The RBA's radical remedy for soaring house prices

The Reserve Bank of Australia is perhaps closer to intervening in the housing market than many expect. A freedom of information request indicates that it has considered a range of macroprudential policies designed to limit the systemic risk arising from the Australian housing market.

Back in February I recommended that the RBA follow in the footsteps of the Reserve Bank of New Zealand and introduce restrictions on the level of high loan-to-valuation ratio lending (A housing policy lesson from New Zealand, February 19). These policies have led to a sharp fall in risky mortgage lending in New Zealand and price falls in recent months.

The FOI release comes just days after RBA governor Glenn Stevens reaffirmed that the bank ‘had thought about this [macroprudential controls]’ and had ‘some preliminary discussions with the Australian Prudential Regulation Authority’. This follows months of discussion -- from myself among others -- that the housing market is at risk of overheating.

Housing accounts for over 60 per cent of household wealth and is valued at over $5 trillion. Our major banks have massive exposure to housing assets and state governments are overly reliant on stamp duty to balance the books.

I don’t necessarily prescribe to the notion that a housing bust is imminent, but I recognise the systemic risks. The reality is that the housing market has become increasingly cyclical -- following two decades of strong growth, house prices have suffered three downturns over the past decade.

These downturns occurred despite solid income growth, low unemployment and the mining boom. What would happen if the economy suffers a genuine setback, such as rising unemployment, a sharp fall in mining investment or government austerity measures? How does a combination of the three sound?

Obviously this line of thinking is also present within the RBA. Comments from Stevens indicate that they are not immediately concerned about the housing market overheating but recognise that if momentum was to shift up a gear that would not be a desirable outcome.

Among macroprudential policy tools examined, including New Zealand-style caps on high LVRs, the RBA head of financial stability, Luci Ellis, believes that ‘the most promising policy response seems to be to introduce a regulatory regime that automatically requires larger interest buffers in loan affordability calculations when interest rates are low’.

So, for example, banks would be forced to consider whether a loan applicant could service the loan if interest rates rose by 4 per cent as opposed to current lower buffers. The advantage of this method over caps on high LVR lending is that it doesn’t exclude lenders who can service high LVRs from the market. On the downside though, it doesn’t protect high LVR borrowers from negative equity during a downturn and it would presumably be easier for banks to ‘game’ an interest rate buffer than a fixed lending rule.

The RBA has yet to make any decision -- and this FOI doesn’t indicate that they will -- but at least they are having the appropriate conversations. The RBA also -- and correctly -- recognises that macroprudential policies are only a temporary solution to an overheated housing market.

Ellis noted that the “tax system can shape the incentives to engage in leveraged property speculation” and “investors were no doubt also influenced by the relatively generous tax treatments of property-related investment expenses”. In short, negative gearing and the capital gains tax both encourage speculative activity and both could be fine-tuned to reduce the level of speculation.

The RBA has perhaps been slow to address macroprudential policy issues for the housing sector but I wouldn’t be surprised if they change their tune soon. The economy itself may demand it, as the RBA tries to balance a soft business sector with strong house price growth. Macroprudential policies would allow the RBA to continue to promote low rates to support the business sector without needing to worry about whether they will create a house price bubble. That is the type of policy flexibility that I’m sure the RBA would love right now.