good article

written by max walsh, from last weeks bulletin.

good article but usual stuff

qte

NSW Treasurer Michael Egan has effectively accelerated the property
slowdown – and that will probably mean John Howard going to the polls
sooner rather than later.

Don Russell, the former Treasury officer who became prime minister Paul
Keating’s trusted economic adviser, claims that he heard the Australian
economy “snap” in 1989. It wasn’t a slowdown, a steady decline, but
something he heard as a “snap” one day in his office. It took some months
before the official figures came through to show that Australia was
actually in recession.

Last week, when NSW Treasurer Michael Egan unveiled his mini-budget, I
didn’t hear a snap but I certainly registered the ominous creaking and
groaning of an economy about to suffer that fate. Had the Reserve Bank
board, which was meeting that same day, opted for an interest-rate
increase, the audio effect would have been loud and unmistakable.

As it was, the RBA, which would have had no idea of the contents of Egan’s
mini-budget, took the view that the economy did not need further monetary
action, that previous rate rises were taking the steam out of the bubbling
residential property market. Egan’s decision to make non-owner-occupied
housing liable for land tax and to impose a 2.5% exit fee on sales by
investors has, in fact, hit a residential property market under intense and
increasing pressure.

Before the RBA began lifting interest rates last year, property prices were
highly vulnerable. Yields on residential investment even taking into
account the tax advantages of negative gearing had reached absurdly
non-economic levels.

According to the RBA’s submission to the Productivity Commission’s Inquiry
on First Home Ownership, rents on properties being pounced on by investors
represented a yield on the full price of just 2.5%. Most purchases were
negatively geared with no prospect of returning positive net rents for
decades.

Housing and apartment prices across Australia, no matter how else they were
computed on the basis of supply and demand or on the metric of
affordability were way too high.

Australia provides more favourable tax treatment for private investment in
housing than any other country. That, combined with the combination of
falling interest rates, easy access to finance and the myth that house
prices never fall, set off a boom that began in 1996. It morphed into a
bubble with the halving of capital gains tax in 1999.

What makes housing bubbles different from and more dangerous than other
asset bubbles, such as equities, is that they are overwhelmingly funded by
credit. The Australian household sector is a world champion of
indebtedness.

Reserve Bank action on interest rates, a more aggressive approach by the
tax office to the exploitation of the negative gearing rules, and the
reality of excessive pricing has certainly taken some of the steam out of
the market. Auction clearances, an early indicator in what is an
information-deficient market, are down significantly.

The full import of the bursting of the housing investment bubble that Egan
has just accelerated is not yet in the marketplace but soon will be. Had
Egan waited for the regular budget process, the investment housing sector
would look parlous, not prosperous.

Egan also moved when he did probably because he suspects federal Treasurer
Peter Costello will act to reduce the favourable tax treatment available
for housing investment.

The Reserve Bank’s submission to the Productivity Commission put the blame
for the bubble squarely at the doorstep of the Treasurer and his tax
policies. Although action now would be too late, a failure to act could
ultimately kill Costello’s political career.

Where Egan has trailblazed this latest exercise in federal-state tax
arbitrage, other state Labor treasurers will soon follow, faced as they are
with revenue contraction as house sales dry up, along with the stamp duty
bonanza. Shrewd investors will understand this and the first reaction
that the NSW changes would drive investment interstate amounted to no
more than real estate hype.

Property meltdowns by their nature are not as immediately obvious as
stockmarket crashes. Usually the initial reaction to a fall in prices is a
reduction in speculative activity. That’s the current phase. Egan has
accelerated it towards the next phase of fire sales and mortgagees in
possession, thus significantly increasing the prospects of an early federal
election.

Unless Prime Minister John Howard’s private polling tells him it would be
suicide to go in August or September, he would be foolish to hang around
any longer. The double-­dissolution election constitutionally available to
him would provide an attractive exit strategy for the Liberal leader. If
successful in that election, the subsequent joint meeting of the houses of
parliament would see the passage of those bills Howard has championed for
years legislation currently blocked in the Senate.

If the investment housing market is going pear-shaped faster than
anticipated, he doesn’t want to delay the election until it’s evident.
There are more than 1.3 million Australian landlords, a startling figure
for a country with less than 9 million taxpayers.

In 1989, when Russell heard the snap, total housing debt was just 17% of
GDP. Now it is 53%. While the 1990 recession involved some household
balance-sheet restructuring, most of the burden fell on the corporate
sector, the impact transmitted mainly through business investment activity
and employment.

Household balance sheets have their largest impact on consumption activity
the main driver of the economy, accounting for more than 60% of total
economic activity and usually the lion’s share of growth. Any rebalancing
of household balance sheets from their present record level of indebtedness
would involve lifting saving activity, as opposed to consumption spending.

This impact on consumption would be exacerbated by the extent to which the
bubble in housing investment has been driven by baby-boomers who see
property as the preferred way to accumulate a retirement nest egg. They are
about to discover housing prices can, and do, fall, that they are in an
illiquid market characterised by high and, thanks to Egan, escalating
transaction costs.

We are all about to discover that much of the claimed magic in the
Australian economic performance was a result of credit expansion. The
limits of that process have now been reached and as a result domestically
generated activity will ease off. The hope is that export demand will fill
the gap.

The optimists suggest China will come to the rescue. It’s likely they will
ultimately be proved correct. But, over the next year, China is more likely
to be part of the problem than the solution. There, an investment bubble of
unprecedented proportions has resulted in an overheated economy.
Bottlenecks such as power shortages and the economic insecurity these
engender are creating social stress.

The central bank has imposed credit restrictions on the banking system
without much effect and interest-rate increases are now being tipped.
China’s growth momentum has been vital to the economic success of the whole
East Asian region and any significant slowdown would have regional
implications, including for Australia.

The Australian economy has not yet snapped. But, the limits of its
tolerance are being put to its toughest stress test since 1990

rgds