Professor Hudson: Housing supply down, profits up

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Michael Hudson

As published in the Business Age
The 2nd most read article in the Age website on the day as per the graphic billing

HIGHER land and house prices typically lead to an increased supply of housing. Yet at the peak of Australia’s perennial housing affordability crisis, the Housing Industry Association declared that there would be a 13 per cent fall in housing starts this calendar year, compounding last year’s 18 per cent fall.

In light of massive rezonings in Victoria and improved planning bureaucracy in many states, this can only be seen as a warning that property insiders expect there to be a price crash.

The public face of the housing industry is quite different. So, what do property investors expect that the rest of the population does not?

Government spokesmen reflect assurances by bankers and their major category of customers – the real estate industry – that Australia’s economy is defying gravity. In reality, that is as impossible in economic life as it is in physical nature.

Property prices are defined by how much a bank will lend. Donald Trump claims that a man is worth what he can borrow. This usually depends on what a borrower can afford to pay, after meeting basic break-even needs (the cost of living, plus taxes). In the corporate sector, it means after-tax cash flow. So property prices are set by the banks, subject to the tax system.

The motto of real estate investors is that rent is for paying interest – and whatever the tax collector relinquishes is available to be capitalised into a bank loan as a flow of interest payments. The guiding idea is that affordability determines property prices. One example of how the tax system affects property prices is in its failure to distinguish land from capital improvements. Speculative withholding of prime locations from the market in an undeveloped or unsold state creates artificial scarcity. This raises prices.

Property speculators are able to afford this hoarding to the degree that the land’s potential site rent remains untaxed. Taxing the land would bring underutilised land and other property on to the market. It also would reduce the available free-lunch rent that is currently capitalised into bank loans to raise prices.

The myth is that higher property taxes increase the cost of housing and office space over time. The reality is that higher taxes would leave less site-rent to be pledged to banks – thereby reducing the financial cost of property ownership – while also enabling the government to shift the tax burden back off labour on to property, as used to be the case in Australia before the mid-1970s.

This explains why the financial lobby supports the real estate lobby in shaping public perceptions of the property market – along with government financial policy towards the finance, insurance and real estate sector.

Australia’s fiscal-financial system has become increasingly dysfunctional in giving tax preference to land-price ”capital” gains and hence property speculation rather than tangible capital formation. Instead of raising living standards by producing more, what passes as post-industrial ”wealth creation” takes the form of inflating asset prices on credit. The result is a bubble economy. And inasmuch as asset-price gains are fuelled by debt leveraging, wealth creation is more accurately viewed as debt creation.

The problem is that debts remain in place even as prices drop.

And they are dropping in response to the economy’s shrinking ability to pay, as more and more income is earmarked to pay debts run up in the past. This debt service is not available for spending on goods and services. The result is debt deflation. Lower spending on goods and services shrinks the domestic market (and also shrinks imports), leading to lower business profits and also lower business rentals. Lower rental income results in lower property prices – and at a point, property falls into negative equity: the mortgage debt exceeds the current market price that home owners or commercial investors can recover.

This is the end stage of debt-leveraged bubbles. In this respect it behoves Australians to look ahead. It seems that Australian property investors are also doing this. How else to explain the cutback in new building?

Michael Hudson is distinguished research professor at the University of Missouri.
Read Bryan Kavanagh’s feedback on some of the comments to this aarticle on The Age website.

10 Comments

  1. Paul14-11-2009

    Shame on our inflationary Mugarbi style housing market
    the lard-lords et al.

  2. Paul25-11-2009

    With income management announed today by Welfare reform, it beyound belief why those on certain benefits like Newstart are deemed irresponsible or inept at managing
    income, not the poverty trap of Austudy while the same inept property sector government ecomics and private market sector are pardoned for never making the cost of housing or the cost of living affordable.Inflation Never before seen in this nations history. It beckons beyound believe the filthy moral backwater that these social policy think tanks like per-capita and (CIS) VECCI et al, inhabit. The madness is these conservatives were responsible for all the social policy engineering 15 years prior and leed up to the crisis, and they still are deemed advisors.

  3. Mat21-12-2009

    What is it with you people. How about taking responsibility for your own actions. Communism doesn’t work – don’t you people get it. If you had ever lived in a communist country you would never sprout this absolute garbage.

    Why don’t you go chill your chardonnay.

  4. Karl Fitzgerald
    Karl Fitzgerald21-12-2009

    Cheers Mat,
    keep reading and you will see we have nothing to do with communism. How does it feel that capitalism has become nothing more than a giant Ponzi game? Why should speculators get all the incentives? Reward for effort has been replaced by speculative largesse.

    Listen to Hudson strip apart modern capitalism or on the Renegade Economists to understand how martini’s can be chilled for all AND the barman AND bar owner earn good money.

  5. Matt21-12-2009

    Karl,

    What incentives are you talking about??? If you are talking about negative gearing, every Australian has the ability to claim it with their property investments. However the big issue in Australia is the uneducated property speculator that has been fuelled by idiotic Television programs where they show all these successful people having made a fortune. This dip in the economy is the best thing that could have happened, because alot of the idiots have had their fingers burnt.

    If we are talking about primary residence and the inability of young Australians to afford their own home, perhaps they need to take a page from their grandparents book of economics, for every dollar you earn save one. The young want a 4 X 2 house with all the luxuries but are not prepared to work up to it. Instead they morgtage themselves to the eyeballs and freak when there is an interest rate hike. Should they not perhaps purchase what they can afford – not what the banks will lend. Banks are there only for their own interest – not for the sake of their customers.

    The proposal of abolished income tax to be replaced with property tax are ludicrous. Essentially you are talking about property nationalisation. Why would anyone then own a property. Who would build the properties, who would maintain the properties. I came from an Eastern European country and you should see how that system worked. I love the comment about reward for effort, the system you propose though in theory seems like it will work flounders in reality.

    I feel that you guys seem to have lots in common with communism, no matter how you paint it.

  6. Karl Fitzgerald
    Karl Fitzgerald30-12-2009

    Matt,

    we have a housing affordability crisis where the average wage can buy the average house at triple what is seen as affordable (mortgage payments constituting less than 30% of our wage…it wasn’t long ago that it was actually at 20%). The tax incentives for those who already own property are some of the most attractive in the world. We are one of the few places in the world where negative gearing is allowed. Let alone low cap gains (postcode hopping anyone?), poor council rates penalising house construction but rewarding land speculation) and an ineffective Land Tax system.

    One would think that with affordability at such crisis levels there would be an increasing in housing supply? But yet it is strongly predicted by no less than the HIA that in our time of need the housing industry will go to sleep next year, crimping supply by an estimated 18%. Why? Because they see a land and housing crash to come. There can be no other reason. They have been awarded over 230,000 sites to build on in Victoria alone, but yet supply will be crimped.

    There is no land nationalisation. Property owners still have private property rights. They still own their house. They possess the land for as long as they pay a yearly land rent. This encourages efficient land use and ushers speculators into more productive activities. If they can’t provide affordable housing at this point in time, maybe it is time they find a new job.

    Your criticism of young people wanting large houses is borne out of a Current Affair mentality. Through the Speed Renting event we run we meet dozens of young people who are virtually begging for a place to call their own, either as renters or owners. Most i meet would prefer an old home to a McMansion. The problem there is that first home buyers are competing with ‘upgraders’ who look at the same site in a once affordable neighbourhood and see the opportunity for 2 or 3 townhouses. From that the genuine home buyer is out bidded and perhaps forced into the McMansion market.

    Many youngsters leave university owing upwards of $30,000 each as HECS debt. If they are lucky enough to live out of home, the uni accommodation around Melb Uni has been increasing by 5% per semester, that’s 10% a year. No part time job offers wage increases like that. Why should this rent-seeking behaviour be encouraged?

    Matt as someone from an Eastern European country, I hope it isn’t Latvia. What a shambles. Michael Hudson talked repeatedly about Latvia having virtually no debt in 1999. Now the country is mortgaged up to their eyeballs and owing their debts to Swedish banks in foreign currency, so they face the double whammy of negative equity and a falling currency.

    You talk as if we should follow Latvia’s policy of taxing income at 59% but yet property owners only at 0.01% on a 1930’s land valuation. This is the policy hotchpotch we have been sold hook, line and sinker. it is essentially flat earth economics. The earth never goes up in value. Effective communities should be penalised. That is the choice you have chosen. Please keep reading. There is a delicate line that we promote that takes the best from human endeavour and the best from community synergies. It’s not communism, it’s not socialism. It’s georgsim.

  7. Matt31-12-2009

    How would you propose such a tax be phased in. Please give me your hypothesis on what would happen to someone that has invested in their own retirement by accquiring four residential properties and two commercial properties with a total market value of $3.5 million. What kind of tax would they look forward to. The incomes generated from these properties would in no way be able to offset the 10% land tax that you are talking about, so what would this person do??? How would they survive as they are asset rich and do not qualify for the old aged pension, though contributing to taxation for their entire working life. This couple is now too old for full time work, and have struggled their entire lives, what would happen to them in this system?

    What would happen with the private rental sector, and who would be brave enough to invest their money into property.

    As for your dislike of the McMansion, if there was no demand – there would be no need to have these 4X2 urban sprawlers if young people did not require the Australian dream of having a backyard. In my previous homeland their solution was to build monstrous high rise low quality apartments. Would this not be a suitable solution to all these young University graduates looking for a place to live.

    I went to Uni just a HECS hit in, and worked three jobs while paying of a mortgage. Sorry if i don’t have sympathy for those that spent their free time enjoying campus life and propping up the bar at the social tavern. My interest rate back then was 21% so again, i know what it is like to struggle.

    The real problem is the Federal and State Governments that jump into bed with the land developers. Governments also make alot more from releasing crown land in only small quantities. The Government itself is helping fuel the speculation because it is a nice source of revenue for them.

    Perhaps one solution is to revitalise regional towns and country areas. How many remote towns are crying out for young professionals, but the young want all the trappings of a city life. So therefore they have to pay for it.

    How many migrants especailly in the 1950’s and 1960’s went to work on the land in country areas. Why did they do that, i am sure they would have liked the lifestyle in the cities as well, but they could not afford it.

    I can see the merits of certain aspects of what you are proposing, but the pain that will be felt by many people in this country would be too great for any political party to even contemplate the idea.

  8. Mat16-02-2010

    What, still no reply?????

    How about a little debate to argue your point.

  9. Karl Fitzgerald
    Karl Fitzgerald25-02-2010

    HI Mat,
    my partner & I had twins a month ago, so excuse the delay!

    Our resource rentals system encourages decentralisation to rural areas (lower land values, lower tax burden). Pensioners will be encouraged to undertake a tree change where land values are lower.
    As a well organised lobby group, pensioners are our biggest obstacle. The old widow gets rolled out by the property lobby every time. It’s a very powerful weapon, even if she is living in her big draughty house in camberwell and young active workers are having to drive past her house from Berwick and endure traffic jams all the way.

    Our system would encourage the old widow to open up her house to other family members etc. Let’s use this huge block of land. If she prefers to keep a massive garden, she pays a little more for it.

    But yes one generations superannuation investment is another’s lost opportunity. That is well covered in the press. Pensioners will lose out on their ‘investments’. With the drop in the prices of milk, bread etc when income, sales, company taxes etc are abolished, their purchasing power will improve.

    Did slave owners receive compensation when it was outlawed? Forcing younger generations to pay higher and higher mortgages does nothing productive for the economy.

    Mat – if you are in Melbourne, I encourage you to come see Phil Anderson speak on March 2nd @ Asset Bubbles Forever

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