Economy at risk as debt bomb grows

Scott Morrison talks down drastic action on house prices after “intervention” from Reserve Bank Governor Philip Lowe.

Reserve Bank of Australia governor Philip Lowe.

The rampant debt-fuelled surge in the Sydney and Melbourne property markets will threaten the health of the national economy if it continues, Reserve Bank governor Philip Lowe has warned.

However, Treasurer Scott Morrison has talked down drastic action on house prices after a “strong intervention” from Dr Lowe.

The RBA is worried that housing debts are rising more than twice as fast as household incomes and that banks are lending to people who cannot afford to repay their debts.

“The concern has been that the longer the recent trends continued, the greater the risk to the ­future health of the Australian economy,” Dr Lowe told a ­business dinner in Melbourne last night. “Stretched balance sheets make for more volatility when things turn down.

“For many people, the high debt levels and low wage growth are a sobering combination.”

The chairman of the government’s Financial System Inquiry, former Future Fund chairman David Murray, yesterday sounded a further alarm on the housing boom, saying a crisis on the scale of the 1890s great property collapse could not be ruled out. “What people should do is look at the 1890s, which was caused by a housing land boom,” he told The Australian. “To say it won’t happen and simply ignore it is wrong.”

Half of the nation’s banks closed their doors following the 1890s crash. “Many people say a crisis has a low probability of ­occurrence, but the problem with that view is that whatever the probability, the severity can be very high if it occurs,” Mr Murray, who is also a former Commonwealth Bank chief executive, said. “It shouldn’t be allowed to grow … it’s too big a risk to take.”

House prices in Australia’s capital cities have risen 12.9 per cent compared with this time last year, with a surge of 18.9 per cent in Sydney and 15.9 per cent in Melbourne, according to data released on Monday by property analytics firm CoreLogic.

Dr Lowe’s comments are part of a co-ordinated campaign by the Council of Financial Regulators, which he chairs, to restrain the surge of property investment in the two major capital cities.

Over the past few days, both the Australian Prudential Regulation Authority and the Australian Securities & Investments Commission have announced steps to limit risky bank lending.

The Reserve Bank’s monthly board meeting, held in Melbourne yesterday, resolved to keep the benchmark cash rate steady at 1.5 per cent for the seventh meeting in a row. The RBA is increasingly confident about the improvement in the world economy but is showing some concern about developments in Australia.

Dr Lowe dismissed fears that the banks would be undermined by a housing downturn, saying the Council of Financial Regulators did not believe the boom was a threat to financial stability. “Our banks are resilient and they are soundly capitalised,” he said.

While the Reserve Bank has confidence in the banks, it is concerned that any economic downturn would be intensified by the financial distress of excessively ­indebted property investors and homebuyers. Dr Lowe said households were coping well so far with rising debt levels. Over the past year, ­housing-related debt has increased by 6.5 per cent while household income has risen by only 3 per cent. However, arrears rates are low and many households are building up buffers in mortgage offset accounts.

Dr Lowe was critical both of lenders advancing mortgages to people who could not ­afford them and of the widespread use of ­interest-only loans that ­required no commitment to repay principal for the first few years.

In a comment that will fuel ­political debate over the housing boom, he said the ­popularity of interest-only loans was partly due to “taxation ­arrangements that apply to investment in residential property in Australia”.

Former National Australia Bank boss Don Argus yesterday added to warnings about the overreliance on interest-only loans, declaring it would “lead to tears” as interest rates moved higher.

The RBA has called for negative gearing and capital gains tax incentives to be ­reviewed in submissions to inquiries. Labor Treasury spokesman Chris Bowen said yesterday tightening tax treatment of investment property was an argument “everybody hears except Malcolm Turnbull and Scott Morrison who have their heads in the sand”.

Dr Lowe said the popularity of interest-only loans in Australia was unusual. Other countries ­allowed them only if the borrower had already contributed a lot of equity. “Too many loans are still made where the borrower has the skinniest of income buffers after interest payments,” he said. “In some cases, lenders are assuming that people can live more frugally than in practice they can, leaving little buffer if things go wrong.”

Dr Lowe said the root cause of the housing boom was the failure of governments to provide the transport infrastructure needed to support strongly growing populations, particularly in the big capital cities. “Nothing increases the supply of well-located land like good transport links,” he said. “Under-investment in this area is one of the factors that has pushed housing prices up.”

Dr Lowe rejected the idea easy credit was the primary cause of the boom, noting prices were subdued in other cities, and falling in Perth, where financial conditions were the same. Treasury, which is on the Council of Financial Regulators, is preparing a housing affordability package for next month’s budget that is expected to focus on increasing land supply.

Mr Murray called for the government to implement the FSI’s recommendation to ban superannuation funds from borrowing. The inquiry saw the ability of self-managed super funds to take on non-recourse loans to invest in residential property as a threat to stability, a view shared by the Reserve. It was the only recommendation from the inquiry rejected by the Abbott government.

Morrison talks down drastic action

Mr Morrison was asked about changes to capital gains tax after speculation Treasury had modeled the impact of alterations to the concession.

While he did not rule out changes, he said it would be difficult to make blanket changes considering the differing housing markets across cities.

“The key judgement that has to be made is in any of these areas that don’t do harm and that status of our housing market around the country are very different.”

“This is why the government in addressing these demand side issues in the housing market has always preferred working with the regulators to ensure they use their common sense calibrated and measured responses,” Mr Morrison told ABC Radio.

Finance Minister Mathias Cormann has previously said the government was not working on any plans to make changes to CGT, while Prime Minister Malcolm Turnbull has criticised Labor’s CGT proposals.

Mr Turnbull, speaking to reporters in Tasmania, refused to be drawn on any speculation about housing changes.

“I encourage everyone to wait for the Budget,” he said.

Mr Turnbull said the government would heed Dr Lowe’s warning but argued the RBA warning was maining about the dangers of interest-only loans.

“There is always a concern about, you know, when property prices rise too quickly and this is particularly an issue in Sydney and in Melbourne.”

“This is the role of the central bank, to monitor these movements in prices and ensure that there is some restraint and you can see that the restraint or the restriction in the amount of interest-only loans made to investors is a very timely one,” Mr Turnbull said.

Labor Shadow Treasurer Chris Bowen said it was a “strong intervention” by Dr Lowe and said it bolstered their case for changes to negative gearing and capital gains tax breaks.

Additional reporting: Adam Creighton