Property bubbles in troubled times
29 July 2014
When considering the mystery of Australian house prices it is worth remembering that the world is still in the grip of the GFC. Interest rates are at historic lows, which is distorting the pricing of assets in a manner that has not been seen for decades.
Australian interest rates are low, although not near zero as elsewhere in the developed world. That means there is still a cost of capital. But remember the way interest rates of 19% broke the overheated property market in the 1990s? They are now about 3%. Little surprise that people are borrowing with their ears pinned back. It is very much an investment market or for existing home owners. First-home sales have dropped from 24 per cent to 16 per cent of sales in eight months.
The whole question of asset bubbles is a vexed one. In the lead up to the GFC US Federal Reserve chairmn Allan Greenspan effectively said there is no such thing as an asset bubble because people are rational so they cannot make irrational decisions. It was a view emulated by many central bankers. Unsurprisingly, Greenspan had to revise his views in 2007, although it did not last long. He is now absurdly blaming governments for the whole thing. Once a hard wired ideologue, always a hard wired ideologue.
As Bloomberg points out, central banks from Scandinavia to the U.K. to New Zealand are sounding the alarm about soaring mortgage debt and trying to curb risky lending. But in Australia, where borrowing is surging, regulators are just watching. They still go for the Greenspan, hands off approach:
"Australia has the third-most overvalued housing market on a price-to-income basis, after Belgium and Canada, according to the International Monetary Fund. The average home price in the nation’s eight major cities rose 16 percent as of June 30 from a May 2012 trough, the RP Data-Rismark Home Value Index showed.“There’s definitely room for caps on lending,” said Martin North, Sydney-based principal at researcherDigital Finance Analytics. “Global house price indices are all showing Australia is close to the top, and the RBA has been too myopic in adjusting to what’s been going on in the housing market.”Australian regulators are hesitant to impose nation-wide rules as only some markets have seen strong price growth, said Kieran Davies, chief economist at Barclays Plc in Sydney.…“The RBA’s probably got at the back of its mind that we’re only in the early stages of the adjustment in the mining sector,” Davies said. “Mining investment still has a long way to fall, and also the job losses to flow from that. So to some extent, the house price growth is a necessary evil.”…The RBA, in response to an e-mailed request for comment, referred to speeches and papers by Head of Financial Stability Luci Ellis.…The RBA and APRA have acknowledged potential benefits of loan limits “but at this stage they don’t believe that this type of policy action is necessary,” said David Ellis, a Sydney-based analyst at Morningstar Inc. “If the housing market was out of control and if loan growth, particularly investor credit, grew exponentially then it’d be introduced.”
What it signifies is that Australian regulators have failed to learn the Greenspan lesson. Markets are not fundamentally rational. That does not mean the answers to proper oversight are easy. Regulators are not necessarily rational, either. We are human beings, we are only partly logical and sensible.
There are no easy answers in an era of meta-money, where $4 trillion spins around the globe each day, making 'normal' investment methods extremely problematic. There is a whole new level of noise distorting markets, sometimes causing them to collapse.
What it means for SMSF investors is this. Most investment options have been profoundly distorted by the low interest rates across the developed world. Australian residential property is one of them, made worse by other distortions like negative gearing. That is a danger signal. But at the same time, there are not a lot of other options available.
The ABS graph below shows where the investments are coming state by state, with NSW out front:
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