Fueling the Fire: Why Coalition plan Won’t Solve Australia’s Crisis

Introduction

Australia’s housing affordability crisis continues to deepen, with homeownership becoming increasingly unattainable for many Australians. In response, the Coalition has proposed reducing the serviceability buffer mandated by the Australian Prudential Regulation Authority (APRA), alongside potential “Help to Buy” schemes. While politically attractive, these approaches fundamentally misdiagnose the problem. This article examines why demand-stimulating measures without addressing supply constraints risk exacerbating rather than alleviating Australia’s housing crisis, potentially threatening both financial stability and housing affordability.

Understanding Serviceability Buffers: Purpose and Function

Serviceability buffers serve as a critical prudential tool within Australia’s financial regulatory framework. Introduced to ensure borrowers can withstand interest rate increases, these buffers require lenders to assess mortgage applications against higher hypothetical interest rates than current market rates. In late 2021, under the Morrison government, APRA increased this buffer from 2.5 to 3 percentage points above existing lending rates. For instance, if a bank’s interest rate is 6%, borrowers must demonstrate capacity to service the loan if rates rose to 9%.

These buffers serve multiple purposes beyond individual loan assessment:

1. Financial system stability protection by reducing the likelihood of widespread mortgage defaults during rate increase cycles
2. Borrower protection by preventing overextension and future financial distress
3. Counter-cyclical market moderation by constraining excessive credit growth during property booms

The 2021 increase was specifically implemented during a period of record-low interest rates, anticipating the inevitable rate increase cycle that followed in 2022-23.

The Coalition’s Proposal: Increasing Borrowing Capacity

The Coalition’s proposal to reduce the serviceability buffer essentially aims to increase borrowing capacity for prospective homebuyers. The underlying logic appears straightforward: with greater borrowing power, more Australians could enter the property market. For a household with combined annual income of $150,000, reducing the buffer from 3% to 2.5% could potentially increase borrowing capacity by approximately $50,000, depending on other financial circumstances.

Proponents argue this would allow more first-home buyers to enter the market without compromising financial stability, as the 2.5% buffer existed for years prior to the 2021 increase. The policy resonates politically by appearing to address housing affordability without requiring significant budget expenditure or market intervention.

Borrowing capacity calculator

The Economic Reality: Demand-Side Solutions in a Supply-Constrained Market

Basic economic principles reveal the fundamental flaw in the Coalition’s approach. Australia faces a significant structural housing supply shortage, with the National Housing Finance and Investment Corporation estimating a shortfall of over 40% at going rate. The construction industry faces persistent capacity constraints, material shortages, and regulatory barriers that limit supply responsiveness.

In supply-constrained markets, policies that enhance purchasing power without addressing supply limitations typically result in one outcome: price inflation. This occurs through a simple economic mechanism:

1. Increased borrowing capacity allows buyers to offer more for properties
2. In competitive bidding scenarios, maximum borrowing capacity often becomes the price ceiling
3. With limited supply, sellers benefit from higher prices rather than buyers gaining affordability
4. The affordability ratio (price-to-income) deteriorates despite higher nominal borrowing capacity

Historical evidence supports this analysis. Previous demand-stimulating policies like the First Home Owner Grant and various stamp duty concessions have consistently been shown to increase house prices in supply-constrained regions, effectively transferring the financial benefit from buyers to existing property owners.

Help to Buy Schemes: Repeating Past Mistakes

Similar problems plague “Help to Buy” schemes, which typically offer shared equity or subsidized deposits to assist first-home buyers. While seemingly beneficial for individual participants, these programs face the same fundamental economic constraints when implemented without addressing supply:

1. Price inflation effects: By increasing effective demand without increasing supply, these schemes can contribute to price growth that erodes affordability for non-participants
2. Limited reach: Budgetary constraints typically limit participation to a small fraction of market entrants
3. Targeting inefficiencies: Benefits often accrue to buyers who would have eventually entered the market anyway
4. Complexity costs: Shared equity arrangements create complex property rights issues and potential distortions in housing decisions

Research by the Grattan Institute suggests that most demand-side interventions without corresponding supply measures result in price increases that largely offset the intended benefits, particularly in supply-inelastic metropolitan markets where affordability pressures are most acute.

Financial Stability Considerations

Beyond affordability concerns, reducing serviceability buffers raises substantial financial stability questions. These buffers exist primarily to protect borrowers and the broader financial system from interest rate and economic shocks. Australia’s household debt-to-income ratio remains among the highest in the developed world at approximately 180%, creating vulnerability to economic downturns.

The Australian housing market has already demonstrated substantial resilience during the recent interest rate increase cycle, partly attributable to the prudential measures implemented by APRA, including serviceability buffers. Weakening these protections precisely when interest rates remain relatively high and economic uncertainty persists represents a potentially significant risk.

International experience from the Global Financial Crisis demonstrates how rapidly weakened lending standards can contribute to systemic financial vulnerabilities. While Australia’s financial regulatory framework differs substantially from pre-GFC United States, the principle remains that prudential safeguards exist to prevent systemic crises, not to be adjusted for cyclical political considerations.

The Supply-Side Challenge: Addressing the Real Problem

Australia’s housing affordability solution requires primarily addressing supply constraints through:

1. Planning reform: Streamlining approval processes and zoning regulations to facilitate increased density in appropriate locations
2. Infrastructure investment: Supporting housing development with necessary transport and community infrastructure
3. Construction industry capacity: Addressing skills shortages, material supply constraints and productivity challenges
4. Federal-state coordination: Aligning incentives across government levels to prioritize housing supply
5. Social and affordable housing: Direct investment in non-market housing for vulnerable populations

Recent research from the Productivity Commission emphasizes that supply constraints represent the primary barrier to housing affordability, particularly in major metropolitan areas. Models suggest that significant planning reform could increase housing supply by 20-30% over a decade, substantially improving affordability without compromising financial stability.

International Evidence: Demand vs. Supply Interventions

International comparisons provide further evidence for the superiority of supply-focused approaches. Countries and regions with responsive housing supply systems (such as parts of Germany, Japan, and some U.S. states) have maintained relative housing affordability despite population growth and economic development. Conversely, jurisdictions with restricted supply responsiveness but generous demand-side subsidies (like parts of the United Kingdom) continue to experience severe affordability challenges.

A 2021 OECD report concluded that “housing supply responsiveness is the single most important determinant of long-term housing affordability,” with demand-side subsidies providing at best temporary relief that is ultimately capitalized into higher prices without corresponding supply increases.

Potential Consequences of Reducing Serviceability Buffers

Reducing serviceability buffers without addressing supply constraints risks several negative outcomes:

1. Price inflation: Increased borrowing capacity is likely to be capitalized into higher property prices in supply-constrained markets
2. Increased household financial vulnerability: Lower buffers may result in some borrowers taking on more debt than is prudent given future interest rate uncertainty
3. Systemic risk increase: The financial system becomes marginally more vulnerable to economic shocks and interest rate increases
4. Intergenerational inequity: Higher prices further advantage existing property owners (typically older) at the expense of potential new entrants (typically younger)
5. Policy distraction: Focus on quick demand-side fixes diverts political attention from more fundamental but politically challenging supply reforms

Economic modeling suggests that in supply-inelastic markets, up to 80% of the benefit from increased borrowing capacity can be captured by sellers through price increases rather than improving affordability for buyers.

Sequencing Reform: The Path Forward

Addressing Australia’s housing affordability crisis requires proper policy sequencing. Supply constraints should be addressed before or simultaneously with demand-side interventions. A more effective approach would involve:

1. Implementing comprehensive planning reforms to increase housing supply
2. Investing in enabling infrastructure to support housing development
3. Establishing supply targets with accountability mechanisms
4. Only then considering targeted support for vulnerable first-home buyers

This sequencing would ensure that increased purchasing capacity translates into improved affordability rather than price inflation. The experience of jurisdictions like Tokyo, which prioritized supply responsiveness, demonstrates that housing can remain relatively affordable even in growing, prosperous cities when supply can effectively respond to demand.

Conclusion: Beyond Political Expediency

Australia’s housing affordability crisis demands solutions that address fundamental market dynamics rather than politically expedient measures that may worsen the underlying problem. Reducing serviceability buffers and implementing Help to Buy schemes without fixing supply constraints risks fueling higher prices, increasing financial vulnerability, and further disadvantaging those already struggling to enter the market.

A genuine commitment to housing affordability requires the political courage to address supply constraints through planning reform, infrastructure investment, and construction industry capacity building. While these solutions lack the immediate political appeal of borrowing capacity increases, they represent the only sustainable path to improving housing affordability while maintaining financial stability.

Australian policymakers must recognize that in a supply-constrained market, making it easier to borrow more without increasing housing supply will primarily benefit existing property owners rather than addressing the fundamental affordability challenges facing new market entrants. True housing affordability reform requires addressing the supply side of the equation before stimulating further demand.