It's possible that Labor's planned changes to negative gearing and capital gains tax could trigger a recession and stock market crash. But if this happened, it really would be the recession we had to have, writes Michael Janda.

Earlier this week, Liberal Immigration Minister Peter Dutton warned that Labor's proposed property investment tax changes would bring the economy to "a shuddering halt" and "crash" the stock market.

His comments drew a swift rebuke from Labor's shadow treasurer Chris Bowen, who described them as "reckless" and part of an "outlandish scare campaign".

But are they really so farfetched?

Given the massive impact of Australia's housing market on the economy as a whole, perhaps not. But that's precisely why something needs to be done now, so that the possibility of a recession doesn't become the threat of a depression.

If we look closely at Australia's GDP figures, we can get a sense of how out of kilter our housing market has become - and what might happen if the rug was pulled out from beneath it.

Over the past year, residential construction and renovations grew by around 10 per cent, according to the ABS national accounts.

The residential building sector alone thus directly added around half a percentage point to the nation's 3 per cent GDP growth.

Obviously, if the sector stopped expanding, other things being equal, GDP growth would slow to 2.5 per cent. If the industry shrank by an equivalent amount, it would have directly pulled GDP growth back closer to 2 per cent.

However, that's only the beginning.

As the home is by far the biggest asset for most of the roughly two-thirds of households who own one (outright or mortgaged), the "wealth effect" of rising property prices is a major driver of household consumption. Unlike residential building which makes up about 5.3 per cent of spending in the economy, household consumption makes up nearly 56 per cent.

Last quarter, "final consumption expenditure" was by far the biggest contributor to Australia's economic growth, adding 0.4 percentage points out of a 0.6 per cent GDP increase.

Its mammoth size relative to the total economy saw household expenditure contribute just over half of Australia's 3 per cent economic growth last year, even though household spending only grew a tepid 2.9 per cent.

If falling home prices halted growth in household consumption, that would take a further 1.6 percentage points off growth.

And if household consumption fell, there is a good chance Australia could see its first recession in a quarter of a century.

These are a lot of ifs, and it is far from certain that home prices would fall if Labor's policy was introduced.

In fact, the move to quarantine existing owners from the changes could see some sort of buying spree before the proposed start date of July 2017, and provide an incentive for many current investors to hang onto their properties rather than put them on the market.

However, over the medium term, it's likely that we would see housing prices drop (which, after all, is the intention, given Labor is pitching this policy as a housing affordability measure).

That's because there would be more supply (negative gearing would only be available for new dwellings, boosting construction) and lower demand (without the incentive of negative gearing, there would be less investor interest in existing properties).

If home prices did start declining, then many of the grandfathered investors could decide that's the time to lock in their eroding capital gains. This in turn could accelerate the price decline, with more properties for sale on the market.

No matter the continued tax breaks for newly built property: if real estate prices were to drop heavily, new construction would dry up with the economic consequences outlined above.

Long-running Ponzi scheme

And this exposes the fundamental weakness of Australia's property market - a weakness that will only get more dangerous over time.

Most of the investors who have been pushing prices higher during the Sydney and Melbourne boom of the past few years have been doing so entirely on the expectation of capital gains.

After all, Australia's two biggest cities are offering investors gross rental returns comparable to, or worse than, a term deposit.

Once you take out management and repair costs, the term deposit is a clear winner, plus it is almost absolutely risk free (Government guaranteed).

The way you get a capital gain on real estate is for someone else to come along later both willing and able to pay more than you did to buy your property.

Thus real estate goes from being a place to live or an income-earning asset to being a Ponzi scheme, where future gains are based on attracting more and more people to buy in.

Once there are insufficient people willing to buy in, the scheme collapses. In this case, that would mean property prices falling to levels where rents justify the purchase price (and probably below this level, because markets tend to overshoot in both booms and busts).

That is ultimately why it doesn't matter whether Labor's policy, should it ever be introduced, triggers a housing bust. If Australia's economy is largely reliant on negatively geared property speculation to keep growing then it's doomed anyway. The bust will eventually come whether negative gearing is retained or not.

The following graph illustrates why:

Not only has Australian household debt-to-income roughly tripled since the late 1980s to a fresh record 184.6 per cent, driven entirely by surging housing debt, but most of that money has been borrowed from offshore.

Australia's net foreign debt is now over a trillion dollars, and less than a quarter of that is public debt.

Aside from hundreds of billions invested in dozens of large mining and LNG projects over the past decade-and-a-half, the other main use of this ballooning foreign debt has been buying houses from each other.

There's only so long that overseas lenders, lured by higher interest rates in Australia compared to other developing nations, will be prepared to put their money towards a housing Ponzi.

There are early signs this willingness is already waning, with falling bank share prices, increased funding costs, and rising prices to insure against a debt default by one of the big four (so-called credit default swaps, or CDS, as featured in The Big Short).

For those who deny Australia has a credit-fuelled housing bubble by pointing to the fact that people have been warning of a crash for years and it hasn't come, the lesson of US fraudster Bernie Madoff is illustrative.

Mr Madoff admitted to running his investment firm as a Ponzi from 1991, and authorities suspect it may have been much longer. He wasn't found out by US authorities until December 2008.

That's not because there were no tip offs - financial analyst Harry Markopolos told the Securities and Exchange Commission repeatedly for almost a decade that Madoff was running a fraud.

But it took the aftermath of the global financial crisis to finally bring Madoff's Ponzi down.

The next international financial crisis risks doing the same to Australia's housing market, whether negative gearing stays or not.

If a government curtails negative gearing and capital gains tax discounts and deflates the Australian housing bubble before this happens, we could end up with the recession we had to have instead of the depression we could have avoided.

Michael Janda is an online business reporter with the ABC.