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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  • OldSkep­tic

    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?

  • OldSkep­tic

    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.

  • exa­zonk

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

  • Bull­turned­bear

    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.

  • blueinca (Paul)

    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

  • Peter W

    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.

  • Bull­turned­bear

    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.

  • Keith

    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 ?

  • 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.

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  • Bull­turned­bear

    Well said Foun­da­tion.

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

  • Bull­turned­bear,

    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!

  • Bull­turned­bear

    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!

  • Jonothon Far­ru­gia

    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

  • 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)

  • OldSkep­tic

    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.

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

  • Peter W

    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.


  • 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?

  • chris

    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.

  • Jonothoan Far­ru­gia

    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.….….

  • anon

    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. 


  • Stu­art

    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.

  • Bull­turned­bear

    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.

  • BrightSpark

    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.