Rescuing the Economy or the Bubble?

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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

Figure One: House Prices vs the CPI

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

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

Mortgage rates and payments

Figure Four

Mortgage debt to disposable income

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

Australian vs US Housing Bubble

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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129 Responses to Rescuing the Economy or the Bubble?

  1. Zap737 says:

    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)?

  2. jc1 says:

    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?

  3. Ed says:

    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.

  4. DJB says:

    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).

  5. blueinca says:

    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!!!

  6. Steve Keen says:

    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.

  7. Steve Keen says:

    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.

  8. Tina says:

    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.

  9. Gary says:

    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.?

  10. Ken says:

    Debt is actually getting close to stabilising, see 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.

  11. Gary says:

    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?

  12. Craig says:


    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.

  13. amphibious says:

    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.

  14. Peter W says:

    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.

  15. Gary B says:

    Hi Steve, I mistakedly posted the below tax rant in the Great Panic Debate section – Great Mistake -sorry for duplication.
    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—.(
    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

  16. Darren says:

    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.

  17. r2t2 says:

    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?

  18. Aac says:

    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.

  19. Keith says:

    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.

    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.

  20. Keith says:

    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 !

  21. Bullturnedbear says:

    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.

  22. Anarchy Is Alive says:

    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.

  23. Peter N says:

    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

  24. Bullturnedbear says:

    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.

  25. lindyhop says:

    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).

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