One theme running through the debate about how to address housing affordability, and the increasing and contrary concerns about an apartment market crunch, is the unwillingness of politicians to use their levers, while expecting the financial regulators to manipulate theirs so adeptly that any number of complex problems can be solved.

This doesn’t merely apply to the current situation of a government that professes to be concerned about housing affordability but which has relinquished the use of its legislative tools — negative gearing and capital gains tax laws — while encouraging regulators to use macro-prudential tools to crack down on property investor lending.

It goes back further under this government, to the role of self-managed super funds (SMSFs) in property investment.

SMSFs don’t play the same massive role in property investment that wealthy households, subsidised via negative gearing and capital gains tax concessions, do — but that role has been growing, and in the event of a property crunch poses even greater risks. In 2007, the Howard-Costello government allowed superannuation funds to borrow — an apparent contradiction to their basic purpose as a savings vehicle but entirely in accord with the Coalition’s longstanding preference for superannuation to be a tax-minimisation vehicle for the wealthy rather than a genuine retirement income policy.

The decision might have gone down well with the Liberal Party base, but regulators and industry veterans have a very different view. In 2014, the RBA said in its submission to David Murray’s Financial System Inquiry:

“[A]s SMSFs increase in importance within the sector, the fact that they can leverage raises concerns about SMSF members being exposed to greater financial risks (including excessive concentration in a single asset) than they understand they are taking … leverage by superannuation funds may increase vulnerabilities in the financial system and supports the consideration of limiting leverage. As emphasised in the Bank’s initial submission, the general absence of leverage in superannuation was a key source of resilience in the Australian financial system during the financial crisis. Furthermore, the compulsory and essential character of retirement savings implies that it should remain largely unlevered. While still in its infancy, the use of leverage by superannuation funds to enhance returns appears to have been mainly taken up by self-managed superannuation funds (SMSFs).”

As banking veteran Graham Hand wrote on the Cuffelinksin 2014:

“SMSFs can usually borrow up to 80% of the value of a property, requiring the fund to have capital of at least 20%. If the value of the property falls 10%, the SMSF will lose half its capital. The impact of leverage is dramatic, in this case, equivalent to falls in sharemarket values seen in the Global Financial Crisis that nearly brought the banking industry to its knees… Many highly leveraged SMSFs would lose all their own equity if there is a decent residential property price correction.”

[Super for housing: the latest example of our war on the young]

The following year, the RBA went further

“Another change in the landscape since 2003 is that superannuation funds are now able to borrow. Some self-managed superannuation funds have taken advantage of this by adding geared property into the fund portfolio, both residential and particularly commercial property. At the margin this has increased the population of potential investors. Although the share of the housing stock owned by these funds is small, it has grown quickly. The Bank has previously advised that leverage in superannuation funds may increase vulnerabilities in the financial system and therefore supports limiting the scope for leverage in these funds.”

And his Financial System Inquiry report, David Murray wrote:

“Direct borrowing by superannuation funds could pose risks to the financial system if it is allowed to grow at high rates. It is also inconsistent with the objectives of superannuation to be a savings vehicle for retirement income. Restoring the original prohibition on direct borrowing by superannuation funds would preserve the strengths and benefits the superannuation system has delivered to individuals, the financial system and the economy, and limit the risks to taxpayers.”

But the government rejected that recommendation — the only one it rejected — in its October 2015 response to Murray, dismissing it as “anecdotal concerns about limited recourse borrowing arrangements”, though promising to revisit the matter in light of additional data in coming years. That review might come too late, given the RBA’s recent warning of a “build-up of risks associated with the housing market”.

In the event of the kind of correction regulators are concerned about, the capital gains tax concession would be irrelevant for thousands of SMSF and other investors — there will be no one to buy their properties except via mortgagee sales and there is no CGT relief on those. Super funds will be in breach of their trust deed because of the losses, banks will face big losses, and property prices will come under pressure — especially apartments. That will flow through into the construction sector, and a full scale rout will quickly emerge, devastating property and threatening the stability of the financial system and the economy (remember, according to RBA estimates dwelling investment was around 12% of GDP in late 2016).

There’s only so much regulators can do when politicians are unwilling to do their jobs properly.

Peter Fray

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