History has shown that the house market has a tendency to cycle between boom and bust. In boom times the value of a house is greater than that justified by the rent the house can obtain. That is the asset class of housing becomes inflated when compared to other assets and with respect to debt. When the boom eventually makes housing unaffordable, it is followed by a period of stagnation and the resulting correction is often a recession or even a depression.

Steve Keen at http://www.debtdeflation.com/blogs/?p=41 gives an explanation of this general phenomena phenomenon in his paper “Developing a monetary model of financial instability”.

The inflation in house prices is mainly caused by inflation in the price of land more than inflation in the cost of building a new house. Addressing the problem of land price inflation will make houses affordable.

The following outlines a system to reduce the impact of the inevitable deflation of Australian residential properties by putting some new houses with “reasonable” prices on the market in such a way that the prices will remain “reasonable” and without deflating the prices of existing houses.

The Australian Housing Market – 1996-2003

The average price of houses throughout Australia doubled in the seven years from 1996 to 2003, even though it was a period of low inflation. The valuation put on houses in this period went up at a compound rate of 10% compared to general inflation of 2 to 3%. While the reasons are many, there is a strong argument that the main underlying cause was lenders encouraging borrowers to purchase existing houses. Why did lenders wish to provide money to people to buy existing houses? It was because the money that people lend is not tied to the underlying value of the houses, but to the ability of the borrower to repay. In other words, the lenders were able to generate loans that had to repaid – not with houses but with other assets and most notably, the future income of borrowers. Lenders are able to isolate themselves from the risk of house prices falling.

Such an increase in the availability of funds for housing will result in an increase to the price of existing homes, because many homeowners are able to “upgrade”. This in turn raises market expectations, whereby land owners can increase the price of new land and so increase the price of new houses, which in turn means that they become too expensive for new entrants to the housing market. This causes a slump in new houses which now feeds into the equation with prices starting to increase because of lack of supply. The end result is unaffordable housing.

The relative value of houses in relation to other assets has become distorted and to “solve” the problem the relative value has to be restored. Traditionally this adjustment comes through a combination of the period of stagnation in house prices plus inflation which restores the relative value of house assets to other assets. The simplest way to restore value is to release new land at low prices. This would make new houses cheaper, demand would reduce and prices would adjust. Unfortunately this does not happen for two reasons. The first is that it would be political suicide for any government to set out to reduce the price of existing houses. The majority of the population own their homes and many have paid of their house debt. They now count the nominal (inflated) value of their land as part of their wealth. The second reason – particularly in the ACT – is that governments of all persuasion are addicted to revenue from the profit of the sale of new land.

Inflated values make it worthwhile for people to turn house assets into other assets, but because people have to continue to live somewhere it only benefits those who do not have to purchase or rent another house, or those who can “downsize”. Thus there is an effective transfer in wealth to those who own houses from those who will pay from their future wages for their housing needs. In a global economy this means the main beneficiary of the Australian housing bubble are the overseas investors in Australian debt.

Other beneficiaries of rising house prices are the owners of under-utilised land and, as alluded to earlier, the governments that benefit from charges and taxes on change of land use for new dwellings. Most home owners do not benefit because they rarely have “under-utilised” land and they always need a place to live.

Another way to bring all house prices down is to reduce the price of changing land use as occurs when we change “greenfields” to housing, or land from single dwelling to multiple dwelling usage. These changes are under the control of governments through their planning agencies. However for it to be politically acceptable, the price reduction would have to be introduced in a way that ensured existing house prices would not collapse.

A solution to the problem for the ACT and later Australia

The ACT government could release a percentage of new land at the price of development. When houses that have been built on this land are sold, they must be sold for what we can call “house dollars”. House dollars are special in that they can only be used to purchase services and goods that are used to build new dwellings in the ACT. That is, the money raised from the sale of a house on cheap land has to be used to build a new dwelling in the ACT. Thus anyone buying a house on cheap land will know that they will receive house dollars when it becomes time to sell. The requirement to sell for house dollars would remain in place for the lifetime of the dwelling. This means that the price of houses built on cheap land will continue to remain close to the price of building a new house anywhere else.

This will ensure a supply of houses in the ACT that will remain affordable and that are divorced from land price inflation. Instead their value will be tied to the cost of goods and services to build houses.

House dollars are created by depositing unrestricted dollars into a backing account. House dollars can be sold for unrestricted dollars for whatever the market will bring but house dollars can be converted to unrestricted dollars when the dollars are spent on materials and services to build a new house.

The system will be simple to introduce – because house sales are already well recorded. It will be easy to police because suppliers who provide goods and services will be expelled from the system (and from a ready market) if they accept house dollars for reasons other than materials and services used in building a new house.

People who genuinely wish to trade houses are not disadvantaged as they can use their house dollars to pay to build a new house, or they can buy another house that is also subject to the house dollars restriction. If they have no use for house dollars they can sell them to someone who wishes to build a new house.

The impact of the system will depend on how much cheap land is released. One of the advantages is that the scheme is not just restricted to low cost housing but can be spread across all block sizes and does not create pockets of low cost housing.

It is expected that the system will rapidly adjust so that the exchange rate between house dollars and unrestricted dollars will reflect the extent that land prices are inflated. Over time as land inflation drops the exchange difference between house dollars and unrestricted dollars will become near zero in which case the government can stop releasing land at low prices. That is the government will now have a strategy for controlling land inflation. As well as providing a stock of affordable housing across all income groups, and ensuring a supply of money for new dwellings, it will mean that prices of housing in the ACT will tend to be lower than prices of houses in other jurisdictions that do not have similar schemes.
The scheme could be started within weeks as the government could sell a proportion of new land releases – some of its existing house public housing stock and some community land released from school closures – with the same conditions. It could approach the Federal Government to fund the difference in the land costs that it loses because, if it works as expected, it has the potential to bring affordable housing to the whole of Australia.

In summary the ACT government could put in place in a matter of weeks a simple scheme to create affordable housing with no immediate impact on the price of existing houses.

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