Don't panic. DON'T PANIC!

Everyone over fifty has some memory of Corporal Jones running in circles exhorting his fellow Home Guard comrades to stay calm in the face of imminent Nazi invasion. It never happens, though some belt tightening and sensible preparations are undertaken. The real action is elsewhere. Large forces are clashing – just not in Walmington-on-Sea. Current headlines in Australia’s mass media have the distinct aroma of Jones’s butcher shop. Housing prices are crashing! The barbarians are at the gates – or the banks in the case of over-leveraged property owners.

In fact, as I argue in an earlier post, there is no one house price measure. There are many because there are many housing submarkets. Over the past six months actual sales prices in many but not all have peaked and begun to decline, faster in some than others. Front page headlines focus on average falls – in fact averages of averages – and extrapolate across submarkets and into the future.  What in fact is happening?

First, it’s important to note that the data quoted pertains to the sales of actual dwellings not the value of the entire dwelling stock. There are current underlying factors taking the steam out of demand in some areas and housing types. Notably, lenders are tightening credit standards and new loan volumes are falling, especially for landlord-investors, in part due to government exhortation, in part to the pre-emptive defences of the banks looking to the imminent presentation of the final report of the banking Royal Commission. On the supply side, the fruit of years of frenetic construction of apartments is coming online. The result has been to spook new construction, with housing commencements in many areas declining sharply. But – and it’s a critical but – the Australian economy remains strong, unemployment is falling, interest rates are still low by past standards and so are mortgage defaults, though there are some signs of increasing arrears. Population growth remains high and focused on the major cities.

In those areas where prices continue to slide from historic highs it will be highly leveraged marginal owners who are forced to sell – either voluntarily or by their lenders. As desperate sellers face more patient buyers, prices are likely to slide further. Whether they continue to drop will depend on how many owners are forced to sell. However, a runaway cascade, still less a spillover to the whole market, is unlikely as long as the economic and demographic fundamentals remain strong. What the headlines capture is the surface waves of impatient and forced sales. For the vast majority of home owners and landlord-investors who remain able to service their current mortgage (and other) debts, it’s life as normal. Unless, that is, they are infected by the current media-hyped gloom and collectively reduce their consumption, either as a reflex of what economists call ‘the wealth effect’ or due to simple fear of an uncertain future.  In that case, declining aggregate demand would lead to slower growth and a kick up in unemployment, the real potential threat to an over-indebted household sector. Failing that, current falling prices do not accurately measure the housing wealth of Australians but signal the plight of those forced to sell in unpropitious market conditions, while everyone else sits pat. The vast majority of residents continue to enjoy the flow of shelter and other housing-related services, while owners also reap incomes in cash or kind and sit on an asset that promises long term security. Of course, tenants unable to afford current rents that have not fallen much continue to suffer from the cumulative effects of decades of policy neglect in the housing affordability area.

To continue the metaphor, a property tsunami is only likely if the fundamentals change. That depends in small part on local conditions but mainly on the forces ‘across the channel’. The interest rate policies of the US Federal Reserve and the outcome of China-American trade conflicts, plus a host of other international factors could trigger a serious economic depression, globally as well as in Australia. A rerun of 2008 is by no means out of the question. And the Western governments, especially Australia, are in a weaker position to deal with another global catastrophe than last time.

How then should we view what is happening in the Australian housing sector? Well, some modest celebration is in order. The unsustainable and dangerous debt-fuelled spiral that made our houses among the most unaffordable in the world has been at least temporarily halted. Declining prices – where they are occurring – are simply clawing back some of the excessive inflation of the past three years. This gives policy makers breathing space to carefully introduce institutional changes designed to prevent future outbreaks. With the right policies and some luck prices can continue to slide – or at least not rise – in an orderly fashion. Changes that reduce the speculative nature of gambling on future house price inflation are called for, especially with respect to mortgage markets. Some of these changes have been made. Much tighter monitoring and enforcement of the financial sector will, I hope, emanate from the Royal Commission recommendations and the sharp wake-up call administered to financial regulators and their political masters. More controversially, taxation reforms like grandfathering changes to negative gearing and capital gains taxation would help take the sting out of the house price inflation beast. Even more controversially, so would reintroduction of an inheritance tax that included ‘the family home’ with generous but not outrageous threshold exemptions. These later policies would have some possible adverse short term economic effects and, of course, would generate a tsunami of political outrage. Nevertheless, it is precisely in a period of relative market slowdown that resides the best hope for sensible reforms that promise long term benefits, both to restoring greater housing affordability and reducing the probability of a serious economic depression. In the latter context, the greatest spectre that still haunts Australia is the deadweight of current housing-related household debt.

Welcome to 2019. Don’t panic.