Submission to NSW Housing Strategy

The New South Wales government is creating a long-term housing strategy. Hooray!

You can read my submission here.

What's the strategy all about? It's always hard to know with these jargon-filled government documents. To avoid accountability for specific outcomes these documents 1) never make direct, clear, points and 2) always use coded language.

To get a feel for what the priorities are in this strategy I did a word count of key terms that seem relevant to me when it comes to housing. If word frequency is any guide, the strategy is all about population, planning and supply.

Notably, it is not about prices.

This is weird. The Housing Strategy discussion paper notes that rents are the best metric for determining the adequacy of supply and that by this metric supply has been sufficient to meet the record population growth of recent years.

Given the large amount of housing supply currently being delivered, the vacancy rate has risen in Sydney and rent increases have moderated.

So we have a whole housing strategy being created on the basis that housing supply is not responding to population growth because of planning. Yet at the same time, there is a hidden admission that this is definitely not a big issue.

The only logical conclusion is that the government needs to be seen to be doing something about housing because of declining homeownership and enormous wealth gaps the housing market is creating. But it cannot actually enact policy to make housing cheaper.

The fact that community concern about rising prices is not the focus of the discussion paper is quite clear evidence of a political balancing act being played out. Housing is desired to be more “affordable”, but policies that actually lower home prices are political suicide and also come with macro-economic risks.
...current renters and future buyers are the main beneficiaries of lower prices. But they are few in number, and low in wealth, compared to the homeowners and housing investors who gain from higher prices and rents.
This is the heart of the NSW and national housing dilemma that should be the focus of any housing strategy at any level of government. A realpolitik view is that this dilemma is behind the promotion of supply-focussed policy—it can plausibly be claimed to be helping reduce prices while in practice not having any price effects, keeping homeowners and investors happy. In addition, it provides a justification for using the planning system to deliver windfall gains to politically connected landowner ‘mates’

There you have it. Expect a lot of talk and debate about housing during the development of this strategy. Expect no substantial changes except for a few more giveaways from the planning system to well-connected developer mates. 

JG advocates want a UBI, they just won't say it

Let’s retire this debate and the endless word-games.

A Job Guarantee (JG) is a way to guarantee a certain income level to anyone willing to do tasks that some administrator decides are good.

A Universal Basic Income (UBI) is a way to guarantee a certain income level to anyone willing to do any task they decide is good.

We know that many JG advocates simply want to give people money for doing what they would do anyway if their income was guaranteed. They just have dogmatic beliefs about the dignity of work and the word "job."

Here’s Bill Mitchell saying that you would eventually do whatever you liked in the JG (my emphasis).

The Job Guarantee in fact provides a vehicle to establish a new employment paradigm where community development jobs become valued. Over time and within this new Job Guarantee employment paradigm, public debate and education can help broaden the concept of valuable work until activities which we might construe today as being “leisure” would become considered to be “gainful” employment.

So I would allow struggling musicians, artists, surfers, Thespians, etc to be working within the Job Guarantee. In return for the income security, the surfer might be required to conduct water safety awareness for school children; and musicians might be required to rehearse some days a week in school and thus impart knowledge about band dynamics and increase the appreciation of music etc.

Further, relating to my earlier remarks – community activism could become a Job Guarantee job. For example, organising and managing a community garden to provide food for the poor could be a paid job. We would see more of that activity if it was rewarded in this way. Start to get the picture – we can re-define the concept of productive work well beyond the realms of “gainful work” which specifically related to activities that generated private profits for firms. My conception of productivity is social, shared, public … and only limited by one’s imagination.

In this way, the Job Guarantee becomes an evolutionary force – providing income security to those who want it but also the platform for wider definitions of what we mean by work!

If we are going to be this lenient and generous with the definitions of a job, why bother at all? How about being a parent, carer, child, or just a citizen? Why aren’t these “jobs”? And if they are, aren't you just advocating for a guaranteed basic income of sorts?

The inflation concerns that JG advocates claim to have with a UBI are nonsense. They are just backfilling excuses. Obviously, most JG jobs wouldn’t in be sectors where output is priced, so wouldn’t enter inflation calculations anyway. Just like my housework isn’t priced, but could be if supplied by the market, a JG that includes my own housework would have no effect on reducing inflationary pressures.

Further, isn’t the insight of MMT that you might have to tax to reduce demand sometimes? In which case, a UBI can be easily designed to include taxes so that it redistributes in a way that doesn’t create demand-pull inflation.

Oh, and then there are people wouldn't participate in the JG anyway, like children, the elderly and the disabled. They would have to just get money anyway.

So let’s retire the debate. Yes, the government can be a money-creator if it wants. There are only real constraints. So let’s now talk about funding things that we think are important for society over things that are not. Let's talk about practical ways to redistribute income and wealth. Let’s get our priorities right and forget the word-games.

UPDATE: Despite all these nice words that have attracted many supporters to MMT, it turns out Bill Mitchell would like to scrap unemployment insurance from the welfare state and force people to take a JG job. He definitely does not want to give people money without workfare. 

Submission to NSW Productivity Commissioner

Review of Infrastructure Contributions

Dr Cameron K. Murray

Henry Halloran Trust, The University of Sydney
May 2020

Download this submission as a pdf here.

Summary:

I argue that betterment is a more transparent, efficient, and certain tax base for raising council revenue for infrastructure or any other expenses. Compared to fixed-rate infrastructure contributions levied on a per-new-dwelling or per-new-building-area basis, a tax on betterment automatically adjusts to local economic circumstances, boosting efficiency.

I recommend the following:
a. Infrastructure contributions be scrapped in NSW.

b. Betterment from the planning system should be called “Community Development Rights” and a betterment tax should be implemented and called a “Sale of Community Development Rights”, or SCDR.

c. An SCDR be required at the time of planning approval.

d. The amount of to be paid for SCDR be calculated at 75% of the difference in site value when valued “at current use” compared to “at approved use”.

e. These valuations should be undertaken by a third party, rather than councils, such as by NSW Revenue using valuation expertise from within the State government.

f. Payment of the SCDR will be via
i. a 10% deposit of the assessed tax when planning approval is issued and,
ii. the balance on development completion (prior to registering the new plan).

g. For simplicity, in high-growth areas a schedule of pre-calculated betterment tax amounts on a per-dwelling or per-building-area basis can be published. These schedules will be produced by valuers based on local market conditions, borrowing from a process used in the ACT in 2012. 

Key points

1. The Terms of Reference for this Review are focussed on economic issues such as improved transparency, efficiency, and certainty of infrastructure contributions. These are desirable features of an infrastructure contribution system.

However, these are not the features of a system desired by those who pay them. If contributions are raised, even if levied in a more transparent, efficient, and certain way, I expect these economic objectives to suddenly become irrelevant to the development industry. This needs to be acknowledged up front.

The development industry mostly wants lower infrastructure contributions.

For example, Queensland implemented changes to tighten up and clarify its infrastructure charging regime in the 2009 Sustainable Planning Act. These changes ensured a tight nexus between the forecast costs of identified trunk infrastructure and the rate of the charge. These infrastructure charges were published in a simple schedule (an Infrastructure Charges Schedule) linked to a supporting document that identified the infrastructure upgrade and investments planned by councils (the Priority Infrastructure Plan). It was transparent, efficient and certain.

However, because many of these charges increased, rather than decreased as expected by developers, they then lobbied to have them capped, which was swiftly done by the Bligh government in 2011.[1]

2. There is a conceptual conflict between the idea that contributions reflect efficient costs while also complying with the principle of beneficiary pays. Benefits of infrastructure investment, as reflected in the value gains to nearby property, may be less or more than the cost of new infrastructure.

3. Betterment is the name for the value gain arising from increases in property value due to external factors, such as local infrastructure or new property rights granted to landowners through the planning system.

4. For property redevelopment, betterment is the value of the new property rights that allow for that development to take place, which are, until then “owned” by the community. We know this because redevelopment rights can be sold to property owners by councils, rather than given for free.

For example, in São Paulo, Brazil, auctions are held periodically to sell to landowners the rights to construct additional density, called Certificates of Additional Construction Potential (CEPACS), raising around $USD 200 million/year in revenue.[2]

Using betterment as a tax base can help side-step many of the technical arguments used against infrastructure charges on economic grounds. Just as property rights are sold at market prices from the public when disposing of land, property rights granted through the planning system can be sold at market prices.

5. Since 1971 the ACT has taxed betterment at 75% of its market value to fund territory government activities. Their system is known as a Lease Variation Charge (formerly a change of use charge). In addition, by being the monopoly developer of land subdivisions they gain 100% of the betterment in converting rural to urban uses.[3]

The below table scales up the revenue from these sources in the ACT for the difference in housing prices and new housing development in the other states, showing that if a similar scheme was enacted, over $18 billion could be gained by councils in other states using this mechanism.

In NSW alone, there was $8.2 billion of potential revenue in 2018-19.[4] Many other methods for capturing betterment for the public have been implements in Australian and abroad.[5]

6. This implies that over $12 billion worth of redevelopment rights, accrued to landowners in NSW at no cost through the planning system, were utilised in 2018-19.

7. From 1970 to 1975 NSW had a betterment levy of 30% of the value gain from the conversion of rural land to urban uses, raising $17 million in that time with $2 million in total administrative costs. This was used to finance the infrastructure necessary for expansion of the metropolitan region.[6]

However, political lobbying by wealthy landowners on Sydney’s fringe led to the demise of this funding mechanism.

In November 2007 the NSW Government foreshadowed a ‘Rezoning Infrastructure Contribution’ (also known as a ‘Staged State contribution’) to be paid either at the time of rezoning or at the time of sale. However, this approach was abandoned in the final package of reforms to developer contributions in NSW.

8. The beauty of using betterment as a tax base is that it prices property rights that are given away by the public that should be instead sold. The ACT system is equivalent to a 25% discount on the market price of the right to redevelop to higher intensity uses.

9. Additionally, like infrastructure contributions, the costs of a betterment tax or levy cannot be added to new housing prices. Instead, these costs are subtracted from the value of land prior to its development. On net, it is an economic transfer from current landowners to the community at large (via the council) that confers these new rights.

This is why the abolition of the Sydney Betterment Levy was such a political issue in city-fringe electorates—the value of the levy came off the value of the land with development potential.

10. Un-priced betterment is also the honeypot around which corruption emerges at both state and local levels. In most states, local councils have a history of corruption involving favourable rezoning and planning decisions. It is the fact that these decisions grant valuable new property rights for free to the recipients that fuels the corruption cycle. A recent example involves Casey Council in Victoria.[7]

A study I co-authored in 2016 showed that landowners in Queensland who were politically connected or employed profession lobbyists were much more likely to find their land within a rezoned area compared to near-identical neighbouring land, and in the process, these connected landowners gained $410m out of the $710m worth of development rights given to all landowners from these rezoning decisions.

UPDATE:
Certainty is greatly increased for the development industry by using betterment as a base for raising revenue as it solves the land purchase price dilemma. If planning outcomes are uncertain, the developer who is the most confident of a generous planning outcome will win any bid for the purchase of a development site. They will then require a generous planning outcome to justify the price they paid for the site. With a tax on betterment, they can pay only slightly above the value at its current use for the site. If they fail to get a generous planning approval then they pay less for the betterment tax. If they get a favourable approval, they pay more. 

Missing middle housing? Blame economics, not planning

A common objective of town planning schemes is the densification of existing suburbs to create “missing middle” density. This is usually enacted by allowing areas previously developed for detached housing to be redeveloped into incrementally more dense uses, such as townhouses and walk-up apartments.

But economic constraints, not planning constraints, are the main reason that this middle-density housing is missing.

First, in low-price areas, the per-unit cost of building higher-density dwellings may exceed the market value of a dwelling. Higher density dwellings are more expensive per unit to build (there are rising marginal costs to density), and they have a lower market value per unit. That is why you won’t see high-rise residential towers at the city fringe, or in small towns, even if they are allowed. Middle-density housing is also relatively more expensive per unit than detached housing.

Second, in high-price areas, if a site is worth redeveloping, it is probably much more profitable to redevelop to higher densities than the desired middle-density.

The diagram below shows the basic economics of this problem. If a single dwelling is built when the price hits P1, the existence of this dwelling makes the site much more expensive to purchase for redevelopment than a vacant site. You now have to bid against potential occupants of the existing detached dwelling to buy the site—effectively buying an extra house you don't want.

This additional cost adds to the redevelopment cost. In the diagram above, this shifts the average cost curve up from the orange line (the cost of developing a vacant site) to the blue line (the cost of developing from a site with an existing dwelling).

Between prices P1 and P2 the “missing middle” density is optimal (the marginal development cost per dwelling equals the price). But in this same price range, the average cost is above the price because of having to purchase the existing dwelling.

Thus, the existing detached dwelling “quarantines” a site from incrementally more dense uses. For example, demolishing multiple detached dwellings to rebuild a slightly more dense townhouse development is usually going to be uneconomical.

When prices are high enough to make redevelopment of detached housing into “missing middle” housing viable, these high prices are also going to make much more dense apartment towers even more profitable. In the above diagram, a price above P2 makes a tower apartment building the most profitable density.

The most economically viable locations to get “missing middle” density are actually in new fringe areas where low-value agricultural or industrial uses are being converted into residential uses. Perversely, it is the outer fringe where the “missing middle” is going to be most viable.

We can see this economic incentive at play in many large housing developments in fringe suburbs of Australian cities—these new suburbs now offer a mix of townhouses, small apartment blocks, and detached homes. In the inner suburbs, “missing middle” housing typically exists in places that were on the fringe of transit-constrained cities when they were built many decades ago.

Rather than fight against economic constraints, higher density in existing areas can be achieved with granny flats and other subdivision types that do not require demolishing existing dwellings. It is these alternatives that can be encouraged in the planning system.

A housing absorption rate formula—first cut

Housing supply is one of the most misunderstood processes in economics. The reason for this is that the core standard theory of economics is a static one-period model of production with a fixed capital endowment. They confuse the optimal density of dwellings, given the fixed capital of one unit of land, with the optimal rate of supply of new dwellings per period of time.

To be clear, the decision to supply existing housing to the rental market at any point in time is short-run production decision given a fixed stock of homes. That is why most homes that exist are not vacant. The marginal cost of renting (compared to keeping vacant) for a dwelling owner is typically far below the marginal revenue.

Building new homes is instead a capital allocation decision. Land and cash assets must be given up to build new homes. These assets earn a return over time and can be used in future periods instead of the current period. Building too many homes today depresses prices and rents, thereby reducing the return to both existing homes and homes you can build in the future.

So how is the optimal rate of new housing determined?

It is clearly not determined by the optimal density, as static models assume. Take a look at the figure below showing a housing subdivision in a street. The static theory says that if you approve a subdivision of five housing lots, you increase the rate of supply per period by five dwellings. They all sell in period one.

In reality, these dwellings do not sell all in period one (i.e. all in one day). They are drip-fed to the market over time, with one possible series of sales shown in the figure below. When I looked at the land banks of Australia’s top eight listed housing developers, the average age of their housing subdivisions and apartment blocks since their first sale, was ten years. The oldest was 25 years! They were still selling housing subdivisions approved in the last millennium. 

This slow rate is optimal because housing developers are rational. Selling faster reduces both the value of the rest of their subdivision and the growth rate of the prices they receive over time. They are giving up future returns if they flood the market today.

What do those future costs look like?

In the figure below we can see the effect of new dwellings sales on market prices and growth. The top line is the counterfactual price path if no new dwellings were supplied. Each additional dwelling when it is sold goes to the highest bidding buyer at that point in time, taking them out of the market and reducing the price to the second bid. This gap between the highest bid and next bid is labelled as alpha, and represents the “thickness” of the market in terms of how many people have bids clustered at the top of the curve. If you rank bidders from highest to lowest and get prices of 1.0, then 0.9, then 0.8, then alpha is -0.1 (the slope of this bid curve when buyers are ranked). If the market is “thicker” the bids might be 1.0, 0.95, 0.9, meaning alpha is -0.05.

Each sale at any point in time takes out a buyer and reduces the maximum price. Meanwhile, the other bids grow over time (or not) depending on macro and market factors. The next sale has the same effect, wiping off the next highest bidder and reducing the price, and so on.

So each sale has a pure price effect in terms of alpha. We can add these up on the above figure, and with a rate of sales of three per period, the price effect—the difference between the end of period price on the counterfactual end of period price is three times alpha.

This is standard economic theory, whereby increasing supply per period has a price effect. No surprise there.

But notice something else. The result of this pure price effect is that the price path is flattened compared to the counterfactual. Not only are end of period prices lower, but seen as a path, prices are growing more slowly.

The faster the rate of sales today, the lower future prices tomorrow. In essence, the pure price effect can be reinterpreted as a reduction in the growth rate of prices over time rather than a static price effect.

We can see this in the figure below where we reduce the rate of sales from three per period. Notice that the first lot is sold at a higher price because it is sold later, as is the next lot, with the third lot still to be sold at the end of the chart at an even higher price.

Somewhere between selling zero new dwellings, and selling enough to ensure that prices never rise above costs, is an optimal rate—an absorption rate that maximises returns to landowners from converting their sites to cash by selling lots to residents.

How should we think about what is optimal? Sticking with the basics, we can choose a rate of supply maximises the expected present value of the flow of lots into cash.

It is tricky to think of supply as a rate. But a simple logic can be used here to understand what is optimal. You want to at a rate that maximises the revenue this period and the value of the flow of revenue from all future periods, based on expectations and discounting. At this optimal point there is no gain from increasing the rate, since increase the rate comes at a cost of future price growth (and vice-versa).

The immediate revenue from the rate of sales is simply the price times the rate of sales. We can ignore the price effect in this because we capture it in the growth term which affects the value of future revenues (you can imagine supply as a sequence of sales, with any individual sale not having a price effect as it is the price setter at the margin at that point, but it reduces the price of the next sale in the sequence).

The value of the flow of future sales is the capitalised value of the end of period price, which is now lower because the rate of current sales has lower the growth rate.

As a mathematical approximation, we have the following equation to maximise (where I use f() to as a shorthand way to say this is some function of this term, but I’m not going to specify that function).

The maximisation happens when the marginal benefits from higher rates of supply today (the derivative of current revenue with respect to the rate of sales) equals the marginal cost in terms of lower value of future revenues (the derivative of the present value of future revenue).[1]

The rate of sales that maximises this value is

What is the intuition here behind the direction of the relationship between each market parameter and the rate of sales?

First, if the growth rate is higher, you need to increase the rate of sales in the next period to capture more of that value of that growth, which, because we are dealing with an instantaneous rate of sales, means increasing sales this period into the next period.

Second, a higher interest rate increases the rate of sales. This is because the future cost of lowering price growth by increasing sales is worth less today with a higher interest rate. A low interest rate means that the price effect on the future is more valuable today.

Third, the alpha term is negatively related to the optimal rate of sales. This makes sense. The thinner the market (the higher the alpha) the fewer sales can be made with the same price effect.

Notice how different this “optimal rate” thinking is to the usual economic analysis housing supply. This equation does not care how big your subdivision is—approving a larger subdivision won’t force anyone to sell or develop more quickly.

There is a lot more to this story. We actually don’t yet have an answer for how fast our five lot subdivision above should sell to be optimal. We know that if price growth and interest rates are low that they will sell lower than otherwise. We know if the market is thin they will sell slower than otherwise (say if they are in a small town compared to a large city).

I am working on a neat way to show the present-future trade-off, but it is not that simple. This might explain why theories of optimal rates of housing supply don’t really exist yet. There is a lot more to this mathematical story and if there are economic theorists out there who would like to help me ensure that my next “absorption rate formula” is consistent, please get in touch. 

_____________________
Fn. [1] I have taken a bit of liberty here to simplify the equation. Strictly speaking, the problem is a recursive one, in which the value of future revenue itself depends on future values. Also, strictly speaking, you could capitalise future incomes by the interest rate minus the expected growth rate, but this has problems. And, there are issues about the representative agent owning all the land, and whether you should account for the value of current housing or the value of the options for development in the price effect. The above equation is the simplest version that captures the direction of all effects and is the clearest way to show the future cost of faster supply.

Economic tide reveals naked policies

Superannuation

It seems that when people want to withdraw their money from super, the money is not there, and it requires asset selling that reduces asset prices across the board. This same effect happens ALL THE TIME. That is why a scheme that requires nearly 10% of wages to be spent on asset purchases is a bad idea, as it boosts asset prices. When the super system needs to pay out more than it gets in, asset prices are squeezed, and the value of what we thought we had saved begins to fall.

If only someone had warned about this.

Valuing life and the cost of lockdowns

Every policy involves trade-offs that can not only be measured in the monetary value of resources, but in blood. It is very standard to think of gains from health policy in terms of Quality-Adjusted Life Years (QALYs) as a metric of performance. Every public policy—from road rules to medical funding, to retirement, to workplace safety, to minimum standards—has an implicit trade-off of resources for lives.

Yet everyone has lost their shit about coronavirus as if lives lost this way are worth orders of magnitude more than lives lost any other way. In two to three weeks time the reality will set in that there are real costs of locking down society that can be measured both in value of resources wasted and in blood. All perspective has been lost at present.

Money was never an issue

Perhaps the greatest change from the crisis is that money was never a constraint. Politicians spend on things they like and don't spend on things they don't like. The budget was always an excuse.

I have often told policy advocates to stop arguing to politicians how cheap their solutions are to homelessness, or environmental losses, and other issues. They should instead argue how large of an investment is required to fix them! At the moment we are in a political vortex of one-upping each other in the ‘tough on the virus’ stakes, and this is coming with ever bigger cash splash promises.

But this is actually how things work all the time. Useless “ego-infrastructure” projects that give politicians a plaque and a ribbon-cutting photo-op are the norm. Big spending decisions are driven by political egos, not logical resources trade-offs. 

Housing was always a macro issue

I have heard for years from experts in my field of housing economics that zoning was constraining supply and rezoning would see a construction boom like never before. In fact, according to their numbers, we could double, or triple, the rate of construction by changing just a few words in a few town plans to allow higher densities.

But I have yet to hear rezoning proposed as the solution to the inevitable construction crash. Why not? Could it be that the argument was always bullshit and that housing supply is (you will never guess) constrained not by regulations, but by demand from new buyers? When buyers leave, construction falls.

This is not some radical “crisis-only” situation. This is always the case.

A "Central Housing Bank" proposal for a crisis and beyond

Cameron Murray
Henry Halloran Trust, The University of Sydney
20 March 2020

Download proposal as a PDF

• We propose that State governments (or Federal) create a “Central Housing Bank” (CHB) that stabilises the housing construction sector by swapping assets, in this case, cash, for new dwellings. Just as the Central Bank swaps cash for other financial assets to solve liquidity problems in financial markets, the CHB would do the same for one of the nation’s largest economic sectors. 

• As a national program, a dwelling target for the first year could be 30,000 dwellings across the 20 largest towns and cities in the country (around 0.5% of the number of dwellings in these towns). This is roughly 15% of the new dwelling completions in 2019, a significant demand buffer for the housing construction industry, supporting an estimated 150,000 highly productive jobs. 

• In balance sheet terms, these actions are costless for any government that undertakes them, as they receive a dwelling of equal (or perhaps higher) value to the cash they give up. Margins on housing development are typically above 25%, so this would be an opportunity for a public agency to engage in discounted counter-cyclical asset purchases to support jobs in the construction sector. 

• The CHB can then use those acquired dwellings in a number of ways to support policy objectives, such as 

1. renting in the private market to help stabilise rents, 
2. using them for public housing at discounted rents, 
3. selling to social housing providers at discounted prices, 
4. or selling to the private market in future periods when prices are rising to dampen the housing cycle. 

• Housing construction investment is a volatile, but productive, part of the economy, currently accounting for around 5% of GDP and 7% of Australia’s workforce (including housing construction and ancillary industries).

• Ensuring continuity and utilisation of productive organisations, such as builders, manufacturers of construction materials, and the design and management professions, can help ensure productive capacity is maintained during the crisis, and in the post-crisis period.

• The basic implementation of a CHB would be as follows:

1. Employ a small group of senior construction and project management experts to manage the CHB, ideally from the non-housing construction sector, such as mining and oil (to avoid conflicts of interest). 
2. This CHB team would request tenders from private housing developers or landowners to supply new apartments at an agreed price. The objective is to utilise the pipeline of already approved housing developments to speed up the process. In Sydney alone, there are an estimated 20,000 approved yet not-yet-commenced dwellings. Nationally, the top eight housing developers have a landbank of over 200,000 apartments and houses. There is a massive pipeline of sites that the private sector has queued up for housing that they will be looking to sell to reduce exposure to falling land prices. 
3. They could also shop for development sites as a market participant. 
4. The CHB management team would be incentivised to meet dwelling supply targets both in terms of the quantity delivered, and the location-adjusted average price paid. Independent assessment by State Valuers, in conjunction with State or Federal Treasury, can determine the value for money and hence the performance bonuses of the management team. 
5. Rough annual new dwelling purchase targets for the CHB could be set as a schedule across major towns and cities in proportion to their population, for example, 0.2% of the population in every town or city above 100,000 residents (of which there are 20 towns and cities nationally). Expansion to smaller towns can be conditional upon the success in the first three years of the CHB. This would be roughly 30,000 dwellings in the first year. 

• There are enormous macroeconomic stabilisation benefits of this system. The accumulated stock of rental housing owned by the CHB can be used to dampen housing price upswings by introducing a selling rule. For example, if dwelling prices begin to rise above a set rate, of say 5% per year, this would trigger sales of the stock of dwellings held in that region to private sector buyers at the rate necessary to keep growth below the target rate (again, like Central bank intervention to stabilise interest rates), absorbing speculative demand and stabilising housing prices.
• This system is not dissimilar to housing systems in Singapore, and public housing systems in Europe, and previous housing systems in Australia and North America.

Economic crisis? How about ‘equity mate’?

During 2009 farmers were paid $61million per month in drought assistance as part of Exceptional Circumstances Subsidies. But the public got nothing for it.

I have often said that public subsidies, even in a crisis, should always come with obligations. The simplest of all is to make the subsidy an asset swap rather than a gift—provide the cash, but take an equity stake in exchange, diluting ownership. This 'equity mate' public policy can help ensure the continuity of productive capacity during crisis periods.

Central banks provide liquidity via asset swaps to financial institutions in exceptional times. 'Equity mate' is just a way to provide cash via asset swaps to the companies that do the actual production in the economy. 

But in practice, this is not easy.

In a crisis, the value of equity falls. By taking a new equity stake when the value is low, you are providing much less cash per share while diluting an already lower equity value.

How this could work in practice is to have a “standing facility” whereby a rule about the value of equity the Treasury or Central Bank would pay is set in advance, and businesses can choose to use it up to a maximum share, of say 10% of the business value. As an example the rule could be:

For listed companies, equity comes at a price of the lower of—

1. The middle of the price range of the two prior years, or
2. The middle of the price range of the prior year, or
3. The current price plus 15%.

For unlisted businesses, equity comes at a price of—

1. The average of the marked-to-market balance sheet from the two prior years.

These rules would have to be broadly considered, but you get the idea. When equity values are rising, the price paid would be too low compared to the option of expanding cash for investment by issuing equity to private investors. Only during downturns would this kick in, when sudden declines in economic activity spook the market as a whole. Having this option in place might also dampen selling during a crisis, just like the government guarantee on bank deposits deters bank runs. 

This ‘equity mate’ injection of funds is a way to provide liquidity insurance to our productive enterprises without massively changing their incentives. A problem with drought assistance, for example, is that the expectation of future subsidies gets capitalised into the value of farmland. The insurance is free, and the incentives to invest in a way to mitigate loses from predictable rain variation are reduced. 

Buying up the nation's companies in a downturn is also just a smart investment. Buy low, sell high, make money. In the 2008-09 financial crisis, the Reserve Bank of Australia used counter-cyclical investment in currency to stabilise the dollar. It bought a lot of AUD using its USD reserves when the AUD fell to below USD0.60. In the following years, the AUD increase to above USD1, making a large profit for the Bank, which is an income for the public sector. Like this example, counter-cyclical purchases of a small public stake in a wide range of companies will provide future public revenues. 

What are your thoughts?

The easiest retirement system - Retiree Tokens

People are often confused about retirement income systems. Understandably so. Most economists, and organisations such as the IMF, OECD, national treasuries, and think-tanks, have promoted a view that countries that rely more heavily on taxation and transfers to facilitate retirement incomes (pay-as-you-go systems) are at an economic disadvantage compared to countries with “pre-funded” systems. The aggregate value of assets held in pension funds is believed to measure a country’s capacity to support a retirement income system. More funds, more capacity.

But this is wrong, and it is easy to demonstrate why.

All retirement income systems merely allocate goods and services to the retired at the time they are needed. They only differ in terms of the accounting system used to implement them. Some use public finance and cash transfers, while others, such as superannuation, require compulsory asset transfers.

But the problem of allocating goods and services to the retired does not necessarily need any accounting system at all. Just make a law that requires all retailers to supply their products to people over retirement age for free. Voilà. Retiree incomes, in terms of the goods and services they consume, are automatically and immediately guaranteed.

When a retiree fills their car with fuel, there is no charge. When they shop at the supermarket, again, there is no charge. When a customer reachers their magical retirement age birthday, their electricity and gas bills go to zero. New clothes? Free for the elderly.

This system redirects real resources to the retired. The cost is borne by the non-retired in the form of higher prices and hence lower real incomes. All retirement income systems do this — the non-retired have less ability to consume goods and services, the retired have more.

But, this "no accounting" retirement could be easily gamed. Retirees could begin to sell their free goods in secondary markets, on-selling to non-retirees to profit for themselves.

To fix this problem you could introduce a Retiree Token system. Each retired person gets a limited number of Retiree Tokens that they use at retailers to exchange for the free goods they are entitled to. This Retiree Token system would limit the ability for retirees to on-sell in secondary markets the goods and services provided to them for free. Hypothetically, you could provide each retiree with, say, 24,000 Retiree Tokens each year that they can swap at a 1:1 exchange rate to the dollar for the free goods and services that businesses are legally obliged to provide.

As you can see, a retirement income system can be achieved without any accounting system. It might be operationally problematic, and could be improved by using Retiree Tokens to limit the free goods and services that the retired are entitled to.

So if retirement income systems do not need money at all, where does that leave the idea of “pre-funding” a system? After all, there is no way to use financial markets to create more Retiree Tokens, just as there is no way for airlines to uses financial markets to “pre-fund” their frequent flyer token system.

The answer is simply that it is not possible to “pre-fund” a retirement income system. In terms of goods and services consumed by the retired, all systems possible systems are pay-as-you-go. There should be no confusion about this.

The puzzle of high home prices and vacant homes

One pattern that stands out in the property market is that although homes prices are at all-time highs, so too is the proportion of vacant dwellings. This is a puzzle. How can it be the case that when housing is in high demand it is also rational to keep more housing vacant?

Australian data shows that the number of residential dwellings has grown faster than the number of households for the past decade, indicating a substantial rise in the proportion of empty homes. This phenomenon has been a broad one, experienced in cities such as Sydney, Vancouver, and Toronto. Here are some of my previous thoughts on the topic.

The resolution to this puzzle is as follows. Housing is an asset, and in asset markets there is a trade-off between liquidity and returns. A vacant home is a more liquid asset than an occupied home. Timing a sale is easier, the sale is faster, and it is likely to result in a higher price when vacant. When capital gains are a large proportion of the total return, and capturing this return requires timing the market because of price variability, the value to liquidity from vacancy can be high.

In short, when yields are low and prices high and variable, the benefits to vacancy are high.

Here’s an example. In Scenarios A and B the total asset return to housing is 10%. But in Scenario A the price is high and yields are low. Here, leaving the property vacant forgoes only a quarter of the total return from the asset. If prices are variable in this Scenario, then timing a sale becomes an important factor for earning the capital gains. Hence, the liquidity from vacancy has a large benefit.

	Return	Cap. gains	Rent
Scenario A	10%	7.5%	2.5%
Scenario B	10%	2.5%	7.5%

In Scenario B the price is low, as the rental yield is 7.5% of the price. Capital gains are also low at 2.5%. In this low price, low capital gain, scenario, keeping the property vacant requires giving up three-quarters of the total return. The benefits from doing so are limited since capital gains are low, and hence less variable.

So there is an economic logic behind the puzzle of high prices and high vacancy, and it stems from the fact that housing is an asset as well as a consumption good. But there is also a criminal logic. Much of the vacant housing in Australia (and probably Canada and a few other locations) is due to money laundering. There are no checks on the source of finance for home purchases and no checks on who the ultimate beneficiaries are in the ownership structure. You can buy a home in a trust or company name, and the identity of the trustees and the company owners need not be disclosed. If you then also do not earn rental income, the corporate structure is protected from scrutiny by tax authorities. Housing is a great way to hide ill-gotten gains.

The criminal logic and economic logic are closely aligned. When most of the return to housing comes from capital gains it makes housing a more attractive place to hide money as three-quarters of the total return can still be had. But when most of the return comes from rent it is much less attractive — and it may require corporate disclosure due to local incomes warranting taxation.

Finally, some new data
On another note, new data from the Australian Bureau of Statistics came out recently, filling one of the holes in the housing data landscape — the share of lending to investors that is directed towards purchasing or building new homes.

This data helps to answer questions about the economic value of new credit in the economy, the real economic effects of monetary policy, and more. In standard economic thinking, low interest rates make borrowing to invest in new buildings and equipment more viable. Because standard economic models do not include secondary markets, the effect on the trade of existing assets is mostly ignored. Yet we can see that the majority of home purchases are simply trades of existing housing, and hence are a key mechanism through which low interest rates mostly cause higher prices without having much effect on new construction.

As you can see in those few months of investor data,  investor lending is not substantially more biased toward new housing than lending for owner-occupiers. For investors, 24% of loans have been for new housing in the past few months, just as 24% of loans to owner-occupiers have been.

The main difference seems to be that the typical existing home bought by owner-occupiers is more expensive than the typical new home, whereas for investors the mean value of lending to both is the same.