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A Reserve Bank paper pointing to a possible 20 per cent slump in house prices has inspired comparisons with the market crash of the 1990s. By Mike Seccombe.
Anatomy of a property crash
Suddenly it seems as if every economic commentator in Australia is making reference to 1990 – and no comparison with 1990 is ever good.
Not since the June quarter of that year has inflation run so hot in Australia. The data released by the Australian Bureau of Statistics on Wednesday showed prices had shot up another 1.8 per cent in the three months to September, making it 7.3 per cent for the year.
Economic history tells us what happened after that shockingly high inflation number 32 years ago: in the next quarter, the economy shrank by 1.6 per cent and the country entered a deep recession.
No wonder then that Treasurer Jim Chalmers – in his post-budget address to the National Press Club, delivered shortly after the ABS released the inflation data – declared inflation “public enemy No. 1”, adding that “inflation is the dragon we need to slay”.
Then treasurer Paul Keating and the Reserve Bank (RBA) couldn’t slay it in 1990. And while the latest inflation data is not quite as bad as the annualised rate of 7.7 per cent that year, it’s looking hard to kill this time too, despite the central bank rapidly jacking up interest rates during the past six months, and the government’s delivery of a notably restrained budget.
Tuesday’s budget anticipated the RBA would have to lift rates from the current 2.6 per cent to 3.35 per cent early next year to stabilise prices. Numerous market analysts now predict the RBA will have to go harder, to maybe 4 per cent. Others worry that would crash the economy. Figures so far suggest the impacts of higher interest rates on inflation have been negligible.
It’s a fine line they must walk, says Peter Tulip, chief economist at the Centre for Independent Studies, formerly of the research department of the RBA and before that of the Federal Reserve Board of Governors in the United States.
“The level of [economic] activity currently is super strong. We have 3.5 per cent unemployment, which is the tightest labour market we’ve had in 50 years. And there are very good reasons for thinking that it’s unsustainably strong. And so we need a slowdown in activity,” he says.
Australia, and the world, have not had to deal with anything like the current economic scenario, Tulip says, so calibrating the amount that they need to raise rates by to slow the economy, without tipping the country into mass unemployment and recession, is very difficult.
“There’s a big chance they’ll do too little; there’s a big chance they’ll do too much,” he says. “My personal view is doing a bit too much too early is safer than crossing your fingers and hoping you’ve done enough. If you don’t do enough, you get accelerating wages and prices, and then have to do a whole lot more.”
And then you get a crash.
“That was sort of what happened in the late ’80s,” Tulip says. “The economy was growing strongly, and so they nudged interest rates up a little bit, and then a little bit more and a little bit more, until finally they had gone up to 18 per cent. And then: whammo, everything collapsed.”
History doesn’t repeat itself, but it often rhymes, as Mark Twain reputedly observed. There are similarities between the circumstances that preceded the 1990 recession and those that preceded the current economic downturn.
Then, as now, inflation was a problem across many developed economies. In Australia, it was fuelled by a resources boom. Then, as now, property markets were overheated.
Another major precipitating factor in 1990 was an energy crisis arising from a war involving major oil producers – just like now, except then it was Iraq invading Kuwait, not Russia invading Ukraine.
There are also big differences. Even before the recession of the early 1990s, interest rates and unemployment were high. This time around, not only is unemployment the lowest in a half-century but interest rates had been trending down for a long time – essentially since the end of the early-’90s recession.
“And that reached a crescendo with a pandemic,” says independent economist Chris Richardson, “when all over the world interest rates dropped to what the Bank of England estimated to essentially be the lowest in 5000 years.
“And when rates fall, asset prices, including housing prices – the most important prices in many economies, but especially in Australia – rise. For decades, house prices have roared ahead of wages and prices.”
Commonly, economic crises are triggered by wages and prices chasing each other up. But in the past decade wages in Australia have remained flat. For the two-thirds of Australians who owned a home, either outright or with a mortgage, appreciating real estate values substituted for pay rises.
In the crazy boom of recent years, many of us “earned” more from our homes than from our jobs, and the consequent “wealth effect” encouraged people to a greater consumption of other things: cars, travel, dining out and entertainment.
It was tough, however, for those priced out of the market. Twenty years ago, the overall home ownership rate was 70 per cent. Last year’s census found it had fallen to 66.
The decline was sharper for the younger and less well paid. Among those aged 35-44, for example, the ownership rate fell from 73 per cent to 61 per cent. For those aged 25-34, it was down from 52 per cent to 37 per cent. Among the middle 20 per cent of income earners, the rate dropped from 73 per cent to 65.
“So we’re now in a world in which interest rates are finally rising again,” says Richardson. “It’s got all sorts of implications.”
The most salient implication for this real estate-obsessed nation is, of course, the effect on home prices. And that has been huge, says Tim Lawless, director of research, Asia Pacific, for CoreLogic.
“Currently we are moving through the fastest downturn in housing values on record. If we look at our national data up to the end of September, we’ve seen housing values fall by 4.8 per cent from their peak around the end of April,” he says.
During the 1990 recession, he says, the national index fell by a comparatively modest 3.3 per cent.
“The biggest decline we’ve seen from peak to trough was the downturn which ran between about the middle of 2017 to the middle of 2019, and, nationally, that was an 8.4 per cent drop in values. But that was over 20 months. We’re only five months into the current downturn.”
With more rate rises yet to come, Lawless thinks the suggestions of a national fall of 20 per cent in house prices – as posited in one RBA paper released under freedom of information laws last week – are “pretty extreme”. More likely, he says, is the bank’s base case of about 11 per cent, and much worse in the big city markets, particularly Sydney.
Lawless does wonder how long the property downturn will last, given the shortage of housing, particularly rental accommodation, and the government’s commitment to bringing in 195,000 migrants each year now borders are open.
But even a 20 per cent fall would not be nearly as dramatic as it sounds. That would only wipe off the price gains of the Covid boom. Given the average mortgagee is about two years ahead on their repayments, and has squirrelled away substantial financial buffers, most people will not be too badly hurt. Unless, of course, they bought at the top of the market. Or they lose their job. Or both.
So far at least, most jobs look secure. The forecast is that unemployment will go up only a little, to 4.5 per cent. In early 1991, it rose to almost 11 per cent.
“Changes in asset prices by themselves are not of first-order importance,” Tulip says. “The huge worry is that borrowers start defaulting on loans to banks, and the banks make losses, and then they go under. And that was essentially the cause of the GFC [global financial crisis] and also the crisis in Australia in 1991. When that happens, then banks stop lending and the economy comes to a stop.”
Obviously the RBA and the government do not want that. What they want is to slow things down a bit, for people to reduce their spending. This week’s inflation numbers suggest that hasn’t happened to any significant extent, but independent economist Nicki Hutley sees early signs the wealth effect that comes with higher property prices may be reversing – even among those who don’t have mortgages.
“The Reserve Bank would say that, in fact, the wealth effect has an even greater impact than the change in mortgages,” Hutley says. “Modelling does show that there is a correlation between house prices and spending, not just on house-related issues.”
Retail sales numbers show Australians are still spending pretty freely, says Hutley, but the rate of annual increase is coming down.
“If you sort of look at things like credit card spending, the rate of credit growth, these things are all slowing down. Yes, they are still strong, but they are softening. These things always have a lag effect as well.”
Assuming Australia does manage to avoid recession, this slowdown might well prove to be a good thing, she suggests, because it has at least brought to an end the “ridiculous” growth in asset prices that was making Australia an increasingly unequal society.
“Governments have been scared to do anything that gets prices down, other than let the cycle do its bit,” she says. “It’s very cowardly.”
Against this, the Albanese government has been trumpeting plans to build a million new homes over five years from 2024, in concert with the states and the nation’s big super funds.
The critics suggest there is a large element of smoke and mirrors in the announcement – that the private sector already builds about a million homes every five years, and that the only real government commitment is to 30,000 affordable and public housing units.
Peter Tulip, whose research work for the RBA focused heavily on housing, is highly sceptical. “The long-term outlook for house prices is a political judgement rather than economic judgement,” he says. “My view is that depends on zoning policy.”
And zoning policy depends on local councils, who are mindful of the wishes of their constituents. “Australian voters have shown themselves reluctant to allow housing to be supplied to meet demand,” Tulip says. “We 60-year-olds vote our interests, which restrict supply and keep prices going up.”
But, now they are not going up, perhaps there is an opportunity for change. Perhaps this could turn out to be the slowdown we had to have.
This article was first published in the print edition of The Saturday Paper on October 29, 2022 as "Crash tackle".
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