Transcript of Question & Answer Session Opening Remarks to Plenary Panel at the Australasian Housing Researchers Conference

So thank you Luci and Dallas and now we have the opportunity to take some questions from people in relation to either of the presentations. Would anyone like to start?

I have a question. I was really interested Luci, in your analysis of HILDA data and I’ve worked with HILDA too and it’s such a fabulous dataset. It occurred to me that in relation to the moving data that that’s kind of like a national average and whether you’d also kind of thought about or looked at, you know, in terms of sort of the variation in terms rural, urban, regional areas in relation to moving and whether that was part of the story or not about the security of tenure issue.

It’s fair to say that this if very early days, it was essentially I had a talk to give and I wanted to look into that particular issue so some of the team helped me with that analysis. But it is also fair to say that at the Reserve Bank we have a number of different strands of work including a dedicated team that looks at microdata in our research department and the use of microdata to facilitate macro analysis is an ongoing project at the RBA.

Yeah, okay thanks.Okay we’ve got some questions. I might work from the front back and I’ll start it here. Do you need a microphone? I’ll grab a microphone. Maybe just do a brief introduction of who you are and where you’re from and then the ask the question.

Larry Murphy, University of Auckland New Zealand. I just wanted to first of all congratulate Luci on your presentation, it was excellent and I want to, particularly again by the fact that you talked about how you calculated certain measures and have [inaudible] toward flexible understanding. If you look at the post-global financial crisis, if you look at regulatory authorities around the world, they’re increasingly being questioned or addressed on home ownership issues and affordability. I imagine that coming up with a locked value of debt to income ratios, they’re applied in a place like the UK and New Zealand and elsewhere. I’m just wondering how does your understanding of this kind of fractured awareness of all these ratios and things align with what exactly happened on the ground in macro prudential provinces, and their impact on the market.

Yeah, so just in case some of the audio didn’t come up. For the recording, the question was what I thought about some of the broader ratios like loan to valuation ratios and loan to income ratios as a macro prudential tool and I should point out that macro prudential tools aren’t directed at achieving housing affordability, they’re directed at achieving financial stability and banking stability. I think you hit the nail on the head the fact that some of these ratios are often quite crude and often don’t map to how lenders actually think about credit risk is exactly the reason why the Australian authorities are, as has been well document, about using these sort of blunt tools, except in extremus, that we’ve been quite sceptical about thinking about lending standards in that way. APRA has quite a multi-dimensional approach in its prudential practice guide around mortgage lending standards. At the Reserve Bank we have a sort of five dimensional framework for thinking about mortgage lending standards that we use. We’re not attracted to the idea of going to a particular intermediate target because that feels a lot like monetary targeting and monetary policy and we know how that worked.

So I guess relative to other countries we’ve been quite sceptical about the use of those measures and that’s not – I’m not saying anything new there, we’ve said that many times before.

I was interested in the comment you made about, we don’t need to just simply focus on home ownership and I think you said security of tenure or something along those lines. Could you amplify what you mean by security of tenure and how it compares with home ownership.

Well I guess what I was getting at was that – I mean not everybody is well served by home ownership at every stage in their life, they may actually need to move around for whatever reason. Sometimes that can be compatible with ownership of a home in the sense that in Australia you can rent out the home you previously lived in, go and rent somewhere else for a while and then come back and that’s not unheard of. What I’m talking about is essentially people being forced to move when they would have preferred to stay and that is particularly an issue for renters whose decision to move is often in the hands of someone else. But from a financial stability perspective it would also refer to people who had previously been home owners and ended up having to become renters because of financial strains, you know, whether they defaulted on the mortgage or just had to sell because they could no longer support that financial obligation. But I think of it, essentially in those times.

Wouldn’t that require change of tenancy protection laws which is hard to achieve in countries like Australia and New Zealand.

I think that’s an interesting conversation to have.

Good point. All right, Peter did you have a question?

Peter [inaudible] from the University of Sydney. Look it’s a question to Luci around the nature of sort of new housing supply in different cities in Australia. Coming from Sydney I’m very struck by the large number of new apartments in Melbourne that are quite geographically constricted, in very large buildings and fairly homogenous in their design. And coming from Sydney I’d hate to say anything negative about Melbourne but it’s an usual sight to see in Sydney apartments with definitely no windows, for instance, to the outside world. Is that something that the Reserve Bank would consider in terms of looking at some financial stability risks. You can imagine as the second and third sales of some of those apartments, you know, if the market does turn a little bit, could be more difficult to negotiate. Do you get that level of detail looking at financial stability risk, I guess, is my question.

Well, that’s a question about my previous role not my current role but I can tell you that the last three years of financial stability reviews have addressed exactly that. I mean we’ve been talking about the concentration of apartments particularly in Melbourne and Brisbane. We’re more concerned about that geographical concentration. Yeah, we’ve been saying that for a number of years; it’s all there.

What did you say?

Sorry, in the Financial Stability Review and elsewhere we’ve been saying there’s been this concentration of apartments, particularly in Melbourne and Brisbane, it’s geographically concentrated, people need to think about the resale value of that. But the financial stability angle of this and I’d refer to a box that was in the FSR in October last year, the financial stability angle of that in terms of the blowback to the financial system and then onwards to the household sector is actually through lending to developers not through lending to households. If you think about the relative loss rates, that’s really the vector of transmission of financial instability but we have been highlighting for at least three years our concerns about the geographic concentrations within cities and the absolute size of apartment supply in Melbourne and Brisbane relative to the existing housing stock in those areas and in fact you’re seeing it now. I mean Brisbane apartment prices are falling. There was more supply coming on line then there had been underlying population demand for it. In some sense Melbourne’s population is growing so quickly it’s less of a concern, and secondly, with Sydney, again, population is growing quite quickly, lots of overseas migration, people have to live somewhere and it’s more dispersed across the city. There has been a lot of housing supply in recent times and what matters again is how it’s distributed and we’ve absolutely been talking about this for the last three or four years in the Financial Stability Review, but that’s my old job.

Peter was your question also a little bit about quality of dwelling?

That certainly is in this situation a consideration looking at you know, the difference of its location, but also the nature of the stock. That might be less resilient from a more discriminating purchaser in a declining market.

Yeah and that’s definitely something, I think in one of the 2013 Financial Stability Reviews we discussed the potential resale value of some of that property and how adaptable it is to different market segments of demand. So if it’s very specific in its appeal that can matter. But again, how that blows back on the rest of the economy is through losses by developers and then on to the people who lent to those developers. The analysis that we’ve done is that’s unlikely to cause widespread household distress.

Okay, a question here?

My name is Julie Wilson. Luci, I’m interested in – you made a comment in the beginning that institutions matter. So settings are very important and much more important is the welfare system. So you can imagine as we’ve heard from [inaudible] generation where prospects for the long term, even if it is insecure, would imply that even close to [inaudible] or revive some of the old [inaudible] and would draw heavily necessarily on some form of [inaudible] system which we don’t have in our late [inaudible] homeowner [inaudible]. So does the Reserve Bank consider those kind of long term [inaudible] demand on the, necessarily demands on the [inaudible].

I mean it’s not within our remit to opine specifically on design of the welfare system but we have said publicly before is that the way the welfare system in Australia is designed is that essentially as long as you own a home outright by the point you retire, that’s kind of the goal of the – that’s in some ways the ownership goal that’s been framed by the design of the welfare system and it’s not obvious to us that there’s a specific public policy imperative to ensure that that ownership starts at a particular early stage in your life as long as when you get to retirement you are not relying on private rental. I mean clearly some people on the aged pension are relying on private rental and I think that’s an important issue for those arms of government with that remit. But yeah, that is certainly something that we’ve observed in the past, given our current design and that’s the thing it’s all connected. The design of our welfare system have implications for how we frame the public policy goal in the housing space. It also has implications for how we think about the idiosyncratic risk posed by households. This is an important thing again in cross-country comparisons. There’s a lot of assumptions in international debate and indeed in international regulatory standard setting that a household sector in one country with mortgages poses the same risk as a household sector in another country. And of course, that’s a very difficult conversation to say well, our households are less risky than yours because x, y and z. When you really don’t want countries gaming the system against each other and using the regulatory system for competitive advantage.

So that’s some of the fun and games that happens in sort of the international policy conversations which I’m no longer involved in.

Jago?

I’ve got a question for Luci. You’ve obviously, have an appreciation within the Reserve Bank that inequality is a question that needs to be considered in these kind of conversations. I was wondering if you could perhaps tell us a little bit more to what extent in terms of your financial stability models if you operate to understand the national economy for the issues relate to your role as regulators. Does inequality have a presence in either the conceptual framework around financial stability in or in the actual technical models that you apply to measure the state of financial stability at any given moment in time.

I think the word I’d use to frame it is distribution. For example, one of the publications that has been done coming out of that work was the household stress testing model, again using the HILDA data. So one of the things you can do is come up with a microsimulation model of how individual households fair under certain stress scenarios based on their current balance sheet and income and labour force participation and so on and that’s a really important input into getting loss ratios for a broader stress testing model. That’s the sort of thing you have to do when you haven’t had a recession for over 25 years that’s a material recession. We’ve had small downturns but we haven’t had a full blown recession, recession. So that means that we don’t have very good data to put in stress testing models. It’s all – every silver lining has a cloud and so that’s one of the things we do. Obviously the distribution matters there and so any kind of stress testing model has that. So on the financial stability side that would be the way we’d frame it and certainly there have been things where we’ve published, you know, the share of households who meet certain criteria and therefore … and indeed the share of businesses who meet certain criteria and therefore might be considered more vulnerable.

On the monetary policy side as I mentioned, actually understanding the cash flow channel of monetary policy and the collateral effects of changes in interest rates really do depend on the distribution. So in that sense it’s not like you have a GD co-efficient on the right hand side of your aggression but those distributional considerations absolutely do aggregate up. I guess what I’m saying is that the representative agent model really doesn’t work for us as well as some people might think.

Michael Bailey from the Australian Financial Review. Two questions to Luci. You referred to falling apartment prices in Brisbane as a result of a greater supply. To your mind is that a sign of some healthy readjustment in the housing supply equation and is it a sign that the system is sort of working the way it should?

Well I think the way I’d frame it is that yes if you have a lot more supply coming on very suddenly, prices will be lower than they otherwise would be, and you do also see that a little bit in the wedge between growth in apartment prices and housing prices in Melbourne although apartment prices are still rising. You know, supply and demand both do matter. I think – you know, would I regard it as healthy? I think people need to again, the reasons why in my previous role we were expressing so many concerns about Brisbane apartments is the concentration and that there are issues, when you have building lags you can end up with a situation where you’ve got a lot of supply coming on line that where the decisions to build were made a couple of years ago, where the decisions to buy were made a couple of years ago and then you end up getting caught out on the other side. So there are risks to when you have big surges of building activity and you know, you can have too much of a good thing in some sense and you can have too concentrated a good thing.

So there are important nuances to be aware of in this debate and I think one of the points I made in my talk is that yeah, things are a little bit more nuanced than just sort of little slogans of, you know, price to income ratio says this or supply is good, or supply, now, now, now is just as good as supply spread out. We need to be aware of those nuances and those risks and that’s the point I’m making.

At the risk of asking another less nuanced question, I have one again about the housing supply. There’s a report today that the federal government is considering reducing the capital gains tax deductions on property investment. What effect will that have do you think on housing supply and secondly, what effect could it have in having limited property, simply have the risk of [inaudible] for instance.

Well firstly, since that has just been announced that they’re considering it. We have not done detailed modelling of that, even if we could, but I can refer you to the statement I made to the House of Economics Enquiry on Home Ownership in 2015 where we talked at length about the tax system and how that related to home ownership and what we said at the time was that it’s the interaction between negative gearing and the capital gains tax discount that create this incentive to leverage into investor housing in Australia. And it goes particularly into investor housing because property is the asset you can leverage the most so that’s where the incentive is most attractive. So it would stand to reason that if you reduce the capital gains discount that incentive to gear up into housing would be less than it were otherwise. So obviously I haven’t had a chance to do that detailed modelling in the time available, but it’s certainly something worth looking at.