Date created:23 October 2002
Last modified:23 October 2002
Maintained by: John Quiggin
John Quiggin

A case for equity partners

Australian Financial Review

10 October

Few policy ideas in recent years have received such a strong, and almost uniformly hostile, reception as the suggestion of the Menzies Research Centre that financial institutions should take an equity stake in owner occupied housing.

There are a range of plausible objections to the proposal. Similar initiatives in the past have failed to overcome the culturally-ingrained unwillingness of Australian homeowners to diminish their equity stake. There are questions regarding the return that financial institutions would require in addition to a half-share in any capital gains and doubts about the incentives of homeowners to improve their property in the presence of an equity partner.

These are serious problems, but none of them is obviously insuperable. In any case, most of them imply nothing more than that, if this form of financing were offered by financial institutions, it would find relatively few takers.

The real reason for the hostile reception is the increasing climate of fear surrounding the bubble in housing prices, particularly for unit developments in Sydney and Melbourne. By late last year, prices had reached a point that was clearly unsustainable relative to the long-term cost of construction. Economists confidently predicted a decline.

But far from declining, prices continued to rise. Many buyers who had held off in the expectation that the boom would cool jumped in for fear of being locked out of home ownership forever. Warnings from economic thinktanks, from major banks and then from the Reserve Bank itself were shrugged aside as prices headed inexorably upwards. Boosters of the boom published new arguments to prove that the price real can only go up or stay the same, never decline.

To those familiar with asset price bubbles, this is scary stuff. Precisely the same arguments were made about Japanese real estate in the 1980s, and about American technology stocks in the 1990s. Buyers were confident because of the belief that the authorities would never allow a catastrophic decline in prices. In the US, this belief was referred to as the 'Greenspan put'.

The collapse of the Japanese bubble inaugurated a period of stagnation that has lasted more than a decade and shows no sign of ending. The outlook for the US following the bursting of the NASDAQ bubble in March 2000 is only marginally less grim.

For those who fear a similar outcome in Australia, the Howard government's close identification with the housing boom and bubble is seen as the equivalent of the Greenspan put. Most obviously, when the boom showed signs of cooling off, the government pumped it up by doubling the First Homebuyers Grant. At a deeper level, the political reliance of the present government on low interest rates and good times for homeowners is deepseated and widely acknowledged.

In these circumstances, a policy proposal emanating from a think tank associated with the Liberal Party and aimed at improving the financial circumstances of homeowners is bound to be viewed with suspicion. The proposal has been widely criticized as one that will extend the life of the housing bubble, causing more hardship for homebuyers in the short run and ensuring that the ultimate bursting of the bubble will be even more painful than is already inevitable.

Reasonable though these fears seem, they are, in my view, misplaced. For new homebuyers, the use of outside equity rather than traditional debt finance reduces both the chance of capital gain and the risk of capital loss. Those who aspire to home ownership but fear the bursting of the bubble should welcome the prospect of equity partnership.

The impact of the proposed innovation on house prices is less clear-cut. On the one hand, to the extent that equity partnerships attract new investment capital from sources other than the traditional suppliers of debt finance, prices will be bid upwards.

On the other hand, there is the possibility that established home owners might use this option to spread their risks and realise some of the capital gains of the past decade, without the necessity of moving out of their homes. To the extent that homeowners exercise this option, the proposed innovation will exert downward pressure on prices.

There are plenty of unresolved questions about equity partnerships, but the proposal does not, as many have suggested, deserve instant dismissal. Along with a number of Australian and international economists, representing a broad spectrum of opinion on economic policy issues, I was a signatory of a statement arguing that further investigation of this proposal was desirable. Nothing I have seen in the ensuing debate has led me to change my mind.

Professor John Quiggin is a Senior Research Fellow of the Australian Research Council, based at the Australian National University and Queensland University of Technology.

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