Are we actually in a housing bubble?

by Miklos Bolza18 Jan 2017
“Are we in a house price bubble right now? We can’t say for sure.”
In an article for Business Insider Australia, Michael Potter, research fellow for the Economics Program at the Centre for Independent Studies (CIS), has questioned warnings that the real estate bubble is due to burst in the near future.
“Market bubbles are never perfectly clear at the time, otherwise the galloping price increases would stop. So don’t let anyone get away with ‘claiming conclusively’ that there is a housing bubble,” he said
However, he predicted that current price growth would be unsustainable for long and will eventually start to slow or fall.
“It may not happen soon, but it will happen.”
Bubble vs. downturn
In an interview with Australian Broker, Potter explained that falling prices do not necessarily indicate that a bubble has popped.
“A downturn is different from a bubble bursting, but this difference isn’t about the speed of a downturn, it is instead about what drove the fall in prices.”
Since bubbles are driven by ongoing expectations of price increases rather than fundamental factors such as supply and demand, a bubble bursts when people no longer expect future price increases and thus stop buying or selling.
“By contrast, price declines can happen due to changes in fundamentals, in particular an increase in supply.”
For instance, RBA forecasts for a substantial spike in the number of apartments in Melbourne and Brisbane could mean that prices flatline or fall, he said.
“But this wouldn’t necessarily indicate that a bubble has been burst, because the price change was driven by supply changes.”
The wrong solution
In response to the risk of falling property prices, the Organisation for Economic Cooperation and Development (OECD) has suggested rates should increase to cool the property market.
This was entirely the wrong solution, Potter said, as it would affect all areas of the Australian economy even those which were still sluggish. Additionally, slow wage growth, low levels of business investment and low levels of inflation mean that forcing rates upwards could create even more collateral damage economically, Potter wrote in his Business Insider Australia article.
Instead, more targeted measures could be implemented, he suggested.
“Banks could be required to hold more capital against home loans, and stricter standards could be required for loans with low deposits, while standards for non-housing lending remain unchanged.”
These changes would be felt by banks and other lenders without doing much damage to the rest of the economy.
“If the goal is to reduce home lending (a goal I don’t necessarily support), then don’t do it by using interest rates,” Potter told Australian Broker. “I argue that it is better to use more targeted measures, such as increasing capital requirements for banks.”
The Australian Prudential Regulation Authority (APRA) has already taken some steps down this path by scrutinising any lender that exhibits strong growth in investment lending above the threshold of 10%.
“These measures on their own may help cause a moderation in home loan growth, which is growing but remains below recent highs.”
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