682 No Housing Bubble in Germany - Eamonn Fingleton

No Housing Bubble in Germany - Eamonn Fingleton

Newsletter published on 30 September 2014

(1) No Housing Bubble in Germany - Eamonn Fingleton
(2) Norway teaches Britain how to choke House Booms without killing economy
(3) The great Australian housing rip-off
(4) Negative gearing could be putting the Australian financial system at
risk: Murray inquiry
(5) First Home Buyers grant pushes up house prices - Saul Eslake
(6) First-home stimulus and Negative Gearing inflate house prices - banker
(7) Imagine a tax system that penalised work
(8) What happens to the Banks when the Housing Bubble bursts? Steve Keen

(1) No Housing Bubble in Germany - Eamonn Fingleton

http://www.forbes.com/sites/eamonnfingleton/2014/02/02/in-worlds-best-run-economy-home-prices-just-keep-falling-because-thats-what-home-prices-are-supposed-to-do/

Eamonn Fingleton

2/02/2014 @ 11:55AM

In World's Best-Run Economy, House Prices Keep Falling -- Because That's
What House Prices Are Supposed To Do

When Americans travel abroad, the culture shocks tend to be unpleasant.
Robert Locke’s experience was different. In buying a charming if rundown
house in the picturesque German town of Goerlitz, he was surprised –
very pleasantly – to find city officials second-guessing the deal. The
price he had agreed was too high, they said, and in short order they
forced the seller to reduce it by nearly one-third. The officials had
the seller’s number because he had previously promised  to renovate the
property and had failed to follow through.

As Locke, a retired historian, points out, the Goerlitz authorities’
attitude is a striking illustration of how differently the German
economy works. Rather than keep their noses out of the economy, German
officials glory in influencing market outcomes. While the Goerlitz
authorities are probably exceptional in the degree to which they
micromanage house prices, a fundamental principle of German economics is
to keep housing costs stable and affordable.

It is hard to quarrel with the results. On figures cited in 2012 by the
British housing consultant Colin Wiles, one-bedroom apartments in Berlin
were then selling for as little as $55,000, and four-bedroom detached
houses in the Rhineland for just $80,000. Broadly equivalent properties
in New York City and Silicon Valley were selling for as much as ten
times higher.

Although conventional wisdom in the English-speaking world holds that
bureaucratic intervention in prices makes for subpar outcomes, the fact
is that the German economy is by any standards one of the world’s most
successful. Just how successful is apparent in, for instance,
international trade. At $238 billion in 2012, Germany’s current account
surplus was the world’s largest. On a per-capita basis it was nearly 15
times China’s and was achieved while German workers were paid some of
the world’s highest wages. Meanwhile German GDP growth has been among
the highest of major economies in the last ten years and unemployment
has been among the lowest.

On Wiles’s figures, German house prices in 2012 represented a 10 percent
decrease in real terms compared to thirty years ago. That is a
particularly astounding performance compared to the UK, where real
prices rose by more than 230 percent in the same period. (Wiles’s
commentaries can be read here and here.)

A key to the story is that German municipal authorities consistently
increase housing supply by releasing land for development on a regular
basis. The ultimate driver is a  central government policy of providing
financial support to municipalities based on an up-to-date and accurate
count of the number of residents in each area.

The German system moreover is deliberately structured to encourage
renting rather than owning. Tenants enjoy strong rights and, provided
they pay their rent, are virtually immune from eviction and even from
significant rent increases.

Meanwhile demand for owner occupation is curbed by German regulation.
German banks, for instance, are rarely permitted to lend more than 80
percent of the value of a property, thus a would-be home buyer first
needs to accumulate a deposit of at least 20 percent. To cap it all,
ownership of a home is subject to a serious consumption tax, while
landlords are encouraged by favorable tax treatment to maximize the
availability of rental properties.

How does all this contribute to Germany’s economic growth? Locke, a
prominent critic of America’s latter-day enthusiasm for doctrinaire
free-market solutions and a professor emeritus at the University of
Hawaii, notes that a key outcome is that Germany’s managed housing
market helps smooth the availability of labor. And by virtually
eliminating  bubbles, the German system minimizes the sort of
misallocation of resources that is more or less unavoidable in the
Anglo-American boom-bust cycle. That cycle is exacerbated by tax
incentives which encourage citizens to view home ownership as an
investment, resulting in much hoarding and underutilization of space.

In the  German system moreover,  house-builders  rarely accumulate the
huge large land banks that are such a dangerous distraction for U.S.
house-builders like Pulte Homes, D. R. Horton, Lennar, and Toll
Brothers. German house-builders just focus on building good-quality
homes cheaply, secure in the knowledge that additional land will become
available at reasonable cost when needed.

Locke is the co-author, with J.C. Spender, of Confronting Managerialism:
How the Business Elite and Their Schools Threw Our Lives Out of Balance,
a book I highly recommend.

Comments

Robert Kelley  6 days ago

Excellent article, Mr. Fingleton. It runs contrary to the conventional
wisdom of both the left and right in America. I have long felt that
overinvestment in residential real estate has been a drag on our economy.

Gemma  6 days ago

Well, that photo was taken twenty years ago! And it shows. If you have
visited the former East Germany (DDR) you’ll know that it’s changed
massively since then. This is what Görlitz looks like today – take a
wander around a truly wonderful barock city.

http://www.goerlitz-altstadtinfo.de/architekturgalerie/klosterplatz/kloserplatz-1.html

It’s in German but there are enough piccies for you to enjoy !! Much of
the former DDR was transformed by the Stadtsanierung – which swept
across the west in the 1980s. I discovered this when we visited Pegau
near Leipzig – where nearly all the house roofs were new. Even on all
but derelict properties!

Only my main thought with this article is more important, and has been
alluded to by the author. That is to say, the impact this slow price
decline has had on the banks. Because from what I can see from here in
Europe, house prices in the UK and US are too high – the only problem
being is that if they make even a modest fall, they’ll destabilize the
banks!

Ralph Grella  6 days ago

so what happens when Germany runs out of land? it becomes America?

Eamonn Fingleton, Contributor  5 days ago

A reply to Ralph Grella:

Germany has 4,300 square meters of land per inhabitant — so no sign yet
of an acute shortage of development space!

Arno Mong Daastoel  5 days ago

Splendid article. Another outcome of affordable housing is that labour
costs are kept down while keeping the same standard of living, thus
promoting employment, tax revenues and a prosperous and stable society.

Chris Lockhart  5 days ago

Well, so long as the only thing that matters is outcomes, why not
centrally plan it entirely and eliminate housing cost altogether?

Eamonn Fingleton, Contributor  5 days ago

A reply to Chris Lockhart:
Most of the world’s economies allow _some_ play to market forces and I
can’t think of a single successful economy that does not use the market
as a safety valve. But allowing market forces some play is not the same
thing as continuing to kowtow to the market when the outcomes produced
are obviously dysfunctional.

(2) Norway teaches Britain how to choke House Booms without killing economy

By Ambrose Evans-Pritchard

Last updated: May 13th, 2014

http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100027252/norway-teaches-britain-how-to-choke-house-booms-without-killing-economy/

British house prices have fallen 6pc since peaking in November 2007 at
an average of £181,618. The average in March this year was £169,124,
according to the Land Registry.

This is based on hard sales data, unlike the asking price indexes used
by the property companies. It is backward looking but not massively so.

The fall in real terms must be around 25pc by now. This is hardly yet a
bubble.

It would be folly for the Bank of England to raise interest rates purely
in order to break a London boomlet at time when broad money (M4Lx)
contracted at a rate of -3.2pc over the last three months.

Or indeed, when UK economic output has barely recovered the lost ground
from the Lehman crash, and when much of the manufacturing hinterland is
still in near slump.

Such action would push sterling through the roof before recovery was
secure. It would lead to an even more calamitous deficit in the current
account, ceteris paribus. The deficit is already running at over 5pc of
GDP on a quarterly basis (the worst in the industrial world).

The proper answer to the housing shortage is to build houses, if
necessary by returning full power to councils to do it themselves.

But if the Bank wishes to contain credit, it should learn from Norway's
success. Instead of raising rates, it has used "macroprudential" tools.
It cut the loan-to-value ceiling on mortgages from 90pc to 85pc. It
forced the banks to raise to capital buffers further.

The Norges Bank has recommended a 1pc counter-cyclical buffer based on
its view of what constitutes a safe level of credit growth.

Contrary to claims that these tools never work, they worked splendidly,
as you can see from this chart today from HSBC's David Bloom.

Norway's house price boom stopped it its tracks. The krone fell.
Collateral damage was limited.

The Banque de France explores the whole experience of such policies
across the world in its latest Stability Report.

It includes this paper from the Hong Kong Monetary Authority's Dong He,
showing that higher stamp duties were indeed successful in reining in
house price spirals.

There have been trials all over Asia. They are not perfect. But they do
work. It is time for the Bank of England to stop trying chip out of
bunkers with a driver.

(3) The great Australian housing rip-off

http://www.businessspectator.com.au/article/2014/7/15/property/great-australian-housing-rip

Callam Pickering

Owning your own home remains a dream for many Australians, but an
increasingly difficult one. In our pursuit of home ownership we are
frequently ripped off, with new evidence from the Reserve Bank of
Australia suggesting that housing is severely overvalued. Combined with
a soft economic outlook, younger Australians would be well advised to
think hard before taking on excess leverage, borrowing from their
parents and entering Australia’s housing market.

The RBA released an interesting research paper yesterday on housing
valuation by economists Ryan Fox and Peter Tulip. They ask the pivotal
question: Is housing overvalued?

I have addressed housing valuation a few times during my tenure at
Business Spectator. My general view is that Australians are frequently
ripped off when purchasing a home. A combination of poor housing policy
-- including negative gearing, capital gains tax concessions or
exemptions and the first-home owner grant -- combined with housing
supply restrictions, excessive bank lending and stamp duty have resulted
in arguably the most expensive housing stock in the world.

And yet Australians keep buying homes, at increasing values and with
increasing levels of mortgage debt. Some argue that it is a bubble but
many Australians believe they are getting a good deal.

Fox and Tulip have taken an opportunity cost approach to home ownership.
A house is considered ‘overvalued’ if the individual would be better off
renting the home compared with owning a similar dwelling.

Should you rent or buy? It’s an age old question but one with a simple
answer for most Australians: “Of course you should buy!” Yet it is far
from a no-brainer, as the analysis from Fox and Tulip shows.

It is important to note that the decision to rent or buy excludes the
decision of whether to become a property investor. Investors face a very
different set of trade-offs compared with those contemplating home
ownership.

In fact, based on the rampant speculation in the Sydney and Melbourne
housing markets, and the low rental yields on residential property, I’d
wager that there is only one consideration for many housing investors:
expectations of massive capital gains.

The goal of Fox and Tulip’s analysis is to create a superior method of
valuation compared with measures such as the house price-to-income and
house price-to-rent ratios. Both these measures are simple but have some
obvious limitations.

Both ratios have also increased significantly over the past few decades,
resulting in organisations such as the International Monetary Fund and
Organisation for Economic Co-operation and Development declaring that
Australian house prices are significantly overvalued (Why Australia is
floored by sky-high house prices, June 13).

Fox and Tulip argue that an upward trending price-to-income ratio is not
surprising. They suggest that it is to be expected when land is in
limited supply; prices need to rise faster than incomes to keep demand
in line with supply.

Land supply is an important determinant of house prices but I’d like to
flip their argument around. Rather than attributing the upward trend to
supply restrictions, I’d place the blame on the willingness of our banks
to lend.

House price multiples began to increase at a rapid pace when the
Australian banking system was deregulated, lifting the shackles from
households and removing the credit rationing that had plagued our
banking system.

Graph for The great Australian housing rip-off

Although they are often ignored, banks determine the level of house
prices by sheer virtue of the fact that they control the purse-strings.
They could create a house-price bubble or bust by simply changing their
tolerance to risk.

House price multiples increased because of greater access to credit,
with supply restrictions playing a more modest role. More importantly,
this reflected a one-off structural shift to Australian housing; it
would be a mistake to assume that it was part of a broader trend or
indicative that house price multiples will increase indefinitely.

But returning to their model, Fox and Tulip compare the cost of renting
against purchasing a home using a matched sample of properties. This
controls for issues of quality changing over time.

They find that the decision to buy or rent is highly sensitive to one’s
expectations regarding capital appreciation. Their base scenario assumes
that house prices will continue to grow at their post-1955 average,
during which time real house prices rose by 2.4 per cent annually. Under
this scenario, housing is perfectly priced compared with rents.

But as I’ve argued frequently it is unreasonable to assume that future
house price growth will match past gains. Banking deregulation ushered
in a period of structural change in lending markets that cannot be
replicated. Prices boomed on the back of rising mortgage lending and
that provided a one-off boost to house prices.

Wisely, Fox and Tulip explore a range of other scenarios. The
sensitivity of their analysis to various price growth assumptions is
contained in the graph below.

Graph for The great Australian housing rip-off

I expect that the media will focus on the base scenario -- the post-1955
average -- but in doing so they will severely overestimate house price
growth over the next couple of decades. Structural shifts in the
Australian economy resulting from an ageing population and a declining
terms of trade, combined with the Chinese economy slowing, will weigh on
income and price growth, while high levels of indebtedness should place
a speed limit on potential growth.

The most interesting scenario considered by Fox and Tulip is the
scenario where real house prices grow at the rate of household income
growth (denoted in the graph by “HHDY”). This scenario is perhaps a
little optimistic (the risks to income growth are on the downside) but
it approximates our current reality since the house price-to-income
ratio has been relatively stable -- by which I mean fluctuating around a
constant mean -- over the past decade. Under this scenario, housing is
overvalued by around 20 per cent.

The great Australian dream might be to own your own home but financially
it no longer makes sense for many Australians. The research by Fox and
Tulip, using plausible assumptions for price growth, suggests that
housing is severely overvalued in Australia and many Australians are
getting ripped off. By comparison, rents remain relatively cheap and are
a better option for many younger Australians who have yet to dip their
toes into the murky waters of Australia’s property market.

(4) Negative gearing could be putting the Australian financial system at
risk: Murray inquiry

http://www.propertyobserver.com.au/forward-planning/investment-strategy/politics-and-policy/33485-negative-gearing-could-be-putting-the-australian-financial-system-at-risk-murray-inquiry.html

Andrew Sadauskas | 16 July 2014

The current tax treatment of investment property losses, through a
combination of negative gearing and capital gains tax, has come under
fire for putting the financial system at risk, according to the federal
government’s Financial System Inquiry interim report.

Currently, negative gearing means that interest costs and other property
expenses are fully tax deductible, while capital gains tax on properties
is applied with a 50% discount.

The Financial System Inquiry, headed up by David Murray, states in its
interim report that these arrangements “encourage leveraged and
speculative investment — particularly in housing”.

“Because of these tax arrangements, owners of residential property have
an incentive to repay their mortgage as slowly as possible to maximise
the tax deductions they can accrue,” says the report.

“Loans with interest-only periods help to maximise these tax deductions
in the early years of a loan, although these loans also give borrowers
more flexibility with repayments. The tax system, therefore, encourages
individuals to take on more risk, which does have implications for risks
to lenders.”

Aside from negative gearing and the asymmetric tax treatment, the report
identifies additional tax-related factors that are also distorting the
housing market.

“In addition to the more favourable tax treatment, individuals have an
extra incentive to put more of their wealth into their primary residence
because of the means test for the age pension, which excludes the
primary home. This leads to higher allocation of wealth to housing and,
for some, an inefficient level of consumption of housing services,” the
interim report states.

Current arrangements also mean family homes are a key savings vehicle
for many Australians.

“Returns on owner-occupied housing (including imputed rent and capital
gains) are exempt from tax, although this is not unusual by
international standards. This makes housing a very attractive vehicle
for savings,” the report states.

The favourable tax treatment for property investment has created a
situation of increasing mortgage indebtedness, which in turn has created
risks for the financial system.

“Since the Wallis Inquiry, the increase in households’ mortgage
indebtedness has been accompanied by banks allocating a greater
proportion of their loan book to mortgages; the share of loans for
housing has increased from 47% in 1997 to its current share of 66%,”
says the report.

“A large enough disruption to the housing market could have significant
implications for household balance sheets, financial stability, economic
growth, and the speed of recovery in household spending and broader
economic activity following a shock.”

Mark Chapman, head of tax with lobby group Taxpayers Australia, told
SmartCompany the report is correct in identifying that tax deductions
people claim over the life of a property are greater than the losses
they claim at the end.

“For high income earners, it’s an astute way to reduce their tax rate.
But 70% of those using negative gearing are not high income earners, and
are required to buy an asset to get a tax deduction,” Chapman says.

“It needs to be reformed. From a tax policy perspective, [negative
gearing in its current form] makes little sense. In most jurisdictions,
offsets for losses on property investments can only be claimed against
profits on other properties, or be carried forward against future profits.”

Philip Soos, a research Masters candidate at the School of Management at
Deakin University specialising in property tax law, told SmartCompany
that since 2001, most investment property rents have not been high
enough to cover interest and expenses.

“Around 60% of investor loans are interest only. It’s a big leverage bet
on a capital gain – as long as wages are high enough to sustain the
rents,” Soos says.

“While the argument is that it encourages new property development,
around 96% of all investment property loans by value are spent on
existing properties.”

“Abolishing negative gearing would be better than reform, but that’s
unlikely, so quarantining it or reforming it so it’s limited to new,
rather than existing properties, is probably the best option,” says Soos.

Brian Chant, managing director of Property Asset Planning, told
SmartCompany negative gearing has some important benefits when applied
to new properties.

“I think it’s very effective when used on brand new property. It allows
you to turn over the economy, and when you turn over the economy, you
employ people. It allows you to build new homes and new affordable
housing,” Chant says.

“It needs to be reviewed and discussed further, but when it’s applied to
new homes, it’s brilliant.”

However, Property Tax Specialists' Shukri Barbara told SmartCompany
reforming negative gearing too quickly could create its own risks.

“One important issue is the banks, who lend up to 90%, are heavily
dependent on negative gearing. If you remove it too quickly, the values
will drop and create the risk that people will sell their properties for
less than they owe on their mortgages,” he says.

This article first appeared on SmartCompany.

(5) First Home Buyers grant pushes up house prices - Saul Eslake

http://www.smh.com.au/business/billions-in-handouts-but-nothing-gained-20110315-1bvvs.html


Billions in handouts but nothing gained

Saul Eslake

March 16, 2011

IT'S hard to think of any government policy that has been pursued for so
long, in the face of such incontrovertible evidence that it doesn't
work, than the policy of giving cash to first home buyers in the belief
that doing so will promote home ownership.

The federal government began giving cash grants to first home buyers in
1964 when, at the urging of the New South Wales division of the Young
Liberal Movement (whose president at the time was a young John Howard),
the Menzies government began paying Home Savings Grants of up to $500 to
"married or engaged couples under the age of 36" on the basis of $1 for
every $3 saved in an "approved form" (generally with a financial
institution whose major business was lending for housing) in the three
years before buying their first home, provided that the home was valued
at no more than $14,000.

This scheme was abolished by the Whitlam government in 1973 (in favour
of an income tax deduction for mortgage interest payments by people with
a taxable income of less than $14,000 a year); reintroduced under the
name of Home Deposit Assistance Grants (without the age or marriage
requirements and the value limits and with a larger maximum grant of
$2500) by the Fraser government in 1976; replaced by the Hawke
government in 1983 with the First Home Owners Assistance Scheme,
initially with a maximum grant of $7000 (later reduced to $6000) and
subject to an income test; abolished by the Hawke government in 1990;
and then reintroduced as the First Home Owners Grant by the Howard
government in 2000, without any income test or upper limit on the
purchase price of homes acquired, ostensibly as "compensation" for the
introduction of the GST (even though the GST only applied to the
purchase of new homes, and not to existing dwellings, which the majority
of first-time buyers purchase).

On two occasions since 2000, the FHOG has been temporarily increased in
response to an actual or feared slump in housing activity (and in 2008,
in response to a feared decline in house prices).

Over the past decade, most state and territory governments have "topped
up" the basic FHOG payments to first-time buyers with grants from their
own resources, with some states providing even larger grants to buyers
meeting certain additional criteria (for example, the Victorian
government provides an additional $5000 for buyers of new homes in rural
and regional areas). State and territory governments also provide
indirect financial assistance to first-time buyers by partially or
totally exempting them from the stamp duty they would otherwise pay on
their purchases.

Governments have thus been providing cash handouts to first-time home
buyers for almost half a century. Yet, strikingly, the home ownership
rate has never been higher than the 72 per cent recorded at the time of
the 1961 census, three years before the first of these schemes began. At
every census since then, it has fluctuated between a low of 68 per cent
(in 1976) and 72 per cent (in 1971). At the past two censuses (in 2001
and 2006), it stood at 70 per cent.

Indeed, the apparent stability of the overall home ownership rate
conceals a substantial decline in home ownership rates among every age
group below 50.

Research by Sydney University's Judy Yates and Hal Kendig, and more
recently by Flinders University's Joe Flood and Emma Baker, undertaken
for the Australian Housing and Urban Research Institute, has shown that
between the 1991 and 2006 censuses, home ownership rates dropped by
between 5 and 7 percentage points among households headed by each of the
five-year age cohorts between 25-29 years and 45-49 years, by 4
percentage points among households headed by 50-54 year-olds, and by 2
percentage points among households headed by 55-59 year-olds. The only
reason the overall home ownership rate hasn't fallen more dramatically
is the substantial increase in the proportion of households headed by
people aged 45 and over, among whom home ownership rates have always
been significantly higher than among younger age groups. In other words,
the billions of dollars spent on cash grants to first home buyers (and
for the first nine years of the FHOG scheme's operations, expenditure on
those grants exceeded $10 billion) have spectacularly failed to achieve
the objective of increasing home-ownership rates.

And it's pretty obvious why. Cash grants and other forms of help to
first-time home buyers have served simply to exacerbate the imbalance
between the underlying demand for housing and the supply of it - an
imbalance which, according to the National Housing Supply Council,
amounted to a shortfall of more than 200,000 dwellings as at June last
year.

Cash handouts for first home buyers have simply added to upward pressure
on housing prices, enriching vendors (and making those who already have
housing feel richer) while doing precisely nothing to help young people
into home ownership.

Contrast this with what happened during the 1950s and early 1960s, when
the Commonwealth government provided low-interest loans to state
governments to build houses for sale to eligible first home buyers. The
home ownership rate rose from just under 53 per cent at the time of the
1947 census (a level unchanged from that reported in the first
Commonwealth census in 1911) to 72 per cent at the time of the 1961
census. In other words, policies that added directly to the supply of
housing worked.

Policies which have, in effect, added only to the demand for housing
(or, more strictly, increased the amount which people can afford to pay
for housing), have conspicuously failed.

Why, then, have governments persisted with policies that have so
miserably failed to meet their ostensible goals? The answer is, surely,
that since about 70 per cent of Australians live in homes that they (or
members of their immediate family) already own, policies that make them
feel richer are much more popular than policies that might allow the
small minority of Australians who don't own their own home, but would
like to, to join them.

If governments really wanted to do something about housing
affordability, they would abolish cash grants to first home buyers, and
"quarantine" tax deductions for interest paid by landlords to the value
of the rent received in any given financial year (with any excess
carried forward against the capital gains tax liability when the
property is sold); and use the resulting savings to help local
governments to reduce upfront charges imposed on developers, and in
various other ways increase the supply of low-cost housing.

But I'd put more money on the chance of Andrew Demetriou becoming an
enthusiastic supporter of a Tasmanian team in the AFL. And even more on
the chance of Ireland making the next round of the cricket World Cup.

Saul Eslake is a program director with the Grattan Institute.

(6) First-home stimulus and Negative Gearing inflate house prices - banker

http://www.theaustralian.com.au/business/first-home-stimulus-inflated-property-prices-says-banker/story-e6frg8zx-1226068248920


First-home stimulus inflated property prices, says banker

Scott Murdoch

The Australian June 03, 2011 12:00AM

ANZ Bank's Australian chief executive Phil Chronican has said the
government's first-home buyer stimulus did nothing but drive up property
prices, and warned that mortgage arrears would remain high as consumers
struggled with cost of living pressures.

As bank shares fell further on the market yesterday, Mr Chronican said
local housing prices were likely to remain flat but governments and
regulators needed to address the chronic demand and supply imbalance in
domestic property.

ANZ has estimated there is a 230,000 shortfall in the supply of
residential houses in Australia, which it blames on governments not
releasing enough land for development.

Mr Chronican, who heads the Australian operations of the bank under
group chief executive Mike Smith, said state and federal governments
needed to invest more in social infrastructure to support housing
development.

The government's increased first-home buyers stimulus, delivered during
the global financial crisis, did little to ease affordability problems,
he said.

"We need to refrain from pursuing short-term policies that add to
demand-side pressures," Mr Chronican told an American Chamber of
Commerce lunch in Sydney.

"If we really want to help people into homes, we need to address the
supply-side issues, not add to the demand that drives prices up.

"We have seen what can happen when (governments) get it wrong in the
case of the first-home owner's grant. These grants were capitalised
against house prices so quickly they didn't so much benefit first-home
buyers ... it was the first-home seller's grant really."

Mr Chronican repeated the warning of major bank bosses that mortgage
arrears were beginning to rise as customers struggled with higher
interest rates and cost-of-living pressures.

Analysts have forecast that arrears could soar to nearly $13 billion in
the next year as mortgages written in 2009 begin to sour.

ANZ was one of the least active banks during the global financial
crisis, as it scaled back its residential mortgage-lending in the downturn.

The two Sydney-based banks, Westpac and Commonwealth, were most active
and were expected to experience higher rates of arrears.

Arrears were "a problem that's going to stay with us for a while", Mr
Chronican said. "I don't know if it will get worse or not."

He said tax policy had created an obsession about investment property
ownership. "Governments might want to look at whether ... negative
gearing tax breaks are fostering an unhealthy focus on housing as an
investment and compounding the affordability issues."

(7) Imagine a tax system that penalised work
http://www.smh.com.au/business/imagine-a-tax-system-that-penalised-work-20110329-1ceqb.html


Saul Eslake

March 30, 2011

IMAGINE that you have just become treasurer or finance minister in the
government of a newly independent nation. Imagine also that, for some
reason, you wanted to create a tax system that encouraged the
accumulation of wealth through borrowing and speculating, as opposed to
working and saving.

So you hire a consultant, who, based on your previous experience, you
anticipate will hand you a voluminous report and a large bill after a
period of extensive research, consultation with interested stakeholders
and all the other things that consultants do. But, to your astonishment,
the consultant comes back the very next day and simply hands you a copy
of the Australian Income Tax Assessment Act, and tells you to forget the
bill.

Why the treasurer of some hypothetical government in a far-away country
would actually want a tax system that encouraged borrowing and
speculating, and penalised working and saving, is, of course, rather
hard to imagine.

Yet that is precisely what Australia's income tax system does: it
imposes the highest rates on wage and salary income - that is, income
from working - and on income from the most common forms of saving (bank,
building society and credit union deposits).

By contrast, Australia's tax system taxes income from investments (other
than deposits) at substantially lower rates than identical amounts of
income derived from working. And if those investments are funded wholly
or partially by debt, it provides a subsidy that reduces even further
the amount of tax payable on the income from those investments.

For most people on relatively high salaries, tax rates aren't as high as
they used to be, as a result of the substantial increases in the
thresholds at which the top rate becomes payable that were implemented
during the last term of the Howard government.

However, for people lower down the income scale, the interaction of the
income tax system with the income tests on various forms of social
security payments can result in them facing effective marginal tax rates
considerably above those paid by those on the highest incomes. These
high effective marginal tax rates can - and according to at least some
research do - adversely affect the willingness of some people,
especially women with children, to enter paid employment.

By contrast, the Australian income tax system provides substantial
incentives for people to borrow money to acquire property, shares or
other assets with a value they expect will appreciate over time. Unlike
most other countries, it has always been possible in Australia to deduct
any excess of interest payments on loans taken out to fund an investment
over the income produced by that investment to reduce the tax payable on
wage or salary income.

Since the Howard government's decision in 1999 to tax capital gains at
half the rate applicable to the same amount of wage and salary income, a
decision that was supported by the then opposition, "negative gearing"
has become a means not only of deferring tax, but also permanently
reducing it.

In 1998-99, when capital gains were last taxed at the same rate as other
types of income (less an allowance for inflation), Australia had 1.3
million tax-paying landlords who in total made a taxable profit of
almost $700 million. By 2007-08, the latest year for which statistics
are available, the number of tax-paying landlords had risen to 1.7
million, but they collectively lost more than $8.6 billion, largely
because the amount they paid out in interest rose more than fourfold
(from about $5 billion to more than $20 billion over this period), while
the amount they collected in rent "only" slightly more than doubled
(from $11 billion to $24 billion), as did other (non-interest) expenses.

If all the 1.2 million landlords who reported net losses in 2007-08 were
in the 38 per cent income tax bracket, their ability to offset those
losses against their other taxable income would have cost more than $4.8
billion in revenue forgone; if (say) a fifth of them had been in the top
tax bracket, then the cost to revenue would have been more than $5 billion.

This is a pretty big subsidy from people who are working and saving to
people who are borrowing and speculating (since those landlords who are
making "running losses" on their property investments expect to more
than make up those losses through capital gains when they eventually
sell them).

And it's hard to think of any worthwhile public policy purpose that is
served by this subsidy. It does nothing to increase the supply of
housing, since the vast majority of landlords buy established
properties. Precisely for that reason, it contributes to upward pressure
on the prices of established dwellings, thereby diminishing housing
affordability for would-be home buyers.

It's also hard to reconcile this subsidy with the government's stated
aim of increasing participation in the workforce, especially when
abolishing it could help pay for reducing some of the high effective
marginal tax rates faced by those contemplating moving from
taxpayer-funded benefits into paid employment.

The revenue forgone through negative gearing could alternatively be used
to build nearly 20,000 new "affordable" homes each year, making
substantial inroads into the massive shortage of affordable housing.

Supporters of negative gearing argue that its abolition would lead to a
"landlords' strike", driving up rents and exacerbating the shortage of
affordable rental housing. They point to "what happened" when the Hawke
government abolished negative gearing (only for property investment) in
1986, claiming that it led to a surge in rents, which prompted the
reintroduction of negative gearing in 1988.

This assertion has attained the status of an urban myth, but it isn't
true. Rents (as measured in the consumer price index) did rise rapidly
(at double-digit annual rates) in Sydney and Perth, but that was because
in those two cities, rental vacancy rates were unusually low before
negative gearing was abolished. In other state capitals (where vacancy
rates were higher), growth in rentals was either unchanged or, in
Melbourne, actually slowed.

Suppose, however, that a large number of landlords were to respond to
the abolition of "negative gearing" by selling their properties. That
would push down the prices of investment properties, making them more
affordable to would-be home buyers, thereby reducing the demand for
rental properties in almost exactly the same proportion as the reduction
in their supply.

And that, of course, is the reason why negative gearing will forever
remain untouched - because the negative reaction and loss of votes from
people who would experience declines in the value of their properties
would outweigh the positive reaction from people who would benefit from
lower property prices and would change their votes accordingly.

It's something to remember next time you hear a politician saying he or
she is committed to improving housing affordability, or increasing
participation in the workforce, or both.

Saul Eslake is a program director with the Grattan Institute.

(8) What happens to the Banks when the Housing Bubble bursts? Steve Keen
http://www.debtdeflation.com/blogs/2011/04/11/this-time-had-better-be-different-house-prices-and-the-banks-part-2/

{visit the above link to see the charts}

This Time Had Better Be Different: House Prices and the Banks Part 2

By Steve Keen on April 11th, 2011 at 8:57 am

Posted In: Debtwatch

Click here for this post in PDF

Figure 1

In last week's post I showed that there is a debt-financed,
government-sponsored bubble in Australian house prices (click here and
here for earlier installments on the same topic). This week I'll
consider what the bursting of this bubble could mean for the banks that
have financed it.

Betting the House

For two decades after the 1987 Stock Market Crash, banks have lived by
the adage "as safe as houses". Mortgage lending surpassed business
blending in 1993, and ever since then it's been on the up and up.
Business lending actually fell during the 1990s recession, and took off
again only in 2006, when the China boom and the leveraged-buyout frenzy
began.

Figure 2

Regular readers will know that I place the responsibility for this
increase in debt on the financial sector itself, not the borrowers. The
banking sector makes money by creating debt and thus has an inherent
desire to pump out as much as possible. The easiest way to do this is to
entice the public into Ponzi Schemes, because then borrowing can be
de-coupled from income.

There's a minor verification of my perspective in this data, since the
one segment of debt that hasn't risen compared to GDP is personal
debt—where the income of the borrower is a serious constraint on how
much debt the borrower will take on. As much as banks have flogged
credit cards, personal debt hasn't increased as a percentage of GDP.

On the other hand, mortgage debt has risen sevenfold (compared to GDP)
in the last two decades.

Figure 3

The post-GFC period in Australia has seen a further increase in the
banking sector's reliance on home loans—due to both the business
sector's heavy deleveraging in the wake of the crisis, and the
government's re-igniting of the house price bubble via the First Home
Vendors Boost in late 2008. Mortgages now account for over 57 percent of
the banks' loan books, an all-time high.

Figure 4

They also account for over 37% of total bank assets—again an all-time
high, and up substantially from the GFC-induced low of 28.5% before the
First Home Vendors Boost reversed the fall in mortgage debt.

Figure 5

So how exposed are the banks to a fall in house prices, and the increase
in non-performing loans that could arise from this? There is no way of
knowing for sure beforehand, but cross-country comparisons and history
can give a guide.

Bigger than Texas

A persistent refrain from the "no bubble" camp has been that Australia
won't suffer anything like a US downturn from a house price crash,
because Australian lending has been much more responsible than American
lending was. I took a swipe at that in last week's post, with a chart
showing that Australia's mortgage debt to GDP ratio exceeds the USA's,
and grew three times more rapidly than did American mortgage debt since
1990 (see Figure 13 of that post).

Similar data, this time seen from the point of view of bank assets, is
shown in the next two charts. Real estate loans are a higher proportion
of Australian bank loans than for US banks, and their rise in
significance in Australia was far faster and sharper than for the USA.

Figure 6

More significantly, real estate loans are a higher proportion of bank
assets in Australia than in the USA, and this applied throughout the
Subprime Era in the USA. The crucial role of the First Home Vendors
Boost in reversing the fall in the banks' dependence on real estate
loans is also strikingly apparent.

Figure 7

Never mind the weight, feel the distribution [...]

Alan Kohler recounted an interesting conversation with "one of
Australia's top retail bankers" a couple of years ago on the latter point:

There is some 'mortgage stress' in the northern suburbs of Melbourne,
the western suburbs of Sydney and some parts of Brisbane, but while all
the banks are bracing themselves for it and increasing general
provisions, there is no sign yet of the defaults that are bringing the
US banking system to its knees.

We often see graphs showing that Australia's ratios of household debt to
GDP and debt to household income had gone up more than in the United
States. So, while the US is deep into a mortgage-based financial crisis,
it is surely a cause for celebration that Australia has not seen even
the slightest uptick in arrears.

"Please explain," I said to my dinner companion. Obviously, low
unemployment and robust national income, including strong retail sales
until recently, have been the most important part of it. But on the
other hand, the US economy was doing okay until the mortgage bust
happened; it was the sub-prime crisis that busted the US economy, not
the other way around.

Apart from that it is down to two things, he says: within the banks,
"sales" did not gain ascendancy over "credit" in Australia to the extent
that it did in the US; and US mortgages are non-recourse whereas banks
in Australia can have full recourse to the borrowers' other assets,
which means borrowers are less inclined to just walk away. (Alan Kohler,
"Healthy by default", Business Spectator August 21, 2008; emphases
added) [...]

So if America's consumers are debt-constrained in their spending,
Australian consumers are even more so—with negative implications for
employment in the retail sector.

Compared to the USA therefore, there is no reason to expect that
Australian banks will fare better from a sustained fall in house prices.
What about the comparison with past financial crises in Australia?

This time really is different

There are at least three ways in which whatever might happen in the near
future will differ from the past:

   On the attenuating side, deposit insurance, which was only implicit
or limited in the past, is much more established now; and

   If the banks face insolvency, the Government and Reserve Bank will
bail them out as the US Government and Federal Reserve did—though let's
hope without also bailing out the management, shareholders and
bondholders, as in the USA (OK, so call me an optimist! And if you
haven't seen Inside Job yet, see it);

On the negative side, however, we have the Big Trifecta:

   The bubbles in debt, housing and bank stocks are far bigger this time
than any previous event—including the Melbourne Land Boom and Bust that
triggered the 1890s Depression.

I'll make some statistical comparisons over the very long term, but the
main focus here is on several periods when house prices fell
substantially in real terms after a preceding boom, and what happened to
bank shares when house prices fell:

   The 1880s-1890s, when the Melbourne Land Boom busted and caused the
1890s Depression;

   The 1920s till early 1930s, when the Roaring Twenties gave way to the
Great Depression;

   The early to mid-1970s, when a speculative bubble in Sydney real
estate caused a rapid acceleration in private debt, and a temporary fall
in private debt compared to GDP due to rampant inflation;

   The late 1980s to early 1990s, when the Stock Market Crash was
followed by a speculative bubble in real estate—stoked by the second
incarnation of the First Home Vendors Boost; and

   From 1997 till now.

I chose the first four periods for two reasons: they were times when
house prices fell in real (and on the first two occasions, also nominal)
terms, and bank share prices suffered a substantial fall; and they also
stand out as periods when an acceleration in debt caused a boom that
gave way to a deleverage-driven slump, when private debt reached either
a long term or short term peak (compared to GDP) and fell afterwards.
They are obvious in the graph of Australia's long term private debt to
GDP ratio. [...]

Now let's see what history tells us about the impact of falling house
prices on bank shares.

The 1880s-1890s

This was the bank bust to end all bank busts—just like WWI was the War
to end all wars. Bank shares increased by over 75% in real terms as
speculative lending financed a land bubble in Melbourne that increased
real house prices by 33% (Stapledon's index combines Sydney and
Melbourne, so this figure understates the degree of rise and fall in
Melbourne prices). The role of debt in driving this bubble and the
subsequent Depression is unmistakable: private debt rose from under 30%
of GDP in 1872 to over 100% in 1892, and then unwound over the next 3
decades to a low of 40% in 1925.

The turnaround in debt and the collapse in house prices precipitated a
50% fall in bank shares in less than six months as house prices started
to fall back to below the pre-boom level. [...]

There was however still a crash in bank shares after house prices turned
south in early 1929. It was not as severe as in 1893, and of course
coincided with a collapse in the general stock market (I can't give
comparable figures because of the different methods used to compile the
two indices—see the Appendix). But still there was a fall of 24% in bank
shares over 7 months at its steepest, and a 39% fall from peak to
trough—preceded by a 25% fall in house prices. [...]

House prices rose 40 percent in real terms from 1967 till 1974, and then
fell 16 percent from 1974 till 1980. Bank shares went through a
roller-coaster ride, following Poseidon up and down from 1967 till 1970,
and then rising sharply as the debt-bubble took off in 1972, with a 31
percent rise between late 1972 and early 1973. But from there it was all
downhill, with bank shares falling 35 percent across 1973 while house
prices were still rising.

But when house prices started to fall, bank shares really tanked,
falling 54 percent in just seven month during 1974. [...]

I have argued elsewhere that the current bubble began in 1997, but the
debt-finance that finally set it off began far earlier—in 1990. [...] By
1997 the sheer pressure of rising mortgage finance brought to an end a
period of flatlining house prices, and the bubbles in both house prices
and bank shares took off in earnest.

The rise in bank shares far outweighed the increase in the overall share
index (the two indices are now comparable, whereas for the longer series
they were compiled in different ways). Bank shares rose 230 percent from
1997 till their peak in 2007, versus a rise of only 110 percent in the
overall market index.

The increase in house prices also dwarfed any previous bubble: an
increase of over 120 percent over fifteen years. [...]