RDP 2017-05: The Property Ladder after the Financial Crisis: The First Step is a Stretch but Those Who Make It Are Doing OK 2. Literature Review

2.1 Declining FHB Housing Accessibility

Several previous studies have examined the falling rate at which households have been transitioning into home ownership. This trend has not been confined to Australia and has also been observed in other advanced economies. It has also occurred despite increased mortgage opportunities through financial deregulation.

In separate submissions to the Standing Committee on Economics Inquiry into Home Ownership, RBA (2015) and Yates (2015) discuss the long-term structural drivers of the decline in home ownership among younger Australian households. The interrelated factors highlighted by these papers include social, demographic, and economic and institutional factors.

Demographic drivers identified include the trend towards later marriage and family formation, and also an increase in single-adult households.^[4] Several studies have examined the growing disconnect between key life-cycle events such as exiting the family home, marriage and having children. For instance, Fisher and Gervias (2011) attribute the majority of the decline in home ownership among younger cohorts in the United States to delays in the average age of first marriage.^[5]

Economic and institutional factors include the relative cost of renting and owning, the level and distribution of current and expected income, the taxation of housing and the provision of public housing. Among economic factors, both RBA (2015) and Yates (2015) recognise that the sharp rise in housing prices in Australia since the mid 1990s has significantly reduced housing affordability, although this has been partially offset by changes in interest rates.

Relatedly, previous research in both Australia (Bourassa 1995; Wood, Watson and Flatau 2006) and overseas (see Gyourko (2003) for a review) find that borrowing constraints, such as the deposit requirement, are important barriers delaying transition into home ownership.^[6] Indeed, existing studies have found that the savings required for a deposit seems to be more important for the transition to home ownership than the ability to service a mortgage from current income thereafter. For example, Wood et al (2006) find that the deposit constraint is binding for around one-third of potential home buyers (or renter households) in Australia, while the repayment constraint is only binding for around 5 per cent of these households.

Other studies find that rising housing prices have increasingly raised the effective deposit requirement. For the United States, Laeven and Popov (2016) exploit spatial variation in housing price growth during the 2001–06 housing boom and show that younger households in 2006 were considerably less likely to have purchased a home in areas where the effective deposit constraint had increased substantially over this period. In other words, they find that higher housing prices have significantly reduced the probability of becoming an FHB.

Larrimore, Schuetz and Dodini (2016) also examine individual housing choices, and the stated motivations for these choices, to try and understand why home ownership has fallen among young households in the United States since the financial crisis. Similar to Laeven and Popov (2016), they find that higher housing prices are associated with lower home ownership among younger households.

2.2 Rising Housing Prices, Household Indebtedness and Financial Stability

As noted in the introduction, concerns have been expressed about both the declining accessibility of home ownership and the level of debt that home owners are taking on if they do manage to make the transition.

Studies examining the drivers of, but more often the consequences of, household leverage have increased significantly since the global financial crisis (GFC).^[7] The literature on rising household indebtedness has proceeded more or less in parallel to the discussion of accessibility.

Dynan and Kohn (2007), for example, finds that rising leverage in households' balance sheets has been driven mainly by higher housing prices, rather than a change in household risk preferences, interest rates or households' expected income. The majority of papers, however, have focused on the consequences of higher leverage. For instance, Mian and Sufi (2010) highlight the role of household leverage in initiating and intensifying periods of economic downturn, focusing on the unprecedented rise in the US household debt-to-income ratio in the years leading up to the GFC. By exploiting cross-sectional variation across different counties, they show that pre-crisis household leverage is a powerful statistical predictor of household default, unemployment, large housing price falls, and a decline in residential investment and durable consumption in the post-financial crisis period.

Other studies that use household-level data also find that household consumption is more affected during periods of economic downturn when households have high initial levels of indebtedness. Such studies include Bunn and Rostom (2015) for the United Kingdom, Andersen, Duus and Jensen (2016) for Denmark, and Dynan (2012) and Mian, Rao and Sufi (2013) for the United States.

There are, however, critics of the view that rising household leverage always has negative effects on an economy. A report by Evidens (2015) argues that a rising household debt-to-income ratio in Sweden is not unsustainable and does not pose a threat to financial stability.^[8] Instead, the paper highlights that the observed increase in housing prices in Sweden has been due to fundamental factors, such as metropolitan growth, rising income and wealth and falling interest rates.^[9] Despite this, the paper does acknowledge that strong housing price growth is problematic from other perspectives. In particular, it excludes groups outside the housing market (such as first home buyers) from purchasing a home.

2.3 The ‘Riskiness’ of FHBs, Particularly after the GFC

There are, to date, few studies that have considered the effect of the declining accessibility of home ownership on financial stability. Indeed, much of the discussion of the GFC was focused on the negative effects of increased accessibility to mortgages in the run up to the crisis. While a number of studies have focused on how rising housing prices have affected the tenure choice decision of potential FHBs, only a few, such as Dynan and Kohn (2007) have examined the effect of rising housing prices on the level of first home buyer debt. And even fewer have looked at whether rising housing prices have resulted in FHBs taking on an unstainable level of debt that affects their financial security in the years after they purchase their first home. Research in this area is particularly limited and this work, therefore, will be one of the first to address this gap in the literature.

Footnotes

Although the change in the age of family formation represents a return to a longer-run trend that was interrupted by the post-WWII baby boom. [4]

Some studies also study the reverse effect of home ownership and housing prices on social events such as fertility choices, marital stability and labour supply. See, for example, Farnham, Schmidt and Sevak (2011), Lovenheim and Mumford (2013), Dettling and Kearney (2014) and Atalay, Barrett and Edwards (2015). [5]

The deposit requirement is the minimum initial upfront payment that mortgage lenders require from buyers when issuing a loan, usually expressed as a share of the total amount due. [6]

Examples include Mian and Sufi (2010) for the United States; Winstrand and Ölcer (2014) and Alfelt and Winstrand (2015) for Sweden; Cateau, Roberts and Zhou (2015) for Canada; and Hendersen and Scobie (2009) and Hunt (2015) for New Zealand. [7]

A great deal of attention has been paid to Swedish debt levels in recent years. Sweden's central bank, the Riksbank, currently has a dedicated ‘About household debt’ section on their website at <http://www.riksbank.se/en/Press-and-published/Published-from-the-Riksbank/About-household-debt-/>. [8]

It goes on to argue that policies aimed at rationing credit could be counterproductive as restricted market mobility and housing construction may lead to upward price pressure on the existing housing stock. [9]