House prices a cancer for the economy

Gareth MorganEconomics

[message_box  color=”red”]This article has been updated an located here – Policy at the root of housing problem in NZ[/message_box]


It is no coincidence that around the world attention has turned to how an economic recovery can be garnered against a backdrop of housing markets still on their knees.

In the US house prices are down 30 per cent from their 2007 peak and 40 per cent of owners have negative equity.

In Spain, Europe’s largest sick dog, house prices are down 20 per cent and the local experts say 20 per cent more is needed.

The populist discussion is that housing in these economies has to be resuscitated before they can enter a prolonged recovery.

Such a view is myopic in the extreme. It is over-investment in housing and the lending largesse that underpinned the orgy of excess that led to the sub-prime crisis and widespread recession in the developed world.

The lending excesses that now show as bad loans have in several countries shown up on government balance sheets and in turn undermined market confidence in those governments’ bonds.

And meanwhile for the ordinary citizen in these economies the cost of housing remains at the highest it’s been relative to income.

Housing remains beyond the reach of many.

Seldom before have we seen a market get so distorted by lending and tax largesse that it has plunged whole economies into despair.

This is the outcome from 30 years of financial deregulation and it is yet to be understood by policymakers seeking a quick fix to the economic malaise.

In short they remain convinced the disease is better than the cure and would do anything to get a housing-led recovery going again.

New Zealand has its own version of this cancer. The price of housing remains at historical highs relative to household income, despite the housing doldrums of the last 5 years.

The over-investment in housing that we’ve sponsored has come at a high price: diversion of capital away from deployment in industry and income and employment and instead into an asset class where the predominant objective of investment has been capital gain.

Of course capital gain is not guaranteed but if there exist sufficient incentives for people to invest here rather than elsewhere, then it will materialise, in time.

The reasons have historically been twofold:

* A directive to banks from our Reserve Bank to favour lending on mortgage to other forms of lending – this is effected by the lower risk weightings it deems residential mortgages deserve compared to other lending types.

* A tax break on housing to the extent that capital gains ensue and are not taxed.

Of course these two conspire to comprise a self-fulfilling outcome of capital gains.

The lending distortion sponsored by the Reserve Bank ensures there’s more credit available for this form of investment than others, so people can get into this activity more easily than, say, funding a business.

And the tax break increases the effective return so of course compared to other investments this will make housing a more attractive alternative.

So lubricated with the credit availability we all pile into the asset in unison and drive up its price. Hardly rocket science.

The point is of course though that this is not a demand that’s driven in any way by economic fundamentals such as the demand for shelter – it’s purely speculative and totally contrived by the regulatory and taxation framework.

It would be fine if there weren’t an opportunity cost – a decided lack of investment in businesses that generate most income and employment.

This is the legacy of the last 30 years. And it has become so entrenched in our psyche that our ability to build businesses and create wealth and employment has been numbed.

A bit like growing your own veges or preserving the summer harvest, it’s a lost craft. The cost to incomes is high, the consequence being our GDP per capita continues to slip down the OECD charts.

As we contemplate economic recovery some thought at least should be given to the quality of the recovery we’d prefer – do we want it to be a housing-led one again where we all seek riches through a speculative race for property; do we want it to be a business-led type where jobs and incomes take priority; or do we really not care? Is it all too much to think about?

The sense one gets is that politicians at least couldn’t care less, just bring recovery on, any recovery.

If they did they would be championing the removal of those regulatory and taxation interventions that have fostered the housing-intensive recoveries of the last 30 years that lie at the heart of the waste of investment capital and ensure our ongoing slide down the OECD rankings.

But there is no talk of that, at least not from the incumbent government.

In other countries it’s even worse. Those where the housing debacle has underpinned the boom and bust cycles that in the end delivered destruction of the government’s balance sheet, the mood is to sponsor a housing-led recovery because without it any recovery will be too anaemic to rekindle jobs and incomes fast enough. Spain and the US are in this situation.

New Zealand, courtesy of the China-propelled support of commodity prices has been in a sweet spot, without doubt.

Our housing boom and subsequent loss of affordability has been as bad as elsewhere but the correction has been more muted, more orderly.

The boom in incomes from our commodity sales has been an absolute saviour.

But the disease remains the same; we have discriminated against productive investment in favour of property speculation. That intensified the morbid dependency on commodity sales to sustain our incomes. If those hadn’t risen we would be another Spain already.

Why would you continue to gamble on being a one-trick pony? We have an opportunity as the economy picks itself up this time, to remove the policies that discriminate in favour of housing speculation. Why wouldn’t we do that and bring affordability within reach of many more families, like it used to be?

Or should I go out and buy another three houses now and just wait for the rest of you to bid the prices up?

House prices a cancer for the economy was last modified: December 15th, 2015 by Gareth Morgan
About the Author

Gareth Morgan

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Gareth Morgan is a New Zealand economist and commentator on public policy who in previous lives has been in business as an economic consultant, funds manager, and professional company director. He is also a motorcycle adventurer and philanthropist. Gareth and his wife Joanne have a charitable foundation, the Morgan Foundation, which has three main stands of philanthropic endeavour – public interest research, conservation and social investment.