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Jan 16, 2009

First home owners grant inflates housing prices

Despite the best political intentions, Kevin Rudd’s much vaunted increase in the first home owner’s grant has had a negative effect on first home owners, writes Adam Schwab.

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It was always going to happen. Despite the best political intentions, Kevin Rudd’s much vaunted increase in the first home owner’s grant has, despite outward appearances, had a negative effect on first home owners. As The Age’s Natalie Craig reported yesterday that house prices in areas dominated by first home owners rose strongly since October, while more exclusive suburbs suffered significant falls in value. According to Residex, house prices in Broadmeadows (in Melbourne’s west) rose by 6 percent since October, Niddrie was up by 4.5 percent “while the first-home buyer’s enclave of Caroline Springs grew 4 per cent to $324,500.”

In nominal terms since the Federal Government increased the first home owners grant, prices in Caroline Springs have broadly risen by $12,000 — almost the exact amount as the increase in the grant. This shouldn’t come as a huge surprise to Crikey readers — we predicted as much last October when Rudd unveiled the grant $10 billion wealth transfer. At the time, Crikey noted that:

The most obvious problem with the grant is that it doesn’t actually benefit home buyers. Most recipients of the grant will be purchasing lower-end properties, probably in competition with each other. Giving them extra money will have the effect of “bidding up” the property up by the value of the grant. It is inflation in its purest form.

As expected, there are winners from the higher grant. Those selling houses in the likes of Broadmeadows and Caroline Springs receive between $7,000 and $14,000 more than they would have previously (depending on whether it is a new house being sold by a developer or a ‘second-hand’ property).

However, while vendors benefit, the higher grant is detrimental to first home buys for two reasons.

  • First, the inflated purchase price leads to increased associated costs such as stamp duty (which is based on the purchase price).
  • Second, the upped grant leads to a greater debt commitment (that is because the grant is used by purchased to fund their deposit, but they end up paying more for the property anyway, so their mortgage will be greater).

There is no point in giving someone $7,000 in free money to buy something which then costs them $10,000 more as a result.

This example in bad policy is not unlike the hundreds of billions which the US Government and Federal Reserve have squandered on its TARP program. Increasing the first home owners grant does not structurally fix any economic problems — rather, it serves to increase the debt load and artificially raise the price of homes. Bill Bonner explained the problem of governments using debt to dig itself out of a hole caused by debt in The Daily Reckoning when he opined that:

The cure for a slump is a slump.

A real correction corrects. Cold turkey. Rehab. Debts are paid off, worked off, or written off. Prices fall to the point where they make sense again. Consumer items become affordable; an ordinary person can buy a house. An ordinary investor can buy a stock… or an apartment building… and get a decent return on his money. An ordinary businessman can make a profit from operations; he doesn’t have to count on stock options and rising share prices in order to make a living.

There is nothing wrong with allowing house prices to fall to the point where they are affordable for teachers, nurses, factory workers and cleaners without requiring the purchaser to assume a mortgage seven times their annual income. Transferring money from taxpayers to first home buyers so they can bid up the price of their first home will not prevent Australia from sinking into recession. In fact, it will have the opposite effect — artificially inflating house prices and requiring purchasers to take on additional debt.

If the Government really wanted to help first home owners they would remove the Howard Government’s grant altogether, but who are we to let a sound economic policy get in the way of a populist vote grab?

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3 comments

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3 thoughts on “First home owners grant inflates housing prices

  1. Andrew

    Both the Rudd and Howard governments have had a choice between two constituencies; those who are invested in the bubble and those who are not. Clearly prices falling is in the interests of everyone waiting to be able to afford a house. If you ‘own a house’, which is our quaint term for owning a mortgage which includes a contractual agreement to use the house under certain circumstances, then falling prices mean negative equity. If you are a bank, that means you can’t pretend you have a whole lot of assets you don’t really have. All this is bad for the bubble investors and the Government has decided their pain is more politically damaging than the pain of those waiting for prices to drop. But since the number of people locked out of the market increases every year, that will change. Personally, I think people should pay for their own investment decisions.

  2. Paul of the Central Highlands

    Not that it would change your POV on the grant, but wasn’t the first home owners grant scheme set up originally by Gough Whitlam?

  3. gARy joHnSOn

    adam i said it before but you are da bright light in da dark room. i suspect da figures you quoted were supplied by da various realestate self-interest groups, so they are probably well under quoted.

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