The Law Of Unintended Consequences

“Across Australia, there is no greater source of financial stress for working families than housing. It is no exaggeration to say that in early 2008, housing affordability is the worst it has been in living memory.”

Kevin Rudd, March 2008

“For investors it [the First Home Saver Account] will be a case of strong prices and capital growth being maintained, and at the very least a consistent amount of demand pressure being applied to the property market, particularly under $700,000, across the nation.”

The Eureka Report, a subscription service for property and share investors.

19 thoughts on “The Law Of Unintended Consequences

  1. How do building restrictions and zoning laws hurt people obtain homes? Or the massive taxes on construction (we have them here and I figure you probably have them there as well) and development? Or how about rent controls which make it unprofitable to construct new rental property. There are alot of market intrusions which make it more difficult to build housing to meet the needs of the growing population. Australia is roughly the same size as the US but has a population lower than than that of Southern California. It is absurd to think that one of the most uninhabited continents in the world is unable to produce more housing. A screwed up financing system might bring the prices up due to cheap money but the problem with a shortage of housing has little to do with financing.

  2. Riley – the average house price / earnings ratio is 7x in Australia. In the US (home of the so-called ‘property bubble’) it is 4x.

    Given that the average earnings are about $50k, that means our building restrictions and zoning laws add about $150k to the price of a typical house.

  3. So the average worker works about 3 years of their life just to pay for the zoning laws and other fees to live in a new house. Lets cut to the chase and say thats like an extra 5-10% income tax over the course over an average career then. Throw on a property tax (which is double for new homes here) and it starts to be considerable.

    The bubble here was really a mind blower. I live and grew up in the same house I live in today in Southern California. About 7 years ago we saw houses near us that were $90-$120k start to sell for $190-220k. Then in 2003-2004 they headed towards $300-$330k. Then many of them recently sold within the last year or so at around $450k-$500k (they pay $5000 a year just in property taxes and will for as long as they own the house). I know many people who owned houses outright but would keep taking loans against the equity of their homes to live the high life. Now that home prices are dropping some of these people owe $300k on a house that they put over $100k into and now won’t sell for over $280k or so.

  4. Riley – isn’t there a crucial difference between US and Australian mortgages though? I understand that most US mortgages are non-recourse to the borrower, hence if the house value falls below the value of the mortgage, the borrower can simply hand the keys back to the lender. Is this correct?

    If so, this should mean a much quicker correction in house prices.

  5. For purchasing a home yeah, in some cases you can hand back the keys to the lender if for some reason you can’t pay the bill. I have heard of some cases where the bank puts the house up for auction with the minimum bid as the amount owed to the bank and you get to keep what is over the minimum bid. In some cases though people already owned the homes but then took loans against their homes. In those cases it gets rather nasty and you may actually give up your home and still owe the bank money. Like people would have their house reappraised each year at a higher and higher value and then take a loan against that gained value. I have known people taking $30,000 a year out in this manner just assuming that the value will keep going up. It is pretty careless on the part of of the homeowners to engage in such behavior.

    There are many many types of loans that have been developed in the last decade or so. I have an uncle who works in loans up in Oregon and he was explaining a few to me. Quite a bit of them seem like careless behavior. Back in the 1980s people could only buy a home by getting a small loan out that was at a large interest rate (12-15%) usually well under $80,000 and in most of America probably more like $30,000. In the last few years the banks have been giving out huge sums of money, say a half million, at 1%-3%. People would go purely off purchasing homes based on what their minimum monthly payment could be and would hope that the interest rate never goes up. So that $3000 a month now jumps up to %7000 a month and people are in trouble. The thing is, people taking out those loans were big spenders a few years ago. $500,000 house, $100,000 in cars for a family, a $35,000 trailer, a $25,000 boat, $20,000 per year housing additions, $15,000 new pool, very expensive living and now it is as if the brakes have been put on them.

    Would you invest ALOT of your hard earned money into a rather high risk investment for such a low interest rate? I know I wouldn’t. From my observations here in Southern California your average person took a hit because the value went up so fast that they could not afford one but the yuppies are taking a huge hit due to all of their wanton spending. People who showed restraint, investment, frugality, and foresight are typically alright.

  6. Dear Mister Riley O’Neill, please don’t prove that all those adverse comments about the American School system are true! Didn’t they also teach you that Australia is the driest continent on Earth? There’s a reason why our major cities are on the coast- that’s where the water is! We have one major river system, which is in a crisis condition (the Murray-Darling). Maybe Alice Springs looks big on a map, but it would just make one suburb of an average city.
    Our Mortgage rates will stay high, because of geography.

  7. Excuse me, but isn’t the point of the original post the fact that the Feds are going to toss a few bucks at one of the sanctioned Victim Groups that will do absolutely nothing to address either the supply of additional housing ( price ) nor the cost of new housing – pretty much responsibility that sits with the State Governments ?

    Meaning, if I am not being unduly cynical yet again – the State governments continue to drop the ball on their main, logical function of service delivery ( housing in this case ); keep the population in a finely balanced state of misery that inclines them to keep voting for Labor and it’s populist solutions even where – at least in NSW – they manifestly fail to do that job while lining the coffers of ‘The Cause’ and probably a few other pockets with developer contributions skimmed off an overheated property market

    AND

    all the while whistling and looking every which way until the Feds kick in some more of our tax dollars as a bit of wallpaper for gross incompetance in the interest of the overall greater good of “The True Believers” ?

    Hello Populist Contemporary Federalism – same horse, just a different jockey and heaven help the poor schmucks of whatever demographic trying to get into housing markets where there are actual jobs to be had !!

    Grumpy Old Cynic

  8. Kev

    one exception to your post. in this case, i believe that young people currently renting are a genuine ‘Victim Group’ in that it must be daunting to realise that you will have to stump up $400k for some tiny one-bedroom inner city unit.

    The ALP’s response to this is to make the situation even worse, for as the Eureka article points out, the houses most likely to be bid up by this new measure are precisely the ones they need to buy.

  9. @6. I could tell you plenty of both hilarious and terrifying stories about the American Education system but as far back as I can remember I don’t think the topic of Australian geography came up. Sorry to disappoint you.

    While I do understand that most of the continent is a very harsh place and don’t expect massively large cities to be built in the middle of the desert any time soon. I also recognize that new technologies over the last few decades have made living in water scarce areas easier and easier. Southern California was seen as nearly the same thing, very tough if not impossible to live in due to water situations but technology has enabled people to live there over the last century. Places like Las Vegas NV, Phoenix Az, Albuquerque NM, Dubai, UAE, and very dry communities all over the world live in desert like conditions with very very little fresh water on hand. People do it all over the world, they can do it in Australia as well and the mount of extra housing needed is not that great to satisfy a severe shortage.

    Like anything else, the market can provide should there be a demand for something. If there was naturally such a huge demand for housing that would justify such expensive homes, and there probably is, then entrepreneurs would jump up to fulfill these demands.

    The point I made earlier applies to nearly every anglo country in the world. That severe licensing fees, building restrictions, zoning controls, and rent controls are all government interventions which usually impede the development of new housing and factor in as part of the high price.

  10. Riley, we built what is called The Snowy Mountains Scheme, which was all about moving water from area to another. This only works if you have water to move! I mentioned that our river system was stressed. Part of the stress comes from the lack of water which no longer flows from the mountains. The other part comes from the fact that inland NSW is going through a drought. Sydney and the coastal regions had rain, but the rest stayed dry.
    The other part of our mortgage costs is that most people want to live in the major cities, like Sydney and Melbourne and Brisbane, etc. We love the amenities. (I’ve never gone to the opera, but it’s nice knowing I could go to one of the world’s most famous buildings, and have an operatic experience. And I have walked across the Sydney Harbour Bridge!)

  11. I suspect that they knew this was bad policy but did it anyway. Modern politicians can’t escape from economic advice, it surrounds them constantly. With the exception of Kim Carr and the Nationals, some of it sticks.

    As for water shortages .. well .. look up Lake Argyle some time. The problem is not that Australia is dry, it’s that people don’t want to move far enough North to where the water is abundant.

  12. The other thing that is different about the US is the ready supply of long term fixed interest loans. Try and find a 20 year fixed interest home loan in Australia and you will be looking for a long time.

  13. Dear Pommy G

    Thanks for the comments and I did not intend to sound uncaring of the individual distress in regard to the housing situation. I live in ‘Stralia too.

    My frustration is that government at all levels seems to be compounding the problem with, as you point out, the latest of the now inevitable tokenistic symbolic gestures tossed in that will simply be captured by the investment sector. Brilliant – and they pay people to think of this ??

    Where were Ken Henry’s Treasury analysts when this one popped up – more money chasing same supply = rising prices and hooray for the sellers and investors ! Don’t tell me that fearless and independent public service advice is, mayhap, being disregarded by the political class – still ?? Surely not – haven’t we been promised a Brave New World of fearless public sector empowerment ?

    And could the Fed/State pass-the-parcel on this sort of fiasco possibly get better ?

    Could it ever !

    “After being Immigration Minister for just a few months, Chris Evans has become responsible for the greatest single expansion of Australia’s immigration program, and there is much more to come.”

    http://www.theaustralian.news.com.au/story/0,25197,23705274-7583,00.html

    If shoving more people – even supposedly skilled worker bees – into a market where there aren’t already enough roofs to go around – at least in the places people want those roofs to be – doesn’t give us a real demand pull/insufficient supply inflation kick, I don’t know what will ?

    Let’s see them try and jawbone the Reserve Bank into overlooking this little inflation tidal wave on the way. All other things being equal – outlook for interest rates and housing affordability is grim.

  14. Governments over-subsidise the big cities. All the State Governments each want their capital city to be the biggest and the best. If infrastructure were left to the market to fund, the suburban sprawl would become infeasible. The smaller cities would become more attactive. People would go to live in them and amenities would follow.

  15. Kev – immigration actually lowers housing prices. A greater degree of specialisation lowers comodity prices. See this:

    “Gary Gang Tian, Jordan Shan (1999) Do Migrants Rob Jobs? New Evidence from Australia, Australian Economic History Review 39 (2) , 133–142”

    The problem is mainly artifical supply constraints.

  16. Mark

    I do not disagree with you, the only question I am posing is:

    IF the artificial supply constraints remain in place ( ie essentially the State and Territory governments with their fingers up where the sun don’t shine ), what is going to happen to prices and inflation as we pump up demand by accelerating the immigration intake ?

    Frankly, what I would like to happen is that folk will correct me and point out that basic infrastructure like housing, transport, water, energy, schools, medical services etc are being expanded rapidly to meet the incoming and planned/predictablle demand growth such that prices will not be bid up and the Reserve Bank will see the effect of the immigration intake as lifting wage and skill pressures ?

    I hope I am completely incorrect.

    Rgds

  17. Well that’ just it. Immigration would relieve labour in short supply and more infrastrucutre would relieve other prices. But like planning, these services often are not privately controlled let alone by profit motive.

    We have a notable infrastrucutre bottleneck but if you tried to privately build a road, you would face many of the same constraints the developer of a block of flats would face (but obviously not some of the rules on subdivision and so forth).

    Planning regulations need to go or need to be more sensible. Our compnay tax rate is no longer competitive and we still try to give foreigners who want to take risks and pay for our infrastructure a hard time. Why we even have the foriegn investment review board is beyond me.

    As for educational infrastrucutre, what universities and technical colleges can teach is decided by minesterial minute (executive orders made by the specific Minister). The fact that we maybe don’t have enough engineers could be entirely arbitrary.

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