A housing revolution is needed

One of the key lessons from the crisis has been that the global financial system had too much leverage, particularly the household sector, which had assumed unsustainably high levels of debt. Yet instead of assaulting the root cause of this problem, US policymakers have delivered an ad-hoc patchwork of mitigants dominated by private risk socialisation. These band-aids overlook the central reason American homeowners were forced to gear themselves up with so much debt in the first place –because they’ve never been able to draw on external “equity”. The longer-term policy imperative is thus not for taxpayers to supplant credit markets, but for government to help households “deleverage” their balance-sheets via a safer mix of debt and equity.

For hundreds of years listed companies have been able to seamlessly issue debt and equity to finance their spending. Yet prior to some innovations pioneered here in Australia, households around the world had never been able to privately source external equity when buying their homes.

Given recent house price falls, the average US homeowner's mortgage now represents an astonishing 95 per cent of the value of their property. That means that around 40 per cent of all US borrowers have “negative equity” (ie. their mortgage is worth more than their home). And this debt is secured against what is in fact a very risky asset. Research shows that a single family home is four to six times riskier than a diversified national property index. Indeed, the risk of an individual property is more akin to that of equities. Yet it represents the average US family’s most important lifetime investment.

In the 2003 report, commissioned by the Prime Minister, my co-authors and I presented a tractable solution to the high levels of household debt that triggered the credit crisis: the development of private markets in “equity finance”.

Under this proposal, households would get access to zero-interest equity finance in exchange for trading away a small portion of the risks and returns of homeownership to outside investors. Instead of taking out, say, a 90 per cent interest-bearing home loan, they could combine a 20 per cent zero-interest equity loan with no monthly repayments with a 70 per cent conventional mortgage product. By doing so, they would permanently slash their monthly mortgage repayments by 30 per cent or more while reducing their vulnerability to adverse economic shocks. Importantly, they also retain complete control of their homes; they choose when to sell, what renovations to make, and at what point during the contract’s 25-year term they wish to repay it.

Portfolio investors, such as super funds, would get extremely low-cost, highly enhanced and long-dated exposures to what has, during the past three decades (including the recent calamity), been the largest and best performing of all asset-classes: residential real estate. Historically, investors have only been able to access highly concentrated, risky development holdings comprising small parcels of properties that incur heinous transaction costs. By investing in a portfolio of thousands of shared equity interests, super funds could avoid these costs.

Business Spectator - A housing revolution is needed - Christopher Joye