Thursday, December 2, 2010

Can the government stop the bubble from bursting?

Houses and Holes has another excellent post today on Wayne Swan's new plan to create a "fifth pillar" of the banking system. I'd urge you to read it in full, and am in agreement that this latest salvo from Captain Swan amounts to nothing but kicking the can down the road without addressing the real issues, which include the banks' unhealthy reliance on offshore wholesale funding. But what struck me was this insightful comment on the post by "rht":
I would agree that it is a victory for the banks and equally so for Black Swan and the Government. The last thing they want is a significant drop in house prices whilst they are in power as it would certainly cause them to lose the next election.

They know that policies such as this only " kick the can down the road" and indeed will make the eventual collapse in house prices that much worse. However they hope that they will have had a good few years in government by then and that it will then be someone else's problem. I have for some time thought that house prices will only significantly decline here in Australia when the Government and the banks no longer have any say in the matter due to external factors /events such as a significant China slow down.

In the meantime they still have plenty of ammunition in their locker in addition to the policy announced today: lower interest rates (why not ZIRP for Australia ?), covered bonds, renewed and increased grants for first time buyers, more tax breaks for investors, abolishing stamp duty and capital gains tax (causing lower govt revenues yes but who cares about balancing the budget when the property ponzi needs to be propped up for as long as possible) and they are no doubt thinking up other policies at this very moment. 
Now I have a lot of sympathy for these views and am in full agreement that the Australian government may THINK it can continue to kick the can down the road, but the question is whether or not this will be possible. Contrary to popular belief, most investment bubbles eventually collapse under their own weight, and do not need an external trigger. This is an issue I would like to write about some time soon.

In any case, let's take a quick look at the experience of the US, where an extraordinary raft of measures have been taken in a desperate attempt to reflate the economy and housing bubble, all with little success:
  • The Fed slashed interest rates from 4.5% to zero 
  • Government takeover of Fannie Mae and Freddie Mac, the country's two biggest mortgage lenders
  • Two rounds of quantitative easing, including the Fed's direct purchase of $1.25 trillion (yes you read that figure correctly - almost 1.5 times Australia's GDP) in agency MBS
  • Introduction of a new $6,500 tax credit for home buyers purchasing a principal residence (recently expired)
  • The introduction of HAMP, a loan modification program designed to reduce delinquent and at-risk borrowers' monthly mortgage payments. 
I'm sure this is not an exhaustive list. But let's take a look below at what US house prices have done in the meantime. At the very least, this should make you think twice about the Australian government's capacity to dig us out of the hole we are in.

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