The head of the Reserve Bank’s Financial Stability Department has dismissed the notion of a housing bubble in Australia, but has warned potential home buyers could overextend themselves to join the market and risk their personal wellbeing in doing so.
The warning comes as recent figures show housing prices have continued to rise, even though finance approvals have dropped and first home buyers are clearing out of the market in droves.
Luci Ellis told a residential property conference that although the property market is experiencing strong growth due to limited land supply, a bubble is not forming.
“Every cycle starts with something real, something fundamental. Recent data suggests that we do not have a credit-fuelled speculative boom on our hands.”
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However, Ellis warned such a situation could occur if home buyers continue to overstretch themselves, and urged lending institutions to remain strict in their finance standards.
“Housing prices have been under upward pressure in Australia. The nature of the demand shock Australia faces means that it would be helpful if more of that demand could be accommodated with extra homes for occupation, instead of by higher prices. Some of that pick-up in construction does seem to be happening.”
“It will therefore be important for lenders to remain prudent in their standards.”
Ellis said prices have risen by about 12% over the last year, adjusted for inflation. Even though loan approvals have fallen 16% from last year, she noted, prices will continue to rise due to a lack of supply.
“In the current episode, by contrast, more of the extra demand is likely taking the form of demand for more dwellings, precisely because of the extra population growth.”
This could push would-be buyers into overstretching their finances, she said. “The more that housing prices rise, the more that some people might feel that they must stretch their finances to buy a home”.
“And if household balance sheets were to become overstretched, household spending would become overly sensitive to income shocks. Such an outcome, if it occurred, would not be conducive to macroeconomic stability.”
However, Ellis also said an overstretching of household balance sheets wouldn’t necessarily cause macroeconomic stress, with the more important factor for economic health being performance in business.
Even so, she said, “It will be equally important for prospective borrowers to have realistic expectations and not to rely on a hoped-for capital gain in order to service their debts”. Additionally, she said lenders must keep their strict lending criteria.
“One crucial precondition is that lending standards in the mortgage market remain prudent. Past experience has clearly shown that in the long run, you don’t improve housing affordability by easing lending standards. That just gets capitalised in the price.”
“In fact, easing mortgage lending standards too far can be outright damaging to long-run affordability. This has been amply demonstrated in the recent United States housing meltdown.”
Harley Dale, economist at the Housing Industry Association, agrees the talk of a housing bubble is an over-exaggeration of the current state of the market.
“We absolutely agree with her comments. We’ve been clear that we don’t buy the housing bubble argument. In terms of sensible commentary, it does more harm than good. It’s been known for some time that the RBA thinks we don’t have a housing bubble, and further confirmation of that is good.”
And while Dale agrees that first home buyers could be over-extending themselves in order to enter the market as soon as possible, he believes such activity won’t have as bad an effect on the market as it did in the US.
“The risk of people over-leveraging is not something new. It was around five, 10, 15 years ago, and it’s always something that people need to be careful of when they are making a purchase decision.”
“It’s already clear that the concerns raised in 2009 were regarding first home buyers overleveraging, and that activity is subsided. Additionally, there is no evidence that any loan arrears or bad loan problems have been significantly worse. If anything, we seem to be reducing the risks of overleveraging in the current market.”