The RBA is concerned about the destabilising impact of property prices on the broader economy once the music stops.
As a result the chorus for limits on lending – so called macro-prudential rules – to certain sectors of the borrowing public have risen. But for all his protestations to the opposite, RBA Governor Glenn Stevens’ recent conversion to the ranks of those who think macro-prudential limits on lending are “worth a try”, seem hollow.
Real estate is one of those markets where the last transaction sets the parameters for the next transaction. Say a house in your street goes for $50,000 more than reserve, there is every chance that adjusted for property differences, your house is now worth more.
Likewise, as properties on the water or in close proximity to the city increase (or decrease as may also be the case) we tend to see suburbs close to those suburbs also rise as buyers either see value or can’t quite afford the exact property they want closer in.
It all means that the marginal player – or the last buyer or seller – sets the price.
In other words, given property in Australia is largely purchased with some amount of debt, the reality in Australia is that he who has the biggest borrowing potential, or can carry the largest mortgage, sets the price.
Which is why the RBA is so worried about investors, borrowing under the tax shelter of negative gearing and able to deduct their interest costs from income, driving property prices higher in Sydney and around the country with no net benefit to the economy. Indeed potentially increasing instability.
Macro-prudential rules usually limit lending on higher risk loans which, by a generally accepted definition, are those loans where a larger proportion of the purchase price is financed through debt – high loan-to-valuation (LVR) loans. Investors often have low LVR’s or at least under the 80% level which would attract lenders mortgage insurance.
So they may not work anyway.
Which brings us to the discussion about higher rates in Australia.
On Tuesday AFR journalist Christopher Joye quoted a “senior banker” who believes that the only way to pull things up in the housing market is for the RBA to “simply bite the bullet and lift interest rates by 25 basis points to send a shot across the bows of borrowers to remind them that the lowest home loan costs in history cannot stay with us forever.”
But would that work if the RBA wasn’t really signalling the start of an interest rate cycle?
Probably not and given their assessment is that “most data are consistent with moderate growth in the economy.”
So macro-prudential may not work effectively. The economy can’t bear too many interest rate hikes and if the RBA is only going to tighten once so it won’t really startle the horses then it may be difficult to cool the housing market through these means.
But as Martin Wolf wrote in the Financial Times this morning – more trouble lies ahead for the Australian economy if the RBA and APRA cannot find a way to get through to investors and cool the market.
“These credit booms did not come out of nowhere. They are the outcome of the policies adopted to sustain demand as previous bubbles collapsed, usually elsewhere in the world economy. That is what has happened to China. We need to escape from this grim and apparently relentless cycle. But for now, we have made a Faustian bargain with private sector-driven credit booms. A great deal more trouble surely lies ahead,” Wolf wrote.
All of which leaves the Reserve Bank, Governor Stevens and APRA caught between a rock and a hard place. But the consequences of a misstep now, as Wolf points out, could be dire for the Australian economy.