The Council of Financial Regulators, displacing APRA, has decided what levers it will pull to slow things down in the housing market.
A bigger serviceability buffer and a cap on the debt to income ratio may work.
The Reserve Bank’s Michele Bullock Assistant Governor (Financial System) delivered her bombshells in a speech - The Housing Market and Financial Stability - to the Bloomberg Inside Track yesterday.
“The unprecedented monetary and fiscal support to the Australian economy through the pandemic has helped ‘build a bridge’ to the other side,” she said, using framing that the RBA still love.
“The strong recovery in the housing market is part of that bridge,” Bullock said, before moving quickly to the counter-factual.
“With the increase in housing prices and housing debt, risks to financial stability could be building.”
“Over-exuberance in the housing market can amplify stability risks in two ways. First, rapid price rises can increase the likelihood that some new borrowers will over-stretch their financial capacity in order to obtain a new loan, making them more likely to reduce their consumption in response to a shock to their incomes,” Bullock said.
“Second, if rapid price rises ultimately prove to be unsustainable they could lead to sharp declines in price and turnover in the future. This in turn could result in reduced spending, both directly as a result of a decline in turnover and through the wealth effect.
Household debt has increased substantially over the past 30, mainly over the long boom years of the 1990s and 2000s “as declines in inflation and interest rates, and rises in real income, meant that people were able to service higher levels of debt”.
“Financial liberalisation in the 1980s also removed some unnecessary credit constraints,” Bullock said.
“Both of these are permanent shifts and no cause for alarm. And although household debt to income in Australia is higher than many overseas countries, this can be partly explained by the fact that, unlike many other countries, households own the rental stock (and hence have the debt) in Australia, rather than corporate landlords owned by specialist firms or pension funds.”
International and domestic evidence suggests households with high levels of debt are more likely to curb consumption in response to shocks in income or wealth.
“A large number of highly indebted households reacting in such a way to an economic downturn or decline in housing prices could amplify the economic shock,” Bullock said.
Although it is picking up, investor activity in the housing market is currently nowhere near the levels it was in 2014 when APRA introduced its investor lending benchmark.
“And it is hard to judge in real time whether housing prices are out of line with fundamentals,” Bullock said.
“Nevertheless, when prices are rising very rapidly and there are expectations that this will continue, borrowers are more likely to overstretch their financial capacity in order to purchase property. We are therefore watching developments in housing markets and credit very closely.”
What can the authorities do, aside from monitoring developments? Bullock went on to ask.
“Unlike in 2014 and 2017, the concerns this time are not specific types of lending such as investor or interest only lending. So the tools used at that time are not really appropriate at this time.”
Any macro-prudential tools brought into play to address rising risks should be targeted at the risks arising from highly indebted borrowers.
“Tools that address serviceability of loans and the amount of credit that can be obtained by individual borrowers are more likely to be relevant. Indeed, we have seen such tools used in a number of countries in recent times and they could be employed in Australia should the circumstances be judged to warrant it,” Bullock said.
In Banking Day’s view, they do.