,000 dwellings to the housing stock in upwards of five years’ time. It’s sensible policy in the longer term but don’t go looking for results next week, the housing crisis will be with us for some time to come.

Interestingly, the Government has had a quite public wrestle with its demons. News cycle after news cycle is dominated by the inflation monster. The Government is now asking itself how it can stimulate construction in an industry with pronounced skills shortages without placing upward pressure on inflation (by posing this question, what they actually mean is not putting upward pressure on wages). The problem with that concern is, it’s driven by a particular ideological enclave of theory in the dismal science – that inflation is always and only and for all time driven by the wage rate. On this view, restraining wages is all you need to do to combat inflation. Forget capacity constraint, forget productivity, the main game is restraining pay packets. This view does not stand much scrutiny. The nod to Milton Friedman is more placebo than panacea.

The wage rate myth is busted by another set of numbers. Many things drive inflation, it’s not just the wage rate. If you dig down a little, it becomes clear that more is going on. Recently the Australian Bureau of Statistics released new figures on profit-taking in the economy. They paint an interesting picture. The proportion of GDP going to profits is now at record highs. The share going to wages is stagnating. Profits share has risen 15.5 per cent in 18 months. By contrast wages rose only 0.9 per cent in the three months to December 2007. Profit growth for that period was 4 per cent. These figures suggest something is happening in the economy. If firms can increase their profits by such a large proportion, it’s likely many (and the construction industry is leading the charge on profit-taking) are subtly pushing up their prices disproportionately to their costs. They’re charging a lot more for their products than it costs to produce them because demand is still high. On this analysis, it’s business – not labour – leading the charge on inflation.

In all of this one fact remains: working families bear the brunt of both the housing crisis and interest rate hikes. About a third of Australians rent, another third are paying (or struggling to pay) off housing. Renters face increased rents as higher rates filter through. Borrowers cop the hit directly. Australian households now carry over a trillion dollars worth of debt. This is the legacy of the Howard years and the new Government faces a battle on many fronts. The Rudd Government appears battle ready, but don’t be surprised if things get worse before they get better.

For more Australian politics, check out our blog PollieGraph

New Matilda

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