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. OldSkeptic says:

    As for prop­erty, I’ve never under­stood the idea that it is an ‘invest­ment”. Now I’m old school (well just old actu­ally). Houses cost money. If your income increases you can have a bet­ter place. It is an expense. The best you can hope for is that when you pay it off you will be liv­ing cheaper then if you rented (basi­cally sped­ing now to save later).

    Now it is nice to live in a good house in an area you like. If you can afford it enjoy, just don’t expect to make any money out of it.

    Another ugly side of treat­ing your house as a cash cow is is that you get the “lit­tle boxes” syn­drome. How many of you have seen the McMan­sions in what used to be nice land? Badly built, unsus­tain­able, ugly rub­bish .. the new slums of the future?

  2. OldSkeptic says:

    There is option: elim­i­nate the debt. Sim­ply can­cel all (mostly irreg­u­lar, pos­si­bly ille­gal) CDO swaps. State “at 0:00 GMT all CDO swaps are null and void”. (Obvi­ously this is inter­na­tion­ally coordinated)

    For those on the down­side of swaps, if they are valu­able to the real econ­omy (eg a con­sumer bank) re-capitalise them. For those on the win­ning side (their oblig­a­tion is writ­ten off), put in an once off spe­cial tax for (say) 10% of their gain.

    Result: this debt gone. More impor­tantly it removes a trans­mis­sion con­duit from the ponzi econ­omy to the real econ­omy, and it is over. This is ‘ring fenc­ing’, pro­tect the real econ­omy, kill the ponzi one. Sim­i­lar to what you do if a seri­ous infec­tious dis­ease out­break happens.

    Ditto for the hedge funds. This is basi­cally an inter­nal econ­omy (or bet­ting house) of its own, with lim­ited links to the real econ­omy. Delete it. If (say) a real bank is hurt by the loss of loans to a hedge fund, recap­i­talise it. If it is a rich investor, let them take the lossses plus add in another once off emer­gency tax change, no tax deduc­tion for their loss (this is not being mean, just clos­ing another trans­mis­sion conduit).

    Funds/banks with secui­tised mort­gages, the Govt buy them at the low­est price (cur­rent rates are less than 10c in the dol­lar). When you buy them, link back to the mort­gage hold­ers, send them a let­ter: “your mort­gage is now worth 10% of what it was”. Trans­lated, keep peo­ple in their houses at a much reduced cost (this improves soci­ety, keeps spend­ing from declin­ing, etc, etc, etc).

    Basi­cally de-leverage fast, while pro­tect­ing the real econ­omy as much as pos­si­ble. I once used and anol­ogy of of cut­ting of an arm to save your life, but this is really a case of expelling some­thing from the body that is harm­ing you, bit like what hap­pens after food poi­son­ing: you are cold and shak­ing com­ing from the toi­let, feel weak but you quickly recover.

    It is too late to avoid a reces­sion, but with the right moves it can be a U rather than an L.

  3. exazonk says:

    I was just won­der­ing if there is an Aus­tralian equiv­a­lent of the Shiller index?

  4. Bullturnedbear says:

    To avoid reces­sion we must con­tinue on the growth path. It’s either up or down.

    Did any­one notice that since about the year 2000 actual infla­tion (what real peo­ple paid for com­modi­ties) has been ris­ing dra­mat­i­cally. I found myself com­plain­ing about it since about 2003. This was most evi­dent mea­sured in gold, oil, other met­als, food, etc. (but not obvi­ous till about 2007)

    That all occurred as a result of mas­sive global expan­sions in the money sup­ply. Which was a con­se­quence of the mas­sive expan­sion of debt. The growth in debt was fueled by overly opti­mistic invest­ment in all forms of assets. An asset mania devel­oped and con­tin­ued longer than any pre­vi­ous time in man’s history.

    Based on his­tory. After an asset mania, peo­ple become risk averse and the process fully retraces itself. The big­ger the mania the big­ger the reversal.

    Most peo­ple I talk to think life will con­tinue as nor­mal. Even many peo­ple read­ing this site appear to believe that. If so you clearly haven’t under­stood or read what Steve and oth­ers have been saying.

    All prices will fall in time (houses too) as the money sup­ply shrinks to cor­rect the mas­sive debt bub­ble. It’s nat­ural and his­tor­i­cal. That is the def­i­n­i­tion of deflation.

    If house prices in Mel­bourne are hold­ing up and you own a house? Sell it before the pub­lic wake up. When they do, fear and risk will take over and the fall in prices will shock everyone.

    What goes up must! must! come down. If not now, some time in the future.

  5. blueinca (Paul) says:

    I think that some of your argu­ments for house prices falling are over-complicated. There is no doubt we are pay­ing ridicu­lous amounts of money for prop­erty, and — yes there are more fore­clo­sures etc these days. But, there are clearly less houses on the mar­ket, there are less peo­ple ready & keen to buy, but there are still many out there (after­all they are still sell­ing hun­dreds of prop­er­ties in each state every week­end) who are still in the market.

    Our intake of migrants is still sig­nif­i­cant– Vic­to­ria has had well over 1,000 new peo­ple each week com­ing to it, for many years now. This peo­ple are not all Soma­lian refugees– these are peo­ple with skills, jobs & money to afford/take on a mortgage.

    I per­son­ally think that with inter­est rates going down– it will relieve a sig­nif­i­cant num­ber of peo­ple who may have come close to fore­clo­sure if rates had stayed high, but now those peo­ple will be able to hold onto their home– ie: no need to sell, there­fore there will be fewer prop­er­ties on the mar­ket. There will still be par­ties who want to pur­chase prop­erty so there will still be a mar­ket– there­fore prop­erty prices will stay rea­son­ably stagnant.

    I WISH I WAS WRONG– because I really need/want to buy a house, but I fear I never will. The dreaded ‘Vendor’s Bid’ by auc­tion­eers used in a tight mar­ket will keep prices up.

    I say again– I hope I am right, because I would love them to fall (30% would be great!) but I fear it won’t hap­pen; there will just be a cycle of hand­ing debt over to next person.

    PS: I see that infla­tion has gone up again. Hey, Mr.Stevens if you fol­low your tip­ping point for putting inter­est rates up based on … what was it?- 2.8% infla­tion while the Lib­er­als were in– you should be putting inter­est rates up! Or, have you finally dis­cov­ered that much of infla­tion­ary causes for this coun­try are external-they are over­seas sourced there­fore they are out of our con­trol, so adjust­ing inter­nal inter­est rates up isn’t going to bring infla­tion down, which is almost at 5% now. I’m glad you have finally fig­ured that out– because you looked incom­pe­tent & sim­plis­tic there for a while

  6. Peter W says:

    A really impor­tant fact is that mort­gage debt is not aver­age in it’s dis­tri­b­u­tion and not symet­ri­cal in its distribution.

    The RBA and the ABS report aver­age debt at roughly $220K (even reported as servicable!)

    This is the ele­phant in the room because they are not think­ing clearly about it.

    Roughly 1/2 of all houses have no mortgage

    Roughly 1/2 have an aver­age mort­gage of $220K

    Of the 1/2 of all houses with a mort­gage the debt is very asy­met­ri­cal, roughly 1/3 of these the debt is <$100K, roughly 1/3 the debt is roughly $400K.

    The 1/2 of all houses that have a mort­gage have a sig­moid shaped debt pro­file if it were graphed.

    (I don’t think I have ever seen Steve do this graph… Give it a crack Steve)

    It’s the asym­e­try and con­cen­tra­tion of unser­vice­able mort­gage debt on 1/6 of all houses that causes the defaults and forced sales in an eco­nomic downturn.

    That causes a con­trac­tion in bank lend­ing = spi­ral effect.

  7. Bullturnedbear says:

    Here’s another way to look at deflation.

    Mar­kets can some­times be a good pre­dic­tor of the future. Even though they tend to over­shoot up or down they usu­ally point in the gen­eral direction.

    Major com­mod­ity prices are down across the board over 50% since their peaks of ear­lier this year. That’s price defla­tion flow­ing from the bet that we will face mon­e­tary deflation.

    Gov­ern­ments will try to cre­ate infla­tion. Can they suc­ceed is the ques­tion. So far the mar­kets don’t think so or the price of com­modi­ties would be rising.

    Japan has tried and failed to beat defla­tion for the last 19 years. I don’t believe gov­ern­ments can cre­ate infla­tion. As the World becomes more fear­ful of loss and sen­ti­ment con­tin­ues to drop defla­tion will intensify.

  8. Keith says:

    Thanks for point­ing that out. I knew it had to be there some­where. The lack of a land com­po­nent is cer­tainly strange to say the least. Per­haps land doesn’t get ‘con­sumed’ ?!?!
    and there­fore isn’t val­ued ?!?!?!?!
    There is a ten­u­ous link to land value through prop­erty rates and charges (when these are based on land val­ues that is), but the weight­ing only reflects the pay­ment of the rates, not the actual charge for the land itself.
    I won­der if the ABS has ever jus­ti­fied this position ?

  9. Foundation says:

    blueinca (Paul) said:
    “But, there are clearly less houses on the market”

    Clearly less? Our inven­tory of unsold homes has risen steadily for over a year. And in the last cou­ple of months, despite falling inter­est rates, this for­merly slow, steady pace has risen dra­mat­i­cally as the num­ber of buy­ers has plunged precipitously!

    Look at the state gov­ern­ments report­ing drops in stamp duty of 30%+. Look at lend­ing finance, down 29% in August com­pared to a year ear­lier (ABS 5671.0 Table 1). The num­ber of Owner Occu­pier loans for estab­lished hous­ing down 31% over the same period, down 25% for con­struc­tion, down 51% for pur­chase of new hous­ing (ABS 5609.0 Table 1). The num­ber of loans to first home buy­ers — upon whom the whole mar­ket ulti­mately depends — down 26% ABS 5609.0 Table 9a).

    The fact is there are plenty of homes out there, and plenty of capac­ity to build more. But there are just not enough peo­ple who are both will­ing and able to buy AT CURRENT PRICES. None of this talk of ‘fun­da­men­tal demand’ makes sense to a per­son with the fog­gi­est clue about eco­nom­ics. Demand is what demand is, and the higher the price, the lower the demand. If the demand is not there at cur­rent prices (and it isn’t), the sit­u­a­tion will ulti­mately resolve itself through a change in price.

    I’m con­stantly amused by the ‘econ­o­mists’ from our major banks, the HIA etcetera who believe that some myth­i­cal short­fall of homes com­pared to this ‘fun­da­men­tal demand’ is build­ing up. It’s a non­sense. But they go on to con­clude that this will put a floor under prices, pre­vent­ing them from falling. What rot! IF there IS a grow­ing pool of peo­ple who wish to buy but can’t or won’t at cur­rent prices, this would not demon­strate a FLOOR under house prices so much as a ROOF atop them!

    Once prices do begin falling (they already are on my data, but the pop­u­lar mea­sures lag way behind), this will let some of these peo­ple buy, but will drive many more away. Falling prices reduce demand. Why? Because the bulk of recent buy­ers have some kind of expec­ta­tion that buy­ing is a good finan­cial move, that prices will increase to com­pen­sate them for the high price they’re pay­ing (2x to 3x equiv­a­lent rent). But the moment prices begin to fall, this expec­ta­tion is gone. It’s replaced with fear of buy­ing today a home that will fall in price in the future.

    The mas­sive spec­u­la­tive pre­mium that is built in to prices becomes not just null, but a NEGATIVE premium!

    There has never been a bet­ter time to sell a home than today. The ratio of achiev­able home price to fun­da­men­tal value has never before been this high, and I doubt it will ever be again within my lifetime.

  10. Pingback: Forgive Mortgage Brokers for They Know Not What They Did | Protect Your Nest Egg in Retirement

  11. Bullturnedbear says:

    Well said Foundation.

    I’m get­ting sick of read­ing the unin­formed opti­mistic denial that every writer keeps spew­ing out.

  12. Foundation says:


    Why do you think no jour­nal­ist has yet picked up on the incred­i­bly sick sale fig­ures or the bal­loon­ing inven­tory of unsold homes? I mean, these were the warn­ing signs in the USA and the UK:
    Prices flat­tened (check)
    Con­struc­tion fell through the floor (check)
    Sales of exist­ing homes slumped (check)
    Inven­to­ries of unsold homes rose (check)
    Prices entered freefall for an unknown length of time (…?)

    And THEN, once prices began to fall, mort­gage defaults began to rise quickly. NOT the other way around. Falling prices were not caused by, they were the cause OF, wide­spread defaults.

    Ditto for falling prices -> credit dry­ing up. And for falling prices -> slump­ing econ­omy and employ­ment. Not the other way around. So I’d really like the jour­nal­ists to stop telling me that prices can’t fall unless one or all of these things hap­pens first!~

    And while I’m on a major rant I wish I never had to again hear any­body tell me that our banks are safe and sound!

  13. Bullturnedbear says:

    Can’t agree more F.

    All I keep hear­ing is that “This will all be over in 6 months” or “We’ll prob­a­bly just avoid reces­sion”. When asked why they believe this, they say “China” or “It’s just a feel­ing” or “The Gov­ern­ment will drop inter­est rates”.

    This denial and mis­placed opti­mism alarms me that the shock and panic will result in much larger dis­lo­ca­tion when it all sinks in!

  14. Jonothon Farrugia says:

    Um, I don’t know where some of you pull your fig­ures from. I have no doubt that ‘blueinca (Paul)’ is cor­rect– there are far less prop­er­ties on the mar­ket at the moment.

    You’ve only got to search through etc, browse through real estate agents brochures to see there is less on the market

  15. I’ll sec­ond that — spot on “F”. I wrote a piece about mort­gage defaults on the “Prop­erty 2009″ online debate being run by Con­trar­ian Investors Jour­nal — Inter­est­ing that there have been quite a few spruik­ers fre­quent­ing the blog, but none have attempted to argue against that piece (or any­thing else I’ve writ­ten there, by the way.) But, hey, I guess they don’t want facts and rea­son­ing to stand in the way of their good time.… (even if it is increas­ingly only in their own minds)

  16. OldSkeptic says:

    blueinca (Paul), don’t worry, keep your job, save your pen­nies and wait. Then you will be able to buy a nice house.

    Now things hap­pen slower here in Oz. We are at the stage of a sell­ers strike, basi­cally because what peo­ple are pre­pared to pay is lower than sell­ers want. That will break (as oth­ers here have so well described).

    Then it will tum­ble. 40% is an aver­age over­all, some areas will do bet­ter (say only 20$) some areas worse (say 50% or more). Good luck.

  17. A friend put me onto this blog, which echoes a lot of Steve’s stuff on Ponzi and Min­sky crises from a US stand­point:

  18. Peter W says:

    What will cause Aus­tralian house prices to come unstuck is the fun­da­men­tal dif­fer­ence between cre­at­ing credit M3 and cre­at­ing cash M0.

    The ele­phant in the room is when both buy­ers and sell­ers dis­cover that credit M3 does not equal cash M0.

    Trans­ac­tions that require a set­tl­ment in cash will fail when it becomes even more obvi­ous the amount of cash in the sys­tem is less than the cash repay­ments of credit out of this cash.


  19. Foundation says:

    Peter W said: “the fun­da­men­tal dif­fer­ence between cre­at­ing credit M3 and cre­at­ing cash M0

    Because they can pro­vide the capac­ity for bor­row­ing but they can’t make us borrow?

  20. chris says:

    All ended up here because the rich peo­ple around the world were all too greedy and the other peo­ple were too opti­mistic that they can also become that rich by doing noth­ing (i.e. investing)

    So it is time to stop being over-optimistic and get more real­is­tic. But the polit­i­cal part of the sober­ing up process will be very, very dif­fi­cult and painful and will prob­a­bly take quite a long time and hope­full will not cause WW3.

  21. Jonothoan Farrugia says:

    Nel­son Alexan­der are sell­ing a Cal­i­forn­ian Bun­ga­low in Pre­ston (Mel­bourne)- which has been ‘updated’ this includes bas­tardiz­ing the whole period detail of the place– includ­ing putting those brown alu­minium slid­ing win­dows in the front and spray­ing the roof that ‘her­itage — Not!’ baby-sick /vomit light brown. And they want over $550,000 for it, no doubt some moronic sap will pay that for it.…. and you think prices are falling.….….

  22. anon says:

    OldSkep­tic, you are right. Sell­ers are on strike, or in denial. Found the fol­low­ing good advice for both buy­ers and sellers: Tough Truth

    The tough truth of a tough mar­ket for sell­ers is this: It’s not “no buy­ers” that’s the prob­lem, it’s that there are “no buy­ers” at the price being asked by the sellers.”

    To poten­tial FHO, do not be a rush unless you enjoy the prospect of Neg­a­tive Equity.


  23. Stuart says:

    Surely, the way to unwind cre­ate is to fix the max­i­mum level of bor­row­ings say the tra­di­tional lev­els. Min­i­mum of 10–20% deposit, and 3 x main wage and 1.5 x sec­ond for aver­age fam­ily. The prob­lem is not just bor­row­ing it is the high per­son tax lev­els, neg­a­tive gear­ing and halved cap­i­tal gains encour­ages spec­u­la­tion. I have bought two rental houses had them neg­a­tively geared, sub-divided the land and sold the new houses built. The profit on the new houses as own over one year are taxed at 1/2 the cap­i­tal gains / mar­gin tax rate. Will a cash injec­tion from the profit after taxes. I have two cash pos­i­tive rental houses.
    Why don’t I put that money into a busi­ness and pro­duce some­thing, try pay­roll tax, the sick days, the non pay­ers and com­pare it with half the mar­gin tax rate and hey..
    The first change must be to alter the tax sys­tem to favour small man­u­afac­tur­ers. Dare I say in mod­ern Aus­tralia make some­thing, not just ser­vice Asia and hope for the best.
    I work in economics/ mar­ket­ing tutor­ing in a uni, where the Asian mar­ket is a lynch pin. I like the guys, I just don’t think
    Y= C + I + G + NX has to be 70–80% C and grow­ing.
    Losses in rental prop­er­ties should be counted as a seper­ate income, losses could only be deducted from future incomes.

  24. Bullturnedbear says:

    Jono F,

    Are you argu­ing that prices have not fallen in Mel­bourne, so they will not fall?

    There­fore you con­clude that, those that say prices will fall are wrong.

    It’s not a very well thought through argument.

    I say sell before the main­stream wakes up. When they wake up and prices do start falling the spi­ral will make it very hard to sell.

  25. BrightSpark says:

    Hello Steve and all

    A thought from the past. Off topic but may be not.

    Henry Lawson’s Dirty Hand of Greed

    Many pseudo “respected” econ­o­mists who espouse the ben­e­fit of the mar­ket refer to the “hid­den hand” described by Adam Smith in his “Wealth of Nations”. He men­tioned it only once in his mas­sive tome and in my opin­ion those who refer to it have nei­ther read nor under­stood Adam Smith’s work at all. These peo­ple use it as a refuge from intel­lec­tu­ally con­sid­er­ing all of the com­plex­i­ties involved if the “mar­ket” and, I feel sure that Mr Smith would be appalled to think that this throw away line in his sem­i­nal work is all that he is now remem­bered for.

    A more valid “hand” is men­tioned by the poet Henry Law­son at a time when the world was faced with prob­lems sim­i­lar to those with which we are pre­sented now, dur­ing the 1890’s depres­sion. In his poem “Free­dom on the Wal­laby” which was quoted in the Queens­land par­lia­ment with demands that Henry be tried for trea­son Henry refers to the “Dirty Hand” of greed.

    And now that we have made the land a gar­den full of promise,
    Old greed must crook his dirty hand and come to take it from us.

    These “respected” pseudo neo econ­o­mists have lead us by the dirty hand of greed into yet another abyss.

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