Wednesday, December 31, 2008

Causes of the housing boom

There have been a number of secular trends in recent decades around household formation and income which have combined to drive up housing prices excessively, and, I hope, unsustainably. These include:

  • greater female participation in the workplace, leading to many more double income families, coupled with free market bidding for housing based on what lenders will lend the individual, not what individuals need
  • smaller family sizes, possibly partly due to greater workforce participation, individual preference, and so on - partly in order to guarantee a better quality of life for individual children

This has been combined with the continuation of rampant free market commodification of residential property for citizens, where government deliberately keeps out of residential real estate pricing, leaving it to a bidding process in the open market, but reaping enormous stamp duty dividends, land tax and Council rates as a result.

These free market conditions include:

  • the sudden liberalisation of credit at a higher risk profile for the banks and other lenders; rise of the NBLs (non-bank lenders) and lo-docs/subprime loans; greater use of interest only loans; and the equalisation of interest rates on loans for investment properties and PPORs (principal places of residence)
  • present low interest rates, which are now steadily increasing to fight 'inflation', a good percentage of which has been caused by overheated housing prices
  • the advent of 'spruikers' promoting get-rich-quick schemes based on speculative and exploitative behaviours in the property market, and maximising tax breaks, especially 'negative gearing' in the Australian case — see http://www.jenman.com.au/ for examples
  • the capitalisation of high stamp duty, and other government levies and charges, into the cost of housing — the 'ratchet' effect
  • increasing desperation of purchasers, leading to more inflation and a hysteria effect — à la the Dutch 'tulip boom'
  • irrational exuberance of speculative investors (yes, just like in the Great Depression, the dotcom 'tech wreck' and numerous other housing bubbles in the last century which have all ended badly); belief that future infinite capital gains will bail them out for high prices and ongoing losses now. See Steve Keen on 'Minsky's Financial Instability Hypothesis' as a counter to the neo-classical 'equilibrium theory' of markets - http://www.debtdeflation.com/blogs/2008/03/10/time-to-read-some-minsky/
  • plenty of developers, real estate agents and baby boomers highly prepared to cash in on this desperation and greed
  • the permeability of the real estate market to other markets as an investment vehicle, and relatively low costs of purchase compared with other countries
  • very few protections for owner-occupiers in terms of cost controls, except the limit of what the market will bear
  • in Australia, very generous negative gearing rates for investors compared with other countries, where housing investment losses are offset against all income, not just income from the property, meaning that the Tax Office is happy to be an equal partner in any loss for top bracket income earners.

Unfortunately, every single spare cent in households then becomes 'capitalised' into purchasing real estate, in a bidding war between couples and investors, both long-term and speculative.

2 comments:

ProblemWithCaring said...

Why is this so hard for other people to understand??

What did people do before blogs? I had to learn all this in a class "the History of Global Economics" in my Masters program.

potential fho said...

Sean

Agree with most points, except for “free market conditions” descriptor.

The govt has become so much of a Nanny state as you point out with “very generous negative gearing rates for investors compared with other countries” that ‘free market’ no longer applies.

This is really the main point – negative gearing has to go.

If we, as a society, can ditch negative gearing, there is hope of housing becoming affordable again.

To this end, the following open letter might be one part of the solution. Letter highlights the tax discrimination against home buyers.
No need to use your real name if you send a complaint to Treasury.

http://firsthomeowner2008.googlepages.com/openlettertreasury2008

http://firsthomeowner2008.googlepages.com/investorsruleok

thanks again, potential fho jul08