BFCSA: Explosive Report from 2003: Who hatched the debt / equity HOME OWNERSHIP PLOT?

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Summary of Findings for The Prime Ministerial Task Force on Home Ownership

Vol. 1, 2 & 3

Reports Commissioned by The Menzies Research Centre

for the Prime Minister’s Home Ownership Task Force

Christopher Joye (Cambridge University), Andrew Caplin (New York

University), Peter Butt (Sydney University), Edward Glaeser

(Harvard University), Michael Kuczynski (Cambridge University),

Joshua Gans (University of Melbourne), Stephen King (University of

Melbourne), David Moloney (Booz Allen & Hamilton) and

Alastair Bor (Booz Allen & Hamilton)

Chairman’s Preface

The three reports published herein have been commissioned by the

Menzies Research Centre as part of its Home Ownership Task Force

which was undertaken at the suggestion of the Prime Minister in

September 2003.

No part of the Australian dream is more instinctively human than the

desire to own our own home. In recent years, however, that worthy

ambition has become harder for many Australians to attain. This is not a

function of high interest rates; they are at record lows, but rather is due

to a combination of other factors including escalating property prices

and, so we contend, inflexibilities in housing finance which limit its

availability.

The Task Force has explored many aspects of the housing market,

including constraints on the supply of housing. These reports present a

series of innovative ideas, some of them worked out in considerable

detail, others presented in a more conceptual fashion.

The most substantial report of the three is that whose leading authors are

Christopher Joye and Andy Caplin. It deals with both the demand side

and the supply side of the housing market. On the demand side, the

report demonstrates that by allowing homeowners to use equity as well

as debt finance, homeowners will benefit from a lower cost of home

ownership and institutions will be able to access an enormous, and

uncorrelated, asset class. The Joye/Caplin report also considers the

supply side. For most of this century home prices have risen in line with

home building costs. In recent years they have taken off on a trajectory

of their own. The report offers some explanations for this disturbing

decoupling and provides some new ideas for increasing the supply of

housing.

The second report, by Joshua Gans and Stephen King, considers the

challenges of making housing more accessible to low income earners. It

examines, and finds wanting, the traditional approaches to public

housing and proposes a new idea; the housing lifeline. This lifeline is

designed to offer bridging assistance to homebuyers suffering from

temporary economic hardship so that short term setbacks will not have

disastrous long term consequences.

The third report, by David Moloney and Alastair Bor, examines the

accessibility and flexibility of mortgage finance in Australia and proposes,

in the light of international best practice, a range of innovative changes

to make housing finance more available and more responsive to the

needs of homebuyers and owners.

While I have had the responsibility of chairing the Task Force, the

driving intellectual leadership of this project has been supplied by

Christopher Joye. As the 300 page first volume of these reports attest,

Christopher has made an enormous contribution to the project. His

work is not simply original and rigorous; it is also the product of a tireless

dedication. All of us who have received emails from Christopher at all

hours of the day know that his capacity for work knows no bounds. He

has refused remuneration for his efforts and while many of our

contributors have been extremely generous with their time, none more

so than Christopher. There has never been a study of this kind to which

so many leading minds have contributed. This is truly a collaborative

effort, not possible before the Internet, with input from people working

in many different time-zones and at least one (Christopher) working in

all time-zones! All of these contributors were recruited by Christopher.

He has demonstrated, therefore, remarkable intellect, creativity,

leadership and determination. We are all in his debt.

All of our authors have been generous with their time. Andy Caplin,

Chris’ co-author of the first volume as well as the other contributors to

that volume have likewise sought no remuneration. David Moloney and

Alastair Bor, both of Booz Allen Hamilton, the authors of the third

volume, also provided their services pro bono.

Likewise we have been very fortunate in receiving a large number of

submissions, and we thank all those parties for their effort in assisting the

Task Force.

We have had some expenses for assistance with research, computing

services and the like and we have therefore been fortunate in receiving

generous and much appreciated support both financial and in kind from

a number of organisations, including Wizard Home Loans, the Housing

Industry Association, JBWere, Booz Allen & Hamilton, Aussie Home

Loans, Resimac, RAMS Home Loans, HomeStart Finance, Clayton Utz,

Ebsworth & Ebsworth, Phillips Fox, ACNielsen.consult, and Home

Australia.

The Menzies Research Centre, while affiliated with the Liberal Party, is

neither an echo chamber for Government policies nor a substitute for

the public service. Our aim is to promote independent, creative and

practical ideas on subjects of public importance. Our political

perspective is simply that of a commitment to individualism, enterprise

and freedom of choice.

We recognise that the most challenging social issues are not susceptible

to quick ideological answers. We need constantly to promote new

approaches and new ideas in social policy as much as we do in science or

technology. We believe that these reports do deliver a wide range of new

ideas, many of them worked out in considerable, groundbreaking

analytical detail.

We do not, however, regard these reports as the last word on the subject.

They have been produced in a collaboration to which many have

contributed. We hope that collaborative spirit will continue and that

these reports will encourage further analysis and policy development,

and, most importantly, encourage leaders in business and government to

take up these ideas and put them to work.

Malcolm Turnbull

Chairman, The Menzies Research Centre

Acknowledgments

A great many people have in one way or another made significant

contributions to this work (though they may not be aware of it). The

Chairman of The Menzies Research Centre, Mr Malcolm Turnbull, is to

be thanked for his vision and leadership in promoting this project at the

outset, and, of course, for his many valuable and insightful contributions

as it has evolved. We are also deeply indebted to the Prime Minister, the

Hon. John Howard MP, who showed the courage to invite us to tackle

one of the most perplexing and important social problems of our

timesdespite the obvious risks inherent in this course of action. At no

point has he sought to impose his views on us; and so, we do not know

whether he will share the opinions that we tender today. But without the

Prime Minister’s profound leadership and his willingness to embrace new

ideas, this work would not have been undertaken.

Volume 1

We would to like to recognize a number of individuals, categorized

according to profession: -

Academic: Professor Stephen Brown (New York

University), Andrew Charlton Esq (Oxford University),

Professor William Duncan (Queensland University of

Technology), Joel Fabre Esq (University of Sydney),

Professor Alex Frino (University of Sydney), Professor

Joshua Gans (University of Melbourne), Professor William

Goetzmann (Yale), Professor Ian Harper (University of

Melbourne), Professor David Hayward (RMIT), Dr Elvis

Jarnecic (University of Sydney), Professor Stephen King

(University of Melbourne), Professor Warwick McKibbin

(ANU), Professor Jayaram Muthuswamy (University of

Sydney), Professor Barry Nalebuff (Yale), Professor Adrian

Pagan (ANU), Professor John Quiggin (ANU), Professor

Ray da Silva Rosa (University of Western Australia), Dr

Raven Saks (Harvard), Professor Robert Shiller (Yale),

Professor Diane Skapinker (University of Sydney),

Professor Peter Swan (University of NSW), Alex Turnbull

Esq (Harvard), Professor Terry Walter (University of

NSW), Professor Justin Wolfers (Harvard), and Professor

Richard Zeckhauser (Harvard).

Institutional: Rob Adams (First State Investments), Dan

Andrews (RBA), Andrew Barger (Housing Industry

Association), David Bell (Australian Bankers Association),

Laura Bennett (Turnbull & Partners), Neil Bird (Urban

Pacific), Mark Bouris (Wizard Home Loans), Angus Boyd

(Foxtel), Jason Briant (The Menzies Research Centre),

Kieran Brush (RAMS), Jasmine Burgess (JP Morgan),

Alexander Calvo (RBA), Louis Christopher (Australian

Property Monitors), Tim Church (JB Were), Bob Cooper

(Tobari Management), Tracy Conlan (CBA), Lorenzo

Crepaldi (Ebsworth & Ebsworth), Peter Crone (Prime

Minister’s Office), Brendan Crotty (Australand), Margaret

Doman (Cambridge Consulting), Tony Davis (Aussie

Home Loans), Bob Day (Home Australia), Craig

Drummond (JB Were), John Edwards (Residex), Lucy Ellis

(RBA), Alex Erskine (Erskinomics), Jason Falinski (IAG),

Arash Farhadieh (Phillips Fox), Guy Farrands (Macquarie

Bank), Lyndell Fraser (CBA), Wayne Gersbach (Housing

Industry Association), Steven Girdis (Macquarie Bank),

Adam Gordon (Baltimore Partnership), Samuel Gullotta

(Goldstream Capital), Michael Gurney (ABS), Jason

Falinski (IAG), Martin Harris (First State Investments),

Nick Hossack (Australian Bankers Association), Chris

Johnson (NSW Government Architect), Alan Jones (2GB),

Sally Jope (Brotherhood of St Laurence), PD Jonson

(HenryThornton.com), Anatoly Kirievsky (RBA), Caroline

Lemezina (Housing Industry Association), Steven Mackay

(Ebsworth & Ebsworth), Angelo Malizis (Wizard Home

Loans), Patrick Mangan (HomeStart Finance), Geordie

Manolas (Goldman Sachs), Ramin Marzbani

(ACNielsen.consult), Patrick McClure (Mission Australia),

Gina McColl (BRW), Bill McConnell (AFR), Robert

McCormack (Allens Arthur Robinson), John McFarlane

(ANZ), Bruce McWilliam (Channel Seven), Robert

McCuaig (Colliers Jardine), Peter McMahon (Clayton Utz),

Alison Miller (Urban Development Institute of Australia),

David Moloney (Booz Allen & Hamilton), Ruth Morschel

(Housing Industry Association), Paul Murnane (JB Were),

Darren Olney Fraser (Australian Public Trustees), Rod

Owen (ABS), John Perrin (Prime Minister’s Office), Daniel

Pillemer (Goldman Sachs), Dr Michael Plumb (RBA), Dr

Steven Posner (Goldman Sachs), Brian Salter (Clayton

Utz), Eloise Scotford (High Court of Australia), Tony

Scotford (Ebsworth & Ebsworth), Nick Selvaratnam

(Goldman Sachs), Tony Shannon (Australian Property

Monitors), Matthew Sherwood (ING), Tim Sims (Pacific

Equity Partners), Dr Tom Skinner (Redbrick Partners),

Arthur Sinodinos (Prime Minister’s Office), Orysia Spinner

(RAMS), Bryan Stevens (Real Estate Institute of Australia),

Gary Storkey (HomeStart Finance), Arvid Streimann

(UBS), Louise Sylvan (Australian Consumers Association),

John Symond (Aussie Home Loans), Scott Taylor

(ACNielsen.consult), Simon Tennent (Housing Industry

Association), Lucy Turnbull (City of Sydney), Nicholas van

der Ploeg (Turnbull & Partners), Peter Verwer (Property

Council of Australia), Nick Vrondas (JB Were), Colin

Whybourne (Resimac), Charles Weiser (RAMS), and Simon

Winston Smith (JP Morgan).

Family & Friends: Willis Ashton (in memoriam), Sean

Burke, Adam Caplin, Ann Harriet Caplin, Charles Caplin,

Eleanor Caplin (in memoriam), Olivia Caplin, David

Endean, Amana Finley (in memoriam), Melissa Fitzpatrick,

Lin Gourlay (especially), Ashley Joye, Daisy Joye, Edward

Joye (in memoriam), Ella Joye, Hermione Joye, Ian Joye

(especially), Jett Joye, Judy Joye (especially), Kai Joye,

Margaret Joye, Muriel Joye, Paula Joye, Penelope Joye,

Saxon Joye, Ross Last, Jacqueline O’Sullivan, Frank

Sensenbrenner, William Stephens, Sam Strong, Elizabeth

Wilson, and Ruth Wyatt (especially).

As a final point, we wish to express our gratitude to Gordon Deane and

Nelson Reynolds for their outstanding programming and research

assistance, respectively, and The Menzies Research Centre for its

financial support. All views expressed herein are our own and do not

necessarily reflect those of the above individuals and organisations.

Inquiries should be directed to (christopher.joye.2002@pem.cam.ac.uk)

Volume 2

This paper is benefited greatly from discussions and comments by Ed

Glaeser, Ian Harper, Elvis Jarnecic, Warwick McKibbin, Adrian Pagan,

Malcolm Turnbull and, especially, Chris Joye. Richard Hayes provided

outstanding research assistance. We also thank the Menzies Research

Centre for financial support. All views expressed here are our own and

do not necessarily reflect those of the above individuals and

organisations.

Volume 3

We gratefully acknowledge the contributions of the following (in

alphabetical order): Ian Bailey, Jason Barker, Kathy Cummings, Scott

Dargan, Patricia Ellard, Lyndell Fraser, Michael Gassmann, Glen

Homan, Bernadette Howlett, Christopher Joye, Nick Kennett, Graham

Lauren, Lisa Mead, David Peligrini, Karen Signorio, Malcolm Turnbull,

Debbie Williams, Craig Wilson, and numerous mortgage lending

executives from Canada, Scandinavia, South Africa, The United

Kingdom, and The United States. In addition, we would like to thank

Task Force Committee Members and all those who responded to the

Prime Minister’s Home Ownership Task Force Survey – December

2002.

The authors take full responsibility for any omissions and errors. Please

direct all questions and comments to David Moloney

(moloney_david@bah.com).

Summary of Task Force Findings

Volume 1

Christopher Joye (Cambridge University), Andrew Caplin (New

York University), Peter Butt (Sydney University), Edward

Glaeser (Harvard University), and Michael Kuczynski

(Cambridge University)

The goal of this synopsis is to provide the reader with a snapshot of

what is a rather large and at times complicated body of work. We will

endeavour to walk you through the report in a chronological fashion,

stepping aside on occasion to discuss the results in more detail than

would have been expected of just an introduction.

In July of 2002, Andrew Caplin and Christopher Joye published a

‘primer’ on a proposal for global housing finance reform under the

auspices of The Menzies Research Centre, a leading Australian thinktank

(see Caplin and Joye (2002)). Several months later the Prime

Minister, the Hon. John Howard MP, invited the Chairman of The

Menzies Research Centre, Mr Malcolm Turnbull, to establish a Task

Force to study innovative approaches to reducing the costs of home

ownership, and the delivery of affordable housing assistance.

Readers may be aware that this is but one of three companion pieces.

The two other reports, authored by Professor Joshua Gans and

Professor Stephen King,1 and Mr Alastair Bor and Mr David

Moloney,2 are synergistic with that which we present to you today (of

which summaries can also be found in the following pages). Whereas

1 Professor Gans and Professor King, of the University of Melbourne, study the

economic issues underlying low income housing policy in Australia. Subsequent to

evaluating a number of alternatives, they submit their own solution. In brief, the

authors believe that the short-term problem of housing affordability arises because

of the income risks faced by disadvantaged dwellers, and the inability of the private

market to provide appropriate services to overcome these difficulties. In response,

they recommend that government establish a ‘housing lifeline’, which would be

made available to any family that finds itself in a short-term tenure crisis. This

mechanism would in fact constitute a form of ‘social insurance’, the likes of which

have rarely been deployed before.

2 Mr Bor and Mr Moloney, of Booz Allen & Hamilton, appraise the architecture of

the housing finance market in the context of the various clienteles it serves.

Subsequently, they tender a suite of suggestions which they believe would advance

its functions.

Summary of Task Force Findings

the former focus on a review of the application of low-income

housing policy, the latter seek to enhance the microstructure of the

existing mortgage market. Our opus concentrates on the broader

ambition of ‘disruptive change’; that is, the implementation of

structural innovations that have the potential to alter the functions of

the demand and supply sides of the housing market.

At the heart of this initiative lies the same conception with which we

started. Simply stated, it is beyond time for capitalism to develop a

more human face. For centuries now, businesses in need of funds

have been able to avail themselves of both debt and equity. Yet for

households who aspire to expand, mortgage finance has been their

one and only option. And so, despite the ever-growing sophistication

of corporate capital markets, consumers around the world are forced

to use only the crudest of financial instruments.3 In our minds at

least, the immature state of Australia’s system of housing finance, and

indeed those across the globe, is absolutely scandalous. The

implications of these deficiencies vary from the merely inconvenient

to the extremely tragic. Suffice to say that many of the severe

economic complications that manifest throughout the course of a

dweller’s life-cycle can be attributed to the ‘all-or-nothing constraint’

on home ownership.

So how did we arrive at this curious set of arrangements? Throughout

the nineteenth century most households rented their homes from

wealthy landlords, since debt was available to few. This in and of itself

is a crucial observation. Many of us tend to take for granted that

mortgage finance has always been readily accessible. Nothing could

be further from the truth. Much like the advent of derivative markets

in the late 1970s, the widespread use of debt is a modern

phenomenon. In fact, the emergence of a liquid secondary market

only occurred in the last ten to fifteen years. If one looks back

through time, it becomes apparent that mortgage contracts were not

easily obtainable prior to the mid nineteenth century. The resultant

dominance of rental accommodation (while not necessarily a bad

thing) left many in a situation of tremendous vulnerability, subject to

the constant risk of being removed from their homes, and the

vagaries of a legal system that lavished property-owners with

extraordinary powers. To make matters worse, decrepit living

conditions characterised this kind of tenure, with a proliferation of

slums in cities such as Sydney throughout the early twentieth century.

All told, life was not especially good for the battlers of the age.

3 This begs the question as to the absence of equity finance in the first instance.

One answer instantly offers itself: securitisation. In the past, it was not practicable

for a single unsponsored entity to go around gobbling up interests in individual

properties in the vain hope that they could bundle these contracts into something

that would look like a regulated holding. Fortunately, there has been spectacular

progress of late in terms of the ability of private sector participants to package

otherwise illiquid instruments into marketable securities.

Summary of Task Force Findings

Even as the mortgage markets began to develop, the hazards to house

and home persisted. The earliest such arrangements were of short

duration, and those who could not refinance were frequently evicted

from their residence. The problems of homelessness and squalor

reached epidemic proportions with the collapse of the economy

during the Great Depression. At around the same time, a nascent

communist movement garnered momentum in both Australia and the

UK, the seeds of which many thought were sown in the difficult

circumstances of the day. These events combined to energise renewed

public interest in the supply of private housing services. Indeed, rapid

growth in the rate of home ownership, and the transmission of the

values it was believed to imbue, became a key political imperative.

Spurred on by economic and social ructions of this kind, the State

and Federal Governments sought to actively expand the supply of

housing finance, and by the mid 1930s mortgage markets had arrived

in Australia. Without widespread support for these changes, it is

doubtful whether they would have materialized at such great pace.

Ironically enough, it was bureaucratic inertia of precisely the opposite

ilk that was to stifle the growth of trading in mortgage-backed

securities some fifty years later. Thankfully, reason prevailed, and

today it is hard to imagine what life would be like without alternative

lenders and the pressures they exert on the banks.

In this report, we renew our call for constituents to take the next

brave step along the evolutionary housing finance path. It is our belief

that there is no longer any need for the household sector to be the

poorer cousin of financial markets. That is to say, aspirants should be

able to access a suite of debt and equity instruments that is no less

rich than that which corporations avail themselves of every day.

Nevertheless, if we were going to simply rehash the views presented

in the primer, it would not have taken us nine long months and some

400 odd pages to accomplish! Why have we invested so much time

and energy pulling all of this additional material together? Is it just an

immature yearning to stretch out our moment on the public stage, or

could there be more to it? Well, we would like to think that there is

indeed more. The purpose of the original manuscript was exactly

what its name impliedto introduce some unusual ideas that were in

our own minds only embryonic in form. Today we have a great deal

more to add to both these arguments, and some entirely new subjects.

Here goes.

In what follows, we undertake four main tasks. First, we offer

evidence that irresistible economic logic motivates the introduction of

‘equity finance’. Second, we tender a vast array of new information,

drawn from, among other things, survey and focus group data, on the

profound socio-economic benefits that these markets could deliver.

Third, we demonstrate the proposal’s institutional viability, and

pinpoint relatively minor adjustments to the legal, fiscal and

regulatory structures that would be required in order to guarantee its

Summary of Task Force Findings

success. In the fourth and final section of the report, we embark on a

detailed appraisal of the ‘supply-side’ in the context of the debate

about the rising costs of housing in this country. Just as we contend

that it is vital to extend ownership opportunities to as many

Australian families as possible, we also think it is critical to remove

artificial constraints on the supply of low-cost properties.

The report itself consists of four distinct ‘parts’. Parts One and Two

take up the challenge of introducing the economic rationale

underpinning our desire to eliminate the ‘indivisibility’ of the housing

asset (which, in layperson’s terms, simply means allowing individuals

to hold less than 100 percent of the equity in their home). Whereas

the first part canvasses historical considerations, the second provides

a much more rigorous quantitative elucidation. In particular, Part One

shows that our ideas should not be interpreted as especially abnormal,

since they flow from sound intellectual principles. In fact, the markets

we advocate are so obvious that our profession builds its models as if

they already exist! Strictly speaking, this is not entirely accurate. The

embarrassing truth is that the economics community has taken the

notion of ‘divisibility’ (i.e., the capacity to issue equity to an external

party) to a ridiculous extreme. Indeed, in the minds of our colleagues,

there is no such thing as home ownership, at least in the conventional

sense. No, most economists prefer to abstract away from tenure

choice and the housing asset’s many idiosyncrasies; rather, they

assume that we all live in rental markets in which perfectly

homogeneous housing services are seamlessly exchanged. Taking

these fantasies one step further, they would have us believe that the

dwellings in which we live are indistinguishable from both physical

capital (e.g., machines), and consumption goods (e.g., bread). Who

can therefore blame us for thinking that our contemporaries ought to

be lambasted for their continued refusal to incorporate even the most

basic features of the housing market into their models?

While it is fine for us to pontificate about the merits of relaxing the

all-or-nothing constraint, a sine qua non of market development is a

validation of the proposal’s commercial durability. Undeniably, the

most important question here is whether the investor community will

be prepared to acquire equity claims at prices that are acceptable to

Australian households. Using a variety of complex methods, Part

Two addresses this matter by simulating the institutional demand and

individual supply curves and then studies equilibrium in the market

for equity finance. Despite the divergent techniques, our findings with

respect to feasibility are very similar. On the demand side, we

conclude that there should be immense interest in securitized pools

of enhanced home equity contractsso much so that it is unlikely

that there will be sufficient funds to sate institutional requirements. In

fact, our tests indicate that this new asset-category could come to

dominate the ‘optimal’ investor portfolio, with conservative

participants dedicating at least 20 percent of all their capital to

‘augmented’ housing. At the same time, our modelling implies that a

Summary of Task Force Findings

very large number of Australians would be willing to issue equity on

terms that are attractive to both parties. We infer, therefore, that as a

purely economic concern, these markets have the potential to sustain

a large volume of trade. In the academic jargon, we have discovered

‘gains from trade’.

As with our evaluation of the innovation’s economic viability, the task

of exploring its socio-economic implications is split into two sections.

In Part One, we explain how equity finance could enhance the

average family’s standard of living at every stage of the life-cycle. We

find that it would accelerate the household’s transition from the rental

to the home ownership market while significantly increasing its

disposable income and expected wealth at retirement. It would also

lower mortgage costs, and thereby alleviate financial pressures in the

middle years. Finally, it could release a large new pool of liquid assets

for those who wish to remain in the dwelling debt-free in later life. In

practical terms, our analysis suggests that when a ‘representative’

younger family use a mixture of debt and equity, the upfront costs of

home ownership, and the interest and principal payments required

thereafter, decline by around 30 percent. There is also a dramatic

reduction in the household’s risk of default, and a 70 percent rise in

their liquid assets once they leave the workforce (see ES Table 1 and

ES Figures 1 through 3 below).

Here we speculate that there may be transformations on an even

larger scale than that which can be envisaged at this stage of the

project. For example, empirical studies suggest that the rate of childbirth

is influenced by the type of housing arrangement. In particular,

an increase in the number of years spent in the parental home and

higher levels of mortgage debt are associated with a reduction in

family fecundity. Might these new markets impact positively on

(organic) population growth? Would the increased rate of home

ownership boost the quality of schools and local public amenities as a

result of the residents’ heightened commitment to their

neighbourhoods? Could the advent of equity finance attenuate the

severe cyclical fluctuations in the housing market? Finally, might a

liquid secondary market enable other forms of risk sharing and spawn

the development of derivative and futures contracts on residential real

estate?

In all of the above cases, it should not be forgotten that the policy

environment plays a central role. How well these new instruments

function depends on the extent to which the key issues are carefully

thought-through, and whether or not one can design them for broad

public interest purposes. This in turn depends on the participation of

policymakers, and their ability to rise above what can be a highly

partisan process.

Summary of Task Force Findings

ES Table 14

Estimated Cost Savings on a $250,000 Home

When Using Both Debt and Equity Finance

Category Debt Finance

Debt and Equity

Finance Saving

Home Loan $212,500 $148,750 30.0%

Deposit $37,500 $26,250 30.0%

Annual Interest & Principal $15,300 $10,704 30.0%

Upfront Purchase Costs $53,297 $41,260 22.6%

Savings Period 3.2yrs 2.5yrs 21.9%

Annual Disposable Income $(2,288) $2,340 $4,628

Source: Australian Bureau of Statistics, Australian Tax Office, Commonwealth Bank of

Australia, and authors’ estimates (see Chapter 1.5)

4 This table assumes the existence of a couple aged under 35 who are currently

saving to buy the dwelling of their dreams: they have no assets and no liabilities;

they hope to acquire a first home in, say, Victoria worth $250,000; their combined

ordinary after-tax earnings are $967 per week; they raise mortgage finance

equivalent to 85 percent of the appraised value of the property (i.e., $212,500); and

their final consumption expenditures average $649 per week. Now imagine a

different state of natureone in which they are able to draw on equity finance.

Specifically, we suppose that an institutional partner contributes 30 percent of the

appraised value of the house up front in exchange for its original investment plus

60 percent of the price appreciation and 30 percent of the depreciation. So how

much less would it cost to acquire a $250,000 home if one were willing to issue

equity capital to an outside investor? ES Table 1 shows that by employing a mixture

of both forms of finance, households are able to assuage a significant proportion of

the economic pressures to which they would have been exposed in the

contemporary scenario. The size of their home loan and the required deposit falls

by nearly one third. Concomitantly, there is a 30 percent decline in the couple’s

ongoing interest and principal payments to $829 per month. Total purchase costs

also plunge from $53,297 to $41,260. This in turn cuts the amount of time it takes

them to save up to purchase a property in the first place. Indeed, it is now feasible

for them to buy their Victorian property within two and a half years, whereas it

would have originally taken three and a quarter years (see ES Figure 1). But wait,

there’s moreby relaxing the all-or-or-nothing constraint on home ownership, and

using debt and equity finance, young Australian families would be able to access a

new realm of consumption and investment possibilities (see ES Figure 2). In

contrast to the couple’s initial circumstances (wherein net disposable income was

significantly negative), free cash flow is now positive at $2,340 per annum. As such,

our newly empowered dwellers can no longer be classified as part of the house

poor. On the contrary, they might even be able to afford to think about

establishing a family! To recap, the simple example above shows that by increasing

the efficiency of their balance sheets, aspirational individuals can reduce their

mortgage debt burden, the required deposit, the up-front purchase costs, and

truncate that onerous period preceding the transaction during which they are forced

to defer consumption in order to save to fund the acquisition. Post purchase, the

use of equity finance contributes to a substantial decline in recurring interest and

principal payments, and significantly boosts the home owner’s disposable income.

Finally, it would seem that lower income dwellers reap the greatest rewards in terms

of minimising the time spent in the rental market and expediting their transition to

owner-occupation (see ES Figure 3).

Summary of Task Force Findings

ES Figure 1

Time it Takes for a Couple to Save up for a $250,000 Home Using Both

Debt and Equity Finance

$600

$800

$1,000

$1,200

$1,400

1 2 3 4 5 6 7 8

Number of Years

Combined Weekly After-Tax

Income

Debt Finance Debt and Equity Finance

Source: Australian Bureau of Statistics, Australian Tax Office, Commonwealth Bank of

Australia, and authors’ estimates (see Chapter 1.5)

ES Figure 2

Combined Weekly Disposable Income after Covering Consumption Costs

and Debt Servicing Requirements, as a Function of After-Tax Income

($300)

($200)

($100)

$100

$200

$300

$400

$650 $750 $850 $950 $1,050 $1,150 $1,250 $1,350

Combined Weekly After-Tax Income

Combined Weekly Disposable

Income

Debt Finance Debt and Equity Finance

Source: Australian Bureau of Statistics, Australian Tax Office, Commonwealth Bank

of Australia, and authors’ estimates (see Chapter 1.5)

Summary of Task Force Findings

ES Figure 3

Accelerating the Household's Transition from the Rental to the Owner-

Occupied Markets: The Impact of Equity Finance

0.0

1.0

2.0

3.0

4.0

$700 $800 $900 $1,000 $1,100 $1,200 $1,300

Combined Weekly After-Tax Income

Time Saved (Years)

Source: Australian Bureau of Statistics, Australian Tax Office, Commonwealth Bank

of Australia, and authors’ estimates (see Chapter 1.5)

ES Figure 45

Simulated Distributions of Liquid Wealth after Ten Years

Shared-Appreciation Contract (LTV=30%; Gain=60%; Loss=30%),

where Housing Constraint = 70%, and Risk Aversion Parameter = 4.0

0.0%

3.0%

6.0%

9.0%

12.0%

15.0%

$125 $225 $325 $425 $525 $625 $725 $825 $925

Simulated Liquid Wealth Outcome ($000') Frequency

Debt Finance Debt and Equity Finance

Debt Finance

Debt & Equity

Finance

Housing Constraint 70.0% 70.0%

Risk Aversion 4.0 4.0

Mean Wealth Outcome $288,996 $493,410

Debt & Equity Gain 70.7%

5 ES Figure 4 shows that there is a striking rightward shift in the retirement

portfolio of dwellers when they issue equity claims.

Source: Authors’ estimates (see Chapter 1.5)

Summary of Task Force Findings

Part Two of the socio-economic exposition recognizes that markets

play a valuable role if and only if they help us achieve goals that are

salient in a social sense. Of course, the most powerful expression of

this is to be found in the context of human satisfaction, not via

theoretical estimates of utility and the like. We therefore went to the

source itself and asked Australians who do not yet own a home for

their views on the appeal of equity finance. And their message was

loud and clear. In the opinion of these households, the ability to draw

on both debt and equity when purchasing a property would be of

great help in their struggle to get a foothold in the home ownership

market. But what exactly did our results reveal? In a survey of a broad

spectrum of consumers, we find that roughly one in two would be

interested in supplying equity claims, even when subject to harsh

financial terms (see ES Figures 5 and 6). By making some cautious

assumptions about the rental segment alone, we calculate that the

market opportunity would, at the very least, be in the order of $130

billion. The supply-side of the equation is wrapped up via two focus

groups, where we discover that nine out of ten liquidity-constrained

dwellers (i.e., those on Centrelink payments) think that the

introduction of this innovation would boost the likelihood of them

acquiring a home to call their own. Throughout all of this it is

worthwhile remembering that these products do not

existanywhere. Hence, the enthusiasm so discerned has prevailed

against the inherent unfamiliarity of the contracts in question.

Yet our work was not finished there. Oh no. With supply sewn up,

we took a step back and asked ourselves: aside from the obvious

candidates (i.e., institutions), are there any other members of the

community who would be eager to obtain exposures to the

securitised pools? And there certainly were. Roughly half of all nonowning

households responded that they would prefer to invest

exclusively in a portfolio consisting of residential real estate than in

cash or a diversified fund. Perhaps most remarkably though, this was

in spite of an explicit warning that such an investment could lose

money in real terms. When we relaxed the restriction and allowed

them to apportion their capital across cash, housing and a balanced

fund, most of their wealth (about 40 percent) ended up in home

equity. Thus, we feel confident that we also have the demand side of

this market under control.

Summary of Task Force Findings

ES Figure 56

Non-Owning Survey Sample

Would the availability of this new product increase the likelihood of you moving

to a new home?

27.6%

55.3%

52.3% 72.4%

44.7%

47.7%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

Agree Somewhat

Agree/Disagree

Disagree

If I lost even a month’s pay, I would find it hard to make ends meet?

Household Sample

Yes No

Source: ACNielsen.consult and authors’ analysis (see Chapter 2.5)

ES Figure 6

Non-Owning Focus Group Sample

Would the availability of this new product increase the likelihood of you moving

to a new home?

50.0%

41.7%

8.3%

46.2%

30.8%

23.1%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

Yes, strongly Yes No

Household Sample

Basic Needs Fairer Deal

Source: HomeStart Finance and authors’ analysis (see Chapter 2.5)

6 Households who think of themselves as being encumbered by liquidity constraints

appear most eager to capitalise on these opportunities.

Summary of Task Force Findings

ES Figure 77

Non-Owning Survey Sample

To which of the following investments would you be most likely to allocate your

money as part of this policy?

18.2%

46.8%

35.1%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

Savings account Balanced fund Property account

Investment Account

Choice

Source: ACNielsen.consult and authors’ analysis (see Chapter 2.5)

Having satisfied the economic and social criteria, Part Three of the

report offers an assessment of the proposal’s institutional viability. As

before, we find much room for optimism. It would appear that the

prevailing legal and regulatory framework can flex to accommodate

the introduction of equity finance. Most exciting though is the

revelation that we can fashion these arrangements as either equity or

hybrid debt instruments. The latter is an especially attractive

alternative since it enables one to circumvent all of the legal and

psychological complications implicit in ‘co-ownership’. In particular,

under the debt option, occupiers always own 100 percent of the

home in which they live. Furthermore, the costs borne by the

institution are noticeably reduced (to take but one example, stamp

duty is no longer relevant). In this sense, we can have our economic

cake, and eat it too!

So where are the much mooted impediments to progress? In the

immortal words of George Harrison, “Let me tell you how it will be,

there’s one for you, nineteen for me.” Our study of the proposal’s

institutional feasibility suggests that over-zealous regulatory

authorities have the capacity to tax away the gains from trade. Here it

7 Here the data plainly says it all (see ES Figure 7 above). Unmistakably, the single

most popular product is the property fund. Almost 50 percent of households would

select this option when required to make an exclusive choice, which is an

extraordinarily compelling result for the demand-side of the equity finance

equation.

Summary of Task Force Findings

is not so much the imposition of new levies, but rather the rigid

interpretation of existing ones.8 This was certainly the case with

several small-scale efforts to launch equity-based products overseas.

Yet what would make these actions especially perverse is that markets

of this type present the Federal Government with unprecedented

revenue raising possibilities. That is to say, the advent of equity

finance would permit the Commonwealth to tax owner-occupied

housing for the very first time. Naturally, these charges would only

apply to the investor’s holding. In this vein, we would submit that

even the most ruthless of bureaucrats should be incentivized to

encourage the promulgation of these products.

ES Table 29

How Valuable is Owner-Occupied Housing?

As at December 2002

Total Value (bn) Proportion

Owner-Occupied Housing $2,478.1 47.4%

Assets of ADIs $1,033.3 19.8%

Domestic Equities $672.8 12.9%

Investment Funds $634.4 12.1%

Corporate Debt Securities $218.3 4.2%

Government Debt Securities $126.6 2.4%

Asset Backed Debt Securities $66.3 1.3%

Total $5,229.80 100.0%

Source: 2001 Census, Reserve Bank of Australia and author estimates (see Chapter 2.1)

Irrespective of what is decided in the post-publication period, we are

convinced that the application of both debt and equity finance will

eventually become standard industry practice. It is more a matter of

whether that day will arrive in the near term or in the far-flung future;

and that, truth be known, is a question that only you (i.e., consumers,

decision-makers, investors and opinion-shapers) can answer.

Unsurprisingly, it is our belief that Australia is well positioned to push

the intellectual envelope and become the very first nation to develop

8 Note that we do not advocate any exemptions whatsoever.

9 Just how big an asset-class is residential real estate? According to the 2001 Census,

there are 7,072,202 private occupied dwellings in Australia. To get a feel for the

order of magnitude involved, we multiply this number by the CBA/HIA all capital

median established dwelling price at December 2002, which gives an almost

incomprehensible $2,478,099,580,800. We can therefore say with some confidence

that the total value of residential property in Australia is in excess of $2 trillion. By

way of comparison, that is nearly four times the size of the value of companies

listed on the Australian Stock Exchange, and over seven times larger than the

Commonwealth, State and corporate debt markets combined.

Summary of Task Force Findings

primary and secondary markets in real estate equity. And at $2.5

trillion, that is no small cheese (see ES Table 1 above).

While the financial reforms described above could have profound

implications for the lifestyles of many Australian households, we do

not limit our analysis to just the demand-side of the housing market.

No, that would be too easy! Accordingly, in Part Four of this report

we conduct a thorough appraisal of the performance of the supplyside,

which is set against the debate about the rising costs of home

ownership in Australia. We conclude that while there is an

affordability problem, it has nothing to do with the distribution of

income, as many of the combatants would seem to imply. Rather, it

appears to be an artefact of government regulations that severely

constrict the stock of low-cost properties. When combined with

burgeoning demand, these artificial constraints on supply propagate

price rises. Consequently, we recommend expanding the affordability

debate to encompass local and State government reform, in favour of

simply confining ourselves to that perennial panaceapublic

housing. Specifically, we believe that several steps can be taken to

enhance the elasticity of supply without resorting to subsidies, and

which would contribute to a marked reduction in the costs of home

ownership right across the country. In particular, we advocate a

system in which local authorities are set (binding) targets vis-à-vis the

number of new permits they issue during any given period. The size

of these quotas would be determined according to a variety of factors,

including environmental considerations, the density of existing

dwellings, and cross-municipality prices. The principal objective here

is to accelerate the approval and land release process so as to

stimulate private sector investment in the delivery of low-cost

housing.

Overall, we are optimistic that while our ideas may seem radical to

some, the logic underpinning them is compelling. One hundred and

fifty years ago, mortgage finance did not, for all intents and purposes,

exist. In fact, the notion that seven out of ten Australians would own

the home in which they live would have been far more outlandish

than the initiatives we canvass herein. However, at the turn of the

twentieth century, a variety of economic and social forces coalesced

to stimulate public action. Stakeholders at the time recognized that

the availability of debt finance would open the ownership door to

many dwellers who were shackled by the landlords’ yoke.

But much like a portrait in which only half the subject’s face has been

painted, Australia’s system of housing finance remains very much a

work in progress. Here it is our view that the nation once again stands

at a historic set of crossroads. Absent substantive reform, the

sustenance of our ‘home owner society’ is far from assured. Two key

challenges confront policymakers. In the first instance, vigilant moves

must be made to cut the cost of housing on the demand-side of the

financing equation. The most powerful way to do this would be

Summary of Task Force Findings

through relaxing the all-or-nothing constraint. Readers will become

familiar with our argument that it makes no sense whatsoever for the

average Australian family to have to tie up over two-thirds of all their

wealth in the world in one highly illiquid and very risky asset: viz., the

owner-occupied residence. Indeed, in Part Two of the report we find

that one in four families lose money (in real terms) when they come

to sell the roof over their heads. For roughly one in ten dwellers, the

situation is even more direthese poor souls are subject to real price

declines in excess of 13.4 percent! In this context, it is high time that

we brought capitalism to the home front and provided all Australians

with the option of issuing both debt and equity capital when

purchasing their properties.

Yet just as important as eliminating distortions on demand is our

desire to elastify the supply-side of this complex theatre. The analysis

of Part Four indicates that there is a growing disjunction between the

price of Australian homes and their underlying costs of production

(see ES Table 3 and ES Figures 8 and 9 below). Significantly, this

does not appear to be a manifestation of natural limitations on the

availability of land, but rather a product of regulatory restrictions that

artificially inflate the cost of housing. Viewed differently, these

constraints on the construction of new dwellings and the release of

greenfield and brownfield sites act as a burdensome tax on building,

which in turn leads to a mismatch between the accommodation needs

of Australian households and the stock of available homes. This

brings us to a more general point, which is that many local and State

Governments have failed to come to the affordable housing party. To

a certain extent, this is an upshot of their deep-seated aversion to

instituting changes that are likely to be perceived as disruptive to

incumbent residents. While we believe that our solution goes a long

way to addressing these concerns, it may not secure adequate political

support. In the event that it does not succeed, councils still have an

arsenal of other strategies on hand. As a minimum, they should strive

to adopt clearer and more objective review standards, and

expeditiously render land use decisions in an attempt to improve the

ownership opportunities available to current and prospective home

owners. The States, on the other hand, must make a much greater

commitment to providing the vital physical infrastructure (or at least

its funding) that is a precursor to new land being useful for housing

purposes.

Summary of Task Force Findings

ES Figure 810

Comparison of House and Building Material Price Indices in Australia

100

150

200

250

300

350

1986 1988 1990 1992 1994 1996 1998 2000 2002

Date

Index

Consumer Prices Building Material Prices

Established House Prices (incl. land) Project House Prices (excl. land)

Source: Australian Bureau of Statistics (see Part Four)

10 When thinking about the cost of supplying new housing, economists like to

identify two broad components: the physical construction charges and everything

else. Historically, building-related expenses (bricks and mortar, wood etc) have

accounted for the lion’s share of supply costs in Australia and the US. To get a

better feel for this dynamic, we examine the time path of dwelling and building

material prices, where the established (project) house price index includes (excludes)

the cost of land. Prior to the asset price inflation of the late 1980s, all three lines

hugged one another quite closely. Since that point, there has been a striking wedge

between the price of established homes and the cost of the inputs used to build

them. This disjunction has become increasingly large over the past one and a half

decades, with unusually rapid growth during the last five years. Yet he high cost of

home ownership in Australia has little to do with swelling construction prices, as

the figure above clearly demonstrates. No, this phenomenon is an artefact of

something else, which might be loosely referred to as the ‘extrinsic’ cost of land.

Here it is useful to distinguish between market-based valuations that recognize

control rights, and intrinsic measures of worth that make no attempt to incorporate

such. Ultimately, a property’s costs of production will be determined by three

factors: the physical characteristics of the dwelling structure, the innate value of the

turf on which it was built, and land use regulations that interfere with the market’s

estimate of the latter. These distortions may take the form of specific rights that

attach to the lot in question (i.e., zoning), or holistic supply-side strategies that

dictate the release of greenfield and brownfield sites. ES Figure 9 quantifies the real

differential between new house prices and the value of approved private sector

dwellings over time. This facilitates a more accurate comparison of the price of a

property with its developer-estimated costs of production (which include all

margins, taxes and related charges), where the disparity between the two should

reflect the market value of land. In June 1985, the land component of the median

Australian dwelling was valued at $30,058. In constant dollar terms, today’s

equivalent figure is three times higher at $103,306a phenomenal increase in

anyone’s books.

Summary of Task Force Findings

ES Figure 9

The Extrinsic Cost of Land: Real Differential Between New House Prices

and the Value of Private Sector Dwellings

Four Quarter Moving Average

$25,000

$50,000

$75,000

$100,000

$125,000

1985 1987 1989 1991 1994 1996 1998 2000 2002

Date

Value of Land

Australia Sydney Melbourne Brisbane Perth Adelaide

Source: Australian Bureau of Statistics and the Housing Industry Association (see

Part Four)

ES Table 411

A First Approximation of the Extrinsic Cost of Land

December 2002

CBA/HIA

Median New

Dwelling

Price

Value of

Approved

Private

Sector

Houses

Estimated

Extrinsic

Cost of Land

Proportion

of New

Dwelling

Price

Proportion

Australian

Average

Sydney $538,200 $180,453 $357,747 66.5% 156.2%

Melbourne $326,200 $169,463 $156,737 48.0% 68.4%

Brisbane $305,700 $154,704 $150,996 49.4% 65.9%

Adelaide $299,200 $128,772 $170,428 57.0% 74.4%

Perth $231,000 $143,239 $87,761 38.0% 38.3%

Australia $390,000 $161,016 $228,984 58.7% 100.0%

Source: Australian Bureau of Statistics, Housing Industry Association and authors’ estimates (see

Part Four)

11 ES Table 4 provides a nominal dissection of the data and shows that a

considerable proportion of the housing costs in this country can be ascribed to the

extrinsic value of land. In Sydney, 66.5 percent of the median dwelling price is

attributable to this factor.

Summary of Task Force Findings

In conclusion, let there be no doubt that the reforms we propose in

this report are as critical to the welfare of Australian families today as

was the emergence of the mortgage market at the turn of the last

century. Notwithstanding this, policymakers as a breed are not known

for their risk appetites. How many will be willing to put their

reputations on the line to facilitate the changes we advocate? If

history is of any guide, the portents do not look especially promising.

Bold political leadership is a rare commodity, particularly in the

sphere of financial innovation. Nonetheless, we have strong grounds

to believe that such vision and foresight might already be in place,

right here in Australia. In this regard, we have unambiguously put our

money (or at least our time and effort) where our mouths are. Absent

such faith in the current Australian leadership, there is no way that we

would have poured so much time and energy into producing this

report.

Volume 2

Joshua Gans (University of Melbourne) and Stephen King

(University of Melbourne)

A longstanding social welfare tradition is for the government to help

low income households who face housing problems. Various

programs to address low income housing have been implemented in

Australia and throughout the world. Many of these programs, at

best, have been only moderately successful and some have

significant limitations and failings. For this reason, the Menzies

Research Centre commissioned us to revisit low income housing

policy in Australia – to analyse the economic issues underlying low

income housing policy, evaluate existing policy options and highlight

new options that are worthy of closer investigation.

We first characterise the housing affordability problem and then use

this to define a set of criteria for evaluating alternative policy

approaches designed to improve the housing services available to

low income households. We use these criteria to evaluate a range of

policies concentrating on new innovative policy approaches. Thus

we provide the framework and preliminary evaluation required for a

systematic reformulation of housing policy by the Federal

Government.

The problem of housing affordability is easily stated: low income

households are unable to purchase housing services that satisfy

minimum levels of quality. Not surprisingly, this problem is most

salient in larger cities where factors such as population density have

driven high land prices.

Summary of Task Force Findings

Upon closer examination, however, affordability problems fall into

two classes: long and short-term. The long-term affordability

problem involves households who, for the foreseeable future and for

whatever reason, will be unlikely to have an income that would allow

them to purchase appropriate housing services. The short-term

affordability problem concerns households who over time have an

average income that would be sufficient to purchase appropriate

housing in the private market, but who face short-term fluctuations in

income that precipitate housing stress or crises. That is, a household

may face the short-term loss of employment or the illness of a

primary income provider or a rise in interest rates or rents

precipitated by macroeconomic conditions. Such households may

find themselves unable to afford their current accommodation in the

short-term and face hardship from being forced to move; losing

personal capital incorporated into their homes. These short-term

fluctuations harm both the households and the parties providing

them with housing. As a result, households with a higher risk of

short-term income fluctuations may find it difficult to gain

appropriate housing in the private market.

The long-term and short-term affordability problems have different

causes and, hence, require different policy approaches. The longterm

problem is a problem of low income as opposed to an issue of

housing policy per se. Government interventions that are designed

to improve conditions in the housing market are no solution to this

type of problem: there is no sense in improving the operation of a

market that these households cannot effectively access. The longterm

affordability problem requires anti-poverty programs with

housing as a key element. For this reason, while it is an important

aspect of overall social welfare programs, the long-term affordability

problem is not the focus of this report.

The short-term problem is a problem of income fluctuations rather

than a permanent lack of income and earning power. Left untreated

it can lead to transitions to longer-term problems but at its heart the

problem is the lack of a mechanism to deal with short-term income

loss. The reason the short-term problem is a concern for

government is that the market is unable to provide a solution to

housing stress caused by income uncertainty. While, in principle,

capital markets should be able to provide short-term finance to get

households through rough patches, in practice, this does not occur.

The main economic reason for this is that, for quite understandable

reasons, banks and other lenders are reluctant to extend loans to

households that have just suffered a dramatic loss of income or a

rise in housing prices. Here we focus on how to address this

problem.

As a matter of economics, long-term housing prices in any region are

driven by the long-term stock of housing. To improve housing

Summary of Task Force Findings

affordability we need to consider how the supply of housing can be

expanded.

Some government policies attack the supply-side constraint directly

by providing incentives for increased private construction or by

providing public housing itself. The problem with these policies,

however, is that housing stock is not a simple homogeneous

commodity. There is a hierarchy of dwellings in terms of quality and

interventions and improving supply in one sub-market has flow-on

effects to other sub-markets. In some situations, this flow-on can be

a good thing with improvements in high quality housing filtering

back to the price of other dwellings. In other situations, the flow-on

can move stock in the quality hierarchy in ways that offset any

reduction in lower housing prices, short-circuiting the objective of

the policy. Thus, any supply-side intervention must be assessed as to

its overall impact on housing prices for low income households; is

the policy encouraging increased housing stock availability at the

lower end of the quality hierarchy of housing submarkets?

Alternatively, constraints on the stock of housing can be tackled

indirectly through demand-side policies. By improving the ability of

low income households to pay for housing, in the long-run,

investors will have an incentive to provide housing that satisfies this

additional demand. However, this type of policy involves two key

choices. First, on what basis are demand-side policies provided? Are

they awarded on the basis of a close examination of need or are they

an entitlement? Current rent assistance policy requires close

micromanagement of eligibility while the first home owners’ scheme

is an entitlement to all households who have never owned a

dwelling. We argue that micromanagement is a poor option

compared with an entitlement. Entitlements tend to be clearer in

their operation and objectives, empower individual households to

make their own housing choices and facilitate appropriate market

responses. Entitlements do not require the government to make

judgments as to individual housing requirements, leaving that

judgement to those most affected.

Second, who should receive demand-side housing benefits? Most

housing policies select eligible recipients on the basis of income.

What this means, however, is that as income rises, households that

currently receive benefits might risk losing them or having them

curtailed. For households requiring assistance due to a short-term

affordability problem, this creates a poor incentive for them to

restore their income levels (they are effectively being taxed at

extremely high marginal rates). At best, this prolongs the burden on

the government. At worst, it may turn a short-term problem into a

long-term one (i.e., a poverty trap). For this reason, we believe that

housing policy directed at alleviating the short-term affordability

problem must be vigilant in avoiding implicit incentive traps.

Summary of Task Force Findings

The short-term problem of housing affordability arises because of

income risk faced by low income households and an inability of the

private market to provide appropriate services to overcome that risk.

Standard approaches to low income housing policy often pay scant

regard to this short-term income risk and are designed in a way that

assumes a long-term affordability problem. In particular, the

eligibility criteria for these programs often create poverty traps that

exacerbate the plight of low income families over the longer term.

Rental and interest guarantees provide one way to help overcome

market failures for low income households. These types of programs

help to remove the risk from lenders and landlords. However, these

programs often lack flexibility and cannot address income shocks

when they arise.

Our proposed alternative approach would involve governments

addressing the income risk associated with low income households

directly. We propose that the government establish a housing lifeline

– essentially, a line of credit – that would be available to any

household with limited wealth (as defined by an assets-based means

test). This could be then utilised if these households finds

themselves in a short-term housing crisis. The lifeline would be a

form of insurance to low income households, to ensure that shortterm

income fluctuations do not create long-term housing problems.

How would this work? Suppose that a household suddenly finds

itself facing a crisis where they are likely to be unable to meet shortterm

commitments for housing payments. A housing lifeline means

that the household would be able to draw down a payment from the

federal government to tide it over the short-term crisis. For example,

the government might allow a household that is able to demonstrate

a short-term drop in income, due to say unemployment or

temporary lay off, to draw down a payment (say up to an eventual

maximum of $5,000 - $10,000) towards rental or mortgage costs.

This payment would be a loan to the household, but the loan would

be automatic. In other words, the household would not need to

prove relevant need or satisfy other eligibility requirements, other

than a liquid assets test in the short-term. However, the household

would incur a future tax liability associated with this loan. The

payment of this liability would be tied to future income, like the

Higher Education Contribution Scheme (HECS).

Payments to a household would be capped both in terms of the

maximum weekly drawdown and the maximum total drawdown. The

housing lifeline is designed to provide short-term relief, not to

provide a permanent source of support for those families who will

not have the means to adequately fund housing in the medium to

long-term. Thus, the lifeline does not replace other long-term poverty

programs but supplements these programs providing more

appropriate assistance to low income households facing temporary

Summary of Task Force Findings

crisis. For example, it might be possible to ‘borrow’ up to $200 per

week under the cap up to a total of $10,000. Thus, the scheme would

provide up to 50 weeks (or more if less than $200 was drawn upon)

support for a relevant household. Nonetheless, a primary benefit of

this scheme is that it would potentially enable to the government to

save on social security costs by preventing short-term income

problems from transitioning into longer-term poverty.

The payments under a housing lifeline would be tied to housing.

Thus, funds would be paid directly to a (registered) landlord or

lender specified by the relevant household. This would require a

contractual agreement that ensures that the funds do reduce the

household’s liability to landlords and lenders directly.

Drawing down the lifeline would be a choice made by the relevant

household. But because this access to an instant ‘line of credit’

removes a substantial amount of the risk that would otherwise face

lenders and landlords who provide housing solutions to low income

families, the lifeline directly addresses the problems embedded in the

rental and mortgage markets. Put simply it reduces the problems of

income risk facing both the households and their housing providers.

While the government takes on board the risk associated with low

income households, through the housing lifeline insurance, the

government is also in a good position to deal with that risk. The

government has the substantial advantage of ensuring appropriate

repayment of any lifeline loan through the taxation system. A low

income household can use the lifeline in periods of crisis and then

would repay the loan when their circumstances improved. This may

be in the short-term or in the longer term, depending on the relevant

household’s circumstances. For example, modest repayments to the

government may begin when household income approaches a set

level above poverty-line income.

In terms of implementation of this scheme, we envisage that it

would naturally apply, in the first instance, to home owners with

mortgages. This should be constituted so as to create a statutory

second mortgage for the benefit of the government and provide a

natural way of underwriting the program. If this proves successful,

then a broader applicability to renters could be achieved as issues of

compatibility with existing rent assistance and other government

programs are resolved.

In summary, the housing lifeline is essentially a government

provided insurance product. It has a number of similarities to HECS

in that it is based on lifetime income rather than current income, it

limits the impost of government funds while providing short-term

relief for relevant households and it is a product where benefits are

determined by the needs and requirements of the low income

Summary of Task Force Findings

household themselves. For these reasons, we believe that it is a

policy worthy of close examination by the Federal Government.

Volume 3

David Moloney (Booz Allen & Hamilton) and Alastair Bor

(Booz Allen & Hamilton)

Australians’ success at purchasing their own homes and quickly

building home equity is widely acknowledged. With the national

psyche so bound up with property ownership as its leading barometer

of status and financial well-being, issues of home ownership are

clearly central to consumers, the Nation’s political landscape, its

Government and its mortgage lenders.

This report comprises a pro bono contribution to the work of the

Prime Minister’s Home Ownership Task Force by Booz Allen

Hamilton, a global leader in strategic management consulting with

extensive experience assisting in improving performance for

commercial and government enterprises.

This report is designed to dovetail with two other volumes prepared

by the Task Force:

Volume 1: Innovative Approaches to Reducing the Costs of Home

Ownership, in which Joye and Caplin investigate innovations

associated with relaxing the all-or-nothing constraint (demand-side),

and regulatory restrictions that artificially inhibit the elasticity of

supply

Volume 2: Policy Options for Housing for Low Income Households,

in which Gans and King consider the delivery of low-income housing

assistance, with particular reference to the public market

This report recognises that while Government and lenders have made

great strides in the past decade, there remain significant opportunities

to address the problems continuing to encumber the housing finance

market. The report attempts to comprehensively identify and

summarily evaluate those opportunities.

The issues and opportunities identified have been compiled through

analysis of Australian and overseas mortgage industries, including

those of the UK, US, Canada, France, Scandinavia, Singapore and

South Africa; interviews with industry stakeholders; the application of

Booz Allen Hamilton intellectual capital; and Task Force Survey

responses.

Summary of Task Force Findings

The ideas contained within this report are designed to help address

some of the major inhibitors to the accessibility of home ownership

and home-wealth flexibility in Australia, including:

• Barriers that limit alignment of credit policies of local lenders with

global best practices

• Barriers created by the average Australian’s lack of understanding

of the options available to them to reduce the costs of their

mortgage or optimally diversify their wealth

• Barriers created by the requirement to pay Lender’s Mortgage

Insurance (LMI) in advance to cover the lender against loss on all

purchases where the loan-to-value ratio is greater than 80 per cent

• Barriers created by the limited availability of ‘reverse’ or ‘equityrelease’

mortgages, enabling those with equity in their properties

to supplement retirement incomes

The report attempts to comprehensively identify issues facing

prospective and current owners by home ownership life-stage,

including those saving for a home; those building property equity;

those diversifying their wealth away from the primary residence; those

consolidating their wealth ahead of retirement; and those choosing to

access or transfer property wealth during retirement.

The major emphasis; however, is concentrated on the first and last of

these life-stage segments, and therefore the ideas generated in this

study focus principally on issues of ‘entry’ and ‘exit’ - addressing

opportunities concerning initial access to the housing market, while

increasing flexibility for asset diversification in retirement for those

with accumulated property wealth.

Focusing on idea-generation, this report first identifies a broad range

of opportunities.

These include:

For aspiring first-home owners

• Creating ‘parental-pledge’ products that enable earlier entry to the

housing market for young people through innovations that

facilitate permanent or temporary intergenerational wealth

transfer

• Developing ‘home super’ products that provide tax incentives on

savings that are quarantined for deposits on first homes

• Reducing costs to lenders and consumers by optimising the

application of LMI, either by accelerating implementation of the

standardised regulatory capital provisions of the Basel II Accord,

or by providing more options to home-purchasers - such as

Summary of Task Force Findings

paying a premium only for the period where the loan-to-value

ratio exceeds 80 per cent

• Developing products that allow certain consumers to borrow up

to 100 per cent or more of the property value

• Improving and/or harmonising stamp duty discounts for firsttime

home buyers to the levels already provided by some

Australian state governments

• Cutting entry costs by creating products that enable third parties

to take a stake in the property in exchange for either a lower

deposit or reduced interest

For those in ownership, building equity

• Enabling less sophisticated borrowers to take advantage of

opportunities to accelerate repayments, reduce interest and lower

repayment costs by mandating that simple education programs

and personal budgeting tools be provided at the point of loan

origination

• Creating more perfectly competitive and transparent safeguards

for customers by requiring brokers to create statements justifying

their selection decisions on the customer’s behalf

For those building and diversifying property wealth to prepare for

retirement

• Educating consumers to encourage uptake of investments which

offer increased diversification benefit and which compare

favourably with accelerated mortgage repayments

• Stimulating investment diversification strategies by enhancing the

tax treatment of investments that are quarantined for retirement

in order to close the return-gap between such investments and

accelerated mortgage repayments

For those who have retired and may wish to access or transfer their

property wealth

• Developing next-generation ‘reverse’ (equity release) mortgages

that improve accessibility and eliminate the potentially distortional

nature of means-testing which may encourage consumer

behaviour against asset liquidation

The above opportunities comprise a subset of a longer list of ideas

and opportunities generated by this study. This report contains a

comprehensive list of those ideas, articulated by life-stage segment,

along with a preliminary qualitative assessment of those given higher

priority in order to assess their stakeholder impact and ease of

implementation.

Summary of Task Force Findings

It should be noted that the ideas in this report represent demand-side

stimulus which must be mitigated by supply-side initiatives in order to

avoid inflationary pressure. Such supply side initiatives are proposed

by Joye and Caplin.

About the Authors

Christopher Joye (PhD (current),

Commonwealth Trust Bursary, Cambridge;

BComm (Joint 1st Class Hons (Economics &

Finance)), Credit Suisse First Boston Scholar,

University Honours Scholar, University Medal

in Economics & Finance, Sydney)

In December 1999, Christopher completed a Joint Honours degree in

Economics & Finance at the University of Sydney. He received 1st

Class Honours and the University of Sydney Medal in Economics &

Finance, with a final Joint Honours year grade of 95 percent, the

highest in the Discipline’s history. Other accolades included The 1999

University of Sydney Honours Scholarship for Economics & Finance,

The 1999 Credit Suisse First Boston Scholarship for Finance, and

The 1999 Securities Industry Research Centre of Asia-Pacific Prize

for the Best Honours Thesis. Christopher’s dissertation was awarded

the highest individual assessment in the Department of Finance’s

history (97 percent). In January 2000, Christopher travelled to

Harvard (Harvard Business School, The JFK School of Government,

and The School of Economics), Yale (Yale School of Management

and The Institute of Finance) and New York University (The Stern

School of Business) to present two of the three studies deriving from

his dissertation. Christopher’s research on financial markets has been

widely covered by press and industry periodicals, including, among

others, The Age, Asia Pulse, The Australian, The Australian Financial

Review, The Bulletin, Business Review Weekly, The Canberra Times,

The Courier Mail, The Daily Telegraph, The Herald Sun, Investor’s

Advisor, Investor Weekly, The Mercury, The Newcastle Herald, The

Sun Herald, The Sunday Telegraph, The Sydney Morning Herald, and

The Weekend Australian. The first paper to be extracted from

Christopher’s undergraduate dissertation is presently under secondround

review at one of the world’s pre-eminent academic

publications, The Journal of Finance. Christopher has previously

worked in mergers and acquisitions with Goldman, Sachs & Co., in

London, New York and Sydney, and with the Reserve Bank of

Australia. In March 2002, Christopher was awarded a Cambridge

Commonwealth Trust Bursary and invited to study for a PhD at

Summary of Task Force Findings

Cambridge University. In his spare time, Christopher acts as a

Visiting Economist at The Menzies Research Centre.

Joshua Gans (PhD, Stanford (Fulbright

Scholar, Stanford Fellow); BEcon (1st Class

Hons, University Medal), QLD)

Joshua is popularly perceived to be Australia’s finest young

economist. At the tender age of 32 he was anointed the Foundation

Professor of Management (Information Economics) at Melbourne

Business School (MBS), University of Melbourne. He has been at

MBS since 1996. Prior to that Joshua was at the School of

Economics, University of New South Wales. He completed a PhD at

Stanford as a Fulbright Scholar and Stanford Fellow under the

supervision of the Nobel Laureate, Kenneth Arrow, and an Honors

degree in Economics with 1st Class Honours and the University

Medal at the University of Queensland. Joshua teaches MBA students

in introductory microeconomics, technology strategy, economics of

organisations, incentives and contracts, and market design using game

theory. He has also co-authored (with Stephen King and Robin

Stonecash) the Australasian edition of Greg Mankiw's “Principles of

Economics”. While Joshua's research interests are varied, he has

developed specialities in the nature of technological competition and

innovation, economic growth, publishing economics, industrial

organisation and regulatory economics. This has culminated in

publications in journals such as The American Economic Review,

The Journal of Political Economy, The Journal of Economic

Perspectives, The Journal of Public Economics, The Journal of

Economics and Management Strategy and The Journal of Regulatory

Economics. He has also recently released a book, “Publishing

Economics: Academic Analyses of Journal Market in Economics”.

Finally, Joshua serves on the editorial boards of Information

Economics and Policy and The BE Journals of Economic Analysis

and Policy, and is Economics Editor at The Australian Journal of

Management. Details of his research activities can be found on his

MBS web page. On the consulting side, Joshua has worked with

several established firms including London Economics, Frontier

Economics and Charles River Associates. He has also been retained

by the Australian Competition and Consumer Commission where he

worked on several abuse of market power cases (against Boral and

Safeway) as well as on issues in telecommunications network

competition. Overall his consulting experience covers energy (gas and

electricity markets), telecommunications, financial services and

banking, pharmaceuticals and rail transport. In 2000, he appeared as

an expert witness for TXU in the Victorian Supreme Court in a case

against the Office of the Regulator General. With Stephen King, he is

Summary of Task Force Findings

presently principal of Australia’s most respected competition and

regulatory economics consultancy, CoRE Research.

Stephen King (PhD, Harvard (Frank Knox

Memorial Fellowship); MEcon, Monash; BEcon

(1st Class Hons, University Medal), ANU)

Stephen King is currently Professor of Management (Economics) at

Melbourne Business School, University of Melbourne. Prior to this

Stephen held positions at the Australian National University, Monash

University and in the Department of Economics at Melbourne.

Stephen received his Ph.D. in economics from Harvard University

and holds other degrees from Monash University and the Australian

National University. At Melbourne, Stephen has taught both

undergraduate and postgraduate microeconomics. He has also coauthored

(with Joshua Gans and Robin Stonecash) the Australasian

edition of Greg Mankiw's Principles of Economics (published by

Harcourt Australia). Stephen specialises in applied microeconomics

concentrating on issues of regulation, competition, privatisation and

information economics. He has written (with Rodney Maddock) an

information book, Unlocking the Infrastructure, on the reform of

public utilities in Australia and has edited a book on Economic

Rationalism. His research work has been published in the Journal of

Political Economy, Journal of Industrial Economics, Journal of

Economic Behavior and Organization, International Journal of

Industrial Organization, Labor Economics, European Economic

Review and Information Economics and Policy. He serves on the

Editorial Board of the BE Journals of Economic Analysis and Policy

and is Editor of the Australian Economic Review. On the consulting

side, Stephen has extensive experience in several industries including

telecommunications, energy (gas and electricity) and financial services.

For many years, he was a retained expert of the Australian

Competition and Consumer Commission and has served as an expert

witness before the Australian Competition Tribunal, Federal Court

and Victorian Supreme Court.

Andrew Caplin (PhD (Distinction), Yale; BA

(1st Class Hons), Cambridge)

Andrew is one of the world’s most eminent economic theorists. He

has been a fully tenured Professor of Economics at New York

University since 1995, prior to which he was Professor and Vice-

Chairman of the Economics Department at Columbia University.

Andrew also served on the faculties of Princeton and Harvard for

eight years. He is Co-Director of New York University’s Centre for

Summary of Task Force Findings

Experimental Social Science, a Fellow of the Econometric Society, an

NBER Research Associate, a member of the NBER Economic

Fluctuations Group, affiliated with the Furman Centre for Real Estate

and Urban Science, and a Director of Equity Headquarters in

Syracuse, New York. Andrew is also responsible for senior faculty

recruiting within the Department of Economics at New York

University. He has published prolifically in many of the most highly

regarded academic journals, including the Rand Journal of

Economics, Quarterly Journal of Economics, Econometrica,

American Economic Review, the Journal of Economic Theory, the

Journal of Monetary Economics, Economic Journal, the Journal of

Money, Credit and Banking, the Review of Economic Studies,

Mathematics of Operations Research, Oxford Economic Papers, and

the New Economy.

Peter Butt (LLM, BA, Sydney)

Peter is one of Australia’s leading authorities on real property law and

author of the highly regarded academic text, “Land Law” (now in its

fourth edition). He is an Associate Professor of Law at the University

of Sydney and has previously held positions as a Visiting Professor at

the University of Bristol, Nottingham University, and Vanderbilt

University. Peter has served on the Editorial Boards of The

Australian Property Law Journal, The Property Law Review (UK),

and Clarity. He has authored or co-authored nine books, including

“Modern Legal Drafting”, “Land Law”, “Contract for Sale of Land in

New South Wales”, “The Perpetuities Act”, “Real Property Cases and

Materials”, “Mabo, Wik & Native Title”, “Property Law Statutes -

New South Wales”, “The Torrens System in New South Wales”, and

the “Australian Legal Dictionary”. Peter has delivered papers at

conferences in Australia, England, Ireland, Canada, and the United

States on the topics of land law, plain language legal drafting, and

native title. He is a Founding Director of the Centre for Plain Legal

Language, President of Clarity (an international plain legal language

organization), and has acted as a Consultant to the Australian

Government on land law aspects of native title legislation, and to the

New South Wales Law Reform Commission on various reforms to

property law. Peter is also a consultant in property law and drafting

with Mallesons Stephen Jaques.

Summary of Task Force Findings

Edward Glaeser (PhD (Sloan Dissertation

Fellowship, Bradley Foundation Grant, Javits

Fellowship, Caisse des Depots Research

Grant), Chicago; AB (Cum Laude), Princeton)

Edward is one of the world’s pre-eminent experts on the

determinants of city growth and a rising star in global economics

community. He has been a Professor of Economics in the Faculty of

Arts and Sciences at Harvard University since 1998. Previously, he

was the Paul Sack Associate Professor of Political Economy in the

Department of Economics. Edward has served as an Arch W. Shaw

National Fellow at the Hoover Institution, Stanford University; a

John M. Olin Fellow in Law and Economics at the University of

Chicago Law School; and as a Visiting Fellow at the Brookings

Institution. He currently acts as a Faculty Research Fellow with the

National Bureau of Economic Research. Edward teaches urban and

social economics and microeconomic theory and has published

dozens of papers on cities, economic growth, and law and economics

in periodicals such as the Journal of Comparative Economics, the

Journal of Legal Studies, Tax Policy and the Economy, European

Economic Review, American Economic Review, the Journal of

Economic Literature, the Journal of Monetary Economics, the

Journal of Regional Science, Economic Journal, the Quarterly Journal

of Economics, the Review of Economics and Statistics, the Journal of

Urban Economics, the Brookings Papers on Economics Affairs,

Journal of Labor Economics, the Journal of Public Economics, the

Journal of Economic Geography, American Law and Economics

Review, the Journal of Housing Economics, the Journal of Urban

Affairs, the Journal of Political Economy, Public Choice, Economic

Inquiry, the Journal of Economic Perspectives, the Journal of

Financial Intermediation, the Journal of Economic Dynamics and

Control, Journal of Comparative Economics, and Economics Letters,

among others. In particular, his work has focused on city growth and

the role of cities as centres of idea transmission. He is Editor of the

Quarterly Journal of Economics; Associate Editor of Journal of

Regional Science, Regional Science and Urban Economics; an

Editorial Board Member of Economic Inquiry, the Journal of

Economic Geography, International Regional Science Review; and a

Board Member of the Bastiat Institute.

Michael Kuczynski (PhD, Cambridge; (1st

Class Hons), Cambridge)

Michael Kuczynski was trained as a mathematician in Cambridge,

England and then as an economist on the research staff of the

Summary of Task Force Findings

International Monetary Fund (Washington D.C.) where he worked

with J. Marcus Fleming on exchange rate arrangements. He has been

back in Cambridge since the mid 1970s, where he directs studies in

Economics at Pembroke College, and lectures in international

economics, monetary economics, and international finance. His

current research is in market mechanisms; international financial

arbitrage; competition processes in banking; and monetary policy in

dollarised economies. He has been a visiting professor at the

European University Institute (Fiesole, Italy); and has lectured

regularly at both the London Business School and the Judge Institute

of Management Studies (Cambridge). He is completing a text on

international finance.

David Moloney (MBA, MIT Sloan School,

BAppSci(Computer Science (1st Class Hons,

University Medal)), University of Technology,

Sydney)

David Moloney is a Principal with the Sydney office of Booz Allen &

Hamilton. He has experience in corporate and business strategy

development within the Banking, Insurance, Investment and

Telecommunications industries in Australia, New Zealand, The

United Kingdom, Europe, USA, Canada, South African and Asia.

David also leads Booz Allen's Global Retail Lending Practice, Global

Round Table Initiative, Strategic Alliance Practice and the Australian

Community Services Program.

David was awarded the University Medal following the completion of

his First Class Honours Degree in Computing Science at the

University of Technology, Sydney. He later received a Master of

Business Administration majoring in Strategy and Information

Technology from the MIT Sloan School of Management. He has

received numerous academic awards and scholarships and is a

frequent presenter at conferences and seminars in the US, Europe,

and Australia on strategic alliances, distribution strategies, and

customer relationship management. He is the author or co-author of

several Booz Allen Hamilton Viewpoints, and many of his

contributions to the strategic planning process are in frequent use

within the firm and its clients.

David can be contacted at moloney_david@bah.com

Summary of Task Force Findings

Alastair Bor (MBA, Tuck School of Business,

Dartmouth College; BA cum laude, High

Honors (Economics), Brandeis University)

Alastair Bor is an Associate with the Sydney office of Booz Allen

Hamilton. He has experience in strategy development and

implementation within the Banking, Insurance and Electricity

industries in Australia, New Zealand, the United Kingdom, Canada,

Denmark, South Africa, Hong Kong and Thailand.

Alastair holds a Masters in Business Administration from the Tuck

School of Business at Dartmouth College and a Bachelor of Arts

degree cum laude with High Honours in Economics from Brandeis

University. While pursuing his MBA, Alastair tutored Statistics,

Finance and Computer Modelling. Alastair was also a tutor in

Finance, Economics and Decision Science at Templeton College,

Oxford University

Alastair can be contacted at bor_alastair@bah.com

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