Is Australia’s housing bubble about to pop?

If Australia’s property bubble bursts, the consequences would be disastrous for an economy dominated by oversized banks. But Government policies aimed at propping up the market are simply making the bubble bigger. And bigger. 

If Australia’s property bubble bursts, the consequences would be disastrous for an economy dominated by oversized banks. But Government policies aimed at propping up the market are simply making the bubble bigger. And bigger. 

A first-time buyer trying to get on the property ladder in London – where houses have risen nearly 20% in 12 months – would find it scarcely credible that the British capital’s prices are a bargain compared to Australian properties. But successive Australian Governments have deliberately inflated a gigantic housing bubble. The ratio of house prices to income is now nine times in Sydney, compared to 7.3 times in London and 6.2 times in New York. Even Adelaide, with a population of little more than a million, is more expensive than New York. 

[quote] “It’s a crazy and unsustainable situation, which the Australian Government has created by continually propping up the market and turning a blind eye when Chinese buyers have broken the rules on overseas purchases. Sometime soon, though, the bubble will burst under its own dynamic,” said Professor Steve Keen, an Australian economist based at London’s Kingston University. [/quote]

“We’ll get to the point where people are not willing to borrow more money and it’ll come crashing down. Then there will be a huge strain on the Australian economy caused by a massive amount of debt that people can’t service and we’ll fall into a long-term slump. That’s exactly what happened to the Japanese back in the 1990s.”

Under the normal rules of the market, the Australian bubble would already have burst. Only the combination of Government interventionism and the enthusiasm of the Chinese for views of blue Australian sky have kept it going. Foreign investors – mainly the Chinese – are buying up to 40% of all newly constructed Australian homes, and account for one in eight ¬nationwide purchases.

The Australian Government claims to have done its best to restrict foreign buying, but its measures have proved toothless. In 2010, the Government tightened up the rules so that offshore buyers could only buy new properties. The Foreign Investment Review Board (FIRB) was tasked with enforcing penalties for non-compliance. But the FIRB has been so ineffectual that it is the subject of a parliamentary inquiry, which will report back on October 1. The head of the inquiry, Liberal MP Kelly O’Dwyer, has already questioned the Board’s competence. [quote] “The FIRB has said to us in evidence that they think everybody is complying a lot better. I simply don’t believe that, I think it defies credibility,” he said. [/quote]

An inherent flaw in the system is that the penalty of AU$85,000 (US$76,000) for breaking the overseas ownership law is piddling. O’Dwyer dismissed it as merely the “cost of doing business” for rich investors.

[quote] “The Government needs to give such an important job to a Doberman. Instead the FIRB acts more like a Chihuahua,” said Professor Keen. “The system is so badly enforced there’s only been one prosecution for breaching the rules of foreign property buying in the past eight years.” [/quote]

Chinese investment is the mystery wildcard in the Australian housing boom saga. Some economists say the inevitable crash in property prices in China – where they are 30 times average incomes in Beijing – will burst the Australian housing bubble. They argue that the Australian economy relies on sales of iron ore to China to build houses and the declining ore market would be plunged into crisis if the Chinese stopped constructing houses altogether. But Keen takes the opposite view. He says a collapse in China could have the paradoxical effect of propping up Australian prices.  

“If china were a normal capitalist nation, a crash there could mean Australia would get tanked as suddenly foreign buying would completely evaporate and the Chinese might even be forced to liquidate their properties in Australia to pay debts at home,” he said. “That’s what happened in Japan when the market collapsed in 1990. A lot of Japanese had invested in Sydney and were forced to liquidate and drop out of the Australian market so we had a downturn.

[quote] “But if things go badly in China, people will want somewhere else to go and live. A huge proportion of the upper classes in China already want to get away from the pollution for their kids’ sakes. You can’t buy blue sky in a major Chinese city. So, if the market crashes in China the bubble could keep on inflating in Australia as even more Chinese buyers flood the market. We have basically thrown all our eggs into a Chinese blender and we don’t know what will come out of it, an omelette or just a smashed egg!” [/quote]

The Government’s complicity in the price inflation has been evident in the introduction of a number of other bubble-friendly policies, such as the First Home Owner Grant (FHOG) scheme. Introduced in 2010, it paid one-off grants to eligible home owners. “I nicknamed it the First Home Vendors scheme as it was all about the Government artificially propping up the market,” said Professor Keen.

Meanwhile, the Government has allowed superannuation funds to take levered positions on property. The Australian superannuation system offers huge tax breaks, especially for the over sixties. If someone in their 40s or 50s bought a US$500,000 property inside their super fund and it doubled in value before they retired at 60, or later, and they sold it, they would pay no capital gains tax on the sale. But if the same property were held outside superannuation, US$250,000 of the gain would be added to their taxable income – resulting in a tax bill of tens of thousands of dollars. 

One of the most criticized housing policies plaguing Australia is negative gearing. This is when investors borrow money to buy a residential property for rental purposes, but the rental value is less than the mortgage interest paid. The Australian Government has allowed taxpayers to deduct the associated costs incurred in earning income from investments, including the cost of borrowing. As a result, most Australian property investors don’t care about rental yield because they can claim tax relief against any losses. Instead, they bank on the inflation of the housing market for profits. 

An investigation by the Australian Tax Office showed that negative gearing has encouraged speculation and boosted house prices by encouraging gambling on the property market rises. According to the ATO, the 1.9 million property investors in the 2011-12 financial year suffered a collective AU$6.8 billion net rental loss. 

One final Government policy that boosted prices was the decision to halve the rate of capital gains tax a decade ago. [quote] “You pay half the rate you do on your income which gives people an incentive to shunt their money across into property in order to halve their tax rate,” said Professor Keen.  [/quote]  

The Australian Government’s policies have turned capitalism into a rentier system, Keen says. “In many ways it’s a return to feudalism as you end up being wealthy because you own property and not because you have done anything especially imaginative in your life,” he said. “It’s a dreadful situation for young people and I think there will be a political revolt at some stage against the Government’s policies.”

When the crash comes, it will inevitably cause a prolonged slump in Australia. The sheer size of Australian banks relative to the economy puts the country in an exposed position. Australia has four of the world’s 20 biggest banks. The Commonwealth Bank, Westpac, NAB and ANZ are all rated AA-. 

[quote] “One of the signs you’re in trouble is when you have so many large banks,” said Professor Keen. “Japan had most of the world’s biggest banks in 1990, but has none of them now. Right now, if you want to sell debt, you sell it to Australian banks and they are especially vulnerable if there’s a downturn.”  [/quote]