Rescuing the Economy or the Bubble?

Flattr this!

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.
Bookmark the permalink.

129 Responses to Rescuing the Economy or the Bubble?

  1. GSM says:

    At this point, FHOG or no, house prices in Australia will be determined by the unemployment situation.

    Rudd knows this clearly. That is his motivation for the big business pow wow and the stimulus package/FHOG expansion.(I would also bet that Rudd chose Channel 7 for his “chat” last Sunday to purposely lower the 60 minutes story where SK appeared and enlightened us all on HIS take on the unemployment future- 10-15%????!!)

    Yes, Australia is very vulnerable to a significant decline in house prices. But the manifestation of can be mitigated by reasonable levels of employment. The major policy shift as I see it is that the Govt now is focussed more on maintaining house prices than in house affordability. This has come about probably because of the devastation witnessed in banking institutions worldwide.

    House prices are clearly coming off- more motivation for Rudd to change course. My expectations are that the “wait and see/there is no rush” mentality will prevail (due to lower future IR’s, the recent market turmoil, slowing consumer spending etc),which will in effect send house prices lower thus keeping fence sitters firmly in place.In this environment all you really need to know is the trajectory of prices.

    I’m sure we will see nightly success stories of renters turned owners but they will be in the minority. Get ready for a massive media onslaught on the virtues of buying a home.

    Unemployment will inexorably rise in Australia. To what levels? Who knows. Correspondingly, house prices will fall. For now, that’s enough to know.

  2. Foundation says:

    Keith said: “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.”
    I’m aware of that. The approach to housing costs has remained unchanged since the 13th series (though weightings have been meddled with). House prices are NOT included. Construction costs and stamp duties etcetera ARE included. But the price of land, the bit that was bid up to astronomical levels by the recent unsustainable bubble, is SPECIFICALLY EXCLUDED! Much as I stated earlier.

    The adjustments to CPI made in 1998 resulted in the average annual CPI reading being around 0.9%pa less than it would have been had mortgage interest costs (the single largest consumption expenditure most families ever face) not been deliberately excluded.

    Regards, F.

    PS – I’m seeing a few comments here still suggesting prices can’t fall by 20%+. That’s amusing as I could buy today in areas of Melbourne I’m tracking, an equivalent house today for more than a 20% discount on similar homes 18 months ago. 😉

  3. Bullturnedbear says:

    Hi John,

    I didn’t say that people don’t buy houses to live in. I just defined what “really” sets the price of those houses. Supply does not set the price. Demand does.

    People pay a set price based on their desire for risk (even without knowing the risk) and their ability to pay.

    That level of risk is now more obvious and people have increased their fear of risk. As a result prices will fall accordingly. Also people’s ability to pay has fallen as finance is harder to get, putting further downward pressure on prices.

  4. furball says:


    This really is dreadful analysis.

    There is nothing in here to say that current debt levels are unsustainable.

    You have ignored a central possibility, while house prices in 1987 may have matched historical norms, this historical norm may have reflected an excessive conservative use of debt in the funding of home purchases.

    I grant that asset prices have grown through increasing use of debt. I accept the relativity that you have demonstrated. But you have not established that Australian and American debt levels at index = 100 were in any way equivalent degrees of financial pressure.

    You have not determined that 13% of HDI to Interest is inappropriate. Please direct me to the spreadsheet or studies that suggest this is unacceptably high.

    Further, you have not presented any information regarding the geographic distribution of salary, such that Western Sydney homes may be over-valued and highly substitutable while inner north, eastern and inner western homes have no ready substitutes, as far as those earning high wages are concerned. Not to mention the valid calculation that seems to stack up – 10 minutes extra travel time valued at two wages at $60/hr x 1.5 – 2.0 wages does describe a good deal of the variance between suburbs heading out.

    You might be onto something regarding the relative performance of the housing market in real terms against its past performance.

    You may have identified that houses are not going to return a ridiculous top line growth averaging 7% per annum (implying 35% on equity if mortgage equity starts at 20%).

    You may have identified a key susceptibility of the economy, should an external shock cause large increases in unemployment (to 7%, say).

    However, you have not identified an impending crash. Just an asset class that has outperformed other asset classes through the use of debt by householders, in a way that could not be repeated for another 20 years.

    If you really believe you are right, please put together the logic in a robust fashion.

    We’re not there yet.

    Best Regards

  5. John, I strongly doubt price falls from here will mainly involve the high end. They will be across the entire spectrum. Yes, prices have been falling in the outer suburbs – 25 kms from CBD (at least in Brissie where I know mainly from friends) – for about a year.

    But it is quite clear that there are many more houses for sale now in the 5 to 15 kms regions containing a lot of older median priced houses.

    Some will be forced sales, others will be retiring or close to retiring sellers. Sure the latter will not be desperate for a sale, but they would like to sell in the next few years. And they have seen cycles before, may see through the baloney and know that prices are not going to go up for many years, and will press on with a sale knowing that even if they sell for 10-15% less than a year ago, they still have done very nicely thank you out of the bubble.

    Your point about houses worth as homes is spot on. I consider the house that I rent to be my home, too. (And I do not own any residential property whatsoever.) So your home does not necessarily need to be a house for which you are repaying the bank. (This factor would be improved if large scale investors – ie superannuation funds – began to provide the bulk of rental housing.)

    And as I’ve shown on my website, the standard of living gap between renting and buying at these prices is enormous. It only makes sense to take such an enormous drop in standard of living – and the stress of high debt levels – if you truly believe that the gap is only going to grow. That is why FHBs and investors bought into the bubble.

    But that myth has been well and truly extinguished. Pricing will now correct back to reflect a true value for the emotional gain of owning your own home. Like many bubbles bursting, pricing may well over correct. And I would suggest, with prevailing conditions, that correction might occur reasonable rapidly.

    Which leads to GSM’s comment. I don’t believe it’s all about unemployment. The US market peaked over two years ago, and has experienced significant falls as we all know – but unemployment has really only begun to increase signficantly there over the last 6 months.

    So conditions can definitely exist to cause house prices to fall in the absence of falling employment, and I would suggest that we too have those conditions in spades.

    On the other hand, that we are likely to be experiencing higher unemployment at the same time that our housing markets have begun to go south would suggest that markets may fall more rapidly than in the US.

  6. Tony says:


    Whats interesting about the credit bubble is what causes it and is there a better way.

    There are two ways the capital accumulation of an economy can be distributed amongst the population:

    1. It can be lent by those who have it to those who don’t for a fee, ie credit

    2. It can be distributed from those who have it to those who don’t through taxation

    Now the economy works through both mechanisms, but over time there has been more reliance on the credit mechanism.

    And fueling credit creation is a fractional reserve banking system that steadily prints money. That money then multiplies many times through the banking system creating an ever increasing expansion of credit along with increased prices and economic activity.

    And the bulk of the population know it makes sense to borrow because their wages aren’t keeping pace with price increases caused by money printing and credit creation, so its better to borrow now because your house will inflate faster than your ability to save.

    If we look at the USA, total debt has now exceeded 50 trillion. This amount has been steadily increasing since world war 2, with a large acceleration since financial deregulation.

    And the creation of this debt along with stagnating wages and regressive taxes, has meant that wealth is flowing from the bottom to the top, instead of the other way around. And now its all collapsing, because a large part of the population can no longer take on any more debt.

    The answer is simple; reduce credit, stop printing money, reduce the role of the bank multiplier effect and improve progressive tax to replace the need for credit. The economics of doing this is easy, the politics however isn’t.

  7. Furball, you make a reasonable point about what is the “optimal HDI” and I would be interested to see whether Steve can add any empirical data to the discussion.

    I would say this. We already know that human beings’ risk tolerance goes through cycles, or at least alters depending on experiences.

    The extreme risk aversion shown by those that lived through the Great Depression, of course, is one very well known such case. It is generally accepted that the children of Great Depression parents were less risk averse. And perhaps ensuing generations have become less and less risk averse. Add to that factor the propensity for human beings to unlearn lessons of history.

    We know that increased risk equals increased probability of greater reward, but with concomitant increased volatility.

    I would suggest that you are correct – that the process of unlearning the lessons of the Great Depression was complete – and the return to the laissez-faire conditions was the root cause of the credit and housing bubbles. As such, people were prepared to take on higher and higher gearing levels. But many did not realise that the increased volatility shown in the rapid ramping up of prices also had a downside – rapid price falls.

    I doubt very much that anybody could determine with any certainty what level societies would choose if there could be a stable trade off between risk return and volatility. I think we know enough that we humans would tweak it up a bit sooner or later if things were stable for a while!

    Even though it may be difficult, probably impossible, to put an exact figure to – it does not change the fact that the phenomenon is real. What’s more, many of the exceptional investors of our time have used their understanding of this to profit greatly.

    Personally, I don’t think it is all that difficult a concept to understand – Buffet’s summation may be the best – “be greedy when others are fearful, and fearful when others are greedy”. The most difficult part is having the clarify of thought to see through the mountains of baloney that vested interests spew forth (eg never seeing market peaks in rising markets and continually calling bottoms in falling ones).

    One question to ponder – imagine a young (but equally wise) Warren Buffet living in Australia with a young family and he has $50,000 in savings. Does he allocate his capital to buying an Australian house (as a home or otherwise) right now at current prices?

  8. chris says:

    I don’t have any real data but I believe that the majority of the families in Australia have mortgages and the minority are renting or have already repaid their homes in full.

    – Assuming that the unemploynment will not increase a lot I believe that the majority of the people will try to keep their morgages and will not sell their houses (at least because they need a place to live and want to avoid the hassle of moving)

    Then if the house prices are going to fall dramatically as some people here suggest, wouldn’t this enrage the majority of the population of Australia? I’m sure that’s not something the government really wants, so they will do *everything* to avoid that, such as this “rescue plan” to keep the prices of the houses high for a longer period of time.

    This is why I think Kevin did what he did. What other options did he have anyway?

  9. michael b says:

    We have recently done some work on ‘affordable housing’ – a very wide and generally ill defined term.
    I didnt like the markets sole comparator of income vs house prices.
    I prefered a comparator of wealth vs house prices.
    While I agree with Steves fundamentals on a house bubble and the silly extension to the FMOG – which I see was intended to ensure housing construction employment doesnt fall – I want to see more analysis on the issue of increasing weath effects on property values.
    2 households each $1000/month, one in their 60’s with lots of assets, and one in their late 20’s with no assets. Same household income, very different wealth.
    what is the weath corrolation with property prices?

  10. Peter W says:

    In Melbourne each weekend there are roughly 900 housing sales at a cost of $400 million (average $444,000). The total number of Melbourne houses is roughly 3 million, so each weekend we are observing roughly 0.03% of all the houses in Melbourne change hands.

    The price of exchange of these 900 houses ‘sets’ everyones opinion of household wealth.

    If, one year from now, 500 people ‘set’ the price of exchange at $178 million (average $355,000 i.e. 20% lower), are the other 3 million Melbourne homeowners 20% poorer because 0.016% of all the houses changed hands at a 20% lower price?

    Think about it!

  11. Lawrie says:

    Why are our house prices inflated – how much of the problem is silly bankers lending too much and how much is silly buyers buying too much(i.e. big houses)and paying too much?

    I put the greater part of the problem down to buyers. I don’t see buyer behaviour changing much until the house price collapse of 2009 is seared into the memory of the nation – until Mums and Dads are telling their kids how they lost the family home because they didn’t leave themselves a margin for safety.

    Yep, the fist home buyers grant sure is is silly policy

  12. Keith says:

    Exactly how do you know what is included in House Purchase ?

  13. Peter W says:

    Invert the previous hypothetical if it makes you ‘feel’ better.

    Is the population of Melbourne 20% richer, if in one year from now, 500 people transact 500 houses at $266 million (average $533,000)

    It appears an astronomical amount of the perception of wealth can be created or destroyed as a result of the transactions of 500 – 1000 people.

    Strange eh!

    This extremely strange phenomenon has destroyed dozens of financial institutions and roughly $30 TRILLION of the worlds stockmarket value during the past 12 months.

  14. Pingback: Contrarian Investors’ Journal » Blog Archive » If property prices follow long-term inflation, will prices not fall in the long-term?

  15. Peter W says:

    There is a very simple difference between investing and speculating.

    Speculators gamble that prices will rise so they can profit from sellling at a higher price.

    Investors (strangely) want prices to fall because at lower prices they recieve a higher rental yield.

    The Speculators focus is “on selling” the balance sheet.

    The Investors focus is “Return on asset = Yield” the P&L

  16. yankeejimc says:

    Steve: I am anxious to see your reply to furball, who asked what data implies current debt levels are unsustainable. As a Yank, I wonder if the answer for the US is the amount of demand fueled by INCREASING debt levels ala Ponzi. That surely is unsustainable. Oz does not seem to be quite so badly off in that respect.


  17. Steve Keen says:

    Dear All,

    As you all probably appreciate, I’m far too busy now to respond to most posts here, but I enjoy the discussion forum the site has evolved into–with regularly over 3500 readers a day as I write.

    The simple answer to Furball’s question about why current levels are unsustainable is history. Check the long term graphs for Australia and USA debt in earlier posts. The long answer is the financial instability hypothesis and my models of it, the simplest of which you will find on the Theory page here.

    For a proper answer, I’m going to have to write two book-length treatments–one popular and the other technical. I have a long overdue contract for the latter with Edward Elgar, and a tentative one for the former with another publisher.

    Once I start on either/both of them, my activity on the blog and in the media will have to fall. But they will together provide a detailed answer as to why levels are unsustainable.

  18. Foundation says:

    Keith said: “Exactly how do you know what is included in House Purchase?”

    It is detailed in the ABS’ Guide to the Consumer Price Index publications. For example:

    The ABS will supply the older documents that are unavailable on the internet if you specifically request them. Here’s a summary of the housing weightings in the 15th series:

    19.53% HOUSING

    Of which:

    5.22% Rents: Rent paid to private and government landlords, including housing authorities (e.g. Defence Housing Authority)
    1.63% Electricity: Electricity charges and connection fees
    0.70% Gas and other household fuels: Mains and bottled gas including connection fees, and other household fuels such as firewood, briquettes and heating oil
    0.77% Water and sewerage: Water supply and sewerage charges
    7.87% House purchase: New homes (excluding land) and major improvements to existing homes, and fixed appliances such as ducted heating, hot water systems and ovens
    1.16% Property rates and charges: State and local council property based rates and charges except water and sewerage
    2.18% House repairs and maintenance: Materials and labour costs for repairs and maintenance to dwellings

    As you can see, the price of land is explicitly excluded. The massive increase in home purchase costs has not been factored into the CPI calculation since 1997.

  19. BrightSpark says:


    There is one other aspect of Engineering which is actaully a law of physics and which seems to be relevant. That is the second law of Thermodynamics and the property of Entropy. Entropy increases indicate loss of order and this occurs when non reversible processes take place.

    This problem of the bubble or the economy is probably the result of a chaotic situation which has arrisen over many years because neo-classical “reforms” which were not reversible have increased the systemic entropy.

    An example of an irreversible change is the deindustrialisation of Australia and the US. “Free Trade” which was not trade (but purchase on credit) resulted in almost instantaneous destruction of wealth creating industries which took years to develop. This was clearly a non reversible process which resulted in increase of entropy.

    The total of these increases in entropy has now resulted in the totally chaotic situation which has developed where people with little understanding of system stability simply do not know what to do.
    The bubble or the economy?

    Many thanks.

    PS I had an LOL situation when I noticed that the RBA has a “System Stability” department. I have never noticed and system stabilty methodology being used by economists!

  20. Bullturnedbear says:

    Hi peter W,

    I couldn’t tell if you were saying wealth had fallen, risen or stayed the same in your two examples.

    Price is extremely arbitrary and that is why over the long term price is susceptible to much larger swings than people believe.

    The commonly held view is that value is relatively stable or constant. Wrong! The people that lived through the great depression know that when the crowd stops buying the value dies. This is true for all assets.

  21. blueinca (Paul) says:

    I still say that house prices are basically maintaining the (high levels)- I live in Melbourne- and if the Real Estate agent doesn’t get what the vendor wants at auction through his dodgey scheming (see my previous rants on ‘Vendor Bidding’) they pass the property in- and eventually the property sells privately – it takes a longer period of time than is has before- but it still eventually sells somewhere near what they want.

    When agents say – there are bargains out there, that prices are falling – DON’T BELIEVE THEM – IT IS SPIN, what is really happening is price GROWTH is not happening- properties are generally making the same prices they did say 4 to 5 months ago- they haven’t continued to rise. But to a real estate agent that means they have another marketing option to push prices, ie: “there are bargains to be had” But:

    There is hardly any property for sale in the Melbourne market in the $400k to $600k range (which these days is classed (in real estate agent speak) as affordable! (What a joke) at the moment.

  22. Peter W says:

    The ‘efficient market’, human behavior, most people measure their wealth against others.

    I don’t believe in the efficient market. I believe that sometimes a significant divergence exists between price and value.

  23. OldSkeptic says:

    Actually this is just another example of “it is really ok, a quick fix and we can go back to business as usual (BAU) again. House prices will continue to rise, speding increase, China buy everything we dig, the richer get richer, the rest get more debt”, that sort of thing. I really think they expect house prices to rise to infinity.

    Wasn’t there an RBA paper just a short while ago, stating that “housing will always be unaffordable” or some rubbish like that?

    Nonsense. BAU is dead. We have to invent another economy for Australia, less consumer speding, more capital spending and investment oriented. A reinvention like what happened after WW2.

    I always remind people that at the start of WW2 Oz was broke, couldn’t even make a gun, basically a large farm and a bit of a mine. By the end we were making the F-22 and F-35 of the era, (the Mustang and Mosquito), plus ships, etc. So rapid change and industrialisation can happen if there is the will to do it.

    Despite determiend efforts it took 50 years to turn back to Oz being a mine and a bit of a farm.

    Off topic: this crisis has have finally answered the age old philosophical question “are humans smarter than yeast”.

  24. Ernie says:

    I would love to see Australia get back to making stuff, all this primary/tertiary sector focus has ruined manufacturing. Even if we only made things for local consumption to reduce some imports of finished goods, with all their crazy global freight. Can anyone see this global financial crisis can help to stimulate local manufacturing as a side effect? Maybe Mr Rudd should have put some of the $10bill into building a government sponsored factory to supply free clothing to people on welfare!

  25. blueinca(Paul), what is typical of a falling housing market is that some vendors are desperate to sell and others are not at all desperate. Clearly, the ones who have more incentive to sell (banks selling repossessed houses, mortgagors defaulting and at risk of foreclosure, and investors\speculators urgently needing capital) will have to accept pricing provided by the market. Others will remove their property from the market. However, once they see the market continuing to trade down, they will be faced with the decision of whether they would like to sell afterall and get the market price at that time or risk getting a lower price later (perhaps when they really do need to sell). This process will take several – perhaps many – years.

    I worked with a guy who bought an investment property in outer Brisbane in 1991 at the tail end of the last property boom. He bought it for $120K and when he retired in 2000 he was tired of the hassles of renting it out and it kept retreating in value. He wanted to consolidate all of his finances going into retirement and spent the best part of a year selling the property. Eventually he sold for $80K – a nominal loss of 33%, a real loss of around 50%, and opportunity cost of much more.

    My advice at the time was to hold on to the property – so I can’t be accused of always being bearish!! (And BTW, right now with the benefit of hindsight that advice might have looked like a no brainer, but I was very much in the minority at the time.)

    I will also add the magnitude and length of this boom – a bubble – suggests that the downturn will be greater and longer. I would not expect new inflation-adjusted highs in housing for a very long time (if ever – following the arguments presented by Steve!)

Leave a Reply