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.

    M3 > M0

  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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