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Federal

Oct 21, 2010

Hockey gets it right on banks

Joe Hockey may have stumbled on interest rate regulation this regulation, but he is right to call for a debate about the way we regulate the banks.

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Joe Hockey may have blundered into the issue of bank regulation, but he is dead right about the need for a fundamental debate about financial regulation.

Hockey overplayed his attack on Wayne Swan this morning over bank interest rate rises outside the RBA cash rate when he appeared to suggest legislative measures to curb interest rate rises. He was very quickly under fire from all quarters, particularly from the bankers’ cartel, not least for the apparent hypocrisy of the party of small government calling for more regulation of markets.

At a press conference this morning he pulled back significantly, and used as his cover a call for a “social compact” and a fundamental debate about the responsibilities of major banks and how they should be regulated. He is not, he made clear, calling for regulation of interest rates.

Hockey will doubtless be hammered by the Press Gallery for his clumsy handling but what he had to say about finance regulation was the most sensible thing we’ve heard from a major party politician on financial regulation since the GFC.

The Reserve Bank made it clear this week that the major banks’ repeated claims that they are facing higher borrowing costs are, not to put too fine a point on it, rubbish. The RBA minutes from its meeting two weeks ago were extraordinarily blunt for the central bank: “members noted staff estimates that banks’ funding costs had been relatively flat over recent months. While the spread between lending rates and funding costs was below its peak in 2009, it remained well above its pre-crisis level.”

If anything, that suggests that, in the event of a rate rise by the RBA, there’s a case for the Big Four to increase rates by less than the increase in the cash rate, not more.

There are two key issues raised by Hockey that should form the basis of the debate he wants to see.

One is the need for greater competition for the big banks, which has been seriously impaired since the GFC. Hockey mentioned an idea he raised in 2009, of a government guarantee for Residential Mortgage Backed Securities, to try to breathe further life into the non-bank lending market. That sector has been on government-funded life support ever since, courtesy of $16b worth of funding from Wayne Swan. It has been slowly — very slowly — recovering, but is obviously not within cooee of providing the sort of competitive pressure it provided for the banks before the GFC.

If Hockey is serious about encouraging more competition for the big banks he should be exploring some of the ideas raised by the Six Economists in July last year, especially around a “people’s bank” that could deliver low-cost financial and lending services (I’ve previously suggested Australia Post could be the delivery mechanism for such a bank, or AP could team up with one of the major regional banks).

The ACCC should also be looking a lot more closely at the manner in which the Big Banks appear to be coordinating their interest rate rises by publicly flagging rate increases beyond the cash rate — behaviour that looks an awful lot like a public kind of collusion between oligopolists.

But Hockey raised a more fundamental issue of whether banks should be growth stocks or yield stocks, and in doing so has opened the way to the sort of debate that some economists have been calling for for some time.

In the wake of the GFC, there is a basic tension at the heart of our regulation of the big banks. Their core activities of domestic borrowing and lending for households and businesses are never going to grow rapidly. But bank executives are ruthlessly focused on growing their share prices. This is where the dilemma over being growth stocks or yield stocks plays out. Our big banks make excellent yield stocks – they are low-risk, have been tested and proven by the GFC, and produce a steady, strong profit stream. But they’re not growth stocks, particularly in a market where the RBA is clearly anxious to limit the growth of credit.

The only way the banks will become growth stocks is by expanding into riskier areas of operation.

Bear in mind that, by accident and design, it was our banks’ non-exposure to riskier activities, unlike their American and European counterparts, that was a key reason why we dodged the GFC bullet. Now our banks are hunting for growth, most obviously in offshore expansion, for example expanding into riskier Asian markets. And they’re doing so with an implicit government guarantee. The Government’s actions in the GFC signalled that, indeed, our largest banks are too big to be allowed to fail. They are so crucial to Australian economy that they will not be allowed to fail — no matter how risky their behaviour.

It’s as good an example of moral hazard as you’ll get at the moment.

The banks are behaving like private companies but should be regulated like utilities, and compelled to focus on lower-risk, bread-and-butter financial services. They already generate, as Hockey said this morning, “super profits”. CEOs’ need to pump up their share prices for the sake of a bigger performance bonus shouldn’t place at risk the critical economic role played by the banks, nor should it be supported by a de facto government guarantee.

These are the issues Hockey has now put on the table, whether by accident or design. It’s in contrast to Wayne Swan, who since his (deft) handling of the GFC has been strangely reticent on the issue of banking competition and regulation. If Swan was smart, he’d put aside bagging Hockey — there’ll be lots of other opportunities to do that — and seize on the chance to pursue them.

Oh and one more thing. Hockey is right about the banks earning super profits. Which begs the question — is a super profits tax on banks worth considering?

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117 comments

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117 thoughts on “Hockey gets it right on banks

  1. John

    Dear Bernard,
    When did you become a communist?

  2. Puff, the Magic Dragon.

    [But Hockey raised a more fundamental issue of whether banks should be growth stocks or yield stocks,]

    [But bank executives are ruthlessly focused on growing their share prices. ]

    I wonder what part do remuneration packages play in driving this focus?

    In my limited knowledge of the financial sector, I have questions. As we have seen, if the foray into ‘riskier activities’ goes horribly wrong the losses are socialised. If these banks (and by extension the investments of their shareholders) are too big to be allowed to fail, they are too big to take decisions that places risk on the taxpayer without the taxpayer (the government) having a say and sharing in the profits.

    If the banks wish to pursue growth of share price and take on risk, without expecting the socialisation of losses, then people need an alternative where they can put their money and avoid that risk.

    Bernard, this point you made is very pertinent.
    [CEOs’ need to pump up their share prices for the sake of a bigger performance bonus shouldn’t place at risk the critical economic role played by the banks, nor should it be supported by a de facto government guarantee.]

  3. Jimmy

    A “super profits tax” (which by the way si the worst name ever thought of) works for the mining sector because effectively all it is doing is charging the miners more for the resources the are buying off the commonwealth. I cna not see how you could apply one to the banking or any other industry and still operate an economy which encourages growth.
    As for greater regulation to promote competition or control rates this sounds to me like one of those things like “stop the boats” which sounds great but doesn’t work in practice.
    Basically until the consumer starts voting with their feet and moving to the smaller banks or credit unions the banks will be allowed to dictate. Earlier this month I was able to take out a loan with a fixed rate for 1 year of 6.5% at a credit union, the same loan with the CBA is 7.09%.

  4. David

    Bernard Hockey says, is not, he made clear, calling for regulation of interest rates. That at a press stop. So why on ABC AM this morning did he launch into a diatribe of evasive nonsense about “different planks” that the Treasurer has available and should use on the banks …”please describe these planks, Mr Hockey?”..well you know there are many and he is scared of the banks, he and the Govt are incapable of managing the economy….”but what are these various planks that you say you would use and Mr Swan is not?”…”well Mr Swan just doesn’t know what he is doing, he is hopeless the banks do as they like and he comes out and says they shouldn’t but does nothing.”…..more evasive rubbish from Hockey. One set of answers for a gaggle of media and another for the great unwashed public, who are sitting ducks for a drop of good old politicising and to hell with the facts. Hockey is an oaf and Swan is right to bag him for the incompetent big mouth fool he is.

  5. dirt armature

    Could Hockey please also ‘stumble onto’ a populist but incredibly accurate spray about the usury levels of interest rates for credit cards? Who regulates those vampiric blood-sucking pieces of plastic?

  6. Apathy

    Bernard – I think you are being very unkind by giving the credit to Joe for raising “these fundamental issues.” One suspects that it was probably more likely a staffer earning their keep by once again partaking in the delicate art of Deflectus Ignoramus. One suspects that these staffers might be the faceless men (and women) of the Liberal Party.

  7. Jimmy

    David, Hockey is one of the best at repeating the same answer to different questions. This is one of the biggest problems with Politics today, the few times journalists ask the hard questions they just get todays sound bite repeated ad nauseum. Interviewer’s should jsut stop the interview and leave dead air time as soon as politicians start to do this.

  8. Martin C. Jones

    Two points: the first on the spread between lending and funding costs, and the second on a super profits tax.

    1) Spreads
    “While the spread between lending rates and funding costs was below its peak in 2009, it remained well above its pre-crisis level.”

    If anything, that suggests that, in the event of a rate rise by the RBA, there’s a case for the Big Four to increase rates by less than the increase in the cash rate, not more.

    Lending/funding spread falls, RBA/bank rate spread increases; Lending/funding spread increases (above pre-crisis level), RBA/bank rate spread falls – makes sense, right? Only if the RBA/bank rate spread increase fully offset the initial lending/funding spread fall; if it didn’t – if the banks absorbed some of the costs – then, depending on the magnitude of the various movements, banks may still have a case to increase their rates more than the RBAs.
    I don’t know the answer to this – perhaps Keane does, but if so he’s ignored it. At any rate, the argument is logically incomplete without this step.

    2) Super profits tax
    I suspect Keane is just provoking us a little, but the prime justification behind the RSPT was the fact that we (Australia) were not getting an equitable return on the sale of non-renewable public assets (resources), rather than that super profits were being made by the mining industry. The “super profits” bit was marketing more than anything else (“those dirty stinking rich buggers deserve to pay more!”), but as a justification for imposing a higher tax rate it’s not nearly as strong.

    That’s not to say a super profits tax is unjustified – we have a progressive personal tax scale, and many arguments for that could be applied to a progressive business tax. But the RSPT/MRRT is a very different kettle of fish to a higher rate of tax on a (renewable) services industry.

  9. Space Kidette

    Bernard,

    The banks have definitely overstepped the mark. And they should be regulated, as there is absolutely no doubt they are gouging customers. I spent many years building computer systems, worth millions, whose sole task was to get their customers to spend more. And this gouging really needs to be be bought into line.

    However, Mr. Hockey’s inept comments this morning, on this topic, did not suggest anything like ‘let’s debate this’, in fact, he lied to the Australian Public by suggesting that the government had the means to control this – now.

  10. Damien

    Bernard, like David, I heard Joe Hockey on AM this morning and he sure didn’t say the words you put in his mouth in this article. Instead he stumbled over the facts, evaded any question in which detail was sought (“Yes, yes, Mr Hockey, but waht are these “levers” the Treasurer controls?” Joe replies: “don’t worry there are plenty of them.”). All here really wanted to say was the Swan has no credibility as Treasurer and would be responsible for any decision made by the big four.

    Anyway as long as it plays well with the shock jocks, like Allan Jones, Joe doesn’t care how stupid he sounded on AM or what credence a debate on financial regulation might have. He and his boss Abbott are most definetly not interested in any such thing and have nothing to add to it in any case.

  11. Jimmy

    “This is one of their lunatic fringe-type ideas but that’s the problem that the Gillard Government’s got now,”

    Liberal MP Don Randall

  12. Observation

    We all see the reports of the banks making increasing profit margins and their share prices keep going up. Most of the working population are locked into mortgages or business loans in order to survive the current credit dependency manufactured over the past decades.

    So what if the banks raised interest rates by 2% or even 4%….what could we do? They will push as hard as they can because no longer is a bank seen as a place to sit down and discuss sensible financial advice. A place where they are seen as good corporate citizens and community benefactors. They are big business, ruthless and calculating.

    Maybe we all should have access to money from the RBA and be charged at their interest rates!

  13. Kevin Cox

    A people’s bank worked very well for Australia 100 years ago when Denison Miller became the first governor of the Commonwealth Bank. It supplied low interest loans to the government to pay for the first world war and build much infrastructure. It did this without borrowing any money from overseas – the total capital of the bank was ten thousand pounds – but it was backed by the people via the Commonwealth Government. A people’s bank can do the same thing and supply credit to Australians at very low rates IF the credit is used to create new productive assets. Such things could be renewable energy plants, Sydney Metros, Murray Darling water saving facilities.

  14. the man on the clapham omnibus

    This was one of the debates in the US congress, how much the public should risk socializing the losses for Casino style banking. One could argue for different prudential regulation or even separate corporations in these circumstances.

    One issue we definitely have is that there isn’t effectively a free market to change banks. In effect it is ‘free’ on their terms.

    The entry and exit fees for mortgages as well as the complexity of the undertaking, are definitely of a punitive nature inhibiting the freedom of choice should a consumer wish to exercise ‘choice’. Legislation in this area would be welcome and would allow consumers to change if they didn’t like the risk profile of the bank they had chosen.

    Investigating Credit card fees, transaction costs for low value withdrawals and the exorbitant entry/exit costs would be ripe for review.

  15. Jimmy

    Observation – yes the big banks are ruthless and just out to make money, I’m sure we’ve all had the experience of being asked if we want a home loan when we are withdrawing our last $20 or not being able to do any meaningful business with the local branch manager as it is all done through head office but there are other options out there and until we start taking our debt elsewhere nothing will change.

  16. Jimmy

    The man – I thought Swan brought in that kind of legislation but it only applied to new loans, meaning it will slowly wash through the system over the next 25 years.

  17. the man on the clapham omnibus

    @Jimmy

    You may be right, wasn’t aware of this undertaking, do you know whether it has taken effect yet?

    Comments on the financial websites seems to indicate that determining the costs of the process and the bureaucratic pain involved is still a fairly large burden.

    On a search just noticed the demise of flickyourbank.com.au.

  18. Jimmy

    The man – I thought legislation was passed mid last term but can’t be sure, and not sure as to what effect it had in the real world.

  19. Observation

    The Man – A peoples bank would be good….but could you imagine the rabble we have in parliament right now (government or opposition) organizing something like that with the pressure that would be applied by the private media. No back bone there I’m afraid.

    Jimmy – I agree with the walking with your feet strategy, Police and Nurses Credit Union or something of the sort….but wouldn’t it be good if there was an option out there with a strong moral stance with company policies that would attract the pro community and greater good people amongst us! If you know of one let me know.

  20. zut alors

    David and Jimmy,

    Waleed Ali conducted a very good interview with Hockey, he persisted in bringing him back to the question and pointed out, firmly, that it had not been answered. It was one of the best interviews I’ve seen on ABC Breakfast. Onya Waleed.

    Joe Hockey is trying to appeal to voters with mortgages. Newsflash!! Not everybody and not every business in Australia has a mortgage. Many voters are self-funded retirees who would relish the banks bumping up their interest rates. Personally, I look forward to it.

  21. the man on the clapham omnibus

    @Observation , agreed , wasn’t explicitly pushing a new ‘socialist’ bank , more for a ‘free’ market and easier change that would hopefully achieve the same outcomes. Hoping Australia Post will propose something soon along the lines of Kiwibank in NZ.

    Just remembered this release from a few months ago from the FSU employee survey:

    These would be the people in the industry and on the so called ‘front-line’ and would be seeing the problems first hand:

    http://www.optuszoo.com.au/news/153711//bank-workers-stressed-by-peddling-debt.html

    To paraphrase:
    * Too much off shoring, decreased service to customers and culling local jobs
    * Pay gap between CEO’s and workers too great
    * 73 per cent said sales targets for debt products increased each year
    * >50 % felt pressure in selling products customers did not need or could not afford
    * Sales targets for debt products are linked to remuneration
    * 80 per cent of respondents said Australia needed tougher regulations on personal debt
    * 82 per cent supported new, international rules to prevent high-risk banking activities

  22. Jimmy

    Zut Alors – I didn’t hear the interivew but I am a big fan of Waleed. I can imagine the interview though, Hockey laughing or sighing in disbelief after every question and then launching into his irrelevant spiel.

    My point was only that these interviews are dull and uniformative with the end result is that it is the sound bite that makes the evening news, if interviewers just shut the interview down 1 minute in when they started this rot and used the other 4 minutes to embarrass the offender with out giving him at right of reply they might think twice.

    Observation, as a rural resident I have seen the Bendigo’s rural banks save many a small town when the big boys left, they aren’t as competitive on rates as the credit union I deal with but a little more community minded.

  23. Jimmy

    The man – Interesting & not suprising survey results. The sell, sell, sell culture is extraordinary. As I said earlier the question of would you like a home loan when withdrawing your last $20 is ridiculous, I mean how many people actually go “Well now you mention it a home loan might come in handy”

  24. zut alors

    Holden Back, Thanks for that enlightening link. The Member for Canning was given an opportunity to make an explanatory statement about his faux-pas at the end of Question Time this arvo but made a dog’s breakfast of it.

    Jimmy, I agree about the Bendigo Bank. Often their term deposit rates are competitive with the big 4 but I’m unsure about mortgage rates. I have one of their Visa cards which is linked to the RSPCA – they charge $3 per month to your balance and it’s sent as a donation to the RSPCA (tax deductible, Bendigo provide a tax statement for it). The last time I looked at their figures they’d donated in excess of $300K via their customers in one year.

  25. freecountry

    First of all, the taxpayer’s $16 billion investment in RMBS to make the mortgage market competitive, was a measure proposed by Turnbull to correct a market distortion that the government had already created by other means.

    In 2007 we had a very competitive mortgage market. In 2008 the non-bank lenders were caught between a credit crisis on one side, and a government on the other side which did several unnecessary favours for the banks. The first of these favours were for banks and non-banks alike:

    [1. Boosting first home owner prices. This was based on a bit of creative interpretation of Treasury’s advice (“Go early, go hard, go households) by Kevin Rudd, scaring up fears of a US-style default crisis, ignoring the fact that Australian borrowers do not have the easy American default option if their house value drops below the loan value. The only default risk in Australia was unemployment, not a drop in house prices.]
    The next two favours were for the big four banks only:
    [2. Guaranteeing about $400 billion in overseas wholesale borrowing (did you know you were guaranteeing that?) for a fee which banks could subsidize out of other profit lines and bigger, riskier home loans, but which non-bank lenders specializing in mortgages could not afford.
    .
    3. Guaranteeing retail deposits, which was limited to the big four banks for the first month, long enough to cause a run on every other deposit-taker. This run was finished when the guarantee was extended a month later.]
    It seems likely Rudd was getting advice not just from Treasury, but from quiet meetings with bank representatives. Whether he did or not, the banks certainly provided a stream of very flattering commentary in the media, on the government’s economic performance throughout 2008-9.

    Anyway, this all created a situation that destroyed most of the non-bank lenders and seriously threatened the credit unions. To compensate for this, Turnbull proposed that the Australian Office of Financial Management purchase RMBS securities to maintain non-bank competition, and Wayne Swan agreed.

    This illustrates the problem with using more and more regulation as the answer to everything. Sometimes the problem is caused by other regulations, and it’s better to do a review and cleanup than to keep piling on more rules.

    The RBA may say that spreads are high and therefore the banks are nice and comfortable. And government cheerleaders like to trumpet our relatively low public debt. In fact $400 billion of overseas bank borrowing represents about 40 per cent of our GDP. And the precedent is now set: banks are too big to fail and are underwritten by the Australian public. The interest spreads and hedging costs may be affordable now, but it’s not the sort of position we can just exit if it turns nasty.

    This was one of the reasons Ken Henry wanted fairer taxation of bank deposits. Currently you can pay up to 100% tax (in real terms) on bank interest, only company tax rate on stock dividends, and negative tax on housing speculation — the public pays speculators to feed the very bubble which depends on that $400 billion of overseas debt. Kevin Rudd responded by exempting interest on the first $1000 of a taxpayer’s bank account — up to $50 interest tax free. A response so tokenistic as to be an insult to the intelligence.

    Overseas borrowing brought many Australians and even state governments into crisis during the 1980s. This was just one of the reason’s for Paul Keating’s superannuation reforms: by raising the private savings rate of Australians, at 15 per cent super contributions he hoped to build a pool of domestic capital big enough to wean Australia off this addiction to overseas debt.

    The Howard goverment reduced public debt, but encouraged Australian private debt to defy gravity by distorting the housing market. A generation of home owners now consider the government responsible for guaranteeing all means necessary to keep their home prices rising, no matter how unsustainable those price rises may be.

    This public underwriting of banks, and public underwriting of housing speculation, has got to stop. And reducing income tax on bank deposits would be a great way to start replacing some of that $400 billion in risky, unpredictable overseas debt.

  26. my say

    no wonder i dont have sub

  27. David Sanderson

    I don’t think Hockey had any of the concerns about the banking cartel that Keane raises. He was just after a stunt that would make life difficult for Swan. The evidence for this is that, when pressed, Hockey was not game to venture that there was any single concrete move against the banks that he might be prepared to support.

    The affair only served to remind everyone, yet again, that Hockey is a lightweight (metaphorically speaking).

  28. my say

    [Joe Hockey is trying to appeal to voters with mortgages. Newsflash!! Not everybody and not every business in Australia has a mortgage. Many voters are self-funded retirees who would relish the banks bumping up their interest rates. Personally, I look forward to it.]

    totally agree

  29. Mike M

    Re-regulation of the interest rates that Banks can charge would be a very backward step.

    Those of us who remember the days of regulated interest rates will have little desire to return to having to beg banks to lend them money. This kind of sentimentality for the past is very short sighted.

    There is plenty of competition in the banking sector – we as consumers need to shop around more than we do.

  30. Jimmy

    Free Country – Interestingly the Libs effectively opposed both an inscrease in compulsory super contributions and the reduction in tax on bank interest (as tokenisitc as it was it at least set the right tone). The ridiculous 0.2% interest offered on ordinary savings accounts is also discouraging cash savings.

    David – You only have to look at some of the responses on the Herald sun website to see that Hockey has hit his target audience, all Labor is weak and the Banks are screwing me.

  31. klewso

    Another “sweet nothings promise” – just because he said it doesn’t make it policy :- ” From the forward of the “Fuck-us Group Handbook” – “If that’s what the punters want to hear when they’re being screwed – that’s what we’ll say!”
    “Facts (as in “When facts change I change my mind – what do you do?”)” can alway change after an erection!

  32. klewso

    Sorry, that should have been “eLection” off course!

  33. Jackol

    Re: competition in banking

    My question is why there hasn’t been a much more hostile approach to M&A involving the big 4 banks in Australia. St George and Bankwest should never have been allowed to merge with Westpac and CBA. Bankwest was a fire sale, but it would have been better if the Oz government had bought it outright during the GFC and sold it later when conditions improved than for it to be sold to CBA. St George being sold to Westpac never made sense to me. Where is the commitment to competition from the ACCC and the government?

  34. klewso

    Another “sweet nothings promise” – just because he said it doesn’t make it policy :- ” From the forward of the “Fucus Group Handbook” – “If that’s what the punters want to hear when they’re being screwed – that’s what we’ll say!”
    “Facts (as in “When facts change I change my mind – what do you do?”)” can always change after an erection!?

  35. David

    Jimmy…certainly talking to the converted in the Murdoch press. His style and attack seems to be the Oppositions battle plan t the moment. Abbott used the same tactic in the house after QT this afternoon. The Govt lies, the Govt is dishonest, no policy, let the ordinary people down, cant cope with being in Govt and while on the unhinged one…after this morning in a door stop refusing to say he had been talking to the mining bosses, immediately commenced his ‘matter of public importance’ speech with a rousing defence of the big mines and Rio Tinto in particular. So he has jumped back into bed with his big money power brokers.

  36. Jimmy

    David – Exactly. And this has basicall been his MO since becoming leader. As Klewso said the Libs under Abbott have been great at saying “this is wrong or we should do this, but that isn’t Liberal party policy just me talking”. They constantly jump up and down about Labor being incompetent but don’t present any alternative.
    I challenged one rusted Liberal on the fact that Abbott wasn’t presenting any policy before the election and his reponse was “he doesn’t have to he’s the opposition not the govt”, that is what we are dealing with

  37. klewso

    Dear “Moderator” – you can axe that first daft, I mean draft!

  38. freecountry

    Many borrowers consider “walking with their feet” when they see the lower interest rates and trivial exit fees (so you’re not at their mercy if they raise rates) of some of the building societies. But they will only lend you something like half as much as the banks will. And with home prices as they are …

    That’s because building societies wear their own risk, but since the Labor government’s $400bn wholesale borrowing guarantee it has been understood loud and clear, that bank risk is carried by the Australian commonwealth, not by bank shareholders or directors.

  39. Jimmy

    Free Country – The Credit Unions lend 80% of the house value & the loan repayment can’t be more than about 1/3 of your income. This to me is logical, I can’t understand how banks can lend to people outside this range when they will very quickly get into trouble.

  40. leone

    That idiot Scott Morrison said this morning that John Howard was always on the end of the phone and was always giving advice. This latest bright idea proves it. Back in 1982 when Howard was treasurer interest rates hit 21.4%. Fraser and Howard legislated to cap home loan interest rates at 13% – a regulation of the banking industry. That meant that taxpayers were subsidising those home loans. Does Hockey really think that’s a great idea? Is it possible that he had a late night conversation with the Short Bloke last night and then tried to sell this dog of an idea as his own?

  41. David

    LEONE…I suspect the influence of the King Rodent Howard has not diminished within the Liberal caucus. Many of the gutter tactics being employed by the Opposition have the odour of the Rodent wafting from them. It is an unmistakable stench.

  42. Apathy

    Jimmy – thanks for pointing that out. I too have notice that everytime Joe gets caught out by a journo, he drops the bottom lip, throws his hands up in the air and has a sook. Which leads me to the conclusion that Joe might not be brightest light bulb in the building considering the calibre of the current crop of journos.

  43. Blowtorch

    Try aspects of http://www.youtube.com/results?search_query=Utube+Dr+Griffin+Central+Banks&aq=f to get the real picture instead of the picture given to the serfs.

  44. Observation

    If we have a distinguished highly educated and qualified board at the RBA (my assumption) making decisions in the best interest for the country then everyone has to tow the line. Yes even the big banks unless they can prove the reason for going outside the norm is a benefit to the country. If they go outside set parameters, tax them hard. I am sure they will still make their profits. If the accounting brains trust of the country is wrong and is not enforcing fair and just treatment to all sectors, somebody prove it!!!

  45. Pasher

    Chris Johnson if you read these blogs can you contact me on my email jay_627@hotmail.. Am the former electorate officer you were looking for in 2008! J Evans

  46. Sean

    Once again, Hockey is talking populist nonsense out of his arse in a desperate appeal to naive voters, just like Tony Abbott.

    I don’t see how more easy credit and relatively low interest rates will do anything about the Australian housing bubble.

    Treasury is already worried about levels of Australian household debt, and rightly so. Reducing interest rates won’t help there either, rather increase them. APRA needs to put more caps on lending.

    The proportion of lower-middle income households in Sydney without their own home rose from 26 per cent to 40 per cent in the 45-to-64 age group between 1986 and 2006.

    ”The substantial loss of home ownership by this age group was concentrated where it is likely to have the worst welfare outcomes as the group ages,” an Australian Housing and Urban Research Institute study reported.

    ”They can expect a very long period of private rental under reduced circumstances.”

    ”The very high housing prices that are currently extant are a major concern. It is our contention that this situation has been caused by government action – a deregulation of finance in the 1980s with no corresponding deregulation of planning.”

  47. Sean

    Nice work, Free Country.

    Crikey is writing rubbish faster than I can rebut it.

  48. eclectic eel

    Since the mining companies felt their oats in the run up to the last election, there seems to have been the tendency of
    major corporations, including the banks, to thumb their noses at any pretence of social responsibility and go for broke.
    Bernard’s observation that they are no longer suffering the competition of smaller lending institutions is a valid one.

    The government guarantee that protected the major banks after the GFC, illustrates the moral hazard that now exists for the public interest. The situation in America is far worse, with record remunerations already returning for banking
    executives – despite their appalling behaviour which got us into this mess in the first place.

    America seems fated – through the inertia, indolence and corruption of the legislators, to repeat the mistakes that led up to the GFC. – the debt is still out there. Australia was saved through prescient regulation of the banks. – we need more of this to shore the country up when the next financial cock up inevitably occurs.

  49. Smithee

    What really irritates me about interest rates is how they’re reported. hen the media says “official interest rates have been lifted to XX” it’s utterly meaningless. Nobody pays that rate. I wish they’d quote the *actual* interest rate that our feudal overlords have decreed.

  50. Jimmy

    I have seen in today’s papers this being dismissed as “Joe being Joe”, a “Tony being Tony” line has also regularly been deployed when he has said similarly stupid things, does this mean the two most important opposition members natural state is idiocy?

    Electric eel, I think the reason America is doomed to repeat it’s mistakes is that it refuses to allow “big government”. You only have to look at the health reform package to see how even the slightest movement towards the left is decried as communism. Their whole attitude is I worked hard and got mine so everyone else can get stuffed.

  51. freecountry

    Banks dominate the economic commentary in the media. This is a good thing–it’s healthy and proper for the biggest private economic analysts to keep Australians informed, and to compete with each other for the prestige of giving the best analyses and most accurate predictions.

    But it also means the banks dominate the commentary on the government’s economic policies and performance. And it is perfectly natural for bank analysts to see things through a certain filter. To believe that whatever is good for the banks is good for the country.

    That’s not always entirely true. For example governments like to talk about low public debt, while playing “look over there” when anyone mentions Australia’s net foreign debt, which is 40 per cent of GDP.

    It has grown this big because tax distortions have enabled Australians to use the home price squeeze as a sort of magic bottle, a miracle that keeps pouring out cash without any requirement for anything to be produced or built. Nothing to do with productivity increases; just a way of transferring tomorrow’s productivity and wages into today’s consumption. But it makes the government look good, and it makes the banks very profitable. So the bank commentators give the government lots of pats on the back in the financial pages.

    I wouldn’t want the banks to stop providing lots of media commentary. But there needs to be some counterweight from outside the banking sector. Maybe the independent RBA could start up a media wing and sponsor news broadcasts.

  52. zut alors

    Jimmy,

    When Joe is Joe I am frequently reminded of the Bud Abbott and Lou Costello classic ‘Who’s on First’. He blusters and confuses just as Lou did. Joe’s comments and content travel in circles which seem to have little substance and inevitably leave me feeling that I’ve missed the major part of the interview even after paying careful attention to it.

    He may be a nice bloke an’ all but that’s not sufficient qualification for a treasurer or shadow treasurer.

  53. Jimmy

    Free COuntry – Maybe this is why the RBA started publishing it’s minutes?

  54. Jimmy

    Zut Alors – Exactly!!

    I must say if find it amazing that the opposition are trying to make the fight about economic management when they clearly are weak and our economy is one of the strongest in the world at the moment. Peter Reith might of give a hint as to why this morning when he claimed Peter Costello got us through the GFC and subsequent global recession.

  55. freecountry

    Sorry, I linked the wrong parliamentary paper. Australia’s net foreign debt is now 50 per cent of GDP, not 40 per cent. And as I discussed above, the bulk of that is to all intents and purposes guaranteed by the Australian taxpayer.

  56. ronin8317

    The Chinese have a saying : “Getting off a tiger’s back is much harder than getting on’. House prices are too high, but the government will implode if house prices fall. Banks increasing their margin on interest rate are minor issues. The huge challenge is to stop the money flowing into housing and redirect them to endeavors that actually produces something. Australia is spending monstrous amount on that ‘extra guest room’ when it should be spent on piped irrigation to save the Murray Darling instead.

    The Government have no incentive politically unpopular action to save the country. This is similar to the situation facing the CEO of failed financial institutions : the leaders are rewarded for short term thinking, and punished when they take a long term view. When Bob Carr introduced the 2% tax on investment properties, Sydney house prices stopped rising immediately, It also created a huge budget black hole in the state government’s coffer. In politics, no good deeds goes unpunished.

  57. freecountry

    Ronin,

    Without causing a crash, a selloff, or a rental crisis, I believe the government could give the housing fiasco a soft landing by closing a loophole in the Capital Gains Tax.

    Both owner-occupiers and investors now follow the common practice of reborrowing against a risen home price. For owner-occupiers, this is a way to consume while keeping their homes, and they only do this with one home each.

    For investors, it’s a way to avoid the Capital Gains Tax, an alternative to selling to fund more home purchases. In this way they accumulate more and more homes, depleting the turnover pool in the housing market and squeezing prices ever upwards.

    Australia’s annual housing turnover has dropped from 7.5 per cent to 5.5 per cent since 2002. That’s 25 per cent less houses for an increasing number of first home buyers to fight over. No wonder prices keep rising faster than wages.

    The government should add to the list of Capital Gains Tax Events: reborrowing against an increase in land value compared to the original purchase price. This would remove the tax advantage for reborrowing against selling. But it would not affect negative gearing, so cashflow would not change and rental tenants would not be affected.

  58. Jimmy

    Free Country – I’m sorry but that capital gains idea isn’t one of your best. Forcing people to borrow extra money to pay capital gains on assets that they have not yet sold is just ludicrous and what would happen if/when the property value drops, will they end up with a capital loss that can only be of benefit to them if they sell the house? What would the cost base be? What happens if the house value has gone up by $100k but they only want to borrow $50k?
    As for the tax advantage I am not sure I understand your point, If I own a rental property that has increased in value and I am competing against a first home buyer for a new property I might find it slightly easier to get a loan but I have no tax advantage, if I am competing against someone who owns the house the live in and are selling that to buy another one the one they are selling is CGT free so again no tax advantage. I would only have a tax advantage against someone who had to sell assets subject to capital gains.

  59. freecountry

    Jimmy,

    No one would actually pay the CGT upon borrowing–the new liability would simply eliminate that tax dodge. Investors would then go back to the pre-CGT practice of selling one property (hopefully for a profit) in order to buy another property. And they would go back to paying CGT when they do so, as the law intended.

    There’s nothing wrong with investors buying low and selling high as they have been doing for thousands of years. The problem is when tax distortions combine with the new debt market to drive a boom in buying which is not balanced by selling.

    The distinction between borrowed cash and earned cash is increasingly blurred these days. Standard advice in property investment books and websites is, “Don’t sell … selling ought to be a last resort.” Capital gains on a property are, in effect, realized without having to sell the property.

    It has nothing to do with giving one buyer a price advantage over another; the point is that the number of buyers is increasing, while the number of houses available for sale is decreasing.

    It took about ten years for lending practices to catch up, but Capital Gains Tax may be the best thing that ever happened to property investors in Australia, because it gave investors a way to convince other investors, through investment websites, books, and seminars, not to sell. It works like a loose, informal sort of price cartel. The simplest way to arrest the growth of the cartel is to extend the definition of Capital Gains Tax Events to reflect current practices.

  60. freecountry

    Typo: I meant to say, “The distinction between borrowed cash and owned cash is increasingly blurred these days.”

  61. Observation

    Well now, everyone in the country has got something to say about Joe and his comments except his glorious leader….where oh where is the rAbbot!!!

  62. David

    Are we seeing a move by Hockey against Abbott and he is using one of the unhinged ones major weak points? Economics is too hard for the monk.

  63. Jimmy

    Free Country I still don’t see the advantage. If bought a house for $300k and it goes up to $400k that does in effect give me a deposit on an investment property and allow me to borrow 100% of the purchase price, but I still need to meet the income tests. If the investment property was $400k and I borrowed all of it at 6.75% over 30 years my weekly repayment would be $598.31, add in rates, insurance, repairs etc and that would easily be a total cost of $700 per week, yes rent would meet some of this but I doubt all. Assuming I still have significant debt on my exiting house it leaves very little room to move on the income side to borrow more money.
    Even if your capital gain regime was in effect if it my principle place of residency would still be exempt allowing free access to my first rental property and even if I had to pay tax on the $100k it would more than likely be less than $20k or 5% of the purchase price which woould add only $30 per week to the repayments.
    Also as I said earlier what happens if you pay tax and the property subsequently drops in value? Or I only borrow a % of the increase in value?

  64. the man on the clapham omnibus

    @FreeCountry

    Like your thinking, the lack of turnover is definitely a problem. Also, don’t forget the Stamp Duty impacts when purchasing new property as a further disincentive to ‘churn’. There is a high increase in areas now building extensions rather than putting a house on the market because they are baulking at a $50K+ Stamp Duty bill.

    As you correctly identify the development of using equity in your home has allowed investors to retain property, which along with generous negative gearing allowances and a range of deductions (capital works, fittings) effectively subsidizes loss making properties as a tax dodge.

    I like the idea of Negative gearing being phased out for older properties or capped. It would increase supply of newly constructed properties and attack the supply side of the problem. For investment certainty any change to negative gearing would have to be phased in over at least a 7 year time-frame.

    The imbalance is also increasingly showing up on our Government’s balance sheet:

    Seven years ago, 650,000 landlords reported just $2.5 billion in losses against the ATO, In 2007-08, investors reported tax losses of $8.6 billion – or an average loss of $5375 a property.

    So each year we are subsidizing loss making property investments to the tune of $6000 per property.

    This has a knock on effect on our economy where more productive investment (i.e Australian shares, infrastructure bonds, Venture capital funding R&D and new products) is not given the same advantage over ‘dead wood’.

  65. Jimmy

    The Man – a large part of the increase in losses between the 2 periods you chose to highlight is interest rates, the RBA cash rate in 02/03 was around 5%, in 07/08 it was around 7%, add in the increase in house prices and therefore the increase in loan sizes and that 2% increase is substantial.
    You also assume that all those landlords are investing in exisitng housing while al lot of the ones able to take advantage of negative gearing (due to higher depreciation claims) would be buying off the plan and their investment creates jobs and properties.

  66. Jimmy

    Also the increase ni property value can also facilitate investment in the other items you mentioned with tax deductibility of the interest against any income earned just like property.

  67. freecountry

    Man on the Clapham Omnibus,

    Yes, stamp duty and other churn turnover costs would remain (for now, anyway) but stamp duty is equivalent to roughly the capital gains tax on a 25 per cent capital appreciation. That’s only a couple of years of appreciation these days.

    Negative gearing phases itself out for long term investments. Inflation drives rental income up and interest payments down, until the investment becomes positively geared.

    Jimmy,

    It sounded amazing to me too, but I know people who do just that. They go to property seminars where investors are taught how to use low doc loans–requiring more collateral and a higher rate of interest–once their total interest and maintenance costs exceed their personal and rental income cover.

    See for example this book: How to Achieve Wealth for Life Through Property Investing by Ed Chan and Tony Melvin. They explain how Chan & Naylor accountants have taught clients to borrow and borrow, and never sell … even borrowing low-doc loans to cover the income-expense gap on existing loans, and living on further low-doc loans for ordinary lifestyle spending. All of it resting on a solid foundation of the inevitable capital appreciation of the brick-and-mortar properties that the investor owns. While that may be a bit hairy for mum and dad investors, many of them have told me that selling a property is for fools.

  68. Jimmy

    Free Country – High Risk is high reward and as an accountant that strategy is very high risk especially borrowing more to cover the income & expense gap, effectively paying off debt with other debt, it works while things are on the way up but if things ever turn down or your income level changes through inability to get a tenant, job loss or injury etc the house of cards comes down very quickly. By the sounds of things these peoples equity position would be almost zero with the market booming, if the market comes off even a little bit they are in a negative equity position ie they sell everything and are still in debt.

    The only people guaranteed to make money from those seminar are the organisers.

  69. freecountry

    Jimmy: “The only people guaranteed to make money from those seminar are the organisers.”

    Of course. That’s why the seminar door prices often barely cover costs and the internet advice is always free, never subscriber-only. These spruikers bought up big (and made sure their own risks were covered) before launching their bull-market education programs. But some pretty smart people have sworn by it and tried to bring me on board.

  70. the man on the clapham omnibus

    @Jimmy , would be interested in your take on this but the following is my experience.

    Having invested in both shares and property via procuring loans, the tax benefits of property is a clear winner and in my experience that can distort the investment market, especially when an aim would be to hold on at all costs to avoid CGT.

    Shares, (while having the advantage of not needing maintenance costs), only really have deductions for interest on loans and incidental management expenses over their lifetime.
    Interest is also usually at a premium because it is not secured , titled property. As far as I know it is unlikely a bank will offer reverse equity on a parcel of shares so selling and incurring CGT at some point is a given to realise the gain (hopefully not the loss).

    Property is able to be secured with a 10% principle loan at a fairly competitive rate, interest only.

    During the first 7 years on a modern sub $250K property, a depreciation schedule allows claims of almost $7000 a year, in addition to this the interest on the loan is deductible. More ‘creative’ accounting also allows other benefits.

    So for me, a pound for pound investment in shares and property has a starkly different tax reduction outcome.

    High earners can use this approach to effectively deduct their whole tax bill and accumulate equity, reducing their income tax and avoiding capital gains tax (and tax deduct airfares to the gold coast on their holiday).

    I think @FreeCountry’s point is that the introduction of ‘reverse equity’ loans has measurably impacted the turnover of properties in the market by offering an investment vehicle that can avoid capital gains taxes and also significantly reduce income tax liability. This affects both the supply of housing on the market and the tax take that needs to be found elsewhere while promoting a particular investment class over others.

    This in my opinion, in turn with negative gearing’s expansion through the ATO has seemingly restricted the supply of properties on the market, concentrated the property holding class and driven up the average price of housing.

  71. freecountry

    Man on the Clapham Omnibus – Exactly. Thank you.

    I would also add that, while negative gearing is deeply offensive to many taxpayers, and while I once advocated a Keating-style quarantine of rental income, negative gearing was available for most of the 20th century without causing house prices to do anything like we’ve seen since 1996. And as Keating found, quarantining is highly disruptive and causes a short term rental crisis.

    Cleaning up Capital Gains Tax, on the other hand, would not affect the cashflow or tax status of any existing homes. All it would do is significantly slow or halt the ongoing investor takeover of the housing market, and its relentless squeeze on the buyer-to-available-stock ratio. A step back towards the level playing field, where investors are welcome to gamble on houses, but they must pay tax when they cash in their chips, like everyone else.

  72. GocomSys

    Hockey gets something right? Really? What went wrong?

  73. freecountry

    Actually, they could impose tighter regulation to bring down interest rates.

    Not by regulating the interest rates themselves, or the spread between mortgage rates and RBA rates, but by limiting exit fees, increasing the borrower’s mobility for refinancing, and thus the level of competition between banks.

    If you choose a mortgage contract with high exit fees, then you are locked in with that bank for better or worse. You have effectively written a blank check for it to unilaterally raise your repayments if it gets into trouble. Your only assurance that it will do so unreasonably, is the loss of market goodwill that would result. But if push comes to shove, if the bank has to choose between goodwill and staying solvent, then you will not be able to escape without paying the exit fee, and some of these are prohibitively high.

    The first step in regulating exit fees is to make them more transparent. In addition to signing the mortgage contract, customers would have to sign an acknowledgement in plain English saying:
    [WARNING: WE MAY RAISE YOUR INTEREST RATES AT ANY TIME, IN EXCESS OF OFFICIAL RATES, AND IN EXCESS OF OTHER LENDERS’ RATES.
    IF YOU WANT TO SWITCH YOUR LOAN TO ANOTHER BANK IN THE FIRST (X) YEARS, YOU WILL HAVE TO PAY US A FEE OF (Y) DOLLARS …]
    If this doesn’t work, the government could take the extreme step of legislating maximum exit fees, for example no more than one months’ interest payment at the previous month’s rate of interest.

    Mobility and competition would do the rest.

  74. Jimmy

    Free Country and The Man – A few points I would like to make.

    1) This type of property investment scheme is the main reason people are now living in their cars in America.
    2) Any investment where the main reason it works is the tax situation is a bad investment – look at the Timber industry.
    3) While I acknowledge you can’t borrow against shares you can invest in shares with the borrowing gained from the increased value in your house – so under your proposal even if I don’t invest in “deadwood” I would still get hit with CGT.
    4) People who gamble on property do pay CGT when they cash in their chips, they just don’t pay it when they are up half way through the game.
    5) The extra deductions available to property owners over share owners are there because property owners have to pay these extra costs (apart from depreciation of course) and at best they will only get 46.5% of their outlay back through tax if they earn over $180k.
    6) Depreciation may start out that high but after about 5 year will be substantially less.
    7)Where are you buying a modern sub $250k property – even in my small regional city 2 bedroom apartments 3 years old are $300k.
    8) As I asked earlier what happens if you pay the tax and then later sell the property for less? Or if I don’t borrow the full increase in value? In short how does it work in reality

    Finally these people are not necessarily accumulating any wealth, yes they may have multiple properties but if they don’t have any equity in any of them because they keep borrowing they don’t have any actual wealth. If they are using low doc loans their interest rate would be substantially more than the example I gave earlier and so the would need large amounts of disposable income to cover loan repayments, if the chose to go interest only it does minimise the cashflow problem but they get no reduction in the principle and therefore no increase in equity unless prices go up. If interest rates rise 1% over the next year 9which has been tipped but I don’t believe it) they could find themselves in real trouble, especiall if a rise in interest rates means a reduction in house prices. As an accountant I am conservative but to me this strategy is a massive risk, ie you risk losing everything, they will either being millionaires in 20 years or bankrupt in 5.

  75. freecountry

    Jimmy,

    I’m not going to do their spruiking for them, defend their model or argue that the risk is worth it. All I’m saying is (1) many investors and even many accountants disagree with you and believe selling property is a last resort, and (2) this is depleting the proportion of homes that are owner-occupier, and I believe, causing the reduction in turnover that we see here.

    See the links I’ve given above, see also the Investment Club. And google NEVER SELL INVESTMENT PROPERTY for sites in Australia if you doubt how prevalent this advice is. The theory is that the more properties you can hold for longer, the more equity in those properties accrues to you, because prices will always rise in the long term while the amount you owe diminishes with inflation. This accrued equity enables you do do whatever you want with borrowed cash, indefinitely, without any need to dispose of a property. And it’s all because of (a) high leverage ratios and (b) tax distortions. What happens to those properties when the investor dies, I do not know.

  76. Jimmy

    Free Country, – I know the theory and it works perfectly when property prices keep going up and you have the disposable income to meet the repayments BUT if you keep using your increse in equity (through increased house prices) to either buy more houses or as you mentioned earlier fund your lifestyle/repayments (meaning you are increasing you liabilities without increasing your assets) when the music stops you will owe as much as your assets are worth. If, as we saw in America house prices fall, you equity is actually negative meaning you can sell everything and still owe money to the bank.
    As I pointed out earlier you need disposable income to make this work, so only those already wealthy can really get to many houses under their belt (for example I myself used the equity in my first house to buy a second but would not be able to get a third as I wouldn’t have the income to satisfy the banks). And if the rental market softens or you can’t rent one of your properties for a period everything can come crashing down.
    As for the CGT plan as I have said, it will not significantly increase the cost of reinvesting (not even $20k per $100k increase in property value), would apply no matter what you are reinvesting in so would impact areas other than property, would reduce off the plan investing therefore putting more pressure on the rental market, increasing rents and making it more attractive to buy investment properties and you have not told me what would happen if I got charged CGT at the peak of the market or the bank over estimated the property value and then Isold at a lower price

  77. Jimmy

    Also when the investor dies those who inherit the asset inherit the debt attached to it, meaning you could saddle you kids with a house they can’t afford and will get nothing for if they sell.

  78. freecountry

    Jimmy, you seem to still think I’m defending this investment model, and to insist on pointing out its flaws. I am not making a prescriptive point about this, I am only making a descriptive point about it. And that point is that many people are practicing this buy-and-hold strategy, whether or not it is wise to do so, and this is distorting the market.

    $20 per cent of accrued price is a lot to pay in tax, enough to cause this buy-and-hold-and-releverage strategy to exist in the first place, and enough to keep it going. It’s also enough reason to arouse huge political resistance against replacing stamp duties with far more efficient land taxes. Stamp duties and CGT can be avoided together; land tax and CGT cannot.

  79. Jimmy

    Free Country – I am pointing out that this is a highly risky strategy most suited to the already wealthy, therefore if someone is prepared to do it to buy a $400k house they wouldn’t be to concerned about paying another $20k in tax as it will only add $30 per week in repayments which is less than a 0.25% interest rate rise would.
    It is also effectively pre paying CGT, which means that if the house was sold later either by the current owners or their children after they die there would be less or maybe even no CGT to pay. Some people would see this a a bonus that they are willing to use some of the equity in their house to get.
    Stamp duties can not be avoided as they are paid when buying a house not when seling one.
    You still haven’t told me what would happen if I padi tax and my house price subsequently fell?

  80. freecountry

    So tax distortions don’t matter.

  81. freecountry

    “You still haven’t told me what would happen if I paid tax and my house price subsequently fell?”

    The housing investor sector is convinced–with a great deal of blogging, books, and other promotion efforts–that any price falls are temporary and will not stop prices “doubling every 7 to 10 years” if you believe them, and that the investor can weather these temporary slumps by joining their investor support clubs and learning how to take precautions.

    Please stop painting me into a corner as a spruiker of this model. If you do not believe all the books and blogs are influencing investors, if you do not believe what the Man on the Clapham Omnibus says, if you do not believe that homes are progressively accumulating into the buy-and-hold pool where first-home-buyers cannot bid for them, the 25 per cent reduction in housing turnover since 2002 is an empirical fact. If you do not believe my explanation, please give me an alternate explanation.

  82. Jimmy

    What tax distortions? I invest in shares I get to claim the expenses against the income generated and I pay CGT on the profit when I sell them, this is exactly the same for property, the fact that I have to incur more expenses to gain my income from my property is neither here nor there. As I said earlier except for depreciation (which is almost non existant on older homes & disappears after about 5 years for newer ones) to get a tax loss on my property I have to actually pay out all that money to get less than 1/2 back in tax (and that is if I am paying an interest only loan).
    The fact I can use the equity in my house to a better advantage than the equity I build up in shares is not a tax issue.
    The fact is you can use the equity in to gain a loans, that is how ABC learning went under the boss borrowed against is shares but once they went below a certain value he was forced to sell to pay the loan, so should you have to pay CGT if you do this?

  83. freecountry

    I originally said: “The government should add to the list of Capital Gains Tax Events: reborrowing against an increase in land value compared to the original purchase price.”

    That means, making a special case of land. Not buildings on that land; not shares; not works of art or rare musical instruments. Only the land value component of a real estate asset, to be determined the same way the states assess Land Tax.

  84. the man on the clapham omnibus

    Looks like this thread has moved on with another BK article..

    I can see what you are saying Jimmy, just because people may choose this approach does not mean that the risk has ‘gone’, or it’s a sensible course of investment advice, or in fact a guarantee you would be any wealthier at the end.

    In fact there is a real danger in this approach spruiked by the industry that seems to have gone pear shaped in the U.S.

    Regardless if this is a line of sensible investment advice, it may pay to look at it from another point of view.

    Consider for a moment though if the ‘popularity’ for want of a better word of this investment vehicle had increased over the last few years and through successful marketing it had gained ‘market share’ in the investment landscape. How would you measure it? What would you look for? How would it impact the housing market?

    I do believe the anecdotal evidence by the ATO claims magnifying, the available housing market shrinking (not matching demand) and the number of these clubs being spruiked are signs that this is actually happening and having an impact on the supply and hence price of housing.

    I don’t have the data but for that 7 year period I quoted earlier, but I would be interested to know if the 650,000 investors claiming deductions had grown in proportion to the ‘bill’ at the ATO.

    This has less of an impact on society with more speculative investments such as shares (because no-one needs shelter in paper certificates) but if the impact is that we reduce the available property pool and increase the ‘landholding’ class then I believe that has a wider impact on the ‘fairness’ of our society and people’s social mobility.

  85. Jimmy

    So how do you calculate the increase in the land & not the buildings? Only taking the land into account will further reduce any CGT liability?

  86. the man on the clapham omnibus

    Even though this is from a currently fairly discredited paper, this article raised some interesting stats I wasn’t aware of , written around the time of the release of the Henry review:

    Unfortunately the reforms recommended would be so controversial I doubt any political party would have the minerals necessary to take them on:

    http://www.theaustralian.com.au/news/opinion/tax-breaks-to-blame-for-rising-house-prices/story-e6frg6zo-1225863653330

    * 90% of negative gearing claims relate to existing homes
    * median house prices have risen from 3x to 5x average household earnings in the past two decades
    * Since 1987, an increase from 8 per cent to 40 per cent in the proportion of finance for existing homes that is taken by investors

  87. freecountry

    States already have mechanisms for isolating the unimproved land value for purposes of calculating land tax. And processes for dealing with appeals, where the owner disagrees how much of the value is the location and how much due to improvements.

    If a person buys some decrepit hovel and builds a nice new house on it, a block of flats, or even a really nice garden, there are two components of any delta in valuation. One part, the improvement, is a product of human industry and human jobs (as are shares or other assets); the other part is simply a function of that location becoming harder to get, relative to demand, over time.

    It’s that second part that enables the land owner to leverage the asset so much more heavily than any other asset class, and to keep releveraging for more and more, in such a way that capital appreciation is able to generate something that looks remarkably like cashflow–as long as that capital appreciation follows the expected cyclic trend, which of course is a big if.

    So it’s that second part of an asset’s capital appreciation, the unimproved land value, which I propose should be deemed to have been realized when the owner reborrows against it. And thus, would incur capital gains tax.

  88. freecountry

    Man on the Clapham Omnibus,

    I like Mike Steketee, and those statistics you quote are the highlights of the article.

    I don’t quite agree that the 50 per cent CGT discount is that bad. The long-term discount was introduced to compensate for removing the inflation discount (a provision which depended on an ironclad definition of “inflation” and highlighted the disturbing disparity between the CPI and the cost of keeping a roof over your head).

    I also see why the government resists–and will always resist–touching negative gearing. Businesses have start-up periods before they can turn a profit, farms have bad years due to acts of god, and even landlords may need to do major repairs some years without an immediate payoff in rent. And anyway, there are too many tenants in place who would become homeless if their landlord’s cashflow suddenly changed.

    I also never really liked capital gains tax at all. It’s an ugly, inefficient tax, which has more to do with entrepeneur-bashing than revenue raising. Its deadweight costs to society are huge, and it causes many investors to restructure assets in complex ways when they should be simply selling them to someone else.

    But if we must have CGT, then let’s keep it up to date and ensure that it captures all the current ways of turning capital gain into cash, as it was intended to do.

  89. Jimmy

    So free country if I buy a house for $300k and 5 years later it is valued at $400k and being extremely generous half that increase is attributed to the unimproved land value that would result in a $10k tax if I borrowed against the equity. This would not have the slightest effect on a purchase decision, especially as I have already stated those best placed to take advantage of the situation are the already wealthy.
    It also makes it all the more confusing when selling the house in that you have effectively created 2 assets and as I have said repeatedly how do you account for a situation where I borrow at the high point of the market and sell later at a lower figure.
    In short it creates a highly complex situation which has almost no impact on the perceived problem you are trying fix.

  90. freecountry

    Jimmy, you’re welcome to disagree, but I don’t think you’re reading what’s written here. If my accountant told me not to worry about 10k tax because I’m rich, I’d sack him. And I already answered your question: the investor would lose, but the housing investor community believes that over 10 year cycles they can assume a doubling of price. And as the Mike Steketee article linked above by The Man explains, this tends to be a self-fulfilling prophecy because 68 per cent of voters expect government to keep distorting their home prices upwards.

  91. Jimmy

    Sorry I missed your answer, the post came up out of order.
    My point is that it si not a matter of not worrying about $10K in is a question of whether an extra $10k of borrowing on a $400k loan (or about $15 per week) to buy a house is really going to deter the investment. I would think not, especially if you have spare capacity in your disposable income. This would be reinforced by the fact that people would probably view this as a prepayment of a tax that would have to be paid when their kids sold the house anyway, in essence it is not lost money.
    When I am asking about the property prices dropping, I am asking what happens to the tax already paid under your scheme? What would happen for example if an investor got an estate agent to add a bit extra to the valuation to get the loan, the investor paid the tax at the higher rate and then subsequently sold the house for less, does he get a tax refund, or has a capital loss been created that is offset against the capital gain on the building on the land?
    I am not arguing that this practice doesn’t happen, I am merely pointing out that it is inherently risky as you never have any equity to cover unforseen circumstances which means it can all go pear shaped pretty quickly.
    I am arguing that capital gain regime you are suggesting will have little impact and add an unnecessary level of complexity.

  92. Jimmy

    You would also be a little harsh on you accountant if you sacked him because he said he had an investment that would double in value from $400k to $800k in 10 years but you have to pay borro0w an extra $10k to pay tax now.

  93. freecountry

    OK, so you buy a home for cost base 100k, financed with an interest-only loan. Ten years later your bank reckons the place is worth 300k, so you now have 200k outright equity. Against that, you borrow 160k.

    In doing so, you have traded in 160k worth of your own equity, in return for cash. The bank now has a claim on that 160k of new equity, leaving you 40k of outright equity. Until the mid 1990s this would have been an exotic sort of loan; for most people the only way to convert capital gain to cash was by selling it.

    Under my proposal, you would then have to declare 160k of capital gain to the ATO, and pay something like 24k in capital gains tax, assuming you’re in the 30% marginal bracket. Leaving you 136k for buying a second investment home. (Unless you’re one of those bums who use it to take a holiday or buy an Audi.)

    (The land may actually have appreciated slightly more than the net gain of 200k, as the building depreciated. But that makes no difference, because the capital gain you just realized is the equity you converted into cash, not the total gain in value. But if you borrow against a new apartment block you built on the land, that’s your own creation, not capital appreciation, so it should not count as a capital gain.)

    Five years after that, the market price of the home drops to 250k. You are annoyed, but the inspiring folks at the investment club assure you this is all part of the 7-10 year property cycle. You do not make any new purchases, sales, or borrowings.

    Another five years on, and the market price is still only 250k. The inspiring folks at the investment club are no longer answering your emails, the government has been voted out because of the property crash, and analysts are all trying to claim they were the first to call the crash.

    Your choices are to keep holding on, or to sell. If you sell, this is what will happen:
    100k goes to repay the original loan from when you bought the place.
    150k goes to repay the second loan, and you still owe the bank 10k.
    Your total capital gain has been 150k.
    You’ve already paid the ATO for 160k of capital gain ten years ago, so you have a credit for overpayment of 10k capital gain. This is now deemed to be a previous overpayment, rather than a capital loss credit, so you can claim back cash in your tax return – the princely sum of $1,500.
    If the other $8,500 is “nothing” because you are wealthy, you can just pay it, and you still own one investment property.
    If you can’t pay it, you may have to sell your second investment property, which you bought at the top of the market, so hopefully you didn’t get a chance to releverage that too.

    But this is all fanciful. In reality, once the act of converting equity into a cash loan became liable for capital gains tax, the entire practice of releveraging investment homes would lose much of its advantage over simple old fashioned selling. There’s still stamp duty to worry about, but the states will soon phase that out, leaving only conveyancing and mortgage overhead. No one would go through the steps above any more, except owner-occupiers who are not liable for CGT anyway.

    Investors would go back to the old practice of buying low and selling high; the proportion of investors crowding out owner-occupiers would stop climbing; the possible looming crash might be averted; the market would slowly return to normal; new home building would become competitive once more; builders would be able to get jobs again building something other than COLOs for the BER revolution.

  94. Jimmy

    Free Country – While you can claim depreciation on your building I would think it a bit fanciful to say that the land is where the entire capital growth is, I would think if anything grows at a lower rate.
    Even on your amazing figures of a $100k property turning into a $300k property and all that growth being in the land it still only adds $24k tax. Assuming the new property you are buying is also worth $300k (using the equity in both properties to get the loan) it still only add $30 per week in repayments (interest only). If you take into account selling costs such as commission & legal you are probably only paying $12k extra to keep both houses so I can’t see how you proposal is going to stop buying investment properties with equity.
    Also as you can get marginal loans on the equity you have in share investments wouldn’t your proposal skew the investmetn landscape towards them as they aren’t subject to this new CGT.
    Also would the ATO pay you interest on the extra tax you have paid that you weren’t laible for 10 years earlier?

  95. freecountry

    Jimmy, many Australian residential values have trebled in nominal price over recent ten-year periods. CGT is based on nominal not real increases. Costs are marginal–it’s not a question of whether you can afford them, but of whether they make an alternative more attractive. Speaking of which, yes of course shares would become relatively more attractive, because tax distortions currently make them unattractive relative to property, and cash or bonds even more so. That’s the whole point.

    That’s it for questions, I’ve answered enough. Let’s hear about your views, what would you prefer?

  96. freecountry

    Just to add one last point: shares, bank deposits, and other financial securities are all, one way or another, instruments for providing working capital to some entity, so that it can engage in productive activities and employ people. This is true even of hedging instruments such as options; these act to correct market inefficiencies and influence capital away from less productive securities and into more productive ones.

    Buying and holding second-hand residential positions is the opposite. No capital is put to work, no one is employed, in fact the effect on employment is negative. What looks like a free lunch is really just a wealth transfer from the future wages of tomorrow’s home buyers into today’s consumption. It’s one of the reasons Australia’s total factor productivity has actually been decreasing since 2005.

  97. Jimmy

    I now this is another question but what do you mean CGT is based on nominal not real increases? CGT is the actual sale price less the actual costs of purchase.
    As I have said a number of times your proposal does not add a significant enough deterent to investment as my equity allows my to borrow much more than the purchase price of a new property and so the additional cost of the CGT (which even at a $200k profit would be less than $15k as shown above) would only lead to a minor increase in debt and I don’t really believe this is a problem that needs fixing. Income restraints curb continual investment.
    As for encouraging investment in shares your proposal deters it on one hand by not letting me borrow against my equity without penalty and I don’t understand the current tax distortions you speak of, currently if I invest in shares I can borrow against them to buy more shares or property, same as property. I can claim a tax deduction for the expenses incurred same as property and I pay CGT when I sell shares same as property. The only difference is I lose more when I sell property through commission and legal fees and I have to pay more when I buy property through stamp duty. I also have to have more money to enter the property market and can more easily transfer my shares which means I can make more for less easier.
    I prefer leaving the CGT regime as is.

  98. Jimmy

    One last point as to why your reigme won’t work.

    If my principle place of residence has gone from $100k to $200k as you suggest I could borrow against that equity CGT free under your regime and use it to buy 3 or 4 properties as that equity only really needs to cover the deposit on the investment property and the investment property itself funds the rest. The only thing preventing this is my income and therefore my ability to repay the loan. I could as you have suggested use some of the equity to borrow to fund the repayments but this is a big risk and dillutes my equity drastically, especially if I am paying interest only loans. Either way I have been able to invest in multiple properties without paying CGT.

    Alternatively if I had invested in say fortescue when they were worth nothing and have now made a few hundred thousand under you proposal I could now borrow against the equity there to buy numerous investment properties with out incurring CGT. Even if If have only made $30-$50k that would be enough to get 1 investment property.

  99. freecountry

    Jimmy, my aim is not to outlaw the practice, just to take some of the excessive wind out of its sails.

  100. Jimmy

    My point is that you won’t tkae any wind out if it’s sails.

    If you are right that property values double every 7-10 years my CGT free principle place of residence will gerneate enough capital growth to keep investing as far as my income allows. This is because the equity in my current property only need to cover the deposit on the new property.

    Even if I need to borrow against one of my investment properties and pay the CGT it is one pre paying an expense that will have to be paid when the property is eventually sold (either on retirement or by my children) and two results in only a small percentage increase in the amount I need to borrow and therefore doesn’t alter my nvestment decision. Especially if I only “borrow” the deposit against my current investment property, say $60k which would result in a $9k increase in the $300k loan. If I sold I would lose the $9k in commission.

  101. freecountry

    Not on its own, perhaps, but in combination with the approaching end of stamp duties, which all the COAG members have agreed to in principle …

  102. Jimmy

    First off wasn’t stamp duty supposed to be stopped when GST came in? I wouldn’t be holding my breath for that to happen.

    But I don’t know how the abolition of stamp duty will stop people investing in & holding property, stamp duty is paid on the acquisition of property, there is no stamp duty on the sale. So the abolition of stamp duty will make cheaper and possibly increase investment buyers.

  103. freecountry

    Deadweight loss. If I sell you something that’s worth $10 to me and worth $11 to you, for price P, there’s a buyer surplus of ($11 – P) to you and a vendor surplus of (P – $10) to me, for a total trading surplus of $1. Impose transaction costs T on either the buyer or the vendor, and it squeezes the margins of what’s a worthwile price for both of us. If T > $1 then the transaction doesn’t take place at all; no surplus, and no tax revenue.

    The combination of stamp duty, CGT, and other auxiliary home-trading costs that are out of governments’ control, prevents many sales from taking place by emiminating the overlap between a worthwhile price for the vendor and a worthwhile (or affordable) price for the buyer.

    As a result, many people don’t move to a bigger home when they have kids, or to a smaller home when their kids leave, or to the other side of town when they have to spend 3 hours a day commuting. And the other costs of excessive house prices that I mentioned, wealth transferred from future wages to present consumption, net foreign debt currently at 40% of GDP, and less support for share market working capital than there could be, which despite the ALP’s boasts of smooth sailing through the GFC, destroyed a lot of good companies when their share prices breached their debt covenants and the morgage rush had crowded out the credit markets.

  104. Jimmy

    So in short you are saying knocking off stamp duty will make it more affordable for buyers meaning more buyers come in to the market and make it easier for those looking to sell to do so which is completely agreed. However while that will increase housing turnover it will have no impact on investors buying up houses which is what I thought you were trying to minimise with your CGT proposal which as I have outlined will not discourage investors from investing or encourage them to sell.

  105. freecountry

    No, I did say there is nothing wrong with investors buying low and selling high. This is a natural part of capitalism, it maintains a sufficient pool of rental homes for people not ready or able to buy, and it smooths out real estate market inefficiencies, which in a level playing field–without perverse democratic incentives for governments to squeeze cities with green belts–would make it worthwhile for building activity to match demand.

  106. Jimmy

    But you are trying to minimise buying and holding properties, correct? Trying to encourage selling, correct? And your CGT proposal will not do either of these things.

  107. freecountry

    Is there a way that you believe buying and selling could be encouraged, without triggering a sudden crash or a rental crisis?

  108. Jimmy

    I suppose if CGT was removed altogether (which is never going to happen) it might lead to more people taking their profit rather than reinvesting.

    The fact that property is seen as a safe option for capital growth and only really starts returning an income stream once your repayments cease means that people are generally in it for the long haul.

    As I have said earlier it is income that restricts people ability to continually purchase property and retain it and the fact is we have had low interest rates, low inflation and high employment which has created a situation where the indivduals wealth has increased and their disposable income has increased which has created opportunities to invest in real estate if you have the deposit. The fact that existing home owners can get access to the deposit does help them as they don’t have to save but their exisitng house mortgage restricts the amount they can borrow. If any of these economic factors declines the situation will naturally revert without any govt intervention

  109. Jimmy

    The other restrictions to selling is that it is a pain in the arse, time consuming and expensive with the legal fees & agents commission and unless peoples circumstances change (retirement, financial pressures or family situation) most are content to maintain the status quo.(people are inherenetly lazy)

  110. Jimmy

    One final thing, people understand property, they can see what they have bought, more than shares or other investments so they are not inclined to take their profit on a property investment and invest in shares at risk.

  111. freecountry

    Capital Gains Tax is a bad tax, as I argued above. But as you say, politically it’s not going anywhere and many voters actually want to extend it. (The same voters who think payroll tax is a bad tax; it’s a good tax, it just needs to be spread more evenly.)

    It’s widely agreed that stamp duty is a bad tax, but people fail to see that stamp duty and Capital Gains Tax are both bad taxes for exactly the same reasons.

    The best solution is to eliminate big-bang taxes like stamp duty and CGT, reduce income tax, and let the states take up the slack with continuous land tax. The reduction in income tax would offset the higher rents that tenants pay to cover the land tax. Some transition measure would be required for low income earners where the rental hike is likely to exceed their income tax cut.

  112. Jimmy

    I am not quite with you there, dropping stamp duty, CGT (is this on all investment or just property) AND reducing income tax would rip billions out of the governments (both state and federal) coffers and reduce funding of heatlh, education, infrastructure etc. I would much rather live in a society where I pay a little more tax and have greater services than the other way around. For example Howards great tax cuts gave the individual between $5-$10 more each week but put the govt into structural deficit.

    As I said we are currently in a prolonged up swing in the economy when things start to decline (and they always do) this issue will correct itself

  113. freecountry

    Drop capital gains tax on everything, abolish the whole thing. In its place, let the states raise land taxes and a new cash flow tax, as recommended in the Henry review.

    The land tax would also subsume the up-front infrastructure levies on new developments, which slow down building activity and favour the purchase of second-hand homes. Perhaps a federal 10 per cent stamp duty on second-hand homes could put them on a level playing field with new homes.

    The changes overall should be revenue-neutral, but there would be no harm in correcting some of the vertical fiscal imbalance between federal and state taxation, which was another issue highlighted in the Henry Review.

    Many stamp duties have been abolished, including FID, lease stamp duties, and stamp duties on the transfer of shares. For the background to the rest, which is more complex than the federal government would have you believe, see Tim Colebatch.

  114. freecountry

    Because of GST, I forgot to say … put them on a level playing field with new homes, which are liable to GST.

  115. Jimmy

    I am against replacing one federal govt tax with 2 state ones, we are one country and everyone should be taxed the same. We should be standardising and reducing all state taxes not bringing in more.
    The Land tax increase would have to be substantial I would of thought to cover the loss of revenue and the new “cashflow tax” isn’t that in effect another GST.
    The stamp duties that have been abolished are small beer.
    Tax reform is warranted but all I know is everytime they bring out a simpler tax system the tax act gets bigger and things get more complicated and to the average man in the street nothing much changes.

  116. freecountry

    Quality of state government will always be degraded until they are once more responsible for enhancing their own productivity reforms and revenue efficiency so as to deliver the best services for voters.

    It’s not very well known, but under the current Commonwealth Grants Commission formula for apportioning GST grants to the states, first a calculation is made of how much their populations should need, on average, to receive the same state services. Second, the funds already available to them, including their internal revenue and any Special Purpose Payments (regardless of the conditions attached) are added up for each state. Third, a grant is made of the average needs amount minus the amount of funds they already have. The amount of GST generated in each state is tracked, but not taken into consideration. Imagine if companies had to pool and redistribute their revenue in this way; there would be no incentive to perform, and they would all decay. Furthermore, costs of labour and materials differs from state to state but this too is averaged out in the Grants formula.

    As Ken Henry wrote:
    [For as long as the States have significant expenditure responsibilities, they should have access to significant and sustainable tax revenue. Furthermore, the States should also have some autonomy over the amount of tax revenue they raise, so they are accountable for their expenditure decisions.
    .
    Although the States currently have access to significant taxes, there are problems with the quality of these taxes or the way they are levied. Increasing the rates of existing State taxes would not be an efficient or sustainable way of funding services in the future. Assuming no change in expenditure responsibilities between levels of government, the States will need better access to sustainable tax revenues to deal with these cost pressures.
    .
    The capacity to phase-out existing narrow-based taxes depends on the States having access to an alternative, more efficient revenue source. This could be a reformed land tax, revenue from a cash flow tax and/or a tax base sharing arrangement for personal income tax.]
    Since taking over income tax for World War 2, the capacity for comparative experimentation in taxation has been lost. Perhaps if states retained fiscal autonomy, one or more of them might have taken the Henry Review a bit more seriously than the federal government did, and the others would soon be racing to catch up.

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