Many elements of the recently announced package are justified. When the economy is about to go into a debt-induced recession, government spending both boosts demand, and provides the private sector with cash flow needed to meet its debt repayment commitments.
Equally vital was the guarantee of all bank deposits. A run on the banks would be disastrous, and this guarantee ensures that this will not happen.
But yet another increase to the First Home Buyers Grant???
Is this because, um, house prices are, like, maybe too low?
Oh please, some reality here: the root cause of this crisis is excessive debt that drove house and share prices to unsustainable levels. Times appeared rosy as the house (and stockmarket) bubble continued, but this was only because borrowed money was adding to demand.
No-one worried about this when it was easy to flog a house for a higher price. But unfortunately, this game had to come to an end, because debt servicing became prohibitive as house prices rapidly outstripped incomes. The bubble burst first in the USA, and the carnage it has wreaked there should warn us all that asset price bubbles are dangerous.
And how does the Australian government respond? By providing yet another stimulus on the demand side.
A collapsing housing bubble may be a scary prospect, but the more it is inflated, the scarier the final bust. And Australia’s, on any measure, is bigger than America’s.
A simple comparison of the ABS Established House Price Index (ABS 641601 and 641603) to the CPI shows just how large the Australian house price bubble is (see Figure One).
Figure One
House Prices vs the CPI
Since 1987–hardly a time when Australian house prices were low by historical standards–house prices have increased two and a half times as fast as consumer prices (see Figure Two). Median incomes have fared little better than the CPI, so that houses are 60 percent less affordable now than in 1987.
Figure Two
Ratio of House Prices to the CPI
That’s also true even when we take into account lower interest rates. Yes, rates are about half what they were in 1987 (see Figure Three); but debt is six times larger as a percentage of household disposable income than it was then (see Figure Four)–so that merely paying the interest on outstanding mortgage debt consumes 13 cents in the household dollar, versus a mere 3.5 cents back in 1987.
Figure Three
Mortgage rates and payments
Figure Four
Mortgage debt to disposable income
Increasing the amount of money that first home buyers can slap down on a home may help those who can’t afford to get into the market do so–great. It will also increase competition for houses, and potentially sustain the Great Australian Housing Price Bubble.
Not great. As the USA shows us, the pain of a bursting house price bubble can be pretty immense–especially since it’s fuelled by excessive levels of debt.
But that pain will only get worse if the bubble is driven any higher. The higher up you are when you fall off a mountain, the more it hurts when you hit the ground. The Australian house price mountain, on any measure, is substantially higher than the USA’s was when it began its long, painful descent (see Figure Five).
Boosting the First Home Buyers Grant is a mistake, just as it was when Howard did it. It will merely delay the day of reckoning.
Figure Five
Australian vs US Housing Bubble
October 19th, 2008 at 1:23 pm
Hi Steve,
Do you think the amount offered for the first home buyers scheme in the “rescue” plan ($14000/$21000) and the number of grants (I believe them to be limited to 150 000 in total) will have a huge effect in boosting house prices?
If the RBA cuts rates to say 2%, won’t it make it easy for borrowers to afford larger loans and therefore inflate the housing bubble more?
Do you think banks will tighten loan requirements – for example requiring a 20% deposit – or will they still lend to 105% (as has been the past practice)?
October 19th, 2008 at 3:11 pm
Hi Steve
I seem to remember reading in a comment on an earlier post that you said that you recently decided not to sell your property as you were not happy with the price you were offered.
If I understand you rightly you are predicting significant drops in property prices in Australia – between 20 and 40%. Wouldn’t it have been better to get out now and park the cash so you can pick up a better place with the same amount of money in the future? Otherwise isn’t your property going to fall in value – to an even lower price than the one you were not happy with?
Or am I missing something in your argument?
October 19th, 2008 at 3:19 pm
I’m not sure it will will make any difference. Maybe the last few diehards will jump in to make the purchase but probably not enough.
My view, not based on hard data, is that the amount of money leaving the system is more than the money entering. The scale of the problem will overwhelm the attempts to pump prime the economy. The housing bubble is only part of the problem. The real problem is (was) equity withdrawal against the inflating asset. In a sense we have a ponzi scheme (housing) morphing into a giant credit card. The contribution that this little arrangement has made to consumption and economic growth over the last decade must be huge. I think that most analysts overlook this and assume that the downturn will be like all others. How will $10 billion and an increase in the first homeowner’s grant compensate for the great equity consumption binge? We’ll need a lot more than $10 billion to cover that tab!
Also, the negative wealth effect will cut consumption substantially, leading to higher unemployment, and underemployment for the casuals. You can pump prime all you like but you still need a job to buy a house. I think that the underemployment factor is being overlooked. Our IR system is far more flexible today. We have an army of casual part-time employees whose work hours can be cut tomorrow. This won’t show up in unemployment numbers. However, the effect on consumption will be immediate. It may be that we have a deep recession with relatively low “official” unemployment and a whole army of miffed bank economists telling us that housing is ready for the next upswing.
Lastly, despite all the middle class welfare, it’s harder to get the dole than it used to be. I think this change over the years of economic rationalism will prove to be a sleeper. Economists tell us that the automatic stabilisers will crank up in a downturn helping to minimise the depth of any recession. If this really is a big recession then making it hard to get the dole will only make it worse.
October 19th, 2008 at 3:26 pm
The impact of the additional $7000 may well be only marginal:
* given that it only represents a small percentage of current house prices:
* given that most first home buyers are likely to be located in areas where prices have already begun to soften significantly;
* if increasing unemployment will leads to lower demand;
* if perceptions of increased demand lead to increased supply (ie more current owners being willing to sell).
October 19th, 2008 at 5:00 pm
I really don’t know what some of you mean by soften! Real Estate agents use this as well. It is a troubling myth that house prices have fallen. Generally they haven’t- Real Estate industry says prices have softened- but the truth is – house prices just simply haven’t kept sky-rocketing upwards (thank goodness, for that!). Generally most areas are reporting 0.5% increases etc over the last quarter- so they are still going up! People need to realise there is NO law that says house prices HAVE TO go up- the fact is they are ridiculously high, & in fact have been for the last decade. Here’s my speel on one the reasons for house prices & therefore debt in this country is so high, pulled from another topic:
so Kevin Rudd is now Mr.Inflation. Couldn’t he have just let well alone- put the money into guaranteeing deposits etc is a good thing BUT why does he think increasing the first home owners grant is going to make property cheaper- it is going to do the opposite. Giving a sector of the market even more money to go to their bank with, means they have more borrowing capactity meaning that they can bid higher at auctions therefore pushing the price up.
Only one person can be successful in the end, so all that extra money is doing is push the price up. IT IS THE LAST THING home buyers want. Unscrupulous real-estate agents and greedy vendors will now factor that into their ‘wanted price’.
If you want to push prices down- outlaw the disgusting, obnoxious practice of vendor bids. Where the price doesn’t reach what the vendor & agent want, so they make a vendor’s bid (why would a vendor- when he/she is selling- its incongruous) and completely distort the price and therefore the value of the property. Auctioneer then pleads with people to bid so they get 1st right to negotiate when passed in, but of course that is at the inflated/artificially creatd post-vendor’s bid amount. It is a disgusting practice, and the increasing of the first-home owners grant just shows how short-sighted this Labor government are. Watch the prices rise as the government encourages more debt!!!
October 19th, 2008 at 6:00 pm
Hi JC1,
Yes I would be better off, but I like this place a great deal, and compared to other economists, I think my job is pretty secure! So given that I will, in all likelihood, do very well in terms of income out of this crisis–in stark contrast to most of society–I’m willing to devote some of that income to paying my mortgage off more rapidly, and avoid the hassles of moving, etc.
On the other hand, if someone is inspired by the FHBG pump to fork out $25K or more than I was offered, I’ll put up with the inanity of our rental markets for a while and sell. We shall see…
A major motivation for putting it on the market was following my own advice, but as noted above, my personal situation means that the consequences of the coming slump are likely to be the opposite of the norm for me.
October 19th, 2008 at 6:06 pm
Ed, You’re spot on. The macro impact of merely stabilising debt is %260 billion–far far more than the $10 boost from the government scheme.
October 19th, 2008 at 7:59 pm
Hi Steve,
I ‘googled’ your name as I was very interested in your opinion regarding the first home grant increase for established properties. I am on the sellers side, selling two 2-bedroom units in Sydney(range $330K – 460K). Two days after the grant was announced, one unit was sold for $10K more than was the previous highest offer. The other unit is going to be auctioned and from what I can see, it also should get around $10K-$15K more than I previously expected. You are absolutly right – the grant is playing into the sellers hands, not the first home buyers. I think that eventually this grant will be Kevin Rudd’s “undoing” as the even more elevated property bubble and then burst will be associated with his grant.
Kind Regards.
October 19th, 2008 at 8:26 pm
Hi Steve,
Its great to see someone who is properly informed about the crisis. I have been following this intensely for 3 years now and it amazes me how traders (economic speakers) still spruik off how things will be ok, when a little googling about derivatives would perhaps change their spiel. But like pushers of credit they’ll say anything to get your money to gamble on the next good thing.
I heard that you were selling your house, getting off the ship before it sinks, so roughly how long do you think before Aust’ goes really bad? Can you estimate based on any available data?
My personal belief is that the upcoming Aussie crash has to happen to normalise things, its ridiculous otherwise, so any actions by government to avoid it, usually by spending money are just going to make it far far worse, one way or another.
My understanding of the derivatives is that basically when companies go bust, thats when all hell breaks loose. Given that credit is, has, will dry up, how can the derivative debts ever be paid, there isnt that amount of money around?
If the major owners of the derivatives are offshore, eg China, wont they simply demand payment in terms of real assets ie “the USA” and when payment doesnt occur try to take it.?
October 19th, 2008 at 8:44 pm
Debt is actually getting close to stabilising, see http://www.rba.gov.au/ChartPack/financial_indicators.pdf I would expect that when the figures are updated next that household debt will actually be growing at less than the inflation rate, so in real terms declining. I assume this is what the RBA told the government last week.
When house prices are dropping 15-20% per year in many countries getting offered a discount of between about 2-5% (based on first home owners spending 140,000-350,000) doesn’t really seem all that good. It should take about a week or two for reality to assert itself.
October 19th, 2008 at 8:49 pm
Thanks, but I still dont see a resolution to how $600-700 trillion in derivatives are ever going to be settled, unless everyone, ie the world, is declared bankrupt. How can the derivatives ever be paid?
October 19th, 2008 at 8:56 pm
Steve
While I agree with your logic on the First Home Buyers Grant I am interested to learn what you think are the policy alternatives the Government has at this point.
October 19th, 2008 at 8:59 pm
I still cannot understand why our government, like ALL others, is determined to ensure that credit continues. Has not experience, from the time of Venice’s experiments in international lending and that strange idea (supposedly brought back by Marco Polo from China) of paper money been fairly conclusive? Fiat (aka unbacked credit) money means a boom inevitably followed by a bust.
As a 15yr old in the 60s my first lesson in economics brought me into conflict with the text (and teacher) because of the magisterial assertion that farmers are dependent on the industrial society. Seemed to then,and now, that it’s a bit difficult chawing down on widgets & polystyrene. The fact that a modern (sic!) farmer would have to eat pesticide & superphosphate just shows how ludicrous the current system.
I actually heard, ABC’ COuntry Hour, that some farming family were suffering malnutrition because they couldn’t afford .. food prices.
Puhleeez!
October 19th, 2008 at 10:12 pm
Banks & Credit are as useful to an economy as Power Utilities and Electrons.
To grow GDP we need both.
I submit… Banking & credit needs the same regulation as Power and electrons.
The economy suffers when there is a shortage or a surplus of both these COMMODITIES.
A regulated 11% ROE would seem reasonable (5% more than AAA bonds).
If a bank wants to pay massive wages in a regulated system it will suffer at the shareholder return level.
October 19th, 2008 at 11:02 pm
Hi Steve, I mistakedly posted the below tax rant in the Great Panic Debate section – Great Mistake -sorry for duplication.
Steve,
the basic cause of the housing bubble not addressed by you and your fan club is TAX.
Tax is the root of all financial and political evil.
The Great Depression was made infinetley worse by the high levels of taxation compounding other economic mismanagement such as credit restriction etc. Hoover raised tax from 25% to 60% to cope with expanding government deficits, only to cause further economic contraction resulting in a further drop in tax revenue. Roosevelt continued this policy, and it was a major factor in the 1937 recession. During WW2, marginal tax rate reached 90%. Obama is going to bring in top marginal tax rates of 60%+ – those who don’t learn from history—.(www.financialsense.com)
The high rates of marginal tax rates that kick in at relatively low income rates ensure that Australia will have a tax avoidance obsession, and that “negative gearing’ will be pursued by all and sundry. I personally know of nurses who have several ‘negatively geared’ properties that are under water, but because of the “tax deductablity of interest and maintenance”, have delayed the inevitable day of reckoning, “because property always comes good”- ho hum. In the meantime, their savings, garnered often from excess overtime go down the financial drain – no wonder Aussie banks are so ’stable’and profitable.(thanks Kevie) Removal of the capital gain excemption for any short term investment would discourage all forms of tax driven speculative investments, and lowering marginal tax rates combined with abolition of all tax deductions (which only distort rational economic decisions – ie.’no free lunches’)would eliminate the perceived need for tax driven investments. Lower tax rates result in higher economic activity and lower tax avoidance which results in higher tax receipts. Legislate for a permanent budget surplus, so politicians can’t steal from future generations, and problem solved.
In a country where 40% of families pay no net tax (recent report in The Australian) and 20%+ are on pensions, and free Medicare and unfunded government pensions remain a future growing liability, a more rational tax system, which is fair reasonable, transparent, adequate and low cost to administer and results in more productive investments than “McMansions” is long overdue.
PS anyone who doesn’t believe that climate change is a serious risk to human existance, that at least needs serious insurance cover, is a complete—— AND, Failure to deal with the Peak Oil(Energy)challenge will result in the Great Great Great Depression.
Cheers, Gary
October 19th, 2008 at 11:15 pm
Gary, regarding the $600-700 Trillion in outstanding derivatives you mention, I beleive this is a ‘notional’ number. The real exposure, assuming each counterparty doesn’t go bust is much lower, because this is a cumulative number of on-sells.
The real netted number would be much lower, I think I read around $10T, but don’t quote me! Of course.. this is why the govts are working so hard to keep these banks liquid and stable so this amount doesn’t expand, and the contracts last until maturity.
October 19th, 2008 at 11:59 pm
I am not an economist and so perhaps I am missing something but someone please tell me why the government is saying, “we are experiencing a serious economic crisis and unemployment WILL rise” and in the same week saying, “ok young would-be-home-owners, go ahead and get yourselves in debt – buy a home at an exhorbitant price.” How are FHB going to pay their mortgage when they are unemployed and exactly how will that scenario assist the long term welfare of the economy and ipso facto the nation?
October 20th, 2008 at 8:12 am
r2t2 – The gov wants high house because if they were to fall by say 20% and forclosures were to increase then our banks will probably look like their US counterparts; ie. CBA has 361b of mortgages on their books. In other words the gov is abusing young families under the guise of helping. In addition our PM is desperate to go to the next election, which is only about two years away now, without a technical recession. Our gov and many others like the UK are on tread mill that they cant get off. Incompetance is too fine a word for our pollies.
October 20th, 2008 at 8:31 am
Steve,
Very interesting charts. While housing is no doubt at unsustainable levels, your comparison of housing with the CPI tends to cast doubt on the CPI. It seems to be out of step with pretty much any other price measure to do with the major contributors to the economy (eg. housing, commodities, manufacturing, local government taxes). Seems to me the ABS has some explaining to do. No doubt the people concerned with producing the CPI take their job seriously and have good reasons for their methodology, but it looks increasingly like an example of people doing a particularly exacting task perfectly, but failing to achieve the objective.
r2t2,
Your comment is very apt, and distils the government position perfectly. Kevin’s appearance on tv last night was particularly telling when Kevin told a young couple to buy a house (but not their dream house) as soon as possible. This kind of advice can only mean two things :
1. the govt believes housing prices will continue to increase indefinitely, and/or
2. they don’t understand actual economic activity, and are totally reliant on money flow measures, therefore causing someone to spend (and go into debt) will improve the numbers, therefore the economy is improved.
The young couple in question should obtain a recording of the PM’s advice – should make for an interesting legal case in the future, if they should decide to follow the advice and things don’t work out.
October 20th, 2008 at 8:40 am
Last night, Kevin was again asked point blank what was contained in the Treasury advice. Kochie allowed Kevin to change the subject. A very soft ball q&a.
In any case it’s not the question I would like answered. I would like to know what ‘advice’ Kevin and Wayne were given during their recent trips to the US, where they were put in rooms with bankers and had the frighteners put on them, and then given their marching orders. National sovereignty – Bah !
October 20th, 2008 at 10:05 am
Interesting comments!
A Government stimulous package is a sign that there are bad probs in the system, not a sign that a turning point is near. The new numbers are just not out yet. This will come as news to all of us, but when the numbers come out the punters will be very shocked and freeze up even more than they are now.
The new first home owners grant is a subsidy for the construction industry, nothing else. Construction has been declining since 2003 and the government is trying to pump prime that industry. The construction industry is now in the absolute toilet and most sub-contractors are looking for work that just isn’t there.
I agree with all you guys that the poor first home buyers will get tricked into taking on massive debts even after the gigantic asset mania has turned sour. The construction lobby is very powerful and they would have been pushing for this for ages.
I don’t believe the increased FHOG will have a material effect either because consumers are becoming increasingly risk averse and the pendulum is swinging very hard back to the conservative side.
Remember Political Science 101. The primary function of a politician is to get re-elected. Most of the decisions we will see out of any government in a downturn will be what the people/voters are asking for. To follow public opinion is the best chance of getting re-elected.
Remember the backlash after the budget regarding no increase for pensioners. Now pensioners get some more money. Give the child bonus to low and middle income earners, Labor’s main constituent. Good politics.
Either way in this case at least a positive is, that those initiatives will go into the hands of those most likely to spend. The FHOG subsidy will encourage a few developers to start new projects and they will likely complete those for a loss. As risk aversion increases making money becomes almost impossible.
October 20th, 2008 at 10:18 am
The cash injection is always a good think to stave off mass panic – since we as humans with emotions rarely think with rationality and hence our worth as people is now tied to the dollar, you give them more of the dollar the more satiated they become.
Much like what a heroin addict would deal with – after coming down off a hit, they need another hit to keep them level.
As for the first home buyers grant. What a crock of shit. We went through this years ago and look what sort of mess this created. The only thing this did was fuel the rapid rise of housing prices along with low interest rates at the time. Much like throwing petrol (first home buyers grant) on a raging fire (low interest speculative environment). But thats all good “politics” not good “common sense” – good ‘ol Super Rudd comes to the rescue once again.
A further point beyond just our domestic plight, is with rescue packages in general. I am disgusted by the desires of governments around the world to rescue established financial businesses of which would make the rich much richer, and support their ability to fund their ferrari in the coming months, while those at the mercy of these institutions rampant greed will have to fall on their sword and REALLY deal with the downturn. The fat cats get paid and the mice get the crumbs.
I think I have tapped out all my analogies for one post today.
October 20th, 2008 at 10:25 am
According to Dr Housing Bubble (in USA)that…..”Figuring out housing prices isn’t rocket science. There is no need for a Master’s degree in financial engineering to figure this out folks. Even as the housing market continues its downward slump, we are still at overpriced levels. Why? Well historically, housing as an investment only tracks with the nation’s inflation rate. That is until a bubble appears and people start getting the notion that this time is different. I’m going to give you a very straightforward math equation on determining how much home you can afford. This is the maximum price you can pay without putting yourself into financial jeopardy and maintaining a cushion = 3 times gross household income is the maximum value of a home one can afford? So if your household income is $100,000 you can buy as much as $300,000 worth of home. If you make $1,000,000, you can buy up to $3,000,000. Makes you wonder if we’ll ever see these ratios again.”
Refer to Dr Housing Bubble blog for more info
http://www.doctorhousingbubble.com/
October 20th, 2008 at 10:49 am
On the Question of should Steve sell his house or not?
Steve it seems as if you are in two minds as to whether or not you should sell your house. Sell sell sell!
Listen to your heart and your own analysis. Not the papers and people at BBQs.
House prices are falling hard already and the falls will intensify as unemployment rises and risk aversion continues to increase. When forced/panic selling starts the spiral down will be intense.
The Sharemarket will prob have one more blow out to the down side, for the moment (this is a guess only). Then the market will need to have a rest from all the downward pressure. This consolidation phase in the World’s sharemarkets will mark one of the last good times to sell your house or any asset for that matter. People may begin to believe that the “crisis” is over and confidence will temporarily flip back. Sell into this false run of optimism.
Some time late this year or early next year, who knows when for sure (only an informed guess) the World’s sharemarkets will begin moving to the downside again (and find new lows) and risk aversion will increase further. Nobody I talked to 2 months ago believed the sharemarket could go much lower and they now believe the market can’t go much lower from this point. When the market defies their belief they will be even further dismayed and then throw their chips in again. Confidence will drain even further and risk aversion will intensify.
The only assets that survived the Great Depression in America was physical cash (not bank deposits).
To be a contrarian takes courage and a large set of earmuffs. Steve, back yourself and move to cash.
October 20th, 2008 at 11:12 am
Traditionally it was believed people should be paying no more than 30% of their net income to service a morgage (otherwise they would be considered in morgage stress). So a couple or individual with a NET income of $1000 a week should be looking at paying no more than $300 a week in morgage. At 7.5% interest that translates to a morgage of $200,000.
Add a 20% deposit to your $200k morgage and that’s $250k total that people could realistically afford for a first home if their net income was $1000 per week.
So, yes, Australian housing prices are unrealistic.
I used that formula when I bought my second home back in 2001 and worked out I’d paid 10-15% over the realistic price. Since then prices have got so much worse.
If the government was going to maintain the 1st home buyers grant they should have kept it only for new builds (which are desperately needed).
October 20th, 2008 at 12:25 pm
Steve,
can we trust CPI in the graphs you have put up?
I’m aware of the work done at shadowstats.com which measures CPI in the US in the same terms as the 1970’s.
Therefore, if the CPI is being manipulated downwards – which is beneficial to the government as they don’t have to increase benefits as much – then perhaps your graphs don’t reflect reality.
October 20th, 2008 at 12:42 pm
Interest % HDI at 13%
This would require a very low cash/deposit rate to pull it down near 5% again.
Funding is 50:50 (deposit funding:commercial funding)
October 20th, 2008 at 1:31 pm
And serendipity strikes
http://business.smh.com.au/business/pensioners-ripped-off-20081020-54d5.html?page=fullpage#contentSwap2
October 20th, 2008 at 1:40 pm
The following post on a propertyinvesting website(16Oct08) shows what our highly subsidized investors think of the increase in FHO Grant announced by PM Rudd on 15Oct:
Prime Minister Rudd has just announced that the First Homebuyers Grant will increase to $21,000 for purchases of newly constructed property.
Something of this magnitude is likely to cause a mini-boom in prices and will substantially fatten the pockets of savvy developers.
If you want to be at the front of the queue of investors who can capitalise on this opportunity then make sure you are at my LAST Development MasterClass for 2008….
http://www.propertyinvesting.com/seminars/development-masterclass?st=mshl2
October 20th, 2008 at 1:45 pm
You are correct, the $14k & $21k First Home Owner grants are about keeping the asset bubble inflated.
I pity any FH Buyers who buy now. Virtually guaranteed negative equity within the next 12 months.
Check what is happening in UK, about 2 million in negative equity by 2010:
http://www.thepropertypin.com/viewforum.php?f=11
October 20th, 2008 at 2:50 pm
When asking yourself why Rudd would make such a poor policy decision as to increase the FHOG, remember to consider state politics. Within 7 months they lost the “Federal and all States under Labor” factor. NSW is looking very shaky, and the drop in stamp duties has blown a hole in their budget! Up here in QLD, the same is true about our budget – although there have been no actual figures released, a minister let it slip the other day that things are looking grim in that regard. (Of course, not long ago they decreased stamp duties – in the hope that they would recoup more than was lost by stimulating more sales – it hasn’t worked).
Simply, the states became addicted to stamp duty revenues through the bubble. Instead of fixing the roof under good weather – now that the cyclone has set in they have been busy trying to patch up the same old roof with a few rusty nails. (In QLD they finally increased mining royalties in the latest budget – just in time for the end of the mining boom!)
As the excellent article posted by Mike Strasse in the other thread shows (http://www.smh.com.au/news/opinion/paul-sheehan/greed-a-deadly-sin-for-the-economy/2008/10/19/1224351052160.html?page=fullpage#contentSwap1), governments in Australia were lazy through the boom years, and we are all going to pay a price for that.
At least the FHOG increase is not going to be expensive to Australian taxpayers – BECAUSE VERY FEW WILL BE FOOLED AT TAKE THE BAIT (OR CARROT)!!!
October 20th, 2008 at 3:15 pm
Sorry for this slightly off-topic post. I’ve seen a couple of comments in the last couple of blogs, for example Swio’s question:
“CPI calculations do not take into account rises in house prices (only “owner equivalent rent”). Would the debt crisis have been mitigated or even avoided if the housing component of CPI was based on actual house prices instead?”
I’m not sure whether Swio is aware of this (most people I mention it to are not), but until rather recently, home prices WERE included in the CPI! The biggest change between the 12th series and 13th series (beginning 1998) was the exclusion of house prices from the index.
Prior to 1998, mortgage interest payments were included. And so 6.6% of CPI movement was a function of interest rate and home price. In 1998, just as the house price boom was about to take off, they removed it! Their reasons were fair enough at first blush – interest rates shouldn’t really feed into CPI, especially when CPI is used for setting interest rates! But they threw the baby (house prices) out with the bathwater! They removed the largest single consumption good the average family ever buys!
I’ve done a back-of-the-fag-packet (bonus points task for a student to do a more thorough job Steve?) calculation, rebuilding CPI with the housing component feeding from house prices and interest rates. (This is by necessity a rough calculation because the resultant index would have forced the RBA’s hand on interest rates much earlier and much further). The upshot is that using the 12th series methodology raises average annual CPI over the last 10 years by 0.9%pa.
Graph:
http://img145.imageshack.us/img145/3176/comparecpi12th13thseriebk4.png
Spreadsheet (image):
http://img147.imageshack.us/img147/6836/cpi12v13spreadsheetzo2.png
See here:
“The most noticeable changes from the current CPI will be the exclusion of mortgage interest and consumer credit charges from the index and the inclusion of net expenditure on new dwellings (excluding land).”
http://www.abs.gov.au/ausstats/abs@.nsf/mediareleasesbyReleaseDate/AF365C5832A5E813CA2568A900136258?OpenDocument
Land prices are where the bubble is. Construction costs have remained fairly flat.
See also:
Mortgage Interest: 6.608% of total basket http://www.aph.gov.au/library/Pubs/cib/1997-98/98cib14.htm
Funnily enough, they kept mortgage interest in when the huge drops in interest rates in the early 1990s were driving CPI down…
For anybody who is interested, there are a few other links on the ABS website to various discussion papers and a 13th series explanation paper.
Regards, F.
October 20th, 2008 at 3:39 pm
Steve,
In your calculations are you differentiating (deriving/estimating) the actual CPI from the Household Affordability Index?
According to an analysis by Michael West (see URL below) the CPI can be anything the ABS wants it to be based on whatever political pressure is bought to bear by the Government of the day!
According to the article the ABS can model (constrain) the CPI to be within a range of 2-3% per annum by playing around with the basket of goods and services and making quantative assumptions and substitutions?
If this analysis is accurate how would this play out in your modeling of median incomes and housing affordability differentials?
If this is not too big a question to answer in this space: What would be the real impact on the *real* economy?
Article URL:
http://business.theage.com.au/business/pensioners-ripped-off-20081020-54d5.html?page=fullpage#
October 20th, 2008 at 4:27 pm
The guarantee of all bank deposits was made to “restore confidence”. It has worked, but I believe this success will be short lived.
I also believe that Kevin Rudd made this promise in the 100% belief that the government would never have to pay up. I believe Kevin Rudd is wrong on both counts.
The argument goes as follows:
The US and European banks are much worse than the Australian Banks. They are about 12 months ahead of us. The World is liquidating all liquid assets at present. That liquidation will continue to put all organisations under financial pressure.
Because of investor/depositor fear and the added risk of CDS. The US and European banks will continue to fail, thus causing an intensifying of the liquidation thus causing the collapse of the Australian Banks.
Now if the World’s banks have just collapsed. Every government will be looking to raise new debt to bail out their banks. When the problem reaches that level, no one will lend any money. No governments, least of all the Australian Government will be able to raise fresh debt.
The only option the Australian Government will have is to swap all depositors Government Bonds for their deposits. The market for Govt Bonds will collapse and people’s money will be tied up for years. The bonds will then begin trading at a fraction of their face value and the money supply will have collapsed.
I guess the Governments of the world could begin printing physical cash and swap that for depositor funds. But logistically that may take a long time.
I would be keen to see if you guys had thought through any other possible scenarios?
October 20th, 2008 at 5:09 pm
Bullturnedbear,
Interesting scenario. US Tbills are looking shaky now. I’m not sure about the 12 month lag any more – witness the AUD/USD xrates since July. Things can happen much faster in this globalised, interconnected world. Another aspect to consider is capital controls. This was unthinkable only a year ago, but many countries must be pondering this. The Iceland collapse has seen the UK implement this with their seizure of Icelandic assets in UK banks – under their anti-terror laws no less. I’m wondering if this action (and others in contemplation) have prompted the announcement of another crisis meeting amongst G7 plus invited guests. Our debt levels will continue to ensure that capital continues to leave our shores, and the recent $30bn propping via USD swaps will prove ineffective, oh and opens us up to currency risk.
October 20th, 2008 at 5:51 pm
Steve,
If you read Tina’s email above about how she sold her properties for an extra 10-15k due to the new FHBG, then it is clear what you should do. Sell to those FHBs. After all, how often have we all been told by the newly landed gentry to get into the market as it’s only going to go up! ‘What’s wrong with you?’ they will ask.
And as for Brett’s assertions: interesting article in the Australian on Saturday. This is the first time I have seen this. And then there was Steve on 60 minutes last night – it would appear the debt deflation idea is going mainstream, apart from the Commsec economists etc.
Article as follows:
House of Credit Cards Tumbles Down
http://www.theaustralian.news.com.au/story/0,25197,24512738-28737,00.html
October 20th, 2008 at 5:54 pm
Steve,
It would appear that the link in my last post has gone out of the border. Might be just my browser, but the symmetry of the post is gone – must be a sign of our assymetrical times!
October 20th, 2008 at 6:43 pm
Here’s the “skinny” on what I think of the stimulus package.
First the FHOG. Some of the comments above highlight the dual purpose of this measure – a “carrot and stock” approach – the carrot being the money, the stick being the reignition of the bull market fears of never being able to afford to buy a home. They attempted to get a quick effect which might show up in auction clearance rates which the media could highlight over the longer term data which is now emerging of widespread price falls.
I strongly doubt that it will have any effect, which is good because 1) few young Aussies will have been duped into paying bubble prices for a home, and 2) it won’t be costly to Australian taxpayers.
On the spending, socially I like that the people who are suffering (especially due to housing costs) are getting a bit in their pocket to help out. I think it will be a quick effect, but not as big as expected (like in the US) because a lot of families will wisely use it to pay down debt (which I don’t think Rudd would be all that disappointed about anyway.)
But I find it a curious policy response. I would suggest it will only delay the inevitable, and I would have thought a first term PM would rather go into recession with the rest of the world than later possibly by ourselves. Then again, I expect that things will get worse in the US before they get better – given their situation, the new US president would rather take all of the bad medicine straight up (and blame it on the previous administration) and aim for a recovery by the time of the next election. Perhaps Rudd is trying to syncrhonise with that seeing as the stimulus will be all over by the new year??
The next phase – the infrastructure building – will be the interesting part. Hopefully it addresses social issues (affordable rental housing for lower and lower middle income Aussies) as well as productivity issues to deal with our current account problem.
October 20th, 2008 at 8:07 pm
Hi Steve,
Should the baby boomers now be renamed the baby busters? Seems like the busters’ particular model for making money is retiring at the same time as them.
Anders
October 20th, 2008 at 8:18 pm
Hi,
I may be over simlifying this – but shouldn’t it be the job of the central bancks to ensure money supply is not significantly larger then gdp?? Wouldnt shi stop the whole bubble bust scenario???
Tim Watts
October 20th, 2008 at 8:21 pm
Dear Bullturnedbear,
You said that the only assets to survive the Great Depression were
cash packages. Do you mean in tin boxes under the bed?
You said “not bank deposits”.
My partner is a “Realistic Pessimist”, but even he has not agreed to my suggestion of recent times that we take our money out of the account
and do this. We are renting, and have meagre savings, so this would be everything. The “Realistic Pessimist” says to me that now the deposits are government guaranteed, it’s fine for now. Is he too optimistic?
I understand the rusty tin box better than any banking edifice.
(Like buying from the farmer directly!)
Perhaps it is simply all too unknown, fearful, daunting and exhausting.
Perhaps to have a little rest, and wait, look at the sky, then set off again is the best action at present. But keep the tin box in the knapsack in case we need it to store the precious “leaves”.
October 20th, 2008 at 8:35 pm
The reason for increasing the FHOG is to increase debt. New credit is dropping off rapidly so they are trying to encourage people to borrow. That way there is a sizeable multiplier in stimulus to the economy. Bad news is that it will add to already excessive debt.
One of the problems is that all the fixes are based on economies being in equilibrium. Then if the economy is going down then it is fair enough to give it a kick back to equilibrium. Our economy is attempting to return to equilibrium, so giving it a kick will push it away maybe for a while but eventually it will collapse back.
My expectation is the stimulus package is so little in reality that it wont do enough to be noticed. A few more people will buy houses but when the housing market starts up after the Christmas break it will be all downhill.
October 20th, 2008 at 9:44 pm
Foundation,
There is a 15th series which began in 2005. Your info appears to be dated.
The weightings for the 15th series certainly includes house purchase at 7.8% of the all groups cpi. It is also present in the 14th series.
The cost of mortgages or any other credit is excluded probably on the basis that the index is meant to indicate the cost of goods and services, not the method of payment for same. That would seem unrealistic for housing, but would certainly be a factor for smaller expenses where personal credit is an alternative to cash payment. Tricky stuff.
October 21st, 2008 at 6:17 am
Hi Janette,
Yes I meant physical cash under the mattress. In the US during the Great Depression 1000s of banks collapsed taking depositors’ money with them.
Couldn’t hurt to keep some physical cash on hand. Better a year too early than a day too late. Banking is all about confidence. When everyone wants their money the banks don’t have it. Banks keep less than 10% of their total deposits on reserve.
I also posted above my argument for the belief that the Government’s guarantee of all bank deposits is not viable. In short, to get to the point of banking collapse, the World would be in massive turmoil as well and our Government would not be able to raise new debt to cover the losses. The Govt would probable issue IOUs to the depositors to be redeemed at some future date.
October 21st, 2008 at 6:56 am
prices may not just fall, like some of you predict when June next year comes, or after Christmas this year. There may be such little property on the market, that values hold
October 21st, 2008 at 8:16 am
Paul,
If unemployment continues to rise, and the economy continues to contract then there will likely be MORE property on the market not less.
I think Steve’s point (correct me if I’m wrong) is that prices and debt levels are now at unsustainable levels. That the demand for houses has been created by people willing and able to take on large amounts of debt and by expectations that prices will rise. I think those days are now over.
We certainly do not have the oversupply problem of the US, but in Britain there was a similar supposed shortage of property before there house bubble burst. That has not stopped the market price from dropping, and a sudden surge in the number of properties available for sale.
I cannot remember where, but i recently come across stats on the Australian property market that suggested the number of properties available for sale are actually rising and not falling. Probably due to forced selling.
October 21st, 2008 at 8:35 am
Austerity, this article by Majella Corrigan is also surprisingly frank – http://www.theaustralian.news.com.au/story/0,,24511094-25658,00.html – It opens with this – “KEVIN Rudd’s increase of the first home owners grant is about shoring up jobs and the economy. But it won’t necessarily cause a burst of buyers and put a floor under housing prices.”
She also mentions the latest RP Data records (which I have not seen mentioned elsewhere) of 2% falls for Sydney, Perth, Melbourne and Adelaide, and Brisbane averaged falls of 3-5%.
These articles are sharply contrasting to ones in News Ltd papers earlier in the week when they were helping REI advertisers and the government by providing the stick (attempting to scare FHBs).
And yes, 60 Minutes was surprisingly frank.
October 21st, 2008 at 8:36 am
Paul, eventually enough people are forced to sell their houses that prices drop, and there will also be a certain amount of fear that will encourage some people to sell. For someone who has an investment property that has doubled in value dropping the price by 20% isn’t going to be too hard.
Bullturnedbear, it is easy for the government to guarantee deposits as they can print money but the they don’t want to as it leads to other problems. What is a more likely possibility is that some banks will be technically insolvent due to borrowers with negative equity. Many of those will keep paying their mortgage, at least for a few years and it wont actually cost the government anything.
October 21st, 2008 at 9:24 am
The demand/supply theory for house price movements has always been dubious, if you ask me.
Even if the market perceived there was a shortage, the real drivers were fear and optimism. Fear of missing out on what everyone else was getting and optimism that a capital gain will result.
That process pushed prices too high. Now fear of loss and pessimism will drive house prices down further than would have been expected as the pendulum swings back to equal out the process.
House prices are driven by two main factors:
1. Willingness to buy, which is derived as a function of optimism or pessimism. Buying houses is speculating just like the sharemarket.
2. Ability to buy. Which is a function of available cash, finance or ongoing optimism about employment/income.
People are clearly much more pessimistic now.
Also banks are lending less and making finance harder to get, the cost of living is higher, wealth is being destroyed in all asset classes including commodities and I am convinced unemployment will begin rising.
There is no way property prices will not keep falling in Australia.
October 21st, 2008 at 10:22 am
Bullturnedbear,
There is another reason why people buy houses: To live in.
As Steve pointed out – he decided not to sell his home at a lower price because:
He has a stable job;
He can afford the home; and
He actually likes where he lives.
There are lots of Australians in that same position. There are lots of Australians that buy homes as a place of residence first, with a view to selling 10 to 20 years down the track providing they can afford the repayments.
I think it’s too simplistic to look at every home purchased as an investment transaction & calculate whether your money is better ‘invested’ in the share market or cash. For many Aussies, renting is not practicle or even affordable.
In my opinion house prices have been heading downwards for the last 5 years. I don’t believe house prices will fall further in lot of the area’s where the price has already come down (I calculate 10% to 15%). It’s the top end (properties priced around or over $1M where we may see the larger falls).
There are currently plenty of affordable properties on the market. The problem (I believe) is people want everything in their first home. There is not a willingness to purchase something modest & well within the budget with a view to working towards something better later on.
All that being said I never liked the FHOG or these subsequent increases. Never liked negative gearing or the capital gains tax relief. I’m a tax guy by profession and could see the problems these changes would cause many moons ago!
My point boils down to this….I think if your ready to crack the circa $800K to $5M range to find that ‘dream HOME’, you may get the chance soon. Good luck with the debt, but I’m assuming that if your ready, the debt won’t be a problem.
If on the other hand your after a HOME that will eat up less of your disposable income – there are plenty on the market at the moment provided your willing to accept this may not be your instant dream home to begin with.