Last week, as was inevitable, the senate voted down Labor’s Carbon Pollution Reduction Scheme, giving Kevin Rudd an opportunity to attack the Liberals and Nationals on their climate change credentials.
But even worse news looms for the Coalition as Australia’s economic situation improves. Amazingly, Australia now looks as though it may escape a serious recession this year. With brighter economic data numbers being issued both here and abroad, it does now seem as though the worst has been averted. That’s certainly what Reserve Bank Governor Glenn Stevens appeared to be suggesting when he told the House of Representatives Economics Committee last week that "This may well turn out to be one of the shallower downturns Australia has experienced."
If this is the case, then fighting an election on the economy really is going to be tough for the Coalition. Despite all the talk about double dissolutions, Kevin Rudd doesn’t actually need to go to the polls until 2011, by which time the domestic economy could be roaring back to rude health. As has now become obvious, Australia’s policymakers reacted unusually well to the global financial crisis: Stevens slashed interest rates deeply and quickly, while Wayne Swan poured stimulus money into the economy. The medicine worked: the extra public spending increased private investment in sectors like construction, while the "cash splash" put money in the pockets of consumers, who gratefully spent it. Despite flat levels of business investment, domestic consumer confidence is back to nearly boom levels.
But the politics of recovery will pose problems as well as opportunities for the Rudd Government. One of its biggest looming problems is Australians’ continuing obsession with buying houses. Buoyed by a temporary levelling off in house prices, low interest rates and bucket-loads of government cash, Australians are rushing back into the housing market. Although it may seem hard to believe given what we just witnessed in Florida and California, Britain and Spain, the situation has all the makings of a damaging real estate bubble.
To find out why, we need look no further than Australia’s trading partners. Almost alone among rich nations, Australia has not experienced a significant housing industry downturn. While top-end property certainly suffered — as the likes of ABC Learning’s Eddy Groves and Allco Finance’s David Coe can testify — at the bottom end of the market, prices have continued to rise. In fact, the IMF thinks Australian house prices are as much as 20 per cent over-valued. As AMP Capital Investors’ Shane Oliver told ABC radio’s PM a couple of weeks ago, "there’s no doubt that Australian housing is very expensive by global standards. We’re paying relative to our income about double what Americans are paying for a house relative to their incomes."
Australian governments have helped throw fuel on the fire. The states offer a first home owners grant of $7000, plus various top-ups for building a new dwelling, building in a regional area and so on. In addition to this, Canberra also tops up the amount to the tune of $7000. So generous are the various handouts that right now, if you build your first home in regional Victoria, you could be eligible for up to $36,500. That’s not a bad little deposit to get you started on your first mortgage.
The effect of these government handouts has been predictable: higher house prices. It’s not just that vendors and real estate agents know that prospective buyers can access the first home grant, and can therefore comfortably add an extra $7,000 or $14,000 to their asking price. The extra money also brings more customers into the market, who then compete with each other to bid up prices. Economics is often criticised for the slanted insights it makes into human behaviour, but, in this case, Australian house prices are responding exactly how the first-year textbooks say they should.
A contributing problem is supply. Unlike the United States, Australia hasn’t built that many dwellings during our long real estate boom. A number of factors are to blame, including local and state government red tape, poor urban planning, the reluctance of Australian governments to invest in public housing, the difficulty of finding tradespeople during the boom and Australia’s very high level of urbanisation which sees around four-fifths of our population concentrated in just five capital cities.
As a result of this fairly anaemic level of new house construction, particularly in urban in-fill developments such as apartment buildings along established public transport routes, first-home buyers are continuing to move to the edge of our cities in order to get into the housing market. This makes them very car dependent and therefore potentially vulnerable to future spikes in petrol prices.
Of course, long before then, mortgagees are likely to feel the sting of rising interest rates as Glenn Stevens has repeatedly hinted in recent weeks. As Michael Pascoe noted in this intelligent piece for The Age last month, the Reserve Bank is likely to move quickly to raise interest rates if it sees a housing bubble start to expand in earnest.
"This ought to be the time when we can add to the dwelling stock without a major run-up in prices," Stevens told a business luncheon last month. "If we fail to do that — if all we end up with is higher prices and not many more dwellings — then it will be very disappointing, indeed quite disturbing."
"Not only would it confirm that there are serious impediments to producing one of the things that previous generations of Australians have taken for granted, namely affordable shelter, it would also pose elevated risks of problems of over-leverage and asset price deflation."
It’s therefore clear that the Reserve Bank has been thinking long and hard about the US housing collapse, which was, after all, the genesis of the global financial crisis. And the longer you think about Australia’s housing obsession, the scarier it gets. Where do first-home owners get their money from? Apart from the Government, which typically provides the deposit, they get it from banks — mostly the four major banks, in fact. And where do they get their money from? Much of it comes from overseas. Australian banks have to roll over something like $400 billion in short term loans every three months. This makes the Australian financial system heavily reliant on the solvency of home-owners and the willingness of overseas money markets to extend credit to Australia’s banks.
In fact, Australia is more similar to countries like Iceland or Estonia — who were hit the hardest by the global financial crisis — than we realise. A small, open economy that relies on foreign investment to finance much of our growth, Australia runs a big current account deficit. The doomsday scenario for Australia would see a local real estate crash followed by the insolvency of one or more major banks, followed by a currency collapse. This is the nightmare Stevens is setting out to prevent.
But the problem for Stevens is that the rest of Australian housing policy and urban planning is largely disconnected and uncoordinated. Local councils rightly insist on developer charges to increase amenity in their suburbs, adding to the cost of housing. State governments are reliant on property taxes for much of their budget, but have also failed to build amenities and public transport out to the rim of our cities. Meanwhile, since Gough Whitlam, Australian governments of both persuasions have shown little policy interest in urban development, including building more public housing. As Pascoe notes, "there’s nothing the Reserve Bank can do to realise the vision splendid of affordable housing other than to smash us all with higher rates if house prices start to take off again."
If there is a bright side to the story it is that many of the supply constraints might eventually start to moderate. For instance, housing supply in Australia is measured in dwellings, but that is not necessarily the most accurate way to measure it. As any share-housing university student will tell you, the real measure of housing capacity is in fact bedrooms, which are, after all, the actual places where we lay our head at night. And while Australians haven’t built a whole lot of new houses in recent years, the houses we have built are big, often four or even five bedroom structures in the suburban McMansion belts. There is a lot of potential capacity in these empty bedrooms.
Another way of looking at housing supply is to examine the number of people who live in each dwelling. Despite record low levels of housing affordability, the number of people per dwelling in Australia continues to fall towards two.
And then there’s demographics. Eventually, many baby boomers will sell their houses, not least because they will need to fund their retirement. For instance, the Federal Government’s Inter-Generational Report predicts that government spending on residential aged care will roughly double from 2011–12 to 2036–37, largely driven by our rapidly ageing population (especially the very old, those aged over 85). This impending wave of baby boomer downsizing appears not to have been factored into future housing demand projections.
Eventually, high house prices will also lead to the increased provision of housing supply as developers and indeed governments move to redress the shortfall. This too is simple economics. In other words, Australia’s housing under-supply may not be as large as it currently seems — and certainly not great enough to justify our current, historically sky-high, house valuations.
In the optimistic scenario, this means that Australian housing affordability will improve over coming years despite the brisk auctioneering going on right now. In the pessimistic scenario, Australia’s house prices will adjust rapidly down, exposing our financial system and economy to serious risk.