Financial System Inquiry skewers housing speculation
A week is a long time in mainstream economic “analysis”. If the recent release of the final report from the Financial System Inquiry (the Murray inquiry) has not made you sit up and take notice of the risky and imbalanced role that housing plays in our economy, you’re not paying attention. But you absolutely should be. Because it’s just officially confirmed that housing speculation and the record level of mortgage debt supporting it is bad for everyone in the long run. And that’s before we even talk about the damaging consequences and economic distortions created by record high house prices relative to incomes and other economic fundamentals.
The real analysts (yes they are out there) and attentive citizens who’ve learnt from history have been saying it for many years, but for this traditionally taboo perspective to have been officially recognised in the first inquiry into the financial system in 16 years, is very significant. In fact, it looks like it may even have marked a turning point in the coverage and debate of this foremost of political, economic, social and cultural issues. It now seems possible to talk about the risks of over-investment in housing in the mainstream press, and indeed impossible to ignore the facts supporting the diagnosis and suggested remedies.
The bottom line about housing as told by the Murray inquiry is this: Over-investment in Australian housing is bad for the economy and the biggest source of risk in our financial system, and unsurprisingly it has been fostered by favourable tax settings at the expense of equality and the rest of the economy as a whole. I would have thought that was obvious by now. But while stopping short of identifying some of the root causes, and the inevitable long-term implications, in recognising this fact, the report has surprised sceptics like myself and taken a shot at the dark heart of Australia’s imbalanced and Dutch-diseased economic structure: the politico-housing complex.
Specifically, the Murray inquiry has drawn the following conclusions about housing and our financial system more broadly:
- The preferential tax treatment of housing investment, especially negative gearing in combination with capital gains tax concessions, has driven speculative over-investment in housing (which is in essence a non-productive asset).
- As a consequence, these tax breaks have contributed to price rises above levels supported by economic fundamentals, increased inequality, discouraged investment in productive enterprise, and punished other traditional means of building wealth such as establishing businesses and saving money.
- The enormous increase in mortgage debt accompanying the last two decades of housing speculation have placed our financial system at very large risk from a potential correction in values, exactly as it did in a number of other developed countries in the lead up to the GFC, who suffered economic devastation from collapsing house prices.
- Perhaps even more importantly, exponential growth in mortgage lending has significantly cannibalised productive investment in other areas of the economy, as the availability of credit to business has decreased, and the general input costs of business have increased thanks to higher land values.
- This process is best referred to as mis-allocation of capital, and among other problems, has resulted in lower productivity and competitiveness, and contributed to a massive restructuring away from a “mixed economy”, not least of which has involved the alarming shrinkage of traditional labour-intensive business sectors like manufacturing and services.
- Additionally, tax breaks flowing to superannuation and the ability to borrow money to invest in housing and equities in self managed super accounts has been identified as a key source of risk and a contributing factor to house price escalation. The report recommends securing in legislation the sole purpose of superannuation as providing for retirement, not speculation in housing or tax evasion (Or for that matter dodgy first home buyer boosts, as a certain Nick Xenophon proposed).
- Perhaps most worryingly, the report has effectively determined that contrary to popular belief, our banks do not hold adequate capital reserves against mortgage credit, and would be at risk of insolvency in the case of a major housing downturn.
- Worse still, since the GFC, the precarious position of bank’s credit books have been backed by an implicit taxpayer-funded guarantee, helping to ensure that the required foreign credit to fund mortgage lending is available at cheap rates, despite the enormous profitability of major banks. And in the case of crisis, the taxpayer would again be on the hook for failing banks, a double whammy.
In short, with respect to housing, mortgage lending and superannuation, the Financial System Inquiry has made the following recommendations (to paraphrase):
- Tax breaks for housing have helped to cause price rises, and must be removed to restore economic balance and equality
- Mortgage lending has cannibalised productive enterprise, and led to a dangerously over-concentrated economy
- Mortgage credit poses the biggest risk to our financial system, and banks must be shored up to mitigate the risk of financial crisis
- The taxpayer must not be held ransom by insolvent banks come the next financial or economic crisis, ie. removing ‘too big to fail’
- Specific macro-prudential policies to arrest the blow-off in investor housing lending are warranted
- Superannuation must only be used for retirement income, which should be protected by legislation
The real story is much worse…
In my view this is still quite far from the whole story, and I will leave the finer details of the inquiry and associated numbers to the real analysts. There are a myriad of causes and imbalances associated with the largest land bubble in Australian history, and my own view is that we are in for the largest economic correction in at least several generations. I’ve written about that previously, and will write more broadly about those themes in my next post.
But as someone who has been researching and monitoring the Australian housing situation for many years, it genuinely feels like there has finally been a collective regulatory and analytical convergence on the fact that the current state of housing has been and is bad for the economy and our society. We’ve let it get completely out of hand and re-engineered our whole economy and political structures to make way for massive speculation in something that produces no real physical wealth, but rather impoverishes us all in the long term.
If a diverse portfolio is a smart investment strategy, we have massively failed investment 101 as a country, instead betting our entire economy on endless demand for iron ore, and the delusional notion that everyone can simultaneously get rich from housing (otherwise known as a ponzi or pyramid scheme).
If you were surprised by the recent stories of economic bad news, and how quickly they’re piling up, you shouldn’t be. In the last 20 years or more, we have turned the human need for shelter into the sole way to get rich (on paper at least), by restructuring our entire economy and tax system around the export of mineral wealth, channelled into housing using huge levels of foreign debt, and augmented it with a tax system gone mad and worst of all a political and regulatory system completely captured by the interests of big finance and real-estate. In no uncertain terms, this wholesale change in the DNA of our economy and society has led to the quickly souring economic outlook. It was always coming, and it will get a lot worse before it gets better.
We’ve brought it on ourselves, and the Murray report should ensure that at the very least we have evidence of the dangerous situation we’ve created for ourselves. No one will be able to say that “No one could have seen it coming”, if and when it all goes pear-shaped. The post GFC world has ensured that we know more about these risks than ever before, even if we are too wilfully ignorant, selfish, short-sighted or delusional to actually reform the root causes before calamity strikes.
And so my parting thoughts, which will be the subject of my next post, is that our failed economic structure is the real crime against youth in this current age, while sky-high house prices are just the main symptom of the first reversal of living standards in many generations. The recently released “The Wealth of Generations” report by the Grattan Institute proved that house prices are the main source of inequality across generations. But I see this as simply the main expression of inequality, not the problem itself. I can live without the crippling mortgage needed to secure a tiny patch of our precious earth, the risk is just too tremendous. I’m happy renting, or potentially emigrating.
But what I refuse to abide is the pending devastation that will be caused by this mother of all structural adjustments ahead of us. Australia’s youth are facing the potential of a lost decade (or two), with secular stagnation, austerity economics, privatisation of the commons, massive unemployment, negative equity, bankruptcies, deflation, hollowed out industry, corrupted democracy, regulatory capture, and a broken economic model that holds very few bright sparks. All so that we could pretend to be the richest country in the world for a few years by selling houses to each other…. And insultingly, it was all predictable and preventable.
That is the real sell-out of Australian youth. You can keep your dodgy houses and mortgages.
Cover image courtesy of the Grattan Institute.