Alun Breward translated a sensational article in the German magazine Der Spiegel for Webdiary before we invaded Iraq. A think tank war: Why old Europe says no went around the world, and became Webdiary’s most read entry. This is his first piece for Webdiary.

 

Maybe Peter Costello doesn’t read newspapers. But if he read the Fairfax press at the end of June, he probably smirked. On 29 June The Age featured Tony Fitzgerald QC arguing that truth is essential to democracy and that the Coalition Government actively misinform us. But a few pages later came an article that showed democracy does not only depend on what politicians say. It was by a noted business journalist who flayed Costello for fibbing to us about the causes of the housing boom. A colleague echoed the attack on a later page.

But Costello was telling the truth when he said that tax policy was not a major driver of the boom in house prices. Here is why.

Both Fairfax commentators nominated capital gains tax changes in 1999 as a crucial trigger for the boom in demand for “investment property”. But as Australian Taxation Office data show, between 1994 and 2000 the number of taxpayers claiming losses on rental property was growing five times faster than the total number of taxpayers [1]. Reserve Bank figures show that between 1990 and 1999, loans to housing investors grew at double the rate of loans to people buying a home [2].

Long before Costello cut capital gains tax, Australians were falling over themselves to get into residential investment property. The absence of meaningful house price rises during much of the 1990s – which one of these two critics of Costello described in The Age of 8 April 1998 – did not dampen investor enthusiasm. That in turn squares with the findings of the most recent Australian Bureau of Statistics study of residential property investors [3]. That showed that many owners of rental properties were not landlords for the tax benefits.

Property booms in the UK and NZ also prove that it is a furphy to claim that tax fuelled Australia’s boom. With zero capital gains tax to pay in the UK, and no deductions through negative gearing either, what the Poms call the “buy-to-let” market has kept their housing industry red hot for years now [4]. Across the Tasman, Capital Gains Tax is unknown and income tax rates are low compared to here, making negative gearing less attractive. Despite this the Kiwis are experiencing a housing boom which according to business magazine The Economist is particularly extreme [5].

However, one of these Fairfax commentators could not stop at just one weak explanation of the housing boom. Drawing a line between tax driven speculation and prudent spending on housing, he claimed the boom was well-grounded to the extent it reflected lower interest rates. Nowadays the line of reasoning that low interest rates bring high house prices is so familiar that it is practically folklore. Unfortunately it is simply an instance of one the great talents of economic rationalists – revisionism.

If economic rationalism has any credibility, it would seem reasonable to expect that it would have a consistent message. Maybe also it would show signs of being useful for predicting, broadly, some things about the future.

Returning to our correspondent’s writings in The Age of 8 April 1998, it’s plain that neither is the case. In 1998, mortgage interest rates had fallen to very close to where they are today. But was our commentator reporting or even anticipating a boom in house prices? No. He was arguing that the property boom of the 1980s had been a one-off, and that in the late 1990s strong price growth might occur only in pockets of our capital cities.

In holding this contradictory set of views on interest rates it must be said he has impeccable company. In late November 1995, when interest rates had fallen most of the way from their 1990 peak to the levels of today, Ian MacFarlane gave a speech. The then Deputy Governor of the Reserve Bank said:

“In an environment in which inflation is low and stable…and interest rates are low, there will most likely be some gentle rise in house prices.” [6]

In October 1997, with MacFarlane now heading the RBA, and house price rises emerging in some areas, Deputy Governor Stevens of the RBA echoed his boss. He said:

“The answer to the first question – will house price inflation and asset price inflation generally be as high in future as it was in the 1980s or even the recent past? – is surely no.” [7]

So if tax policy and interest rates are not credible explanations of the housing boom, what is? It’s probably best described as the Skase effect – the decision of the banks in the early 1990s to increase lending for housing.

Cast your mind back. In the early 1990s the banks were in deep trouble. Westpac nearly failed. The State Banks of Victoria and of South Australia needed rescue. Banks’ loans to corporate Australia were stinking to high heaven. If anyone in business wanted to borrow from them, the banks ran a mile. As Reserve Bank Deputy Governor Stevens observed in the speech quoted earlier, banks had only one place to turn – lending for housing to householders.

The results were fantastic. By 31 October 1998 the Australian Financial Review was writing that the 1990s had seen the greatest real estate lending boom in the history of this country and had been “a golden era for big banks”.

And then, the housing sector got seriously hot.

It remains so to this day; whatever the Reserve Bank Governor and numerous other economic rationalist pundits may say.

Now I do not intend to get into conjecture about why two noted business commentators might ignore the evidence that the housing boom was created by the banks. Why journalists might give an airing to furphies is not the issue. Blind Freddie could probably work out the reasons for their actions anyway.

The point is that if Tony Fitzgerald QC was correct about the importance of truth to democracy, it’s not just politicians who owe us the truth. Journalists do too.

Footnotes

[1] The Age 23 Sept 2002

[2] rba.gov.au/Statistics/Bulletin/index.html. See Table D5.

[3] Household Investors in Rental Dwellings – ABS Catalogue Number 8711.0

[4] news.bbc.co.uk/1/hi/business/2222759.stm,

news.bbc.co.uk/1/hi/business/3829435.stm

[5] See The Economist of 5 June 2004

[6] See rba.gov.au/Speeches/1995/index.html

[7] See rba.gov.au/Speeches/1997/index.html