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Top economists say rein in bank lending to avoid bubble

According to the Australian Financial Review, two of the country’s top economists, Professors Bob Gregory and Ross Garnaut, have warned that without intervention Australia’s housing sector will face a bubble.

Self-managed superannuation funds (SMSFs) are able to take advantage of tax savings and large sums of money to invest into property and other assets to generate wealth but the RBA is becoming concerned about SMSFs fuelling a rise in house prices. Minutes from the RBA board meeting showed that individuals are willing to take on extra risk as long as the opportunity to take advantage of low interest rates exists.

On September 3 the RBA noted, “In the current environment of low interest rates and slow credit growth, members agreed that it was especially important that banks maintained prudent lending standards”. The issue has been at the forefront of concerns for both regulators and investors in Australia’s biggest banks, including Westpac (ASX: WBC), Commonwealth Bank (ASX: CBA) and ANZ (ASX: ANZ), exposure to property and willingness to fiercely compete for their market share of mortgages.

The dilemma, according to SQM Research property analyst Louis Christopher, is that rising house prices will place upwards pressure on interest rates but poor consumer and business confidence would make it tough to justify a hike in rates. This is why many have queried the usefulness of “macro-prudential tools”.

“If you are worried about the risk of a bubble in the housing market, the simple and logical thing to do is remove the privileged risk-weighting of housing in bank capital adequacy ratios”, Professor Garnaut said. Placing a greater responsibility on banks to ensure they hold a certain amount of capital against their ‘safe’ property loans will make it more costly to lend.

According to Professor Gregory, a former RBA board member, the RBA’s comments over property “suggest that a further acceleration in house price growth would make the RBA extremely reluctant to cut again, even if the currency stayed high”. This would put considerable strain on companies that are competing on the international market including the tourism and manufacturing sectors.

However the RBA also noted that recent rate cuts were providing stimulus to the economy but parts of it were experiencing “lags” in the effect of policy. It went on to say that “earlier actions were still likely to take some time to have their full effect on demand more generally”. This will bode well for consumers and businesses such as retail stores like Myer (ASX: MYR) and Harvey Norman (ASX: HVN).

Undeniably the reduction in mining and resources investment will have an effect on the economy and put further pressure on a rate cut, exacerbating the property dilemma and increasing the willingness for both investors and homeowners to invest in property and other assets such as equities.

It seems all roads led to greater control of the banks whilst the investment environment is favourable. Professor Gregory said that everyone is, “Hoping that the economy will recover soon enough and quick enough that we can reverse the stance of policy”.

No housing bubble yet says RBA

Today senior RBA official Malcolm Edey said the growing concerns of a housing bubble were “unrealistically alarmist” and that vital indictors such as the ratio of average dwelling prices to average housing incomes have pointed to sustainable gains.

Mr Edey, who was speaking at conference in Sydney, said “there’s no doubt demand for housing now is strengthening, but important to keep this in perspective”. According to RBA figures the ratio of dwelling prices to incomes has hovered between 4 and 5 since 2003 but this ignores variation across states.

During the US housing boom, regions were experiencing average dwelling to family (household) income ratios of around 12. However without taking into consideration that dwellings in cities were much more expensive than those on ‘average’ and in other areas meant that urban hubs, such as Las Vegas, San Francisco, Los Angeles and Miami experienced rates of around 15 times family income – no wonder it went bust.

According to The Australian “Australian capital city house prices, routinely ranked among the highest in the world, rose at an annual pace of almost 10 per cent over the three months to June and have continued to edge up since”.  The Australian Prudential Regulation Authority’s head, John Laker, said regulating the banks’ lending practices, through interventions such as loan-to-valuation ratios, would be used if necessary to maintain sustainable prices, “there are a range of other actions that each supervisor can take before taking recourse to such monetary policy instruments, and those tools really involve engagement with institutions day by day”.

Foolish takeaway

Experienced investors know when it is a good time to buy or sell. Although it may seem highly unlikely that Australian property is in bubble territory at the moment, without intervention a continuous low interest rate environment could see house prices rise exorbitantly. Successful investing, whether it is in property, stocks or anything is best done by buying in the troughs and selling at the peaks.

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Motley Fool contributor Owen Raszkiewicz owns shares in Myer Holdings. 

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