This article originally appeared in Quadrant
The residential vacancy rate across Australia as of October 2022 (the latest available CoreLogic data) is hovering around 1 per cent, with Perth, Adelaide and Hobart struggling with between 0.4 and 0.5 per cent vacancy rates. This is indicative of an extremely overheated real estate market, where demand far outstrips supply and house prices are falling at a decreasing rate. Across the capital cities, the month-to-month decline in the rate of housing price has eased from a maximum of –1.6 per cent in August to –1.2 per cent in October. While a decline in the fall of house prices is good news to investors and homeowners, it spells trouble for those looking to get into the housing market. Even with the declining fall in prices, it is still too early to say we’ve seen the worst of it. To compound these issues, major construction companies across the country are collapsing with at least sixteen major firms (as of December 2022) going into voluntary administration owing billions of dollars, stifling the market’s ability to respond to the crisis.
The housing crisis has the potential to teach us some serious lessons about the interaction between markets and governments, but it is up to us to pay close attention and respond proactively with sound institutional design and constraints on political activism in government policy. Crises like this only blindside those who are blind to the economic reality of market forces.
Is the free market the problem? Classical liberals respond with a confident and resounding “No!” for two important, but thoroughly misrepresented reasons. First, private businesses, and consumers by extension, do not operate within a free market by any stretch of the imagination; where the government can interfere with the economy on a broad and specific level through taxation, expansionary fiscal and monetary policy, and excessive regulation, the market is not free but is instead somewhat planned. Second, the crisis can be explained more reasonably by drawing upon Austrian business cycle theory (ABCT), which posits that boom-and-bust cycles are the result of distorted price signals through interest-rate manipulation by central banks. This price distortion incentivises malinvestment by private investors, who make a loss when they later discover that their expectations about the future were based on flawed or stale information from the period in which they formed expectations about the current period. Note that unlike the relatively orthodox economic view, the Misesean-Hayekian Austrian economic tradition does not hold to the idea of economic agents with perfectly rational expectations, and thus believe that people can be misled by false information (in the form of distorted price signals) since agents do not and cannot gather all relevant and profitable information to form reliable expectations about the future.
While the Reserve Bank of Australia does not draw on ABCT for its modelling, the admission that the Australian construction boom over the last two decades is largely due to artificially low interest rates sits comfortably within the ABCT framework. In its discussion paper A Model of the Australian Housing Market (2019), the Reserve Bank points to the trend of artificially low interest rates as a major factor (in conjunction with high demand and high immigration) in the growth of housing construction during the 2000s. This period of low interest rates started with the RBA’s inflation targeting strategy which began in the early 1990s and aimed to kept inflation low and stable—between 2 and 3 per cent—to promote growth and investment. Austrian school economists would cringe at this, and rightly so, given their aversion to any sort of price signal distortion.
Humans want to know why and how something happened, especially if it affects our lives in a dramatic way, so we participate in the blame game. The game is easy to play, especially when our emotions interact with complex systems and conflicting theoretical models which rest on starkly different standards of value. The biggest blame game in our generation stems from the Covid pandemic.
Governments around the world are still largely unsure about the origins of the virus itself but were seemingly in consensus (with few exceptions) about the proper response to it. When it struck, there was no time for political experimentation, there was no room for discussion, there was only an uncompromising blanket approach which was not timely, or targeted, or temporary. Response to the pandemic was essentially reactive, without any limit to the scope of its expansion or consideration of the legal precedent it set; everything seemed to be done in a hurry, with one shoe on, while hopping out the front door. It was applied to virtually everyone, regardless of risk status, while exceptions to the rules were granted to those who were deemed essential to the economy by a committee, or those with friends in high places.
This policy approach, based on broad statistical aggregation, sacrifices precision for speed of execution; it loses the nuance of individual human action and treats the population as a collective organism which reacts in step with the policy response of government. The economic reality of the situation however is not so smooth. Not all people, for example, faced the same risk of severe illness, and not all people could withstand the toll that lockdowns took on their livelihoods and, crucially for this discussion, not all businesses could withstand the volatile political shifts we were all subject to.
The recent tranches of cash-rate rises by the RBA, in an attempt to cool the overheated economy, precipitated a negative change in business confidence particularly in construction, while the increase in global supply-chain pressure means that it is now more expensive to build and own a home. The economic turbulence associated with this political volatility is now coming to the fore and affecting our housing market. One measure of note is the Australian Private Housing Approvals MoM indicator, which faced a volatile but generally downward trend over the last two years. The uncertainty in construction-adjacent sectors has almost certainly been a major factor in the collapse of large building firms over the last year. But what is the chain of causation here? On whom or what can we place blame?
First, the initial response to the pandemic in the form of lockdowns and work-from-home orders, led to a shift in workplace culture from the office to the home. This exodus of office workers from cities sparked a boom in the housing market. In Australia, many people left their cramped inner-city apartments and moved to the suburbs or regionally to enjoy the greater space these areas afforded them. The market trended towards larger, more spacious homes; a trend supported by highly affordable home loans thanks to artificially low interest rates during that period.
Second, with the increased uptake in cheap home loans, and thus an increase in building approvals during and following the pandemic period, construction companies saw an opportunity to profit from people’s need for space. As these companies had no way of knowing how long the pandemic or the work-from-home trend would last, they tentatively invested in new capital, took on debt, hired what workers they could and started on projects which they expected to have the materials for, at the prices they were initially quoted, way down the line.
Finally, however, during the last year and a half, building companies faced skyrocketing materials costs, particularly in timber and steel, a severe labour shortage made worse by a ban on foreign entry into Australia, and a chronic global supply-chain slowdown. The result? Assets have become liabilities, half-built homes sit unfinished, families are in debt and building companies are collapsing across Australia. This is where we see the effects of malinvestment as predicted by ABCT. This should alarm us, since over 60 per cent of all Australian household debt is in property, and thus a serious crash in prices caused by RBA intervention could spell a major financial crisis. While house prices have been falling in recent months, there is still no way for us to know whether the storm has passed. And so, the question remains: What’s next? We just don’t know.
The housing crisis is highly complex, and a full investigation would require a dedicated team from different fields of expertise to disentangle all of its interrelated constituent elements. What is known and knowable about the crisis is that it did not emerge from so-called free market capitalism, where people are free to buy and sell whatever they own, but instead it arose from the systemic shock to the global economy caused by short-sighted economic policy and the perverse incentives which that policy created. Consumers and businesses alike took advantage of artificially low interest rates. When the cheap money stopped, supply chains ground to a halt, and interest rates increased, home builders found themselves under water and unable to float again. This, according to the Austrian School, is what happens when we try to solve the problems of today by taking from the future without considering the economic consequences. To draw on the wisdom of Nobel Prize-winning economist Milton Friedman: Where we expected to feast on a free lunch, we were instead confronted by an empty plate and a single sticky note with the letters “IOU” scrawled across it, signed with our own name.