A couple of weeks ago the deputy governor of the RBA, Dr Phil Lowe, revealed that the “biggest surprise” for the central bank in 2011 had been the very low level of “home building.” I laughed when I read this because I had debated exactly this issue with the RBA in 2009 and 2010. It was entirely predictable.
Pondering how the RBA had misjudged the level of new building activity over 2011, Lowe said he thought that “a lowering of expected capital gains on housing … has made developers, financiers and households less willing to commit to new construction despite rising rental yields, lower prices relative to income and ongoing growth in population.”
In 2009 and early 2010 I publicly and privately expressed anxiety that high-profile “jaw-boning” of house price rises by Glenn Stevens, Phil Lowe, and Tony Richards would exacerbate the supply-side problems that these same individuals claimed they were concerned about. I also warned economist buddies of mine that there was no way building approvals would recover to the levels they forecast while the RBA left the community with the impression there was a house price bubble. Here’s what happened to building approvals after the RBA’s “open-mouth operations”.
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On the one hand, the bank has frequently argued via its bi-annual Financial Stability Review that the housing market’s fundamentals are solid, with an inelastic supply-side (something I had highlighted back in 2003), internationally low default rates, healthy population growth, a reasonable price-to-income ratio, and low vacancy rates. The bank has also regularly said it would welcome more developer activity.
On the other hand, the bank was worried that the rapid house price appreciation in 2009-10 could lead to future financial stability complications. It was a forward-looking critique: if asset price growth continued it could feed back into credit growth, which is something the bank wanted to avoid. In March 2010 the governor, Glenn Stevens, famously gave an unprecedented, and widely covered, interview to Sunrise’s David Koch warning home buyers that house prices were not a one-way bet.
Several months earlier, the RBA’s Tony Richards had offered the argument, which also got wide media airtime, that “[A]s a nation, we are not really any richer when the price of housing rises, but the more vulnerable tend to be hurt.”
The net result of the RBA’s posturing was that many commentators reported that the central bank thought Aussie housing was expensive. In truth, the RBA was trying to deliver more nuanced messages. One of these was that we should not expect to see a repeat of the 7-8% capital gains home owners realised over the last 30 years. A second was a reminder that house prices can go up and down.
In abstract, this was wise advice. Indeed, I had myself regularly argued that the risk of an individual family home was much higher than many people understood. In this May 2010 column, I revealed research by Rismark that had, for the first time in Australian history, quantified precisely how risky an individual home is.
Before diving further into this issue, it is useful to get some context. After three years of relatively low house price growth in 2004, 2005, and 2006, capital gains accelerated by 13% in 2007. The coincidence of rising variable mortgage rates, which peaked at a scorching 9.6% in August 2008, and the onset of the GFC saw prices drop by about 4% that year (see chart below).
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Yet the unwinding of the RBA’s tight monetary policy in 2008 together with fiscal stimulus from the government helped the market recover quickly in 2009. That year prices rose 13.7%.
In October 2009 the RBA started to normalise monetary policy again with four quick rate hikes. The bank was keen to do so in part because of worries it had about the effects of leaving rates too low for too long.