Last week's hero, this week's villain

Some weeks ago BIS Shrapnel forecast 20% growth for house prices over the next 3 years. The research, sponsored by the mortgage insurer LMI, is looking pretty ridiculous. Indeed, there is a marked splintering in the bulls, with noted spruikers joining the bearish camp over the past month.

However, the bulls turned bears, the unbulls we'll call them, have for the most part stopped at the halfway house of a soft-landing scenario for housing.

Regular readers will know that that is the position occupied by this blogger based upon the hypothesis that we will replay on a national basis the 2003 post-FHBG Sydney process of falling prices in fringe suburbs stalling the move-up ladder and plateauing inner-city prices.

To say that this blogger finds it uncomfortable sharing his turf with a stampede of unbulls hardly sums up its chagrin.

The Australian's Michael Stutchbury is the latest to muscle in on the territory. Stutuchbury's piece runs through the now regularly rehearsed rubbish that there is no bubble, quoting the usual unbulls to prove it. To his credit he at least references some prominent bears too, including Jeremy Grantham.

But the sting in the tale is how Stutchbury concludes we'll engineer a soft-landing:

...the Reserve Bank now suggests that households remain "sensitive to possible future negative shocks to incomes, interest rates and housing prices". While there may be no bubble, that's code for saying that Australians have both borrowed too much and pushed housing prices too high for comfort.

The problem is that the Reserve Bank's interest rate hikes initially make things worse. The rate-sensitive house building sector is being crunched as the central bank pushes up the price of money.

Goldman Sachs' Toohey tips a further 15 per cent fall in house building approvals as the Reserve Bank lifts interest rates higher next year to keep inflation tamed amid the mining boom. Yet worsening housing shortages will push up rents, which in turn will feed into the consumer price index.

But the Reserve Bank documents suggest this is part of correcting the problem that "purchasing a house" has become "more expensive than renting a house".

That is, soaring house prices have way outpaced rents. That's depressed the yields on investing in housing; you can get more by just putting your money in the bank or even into Telstra shares.

That didn't matter when investors could confidently punt on getting a capital gain. But now houses cost too much for buyers and rents are too low for investors, even with strong population demand.

"It doesn't matter if two million people turn up next year," Toohey says. " If they can't afford it, they won't buy it. If an investor can't make a dollar, he won't build it."

With excess housing demand worsening, rising rents and softening prices will allow the housing investment yield to recover. That eventually will encourage builders and investors to construct more dwellings, zoning and planning restrictions permitting.

That's the theory. Treasury's Garton reckons high immigration means Australia's housing price correction is "more likely to occur through higher rents rather than lower prices", which would probably be the least painful option.

But it still means Australians should shelve their favoured investment strategy of negatively gearing into residential property in expectation of a big capital gain. It won't be there.

Although this blogger agrees with the final statement, it finds the reasoning quite bizarre.

On its own terms, the Garton theory is perverse. If falling prices and rising yields stimulate building investment then both prices and yields keep falling as supply caches up to demand.

Of course, it's wrong because of one further factual error.

Since when did an improvement in rental yield lead to increased investment in new dwellings? As the spectacular chart from The Unconventional Economist above shows, that nexus broke in 1987.

Investors have put nearly all of their money into existing dwellings ever since for the simple reason that they know that's where the capital growth is.

Factoring that in, the Garton theory is actually an argument for further house price growth. If investors/speculators hold onto their properties through the correction because rental yields rise (or there is enough talk of it happening) then confidence will rise that the shakeout is shallow and new investors will enter the existing dwelling market chasing the next growth cycle.

It will do nothing for supply.

It's a government supported bubble. If the speculators capitulate, it's gonna bust. If they don't, we'll have to wait for the government to bust for sanity to return.