Author: Quentin Grafton, Crawford School, ANU

Many of the new Aussie homebuyers who have taken advantage of the boosted First-home Buyers Grant since October 2008 appear to be blissfully unaware (or it wishful thinking?) of the global financial crisis. Thousands have rushed to buy over-priced houses, sign up to mortgages that they can barely afford and, seemingly, with little or no understanding there is a property price bubble.

In the days before the federal budget and the June 30 deadline for the end of the boosted First-Home Buyers Grant (raised in October last year to $21,000 for new homes and $14,000 for existing homes), it’s a good time to take a look at the price of our housing stock and the current recession and the Great Financial Crisis.

Robert Shiller in his book, The Subprime Solution, convincingly argues that speculative bubbles and busts in the US stock market (peaked in 2007), and in particular the US housing market (peaked in 2006), were important causes of the current crisis. Between 1997 and 2006 real house prices in the US rose 85 per cent. This housing boom encouraged lenders to make loans that couldn’t be afforded by some borrowers (the subprime and low doc loans). Lenders believed that house prices would not fall. They also took greater risks because their loans could be ‘securitised’ and the risk of default passed on to others. As interest rates started rise from record lows in 2002-2004, foreclosures increased and prices started to fall. The rest is history.  We are now in a worldwide recession as confidence in the banking sector has slumped and consumer confidence has fallen off a cliff. 

The bad news doesn’t seem to have registered with the more than 10,000 Australians who have signed up for the boosted First-home Buyer’s Grant. They seem to be blissfully unaware, or have chosen to ignore, falling property prices overseas (US, UK, Spain, Singapore, New Zealand, etc.). In the US, the average price of single-family dwellings in major metropolitan areas fell by 20 per cent in 2008 and continues to fall. 

Australia has its own property price bubble that is about to deflate. Housing prices (accounting for quality changes) will, over the long-run, track closely changes in disposable income and the general price level. In fact, the price-to-rent ratio in Australia has risen by about 60 per cent over the past decade and the price-to-income ratio by about 50 per cent, even with the recent fall off in prices at the high end of the housing market. As the recession bites, and our interest rates start to rise towards the end of next year because of our rapidly increasing public debt, our bubble will also deflate. 

The latest International Housing Affordability Survey shows that not only is our own property price bubble unprecedented historically (for Australia), but it’s bigger than just about any other property bubble in the world. The survey uses a ratio of median house prices to median household income to determine housing affordability. A ‘severely unaffordable’ housing market is one where the price-to-income ratio exceeds 5.1. In the 3rd quarter of 2008, 24 Australian towns and cities (out of a total of 64 markets globally) were deemed severely unaffordable. The 24 on this list include Canberra, Darwin and every state capital. We had the dubious honour of ‘winning gold’ with the world’s most unaffordable housing market being the Sunshine Coast, and ‘bronze’ with the third most unaffordable being the Gold Coast. Sydney takes top honours (5th most unaffordable in the world) among our state capitals.

The implications of the bubble are disturbing. As it deflates it will both exacerbate and lengthen the recession in Australia. People will feel less wealthy and will spend less. Construction will fall off resulting in job losses and this will multiply negatively through the rest of the economy. Continuing the boosted First-home Buyers Grant is not a solution. It has artificially supported prices at the low end of the housing market to the benefit of vendors rather than buyers. If continued, the boost in the grant will further encourage young and lower income Australians to jump into a ‘sinking boat’. They deserve better. Instead, at least until the bubble deflates, our regulators should be insisting that banks only lend to people with a minimum 20 per cent deposit and that borrowers are given a ‘stress test’ at a mortgage rate substantially higher than current interest rates. 

This article first appeared in the Canberra Times on April 29, 2009