Why the RBA's macroprudential move will fail

The great flaw in the macroprudential view of the world is that it confuses short-term speculative demand with prudent, long-term property investment.

The Reserve Bank of Australia’s Financial Stability Review spells out clearly the case against macroprudential regulation. Indeed it’s apparent that the call to increase the regulatory burden is a highly emotional one. Vindictive at its core, it stems from the growing frustration of officials, and others, who do not understand the current housing market dynamic or the economy more broadly.

Indeed macroprudential regulation simply cannot do what its supporters suggest.  Why else would the Reserve Bank of New Zealand increase rates so quickly after imposing their own controls late last year? Obviously because it wasn’t working. Nearly 12 months on, and notwithstanding 100 basis points of rate hikes, house prices in New Zealand are still on the up -- around 7 per cent over the year and in Auckland -- the epicentre of the boom -- they are still rising by double digit rates (11 per cent annually on the latest figures).   

The great flaw in the macroprudential view of the world is that it confuses short-term speculative demand with prudent, long-term property investment. It is childish to try and reduce the pragmatic decision-making of households to some irrational speculative frenzy when that is a misrepresentation of the facts.  People are smarter than that -- and obviously smarter than our policy makers and property doomsters.  

As I’ve shown before, property as a long-term investment is simply a no brainer: It isn’t that risky over the medium to long-term and it’s baseless to suggest it is, both historically and with reference to current fundamentals.  

If that wasn’t argument enough against macroprudential regulation -- and it is -- the RBA continues to present further evidence against its use in the latest stability review. At the very least, the central bank highlights the difficulty policy wags will have in its implementation. 

For a start, property investors account for only 38 per cent of the value of total loans. Much is made of the fact that this is the highest rate since 2000, but such comments are highly misleading. These are rates not much above the average (around 33 per cent). Indeed the RBA notes that the proportion of the population who are property investors actually remains very low -- rising from 8 per cent in the mid 1990s to only about 10 per cent in 2011-12. Maybe that’s 11 per cent now. 

Of most importance, the RBA suggests is that investors, seeking to avoid lenders mortgage insurance (which kicks in at 80 per cent), typically have lower loan-to-value ratios than owner-occupiers. They have higher incomes and much more wealth.

It’s quite clear that property investors are well placed to service their debt. This is something acknowledged by the RBA. The data shows that investors are typically cashed up, know what they doing, and present little risk to the financial system or the economy more generally.  

Eighty per cent of property investors are geared and of these, 80 per cent are in the top income brackets (60 per cent in the top bracket), paying only one-third of their disposable income on repayments (which includes principal) and with more than half ahead on their repayments.  Seventy per cent of property investors are 40 or over, which is important because the unemployment rate for this age group is very low -- 3 or 4 point-something-per cent.

That macroprudential regulation will fail is obvious when you look at these metrics - investors will be able to side step them with relative ease. At a very basic level they could simply front up with a higher deposit. That this doesn’t occur now is simply a function of record low rates. It creates a huge incentive to carry a debt burden greater than needed to fund any particular investment.  Otherwise recall that savings are high in this country. Cash deposits are at record highs. Logically, higher income earners (80 per cent of the property investment community) have the largest claim to those savings.  Then of course other assets can be liquidated or a cheaper purchase made. Robust price growth -- and the credit upturn -- isn’t going to stall -- it will simply manifest elsewhere in the market.

Property is and will remain extremely attractive even as macroprudential controls are introduced -- this is clear. Indeed the fact is the debate has already been lost by property doomsayers. All the arguments they present as to why property prices can’t possibly go higher and why investors have made a huge mistake are already wrong. Property prices are pushing higher -- in real time and rapidly. Investors have made a lot of money. All the theorising about why they shouldn’t, and why they won’t, doesn’t change the reality that they have -- and will.

Households need and will seek out investment opportunities. Given that the after-tax, after-inflation returns on cash and bonds are effectively zero, equity and property are the only real alternatives.  On the equity side, our market has consistently underperformed global benchmarks because of the constant doom-saying of policymakers and the desperate bid to lower the dollar. Indeed the recent slump in the Australian dollar has seen the All Ords drop about 5 per cent or so, as international investors head for the exits. The S&P 500 in contrast is pushing new records.  

That house prices are surging should have been anticipated by policy makers and those who advocated lower rates. That it wasn’t, no doubt frustrates them. Yet that is no basis for allowing their emotions to dictate policy making. That it currently does, risks disaster. If the RBA wants investor interest in the housing market to ease, it should lift the returns to cash. It’s that simple.

Investors should otherwise not be unnecessarily concerned over a property price slump. At the very least they can rely on the ’RBA put’. The inability of our policymakers to think independently of global fads, guarantees that in the event of a house price drop, the RBA would cut rates to zero and start its own quantitative easing program. Ironically, a stance that would be met with the fanatical approval of Australia’s property bears. A new boom would ensue.