INTEREST rates are on the rise again. The Reserve Bank appears to have lightly applied the economic brakes by increasing the cash rate to 5.25 per cent. Those who remember double-digit interest rates in the late-1980s might think that a series of small interest rate rises is insignificant. But are they? Could a series of small increases in interest rates do more harm than good?

In the early 1990s household debt in Australia was about $20 billion. By 2002 it had risen to about $225 billion. Many Australian households have run down their savings and are heavily in debt. Household debt increased from 76 per cent of disposable income in 1990 to 146 per cent of disposable income by 2002-03. In this context, relatively small increases in interest rates will put a large number of households under financial pressure. The question is not so much if but when the debt-driven boom will end? The Reserve Bank wants to engineer a “soft landing” by increasing interest rates but it risks precipitating an economic downturn.

Interest rate rises are a very blunt policy instrument for curbing speculative investment in property. They damage our economic prospects by pushing up the Australian dollar, making our exports less competitive. This inevitably leads to job losses in the manufacturing, agricultural and tourism sectors.

Rate rises also push more households into financial stress. Low-income households with mortgages are the most adversely affected. About half of Australia’s households with an income of $21,000 or less, and one fifth of households with an income of $41,000 or less, are experiencing “mortgage stress”. Rising rates will also inevitably slow down new housing construction and renovations, leading to significant job losses in one of the few sectors to generate full-time jobs in South Australia over the past two years.

Like the rest of Australia, SA’s recent economic growth has relied heavily on a build-up in household debt. Hardly a month goes by without a bank or financial institution offering an increase in your credit card limit. But one of the main problems fuelling the growth in household debt has been the rise of the property investment evangelist. These slick-talking, latter-day snake oil merchants are selling a get rich-quick utopia to hundreds at their popular seminars. Aided by low interest rates, negative gearing and the promise of making a fortune, they have recruited thousands of new investors seeking a better alternative to the share market.

Henry Kaye’s property investment advice empire is the first to collapse under the weight of close scrutiny by the Australian Investment and Securities Commission and the Australian Competition and Consumer Commission. More are likely to follow.

Testimony to the switch from shares to property are the symbols of a property boom – cranes standing tall across the Adelaide skyline, building multi-storey apartment complexes to satisfy an apparently insatiable appetite for investment properties. For the time being, a large number of South Australians appear to be lining up to buy and they are borrowing more than ever before. As their exposure to household debt grows, so does their level of financial risk, particularly if property values decline after a period of unsustainable growth. There is evidence that housing prices might be as much as 25 per cent above their true value in capital cities on the eastern seaboard. If this is the case, many new investors are likely to get burnt financially when prices begin to slide.

The downside to rising property prices is declining housing affordability, which has fallen to pre-1990s recession levels. In Adelaide, housing prices rose by about 17 per cent over the 12 months to June 2003. The dream of home ownership is becoming a nightmare for low-income earners.

Low interest rates in a deregulated financial system have fuelled a consumer expenditure and property boom that seems destined to end badly. The lesson that policy makers should have learnt from the early 1990s recession was that increases in interest rates cause “collateral damage”. It is time to tackle the problem of speculation and excessive household debt by increasing the prudential standards imposed on the banking and financial sector.

New homebuyers and businesses investing for productive purposes should not be subject to higher interest rates designed to curb over-zealous speculative behaviour. This is one of the great failures of de-regulation of the financial system in Australia. It can be remedied by creating separate financial markets for the provision of productive and speculative capital, to insulate home owners and low income households from excessive interest rates and rate shocks. The Federal Government might also reform negative gearing to eliminate excessive property market speculation.

The State Government also has an important role to play in ensuring housing affordability. SA has enjoyed relatively affordable and high-quality housing because successive governments have chosen to intervene in housing and land markets. The Housing Trust has been a key instrument to help stabilize housing prices through the development of a significant stock of public housing. This stock is now being eroded. Any strategy designed to increase housing affordability must include rebuilding the State’s public housing stock.

Meanwhile, South Australians face the prospect of rising interest rates over the next few months. For those households that have borrowed to the limit and invested in a second property, it is a good time to take stock and develop a strategy to manage further rate rises. Others might consider it appropriate to send a message to Canberra that rising interest rates and declining housing affordability will be key Federal election issues next year. Indeed, these issues have the potential to undermine what appears to be an unassailable electoral position for the Howard Government.

It is worth noting that there are a large number of households experiencing mortgage stress in vulnerable SA electorates, such as Hindmarsh and Adelaide. The Howard Government will find it difficult to claim that it is the party of the battler when battlers are facing rising interest rates and declining home affordability. The new Federal Opposition Leader, Mark Latham, appears to be in tune with this, positioning himself in his working class electorate in Western Sydney to recapture the battler vote. He might just have history on his side as he approaches his biggest political challenge.