A week after delivering a slap to responsible savers through its 50 basis points interest rate cut (and handing a free kick to banks and speculators), the RBA’s minutes, released yesterday, provided one of the more bizarre attempted justifications for weakness in the property market.

The RBA provided that its decision to lower rates by 50 basis points was partially based on “information from liaison suggested that households were unwilling to commit to contracts for new dwellings because of concerns about job security and declining dwelling prices”. The RBA added that “despite dwelling prices declining relative to incomes and rises in rental yields, forward-looking indicators implied little prospect of an imminent recovery in housing construction”.

It is somewhat concerning that the organisation responsible for price fixing the base cost of funds in Australia has little or no idea how the housing market works and the reasons for the sustained drop in property prices over the past 12 months. It appears the RBA’s thinking is that house prices are falling because people expect house prices to fall and because people are fearful of losing their jobs.

However, this is a flawed understanding of property prices. Lower price expectations is the symptom of falling house prices not the cause.

Readers would be well aware that house prices have fallen (and will continue to fall) because their prices have far exceeded the intrinsic value. Returns that can be achieved from housing as an asset class are around half of what they should be (capital city residential property typically returns about 3%). Property prices have rocketed since 1997 largely due to excessive bank lending (which has caused the proportion of mortgage debt to GDP to more than quadruple). At the same time, returns on property have slumped as rents have failed to keep up with price rises. In short, one of two things will need to happen: (1) property prices will continue to fall until return on equity reach a reasonable level; or (2) rental prices will need to double.

Over the past year, home buyers have realised that (2) is highly unlikely (rents didn’t increase at all last year in most capital cities) and have simply delayed their purchase, or refused to meets seller’s inflated asking prices. For most people, renting is far cheaper than buying anyway, so there is little impetus to purchase a property.

There are many reasons for the housing bubble, but one key reason that the bubble is able to remain inflated for such a long period is because there only needs to be a very small number of foolish property buyers who are keeping the price inflated. With only about 10% of dwellings changing hands annually, the majority of home buyers staying away from the market were overcome by a small number of fools (10%) whose buying was able to keep prices high. As the number of fools diminish, property prices gradually fall — as has occurred in the past year. Since June 2010, real property prices have slumped by 10%. Even the staunchest of property bulls would concede that that drop is significant. Like the end of a Ponzi scheme, eventually the bitter realisation sinks in that the supposed profits are fictional, then the bottom really falls out of the market.

The RBA has completely misunderstood the current situation and is instead, trying to use monetary policy to prevent prices from adjusting to their intrinsic value (and at the same time, trying to boosting GDP through spurring construction spending).

The problem is, the reason for the property bubble is because banks have lent too much money to home buyers. Like in the United States and Ireland, this caused prices to exceed their intrinsic value (and also, led to a misallocation of resources from productive areas of the economy into housing, a relatively unproductive use of capital). Glenn Stevens’ RBA had been one of the more responsible central banks, aware that that the long-term effects of the housing bubble. But this responsibility appears to have vanished in recent times.

Interest rates are effectively the price of money. Price fixers like Alan Greenspan’s Federal Reserve have caused far more harm than good in recent years for setting the price of money too low (many blame Greenspan’s monetary ease for the global financial crisis). Australia’s housing bubble was caused by too much debt. It appears the RBA doesn’t understand this, and is doing its best to re-encourage the use of debt (by lowering interest rates) in order to solve the problem that was essentially created by too much one of too much debt. The RBA isn’t merely buying the drunk another drink, it’s giving them the keys to the bar.

Stevens and his merry band of price fixers would be well advised to stop taking advice from the real estate sector or poor run retailers or lobbyists unless Stevens wants his reputation to <a href="Property Observer.” target=”_blank”>turn out like Alan Greenspan’s.