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It's coming: 10 ways to cool rampant housing prices

It’s finally coming. After watching house prices surge around 20% in a year in many parts of Australia (and Sydney 23%), Treasurer Josh Frydenberg has signalled action to control rampaging prices and potential financial instability threats.

Although prices are rising around the world, when it comes to citing a prime example, even The Wall Street Journal turns to Sydney. On 27 September 2021, it reported:

In cities from Austin to Dublin to Seoul, more families are finding it impossible to pay higher prices unleashed by a global property boom. Sydney house prices leapt by nearly $870 a day in the second quarter of the year, said real-estate firm Ray White. In the U.K., first-time buyers are paying on average 32% more than 12 months ago, according to Benham and Reeves, a real estate agency.”

Australia’s regulators, notably the Reserve Bank of Australia (RBA) and the Australian Prudential Regulation Authority (APRA), have been slow to respond. Both deny responsibility. Governor Philip Lowe recently said higher house prices are "outside the domain of monetary policy and the central bank", although Assistant Governor Michele Bullock later said: "developments in the housing market (including prices) provide information on the emergence of financial stability risks".

It’s time to act, not only for financial stability reasons and because borrowers are taking on too much debt, but a generation of Australian families are increasingly priced out of the home market.

Shane Oliver of AMP Capital and I recently appeared on Saturday Extra on Radio National, and Shane addressed the intergenerational social tensions:

“I think it’s grossly unfair … We can’t organise our property market in a way that makes it affordable for younger people without massive amounts of debt. This is a major social problem. The longer we leave it, it will lead to rising discontent and we’ve seen what that leads to in the US.”

There are plenty of policy choices capable of taking the steam out of the market. Clearly some of these are politically difficult but that does not mean they should be ignored. 

1. Introduce macroprudential controls

Australian banks are more generous than their peers in other countries on standards for housing lending. A recent Macquarie Research Report said Australian banks are willing to lend at about seven times a borrower’s gross income (and up to nine times with senior approval) versus around four or five in places like the UK, Canada, the US and Sweden. In Australia, 22% of loans have a debt-to-income ratio of six and over according to APRA, a rapid rise in the last year. Macquarie also reported that about 38% of borrowers (on a weighted average basis) took on debt at their maximum capacity in FY21.

This chart from CoreLogic shows macroprudential limits can reduce housing prices, such as when the Hayne Royal Commission supported strong responsible lending laws and when limits were placed on interest-only loans.

Josh Frydenberg finally accepted the need to tighten the reins, telling The Australian Financial Review:

“... it is important to continually assess the appropriateness of our macroprudential settings. We must be mindful of the balance between credit and income growth to prevent the build-up of future risks in the financial system. Carefully targeted and timely adjustments are sometimes necessary. There are a range of tools available to APRA to deliver this outcome.”

The International Monetary Fund also weighed into the debate, advocating the need for debt-to-income ratio or loan-to-value ratio caps on mortgage lending.

“Surging housing prices raise concerns about affordability and financial stability ... Macroprudential policy should be tightened and lending standards closely monitored.”

The Reserve Bank of New Zealand acted along these lines as their house prices rose rapidly, also favouring debt serviceability restrictions to meet its housing price stability goals.

“Our analysis detailed that debt serviceability restrictions, such as a debt-to-income (DTI) limit, are likely to be the most effective additional tool that could be deployed by the Reserve Bank to support financial stability and house price sustainability."

So DTI is shaping up as a target. DTI is total debt divided by gross income (before tax). ANZ and NAB cap their DTI at nine, while CBA and Westpac allow above seven with special approval. What does this mean? If two people earn $100,000 each, that’s $200,000 gross income before tax. With a DTI of nine, they can borrow $1.8 million. Throw in their own savings and generous assistance from the Bank of Mum and Dad, and that’s why many buyers have $3 million to spend.

2. Increase the ‘floor rate’ or ‘buffer’ used to assess repayment capacity

At the moment, APRA requires banks to calculate borrower repayments at 2.5% above the interest rate charged. Alternatively, the bank can set a ‘floor rate’, and use whichever rate is higher. APRA previously imposed a floor rate of 7% but it was removed in 2019 as it was seen as a major limit to borrowing capacity.

Although borrowers might look at a stated lending rate of 2% and calculate for every $1 million they borrow, the repayment is only $20,000, banks use different rates to provide an affordability buffer and to cover future rate rises. CBA Managing Director, Matt Comyn, advised the Senate Economic Committee last week that his bank is increasingly concerned about the mortgage stress on its customers, and he supported ‘modest’ measures to control house prices. He added:

“We have put up our benchmark floor rate to 5.25% which is well above the rate customers would pay.”

One reason Matt Comyn voluntarily increased the floor rate is that he considers loan-to-valuation hits first home buyers as they have not built up enough of a deposit to justify the loan size, whereas they may have the future servicing capacity to pay the loan.

3. Tighten lending standards

The Macquarie Research Report estimates Australian banks offer their clients between 35% and 65% more than their global peers. Adding to the concerns around high debts are doubts about the accuracy of mortgage applications.

UBS’s Evidence Lab surveyed 900 Australians who took out a mortgage in the last year, looking for "factually inaccurate" mortgage applications. The 2021 Report “suggests a material deterioration in lending standards” with the share of misstated applications rising to 41% from 38% in 2020 and 27% in 2015. Application errors included over-statement of income and assets and an under-statement of financial commitments and living costs.

Share of home loans misstated (not factually accurate)

UBS also reported the time for approval had lengthened, but this was more likely due to the record volume of loans rather than tighter lending standards.

ANZ Managing Director, Shayne Elliott, also speaking to the Senate Economics Committee, said:

“We’re taking more time to be careful, to ask more questions, to really assess whether people do have the capacity to take on the debt that they would like. In our case, we’ve lost a bit of market share … as a result of that, but it’s just a time to be prudent and a bit more cautious.”

4. Overhaul planning rules and land availability

The IMF also suggested Australia could improve housing supply and affordability, with new infrastructure provisions to address scepticism about new developments.

This view gained some support from Philip Lowe, who said rising housing prices should be addressed through changing the factors that influence the value of land:

More broadly, society-wide concerns about the level of housing prices are not best addressed through increasing interest rates and curbs on lending. While monetary policy is contributing to higher housing prices at the moment, the way to address these concerns is through the structural factors that influence the value of the land upon which our dwellings are built. The factors include: the design of our taxation and social security systems; planning and zoning restrictions; the type of dwellings that are built; and the nature of our transportation networks. These are all obviously areas outside the domain of monetary policy and the central bank.”

The Chair of the current Inquiry into Housing Affordability and Supply, Jason Falinski, has made his views clear, saying:

“the research points to limitations on land and restrictive planning laws as the major causes of shortages in supply.”

However, this opinion is not universally supported, as the vast majority of sales are existing houses in major cities. How does a new land release 50 kilometres from the CBD improve affordability in the inner city?

5. Review the role of the RBA in housing policy

Australia has a complex mix of official bodies with some clear and some overlapping responsibilities. The Council of Financial Regulators (CFR) chaired by Governor Philip Lowe also includes the heads of APRA, the Australian Securities and Investments Commission and Treasury, and it meets quarterly to improve coordination and discuss policy. House prices were on the agenda last week, and under Josh Frydenberg’s direction, the group has been charged with looking at policy solutions.

The above quote from Philip Lowe on "areas outside the domain of monetary policy and the central bank” shows he believes interest rates and curbs on lending are not the best moves to control prices, and other factors are more important.

But Michele Bullock said in an online speech:

“Sharp rises in housing prices that are not associated with fundamentals could lead to instability by raising the risk of a subsequent decline. Whether or not there is need to consider macro-prudential tools to address these risks is something we are continually assessing.”

Last week, the Organisation for Economic Cooperation and Development (OECD) said the RBA had missed its key targets in recent years and its operations should be reviewed. Josh Frydenberg is open to the idea, and it should be clarified whether the RBA has any responsibility for housing prices, especially in the context of financial stability.

6. Lightly tap the interest rate brake

Interest rates are set at levels which are appropriate for the entire economy, including business borrowing, and cannot be used solely to reduce house prices. Governor Philip Lowe’s recent speech set jobs growth as a far more important goal:

“I would like to address the question of housing prices, as some analysts have suggested we might lift the cash rate to cool the property market. I want to be clear that this is not on our agenda. While it is true that higher interest rates would, all else equal, see lower housing prices, they would also mean fewer jobs and lower wages growth. This is a poor trade-off in the current circumstances.”

To the extent that the Fear of Missing Out drives rising property prices, there is probably no greater measure than a slight tap on the interest rate brake. A rise from the current 0.1% to 0.2% would send a signal. However, Lowe is looking to other members of CFR to do the housing price work. Confirming other steps are coming:

“That is not to say that there aren't public policy issues to be addressed here. On the financial side, the issue is the sustainability of trends in household borrowing. We are continuing to watch this closely, with the Council of Financial Regulators discussing possible regulatory steps if lending standards deteriorate or credit growth accelerates too much.”

7. Maintain responsible lending rules

Josh Frydenberg has flipped around on responsible lending rules. The Hayne Royal Commission made the retention of these laws its first recommendation after much evidence that banks had engaged in predatory lending, making loans to people who had no chance of repaying. ASIC mounted the so-called 'wagyu and shiraz' action against Westpac in 2017 to prove it had ignored responsible lending laws prior to 2015 but the lawsuit was unsuccessful.

The Treasurer initially supported the Hayne recommendations strongly, but he later argued access to credit had become restrictive and was compromising economic activity. He said:

“What began as responsible lending principles has translated into a practice that has become imbalanced between a lender and its customer, leading to the undesirable consequence of unduly restricting lending.”

He introduced legislation to repeal the responsible lending laws in September 2020 but they did not pass through the Senate.

There’s not much evidence that lending has been restricted. All the signs are the opposite, that access to mortgage credit is relaxed and lending is surging, as shown below from the RBA Chart Pack. Housing loan commitments have surged in the last year.

8. Examine a wide range of tax and welfare rules that benefit property

Australia’s tax and social security system strongly favours home ownership and investing in residential property. Many of these policies are sacred ground for homeowners and investors, and there are plenty of Australian politicians with investment property on their personal interests register.

Much good policy is politically difficult, which is why small policy targets have become smart politics. The Labor Party proposal to reduce the capital gains tax discount taken to the last election has now been abandoned.

Without elaborating in detail, consider:

  1. Exemption of Principal Place of Residence (PPR) from capital gains tax.
  2. Exemption of PPR from age pension asset test (a subject discussed extensively recently with an unprecedented response, including an article viewed over 30,000 times).
  3. Negative gearing allows losses from investment property to offset other income, whereas losses from business must be carried forward.
  4. Where a PPR is passed to the next generation, there is no capital gains tax if the asset is sold within two years.

New Zealand passed laws in March 2021 to curb price increases including the removal of tax deductions for interest payments on investment property loans.

9. Talk it down

For all the controls and changes the regulators and governments could bring to housing policy, it is the mood and perception of buyers and sellers that drives panic buying. I have written previously about attending inspections and auctions recently where price guides are smashed by half a million on houses that need a lot of money spent on them. Supply is at record lows during lockdowns, and in the current market, few people want to sell before they buy in a fear of missing out.

In a FOMO market, signalling from the Treasurer and Government officials that they would prefer to see price stability and avoid future stress might release some pressure.

There is too much complacency by borrowers taking massive debts. Digital Finance Analytics claims half of borrowers hold too much debt for their income, and their modelling suggests a 0.5% rise in interest rates would increase the number of households facing mortgage stress by 220,000 to 1.7 million families. Interest rate will rise at some time, and it's better to issue warnings now than face rising foreclosures in the future.

10. Move quickly

The CFR issued a statement following its 24 September 2021 meeting. It confirmed action is coming on macroprudential controls but with little immediate policy change:

"The Council is mindful that a period of credit growth materially outpacing growth in household income would add to the medium-term risks facing the economy ... Over the next couple of months, APRA also plans to publish an information paper on its framework for implementing macroprudential policy."

But it's a mystery why APRA needs another two months. In March 2021, six months ago, the Chair of APRA, Wayne Byers, told a Parliamentary Committee that it was watching key metrics while deciding if macroprudential intervention is required. But then he added:

“It’s not our job to solve house prices and it’s not our job to solve house pricing affordability.” 

If it's not the responsibility of the RBA or APRA, whose is it? Given substantial support for greater controls, even among banks themselves, the delay brings further dangers. Already, buyers' agents are encouraging clients to rush into the market before APRA strikes. This will make the indebtedness and financial vulnerability worse while APRA thinks about it.

Even when all the ducks are in a line, nobody wants to pull the trigger.


Graham Hand is Managing Editor of Firstlinks.


October 03, 2021

Unfortunately too many snouts in the trough. The higher housing prices go, the more money real estate agents make, and the more money for state revenue from transfer costs. Then we have land developers, etc. etc.
Of course most home owners and investors will squeal like cut pigs if anyone dares to rein in the rort known as negative gearing, or make the value of a home part of the eligibility criteria for the aged pension. Have I left anyone out? Only a brave government would try to intervene in this runaway bus before it gets to the cliff - then watch them line up to say "told you so".

October 03, 2021

Developer charges by Government is another form of taxation, especially in Sydney.

October 03, 2021

Tax is not a response as we already pay too much. Homes are off limits. The Govt needs to spend what it has better and curtail prolific waste and failed programs. Simply, the biggies are overly restrictive planning policies (eg Bob Carr), high levels of international migration, excessively low interest rates, and lending policies. The millennials are not much different to the baby boomers except younger and poorer. When they approach early retirement phase would they be prepared to hand over their life’s wealth to an entitled younger generation? Thought not. (For the record I’m Gen x and missed them late 80’s property boom. It hurt me a lot but I made it through. If you want something bad enough you work for it and find a solution. It’s not all the governments fault)

Steve McCarthy
October 03, 2021

Wow!! The answer is so simple. RBA, APRA Federal and State Ministers & associated boffins spend 1 certified week having dinner in the households of REAL PEOPLE across all income groups! Listening to their real world problems & the hardships mortgage stress creates, we will have policy changes effective within a month. It’s just not rocket science, any sensible person knows a crisis is coming in housing. Cooley Auctions shows in its latest report yr on yr that on avg reflected sale prices have increased by around $750k. No one who is sane can think this is OK?? Remove deductibility on investment property interest immediately, that will help start the process. It seems to me extraordinary that the RBA continues to repeat its monetary policy on growth and jobs? This is obviously not working, low interest rates slack bank lending and fact checking are all part of a serious issue. Finally thank you for your newsletter, outstanding.

October 01, 2021

Transfer of wealth from the baby boomers to Government. The Feds are virtually paying nothing on billions of dollars of debt so why would they want to see interest rates rise?

September 30, 2021

"Good policy is politically difficult" and is exactly why we haven't heard a peep from the Fed government except to blame the RBA.

September 30, 2021

Great read Graham.

September 30, 2021

And showing the problem with the delay, here's advice from another newsletter this morning. "Finally, the council of financial regulators (RBA, APRA, ASIC, Treasury) released a statement post its quarterly meeting held last Friday. Of particular significance was a relatively clear sign that macroprudential policies are coming soon given the housing market is now simply overheating. If you are a potential first time buyer and consider moving soon, act now because it’s likely that you won’t be able to borrow as much as you can now. The move is not that surprising given how house prices have risen to ridiculous levels in the last 12 months and ultimately it’s probably a good thing for the overall economy even if it leads to a slowdown in Australian household wealth growth, with a potential flow-on effect on consumption."

Peter Symonds
September 30, 2021

I have no faith in Phillip Lowe, interest rates have to be in balance. You cant have zero interest rates without causing pain to sections of society. The losers are a whole generation of home seekers. Winners are the always the financial industry, risk taking developers, lets see what happens to evergrande. If you want capitalism you have to have booms and busts but Lowe and other central bankers think they can manufacture a never ending boom. Good luck with that.

September 30, 2021

Simplest and most effective I would suggest is macro prudential on minimum service ratios and increase the interest rate buffer for investors to say 7% and leave FHB at a lower rate. This gives them an advantage and isn't a naïve government grant which simply increases purchase prices. Lift the stamp duty exemptions for FHB .

Finally the suggestion to quarantine losses to the property is an excellent one. By making investors realise how long it takes to earn back their losses will cool the interest for many I would expect.

Andrew Smith
September 30, 2021

Good idea, and the latter part too. Make investors understand what they are purchasing in real term value over time, including risks, when headline nominal price masks many costs and outlays. Further, learning about financial literacy in schools and especially communities for adults too; prices do not always go up and even less frequently in real terms.....

September 30, 2021

Good article on 10 steps. Unfortunately, there is no one single bullet. All real asset classes are running hard at the moment (non-residential property yields are at record lows and look at the money chasing infrastructure assets). Definitely think lending standards have slipped.

One other cause not really canvassed enough in the debate is intergenerational wealth transfer. We are now in the early stages of an upward cycle where baby boomers have accumulated more wealth than their parents and grandparents ever had so the bank of mum and dad and the estates of the deceased are a major source of equity for many buyers. It would be a brave govt to put an inheritance tax on.

September 30, 2021

With state government debt at record levels, the very last thing state treasurers want is less revenue from stamp duty, or for local governments to have stagnating rates income. Yet as one of the biggest stakeholders in house pricing, state governments are not included in the debate. Haven't we seen through the pandemic that the states are at the summit, with huge powers and a willingness to use those powers?

September 30, 2021

And no mention of the two elephants in the room: massive immigration and foreign investment in residential property. Put an end to both first, it will have support in the community.

October 03, 2021

I am a bit disappointed. We all know that house prices are increasing yet politicians and others are loathe to put in any real measure to slow, or heaven forbid, lower house prices. The reality is that investment in housing is too attractive. Too many people now have 3,4,5,6 houses or more. Many people have lazy cash that needs a home (excuse the pun) and the housing market is the best bet. My suggestions: Limit the attractiveness of investment eg can only claim losses on 1 or 2 properties; the suggestion to significantly increase investment interest rates is a good one; stop overseas investment (particularly for people from countries where we can't buy)

October 05, 2021

Governor Lowe knows what he is doing. The RBA has to act with reference to other countries with zero/negative interest rates. If our rates are too high, the AUD will rise and impact export markets. That is the last thing we need now while attempting to diversify markets. The RBA is also the first to exercise yield curve control which will assist in keeping our debt down to some extent.

October 05, 2021

The majority of landlords own 1 property (70%) and those owning 3 or more are about 1% according to ATO stats, last time I looked. Most don't buy more than one because negative gearing (a legitimate interest deduction on a loan) has not been a very effective strategt for 20 years since tax reform, and because landlords make far less profit than people think.

October 05, 2021

All the measures taken prevent only citizens from buying property. Foreigners can buy for cash over the phone, sometimes parents buying a residence for a student.

September 30, 2021

A great read, thanks!

September 30, 2021

A great read, thanks Graham. My two cents: 1) The Inquiry would achieve nothing. It’s not like we don’t know what’s going on and what to do. The government just doesn’t do anything - Please see Saul’s article. 2) FOMO - I think there is more to FOMO. With all the money printing, people are justified to be concerned about inflation. Only Mr. Lowe and his PhDs are incapable of thinking of anything else but his 2-3% inflation target.

September 30, 2021

The responsible lending laws are in fact still in place, so if we are seeing a relaxation of standards then maybe there are some breaches of these laws? My understanding was that treasurer Frydenberg was actually talking about removing the effect of responsible lending law "creep" from consumer lending (where they originated) to business lending, rather than dispensing with it entirely.


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