Is a housing price crash really going to send Australia into recession?

The short answer is probably not. The longer answer is pretty interesting, I reckon, so please, keep on reading.

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There’s two questions here. Will we have a housing price crash? And if so, will that send us into recession?

Both are hard to answer. But here goes.

The idea house prices can keep growing at recent rates seems crazy. The perfect storm of record low interest rates and free-flowing Chinese money must come to an end at some point. Are we in a bubble yet? As a rule of thumb, when a price graph gets close to vertical — like Sydney in the graph below — that’s a sign of a bubble.

But this graph reveals many shades of truth.

While Sydney house prices look crazy, the same can’t be said for most of the rest. Since 2010, house price growth in Adelaide, Canberra, Brisbane and Perth has actually been quite modest. The house price growth story is really about Melbourne, and especially about Sydney.

And that complicates matters. While Sydney is part of Australia’s housing market, it’s also in the global housing market. Arguing Sydney’s house prices are too high requires us to turn our eyes to comparator cities. Abroad, we find highly desirable cities have very high house prices.

When you search for studio apartments in London the top result costs 3 million pounds. In Sydney the top result is more like $750,000.

The average home price in London is 481,820 pounds  (A$1.02 million). In greater New York, US$571,700 (A$783,000). (If comparing to the graph above, please remember the RBA graph excludes apartments).

I make these points not to defend Sydney’s current house prices, only to point out that the “correct” level is very difficult to determine.

Never believe anyone who claims they can predict asset prices. After any crash, there are always grinning pundits that predicted it correctly, but that is only because so many pundits make so many predictions.

You can’t talk about house prices without mentioning the ratio of house prices to income, which has risen enormously. But that could be explained, too. People earn more, houses are funded on two incomes, loans are easier to get, and you could be more confident in a stable economy to repay a big one.

Every argument for the bubble has a rebuttal. Nothing is obvious. Anything could happen.

By this point I hope to have led you to a place of uncertainty on the future direction of house prices. Now I intend to do the same on their impact on the economy.

On innumerable occasions a crash in asset prices has caused severe damage in the real economy. The global financial crisis is a good example. But the problem wasn’t just lower asset prices. It was that lower asset prices crashed banks, setting off a chain reaction.

Australia’s banks, its fair to say, are generally safer than those in the United States and Iceland. A stress test late last year modelled what would happen to banks if house prices fell 40%. Banks would survive, although the test caused some concerns, and now banks have to hold even more capital.

So while there would be a lot of panic, a huge house price crash would not cause the big pillars of our banking sector to crumble. That means the impact of a house price crash should be mainly limited to effects in the real economy, not in the financial sector.

In the real economy, we find a much more mixed picture.

Lower house prices could be good for the economy — they would free up money for us to spend on other things. At the moment, fewer Australians own their place outright than has been the case for many years, and more and more rent. All that money going to mortgages means less to spend on other, job-creating consumption.

The deputy governor of the Reserve Bank, Phil Lowe, has pointed out until we can make more land, higher house prices tend to make some people rich at the expense of others. Lowe said this in August:

“From the perspective of society as a whole, much of what is gained on the one hand is lost on the other: there are windfall gains from higher land prices but then everyone pays more for housing services … it is arguable that the main impact of higher land prices is not really to increase our national wealth, but to change the distribution of that wealth.”

He pointed out that even the rich can be trapped on the money-go-round. Some older people who own their own homes are helping their children obtain homes. And this will only get worse if house prices keep rising:

“Fewer parents will be able to use the capital gains that they have benefited from to boost their own consumption. Instead, in effect, they will be using those capital gains to support the following generations.”

But of course, a house price crash will not be a huge emancipation party for all generations. High house prices can help the economy. They boost bank stocks and encourage construction.

If you own a house and the price of it goes up, you tend to happily spend more. RBA evidence suggests that if your house goes up in value by $100,000 you will spend $6000 more on cars than if it hadn’t gone up. The same sort of effect is likely present for other types of consumption.

So if we see house prices come off by 10% or 20%, consumption will fall, consumer confidence will ebb a bit, bank stocks will tumble, and people will focus on paying back their mortgages.

But most likely at that time, our dollar will fall and the RBA will cut rates and the economy will still grow. So long as prices fall only a little and banks don’t fail, we may yet dodge a recession.

If that happens, parents might be able to stop helping their kids get on the property merry-go-round. Those kids whose parents don’t own property will probably be very thankful for that.

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Peter Fray
Peter Fray
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