Why no one should be wishing for a house price crash
Most of us are familiar with the phrase “be careful what you wish for” – a wise saying that simply means the things we think we want sometimes have bad consequences. It’s a saying I’m reminded of when I think about what would happen if the property market ever actually crashed.
First off, a market crash in New Zealand is highly unlikely for a whole range of historic and economic reasons. But there are those who say that we should actually make a crash happen, including former chief economist and former chair of the Reserve Bank Arthur Grimes, who advocated as recently as July 2016 a "managed crash" to bring house prices down by 40 per cent.
At a superficial level, I can understand the appeal of that argument. Afterall, house prices in Auckland have risen from around five times annual household income in the early 2000s to more than nine times annual household income today.
If house prices were to crash, so the argument goes, we’d simply be getting back to the situation which used to prevail. Surely this would make houses more affordable, which means that more people would be able to get into the market?
Perhaps, but at what price? Let’s assume that the proposal to crash the market by 40 per cent had gained traction and had become policy. There are several entirely predictable consequences of that which would have a devastating impact on the entire economy:
1. Anybody who borrowed 80 per cent or more of the cost of buying a house in the last couple of years would now be in negative equity ie owe more to the bank than their house was actually worth. For example, a couple buying a home for $850,000 (the median price in Auckland) would have paid a
20 per cent deposit ($170,000) and borrowed the remaining $680,000 from the bank. In a scenario where values were crashed by 40 per cent, they would see the value of their deposit wiped out. In addition, they would have $170,000 of ‘negative equity’ in their home because it would now only be worth $510,000 – less than what they borrowed from the bank.
First-home buyers would be particularly vulnerable as they are the buyer group most likely to have borrowed the maximum amount possible.
In the past, banks have been known to force owners to sell up in situations of negative equity, although that would be unlikely to happen in a scenario where the problem was widespread (as it would be following a deliberate market crash).
2. Homeowners who had used the equity in their home to buy a business, or fund business cashflow, would also be negatively impacted. The knock-on effect of banks reducing cashflow facilities for businesses, or even calling in business loans, would inevitably lead to a very large number of business failures. This would have devastating consequences for mum and dad Kiwi businesses and the people who rely on them for their jobs.
3. Spending on larger consumer items – such as cars, renovations, travel, boats and kids education - would plummet, as more oftern than not they are funded by loans raised against household equity. This would have knock-on effects throughout the wider economy.
4. Those approaching retirement and who had been planning on utilising household equity to fund those years in a level of comfort would be less likely to be able to do so.
5. Conversely, property investors - who up until a couple of years ago were required to have a 40 per cent deposit when buying an investment property – would, therefore, be affected to a much smaller degree and would be in a strong position to “snap up” bargains created by the market crash, something I doubt would be welcomed by those who are advocates of such a crash.
And, as if these consequences weren’t bad enough, crashing the market wouldn’t actually “fix” the housing market. At best, it would provide some price relief for one set of Kiwis at the expense of another, but it would do nothing to resolve the supply, productivity and income issues which underpin our housing problems, which means we would inevitably see another round of house price inflation and the cycle would simply continue.