Putting out fire with gasoline
…or why assistance to home buyers (first or otherwise) is a bad idea.
In a very civil facebook debate (they are rare, but possible) about housing affordability discussion turned to incentives for new home owners. “Surely this is the scalpel-like policy that we need?”, said my interlocutor. I argued this was a really dumb policy. The idea crops up so often, including apparently in the forthcoming federal budget, that it’s worth going into print about it.
On first principals, policies which add to demand are not the optimal way to improve affordability. Almost by definition, policies should seek to increase housing supply or reduce demand, not add to it. That’s another article.
Secondly, by virtue of the banking system and the auction process, attempts to assist targeted groups may have a disproportionate impact on prices and not actually solve the targets’ problem.
For the sake of the argument, I’ll divide the market into “battlers” and “others” – and assume the others have access to materially more money than the battlers. If you give battlers an extra $20k, say, (whether it be by way of direct assistance, subsidised stamp duty, access to their super fund or otherwise) it is likely that they would add this to their deposit; borrow an extra $180k (assuming a 90% LVR); and prices will rise by $200k.
“But”, comes the response, “not everyone will receive the benefit. So prices won’t go up by anything near $200K.” This reflects a fundamental misunderstanding of the auction process.
If we were talking about a consumer good, where the actions of buyers generally have no short term impact on price, then handouts will help battlers obtain the goods. But the situation is different in markets where the majority of houses are sold by auction. This is because by definition, the auction process only tells us how much the second highest bidder was prepared to pay.
“…the auction process only tells us how much the second highest bidder was prepared to pay.”
Provided the others are less constrained than the battlers who receive the handout, battlers could, in theory, raise the overall market price by $200k by going to auctions and bidding an extra $200k only to be topped by their wealthier rivals. Having missed out at the first auction they go to, the battlers go to more auctions and the process repeats until the price at every auction has been pushed up by $200k.
That way the number of property prices lifted is much greater than the number of battlers receiving the hand out and the amount of the increase can be exactly the amount of extra firepower (the hand out geared up by the increased borrowing power) given to the battler. And the battlers still haven’t bought homes!!