11 May 2017

This forum is the latest iteration of the McKell Institutes very worthwhile contribution to the public policy debate in Australia, particularly around housing affordability.

Ive said before that it is always a pleasure to speak at McKell Institute events, partly because of the quality of the Institutes work, and partly because I regard William McKell as one of the key architects of the successful Labor governing model.

This forum is important because housing affordability is important.

We have made housing affordability a key focus of our policy developments and announcements.

We were told the Government was going to catch up with us by making housing affordability a centre piece of the May budget.

Last week the Prime Minister denied this and despite all the hype from the Treasurer and Minister Sukkar said that in fact housing affordability wouldnt be a major focus.

We knew they were all at internal war about what would be in their package, now it appears they cant even agree on whether there will be a package in their budget.

Of course, improving housing affordability should be a focus for all governments, including the Federal Government.

The evidence that we are facing a crisis in housing affordability is crystal clear.

Lets have a brief look at the key data:

  • House prices have risen 30% on average across the country since the Liberals came to office, 50% here in Sydney.
  • Home ownership rates for 25 to 34 year olds have collapsed from around 60% to 40% over the past 30 years.
  • While home ownership is at 60-year lows.
  • Rates of property investment have been at record highs. Rates of first home ownership are at record lows.
  • The number of investors with at least 5 properties is growing at three times the rate as the group with just one property.

Our reforms will put first home buyers back on a level playing field with investors.

This is a matter of social justice.

A matter of intergenerational equity. Young people in Australia have every right to say that the system is not currently working for them. Because it isnt.

And let us have none of this nonsense that the market should be allowed to rip in housing.

The fact of the matter is that there is no sector of our economy more impacted by government regulation now.

Between the tax system, with the most generous property investment tax concessions in the world, the regulation of superannuation investments in property, foreign investment rules, infrastructure spending, state and local planning regulations, Government affects housing affordability every day.

And at the moment, Government intervention makes affordability worse, not better. This has to change.

Eighteen months ago, Labor announced our negative gearing and capital gains tax reform policies.

As I said, we currently have the most generous tax concessions for property investment in the world.

Any so-called housing affordability policy which doesnt deal with this is a sham.

A refusal to deal with negative gearing in particular puts potential first home buyers at a distinct disadvantage compared to investors.

Negative gearing reform has to be the start of proper housing affordability policy. But it doesnt need to be the end.

Last week we announced our second tranche of housing affordability policies, building on tax reform.

The policies we announced last week include:

  • Facilitating a COAG process attempt to get a consistently applied state based vacant property tax across all major cities.
  • Increasing foreign investor fees and penalties
  • Establishing a bond aggregator to increase investment in affordable housing
  • Boosting homelessness support for vulnerable Australians
  • Getting better results from the National Affordable Housing Agreement, including in areas like housing supply and inclusionary zoning.
  • And, importantly, prohibiting self-managed superannuation funds from borrowing.

This last aspect of what we announced last week is important.

It is about financial stability.

And today, I want to make the case to you specifically as to why financial stability is an important part of this debate.

And its one the Government has been wilfully ignoring.

Over the last few years, housing affordability, rapid house price growth and record leverage has increasingly become an issue not only of fairness and equity, but also one of financial stability.

I made the case last year that the alarm bells were starting to ring on household debt and that ballooning leverage undermines our financial stability and provides for dangers in the event of a global downturn.

Its not the governments responsibility to dictate to households and businesses whether they should borrow money and how they spend it.

But it is a governments responsibility to ensure that policy settings are appropriate and do not adversely distort economic decision making.

If Australia faced the unfortunate scenario of an economic shock down the track a responsible government would be able to tell the Australian people they did everything in their power to prevent a situation being worse than it could otherwise have been.

The current Government would simply be unable to do this.

We know that financial instability can cause real damage to the economy.

But it is important to note, particularly at a progressive think tank such as McKell, that this damage is not equally shared throughout the economy or society.

In the Australian context, a property based economic shock would impact on those who can least afford it.

People of wealth can and usually do diversity their portfolio, spreading their risk.

People of less wealth tend to have most or all of that wealth tied up in the family home, and thus be particularly vulnerable to shocks.

As the RBAs recent Financial Stability Review noted, around one-third of borrowers currently have no accrued buffer or a buffer of less than one months repayments and most worryingly these people tend to be those with newer mortgages or are lower-income or lower-wealth households.

Now I am not, and never will be alarmist about the risks facing the Australian economy.

We in the Opposition are always careful in our language.

But we are also realistic: Governments and Oppositions need to be alert to potential risks in the economy, even if they are not overwhelmingly likely. The Opposition is alive to the risks. The Government, frankly is asleep at the wheel.

It is the job of Government to manage risks, and this Government has not been doing it.

What does history tell us?

We know that leverage matters for financial stability.

As Glenn Stevens said in 2012 in the RBAs report on Property Markets and Financial Stability when it comes to property prices, Its actually the leverage that matters.

Particularly for property because of the sheer size of the housing market, the importance it plays in underpinning the ability of households to spend, and the interconnections between the housing market and the broader financial system particularly the banks.

But its also the composition of the property market and how it might behave in the event of a downturn.

As the RBA has noted in previous speeches there is one aspect of systemic risk that makes property markets especially important for financial stability, it is pro-cyclicality.

That is, say an investor sells his or her property after its price falls, it may induce others to sell theirs which can drive large pro-cyclical swings in asset prices.

We can draw on experience from the GFC.

Commentators rightly talk a lot about Lehman Brothers being the catalyst for the ensuring credit crisis, but the reality is that well before this time, risks were beginning to rise.

One of the reasons cited for the depth and severity of the US slowdown was the rapid increase in household leverage in the lead up to the crisis.

The IMF Economic Review has observed that the initial economic slowdown was a result of a highly leveraged household sector unable to keep pace with its debt obligations.

The IMF has also pointed out that the Great Recession became more severe in high-leverage growth counties relative to low-leverage growth countries.

Leverage rose at a fast clip around the world on the back of surging asset prices.

OECD data shows that US household debt to net disposable income grew from 112% to 143% in the period from 2002 to 2007.

Similarly, UK household debt to disposable income increased from 129% to 173%.

Australia was no different, with household debt to disposable income increasing from 158% to a very high 196% over the 5 years to 2007.

Over the last decade, despite record low interest rates US and UK households have deleveraged somewhat.

US and UK debt to disposable incomes is now down to 112% and 150% respectively, well down on the peaks they experienced in the lead up to the GFC.

But Australias household indebtedness has gone in the other direction with an investor led property boom playing a major role. We are going against international trends, and in the wrong direction.

The most recent OECD data shows Australias household debt to disposable income hit 211% in 2015 and has continued its ascent since then.

Australia now has the silver medal amongst advanced nations when it comes to the indebtedness of households a proportion of the economy.

Bank of International Settlements data shows that Australias households debt to GDP is now worth 123% of GDP. Only Switzerland has a higher percentage at 128%.

To put this into perspective, the aggregate for advanced economies is around 76% of GDP.

This is no doubt why the RBA is increasingly worried about the risks associated with high indebtedness.

The RBAs recent financial stability review concluded that vulnerabilities related to household debt and the housing market more generally have increased.

The regulators are increasingly concerned of what these trends mean for the health of the Australian economy.

This is because there is macroeconomic dimension to rapidly rising leverage.

As the IMF has stated high private debt not only increases the likelihood of a financial crisis but can also hamper growth even in its absence, as highly indebted borrowers eventually decrease their consumption and investment.

The Australian economy relies heavily on people going out and spending money on goods and services.

Consumption makes up close to 60% of all economic activity in Australia.

If consumption falters, so does the economy.

As Moodys has said in event of a negative income shock, the scope for Australian households to draw down parts of their financial assets to maintain debt service and overall spending is more limited than elsewhere.

Its now been nearly 2 years since this Government received its Financial System Inquiry from David Murray.

28 months ago.

The Liberal Government established the Murray Inquiry with much fanfare and rhetoric.

But in relation to some important findings in the Murray Report, they are collecting dust. This is just plain negligent.

David Murray put up in big red flashing lights that negative gearing and capital gains tax concessions are major tax distortions which tend to encourage leveraged and speculative investment and housing is a potential source of systemic risk for the financial system and the economy".

He also recommended restoring the prohibition on direct borrowing in superannuation funds because further growth in superannuation funds direct borrowing would, over time, increase risk in the financial system.

David Murray made it very clear that tax settings for housing encourage leverage and speculative activity because of the asymmetry of housing expenses and the capital gains on housing.

This is because investors can deduct the full value of their housing related investment expenses, but then are taxed at just half their marginal rate on the eventual capital gain.

This means that the higher the leverage, the bigger the potential windfall for investors if asset prices continue rising.

This is one of the reasons weve seen investors account for a record half of all property purchases at times in recent years.

Since the December 2014 when the government received the FSI report and when property prices had already been rising strongly weve seen:

  • property prices increase by 21% country wide, 26% in Sydney;
  • APRA announce two rounds of macruprudential interventions, increasingly worried by the investor segment of the market and the rise in interest only loans;
  • The IMF, RBA, Grattan Institute, I could go through dozens more making the case since 2014 that tax policies that encourage leverage increase risks for the financial system.

The IMF came out last year saying the tax system provides households with incentives for leveraged real estate investment that likely amplifies housing cycles.

And the Grattan Institute has stated Negative gearing has many undesirable consequences. It reduces rates of home ownership. It reduces the availability of long-term rentals. It increases the volatility of housing markets, increasing the risks to the Australian financial system.

But the Government has been too busy trying to get its political strategy in shape, spending more time trying to run ridiculous scare campaigns than spending time reflecting on the policy substance of this advice.

When experts like David Murray, the IMF, Grattan Institute, and the RBA warn the government that there are issues with our tax system and other areas of the financial system that could over time generate systemic risks, they should listen, and act.

As the Bank for International Settlements states financial stability is a precondition for sustained economic growth and prosperity.

Its why its more important than ever to ensure we have domestic policy settings in place which support and not hinder financial stability.

Its why weve seen APRA intervene with its second round of macruprudential policies, the most recent round trying to rein in the growth in interest only loans.

The RBAs Financial Stability Review said recently that:

Household indebtedness has continued to rise and some riskier types of borrowing, such as interest-only lending, remain prevalent[1]

Interest only loans now account nearly two thirds of all investor loans [64%] and nearly a quarter of all owner occupier loans.

And not surprisingly, just days after APRAs intervention, Philip Lowe went on the record as saying one of the key factors driving the increase in interest only loans is the taxation arrangements that apply to investment in residential property in Australia.

As the RBA said very clearly in its Financial Stability Review Since interest payments on investment loans are tax deductible, the incentive to pay down a loans principal is reduced and that interest only loans enable investors to maintain a higher level of leverage and so magnify potential gains or losses if housing prices rise or fall.

In a similar vein, last week we announced our decision to implement the Murray Inquirys recommendation to restore the prohibition on borrowing in superannuation funds.

As the FSI report stated Further growth in superannuation funds direct borrowing would, over time, increase risk in the financial system.

To be clear, limited recourse borrowing in self-managed superannuation funds (SMSFs) is still a relatively small part of the investor base, but this borrowing has grown by more than 860% since 2012.

But the fact is SMSFs remain outside the regulatory net of APRA and as such SMSFs are likely to be less scrutinised over the long-run.

Implementing the Murray recommendation will achieve a trifecta of positive policy outcomes.

It will prevent the unnecessary build-up of risk in Australias superannuation system, reduce future calls on the aged pension as a result of a less diversified superannuation system and make the financial system more resilient in the face of potential economic shocks.

Given our diversified superannuation system helped cushion us from the credit squeeze during the GFC, it would be negligent to ignore this.

We call on the Government to adopt this immediately. If they dont we will, as a priority on coming to office.

Its why Labor has set out its comprehensive plan for reforms to negative gearing and capital gains tax concessions, while also looking at other settings like borrowing in super which present risks to the financial system.

Our reforms arent piecemeal.

Suggestions that the Government may trim the capital gains tax discount to 40% just for one asset like housing would be tinkering at the edges and would introduce another unfavourable distortion as people would be encouraged to purchase potentially more risky assets like shares.

Reforming tax and other settings which encourage excessive leverage will ultimately leave our economy better placed over time and will help reduce the impact and severity of any shock.


So hopefully today Ive made the case that reforming negative gearing and the capital gains tax discount and changes to superannuation rules are not only in the interests of Australias first home buyers, but are also in the interests of a healthy Australian economy and a resilient financial system.

Australias household balance sheets are virtually the most indebted in the developed world which is not helped by policies which encourage them to take on more debt.

Labor will continue to prosecute the case that changes to negative gearing and capital gains will not only help first home buyers but will reduce distortions reducing risk the economy something that is good for financial stability.

I look forward to the McKell Institute playing a valuable public role in this on-going debate, as you already have done.