“Lies, damned lies, and statistics” is part of a phrase attributed to Benjamin Disraeli and popularised in the United States by Mark Twain: “There are three kinds of lies: lies, damned lies, and statistics.” The statement refers to the persuasive power of numbers, the use of statistics to bolster weak arguments, and the tendency of people to disparage statistics that do not support their positions. (Wikipedia)
Two recent speeches by the RBA supported the contention that Australian house prices are no longer overvalued, that mortgage repayment costs have returned to historic averages, that Australia is suffering a housing shortage, and therefore that the Australian housing market should not experience the catastrophic falls that are now commonplace across the OECD–and especially in the USA.
Ric Battellino’s speech to the Urban Development Institute of Australia (An Update on the Economy and Financial Developments) gave no data, but was optimistic about the future prospects of the housing sector. The data supporting this optimism was supplied in a speech by Anthony Richards to the 4th Annual Housing Congress (Conditions and Prospects in the Housing Sector).
Though Richards acknowledged that prices had fallen somewhat in 2008, he emphasised that this was less than had been experienced overseas. He also hypothesised that our market would not suffer similar falls in the future:
there are a number of reasons to think that outcomes here might remain better than elsewhere. These relate both to the role of policy in responding to the downturn and the consolidation of household finances that has occurred in Australia since our housing boom slowed earlier in this decade, around the end of 2003.
Two key pieces of evidence Richards presented were the following graphs. The first compares current mortgage repayments to a “long run average” that was based on data from June 1986 until now.
On this indicator, a house purchase is currently about 15% more affordable than the long term average (the dot on the graph estimates current affordability after recent rate cuts).
The second graph shows the ratio of the median dwelling price to household disposable income, again with a comparison to the average (this time from 1993 till now).
From this perspective, housing was not quite as affordable when compared to historic averages as the above measure implies, (since the former includes the impact of today’s very low interest rates whereas the latter does not). But it was still only marginally above the historical average, and Richards surmised that the rising trend up till 2003 may have reflected the transition to a lower inflation environment:
In addition to mortgage rates, the second determinant of standard affordability measures is the ratio of housing prices to income. At present, this ratio remains slightly above its average over the low-inflation period (Graph 3). Of course, there may be good reasons for it to have experienced a trend increase over recent decades as the economy adjusted to a structural shift to lower inflation.
Richards’ overall conclusion was that, on the statistics, Australian house prices were not overvalued,
… it is noteworthy that the housing price to income ratio has declined significantly since its peak in late 2003. Over the period since end 2003, nationwide house prices have grown on average by 4 per cent per annum, versus annual growth of 14 per cent in the prior five-year period. And the growth rate of house prices in the past five years has been well below the 8 per cent average annual nominal growth in household disposable incomes.
So the price-income ratio, a frequently used – but crude – measure of housing price valuation suggests that any overvaluation of housing prices has eased significantly since the Australian housing boom slowed significantly in late 2003. Since then, households have had significant income growth, but that growth has flowed only to a modest extent into housing prices.
Richards expressed some reservations about the degree of undersupply of housing in the Australian market, but overall agreed with the common assessment that the relative shortage of housing supply would place a floor under the Australian market, in contrast to the oversupply situation in the USA:
“Whatever the true shortfall of dwellings, we can say with some confidence that our housing market is relatively tight. This can be contrasted with the US market which many observers characterise as having been subject to overbuilding during their housing boom. And the relative tightness of the Australian housing market is one factor that will support home-building in the period ahead.”
His conclusion supported the belief that, even though a recession will occur, the housing sector will not suffer price falls like those that are commonplace overseas, nor will problems with housing exacerbate the recession itself. If anything, the housing sector should boost the wider economy rather than drag it down:
First, the recent significant falls in the cash rate are having positive effects on the economy and the household sector, and have contributed to a significant improvement in household cash flows and in measures of housing affordability for people paying mortgages or contemplating home ownership. Second, although home-building is likely to remain weak in the near term, there are a number of factors which should support activity over the medium term, providing stimulus to the broader economy. Finally, when one looks at the behaviour of the household sector over the past five years – in particular the trends in housing prices, and household income, spending and borrowing – it is evident that there has been a significant degree of consolidation since the housing boom slowed in 2003. This will reduce the vulnerability of the household sector in the current slowdown.
Richards analysis, along with Battellino’s implicit endorsement of its conclusions, was picked up by commentators like Alan Woods in “Housing damage won’t be drastic” (The Australian, April 03):
Now, of course, we have the worst global recession since the ’30s and an international credit crisis, but an authoritative analysis last week by Anthony Richards, the Reserve Bank of Australia’s resident housing expert, highlights several important reasons for expecting Australian housing prices to perform better than in many other countries.
Woods was reassured by the reported fall in “the ratio of housing prices to income, … Richards says this suggests any overvaluation of housing prices in the boom years also has eased significantly”, and his qualified endorsement of the argument that house prices will be buoyed here by “the gap between housing supply and demand as a result of a rapidly growing population.” However on the latter point, Woods noted that “a shortage of housing hasn’t stopped a crash in prices in Britain”.
Overall, while he emphasised that Richards’ speech provided “an impressive list of positives”, he felt that the recession would still come out trumps: “the most likely outcome is at best a period of stagnating house prices, with a real risk of a fall, albeit a far more modest one than in the US and Britain.”
Now, in the spirit of Benjamin Disraeli, let’s take a slightly more critical look at the numbers–starting with the comparison of the median house price to income.
House Prices to Income
The footnote to Richards’ Graph 3 states that the figure used for average household disposable income was “after tax and before the deduction of interest payments”. This is curious, since the RBA’s own measure of household disposable income is after the deduction of interest payments (see RBA Bulletin Table G12 and the Notes).
The average line Richards drew on Graph 3 is also curious, since it is an average since 1993. This may reflect how long a time series for the median house price that the RBA got from the Real Estate Institute of Australia, but it would not have taken much effort to combine this with the ABS’s median house price indices and provide a house price to disposable income calculation that went back to 1987. That is done in the next Figure–using index numbers since I don’t have access to the REIA’s median house price data.
This Figure paints a very different picture of the current house price to income ratio.
Firstly, there are now “twin peaks”: unlike the RBA’s modified house price to disposable income ratio that peaked in 2004 and clearly fell thereafter, the highest value of this ratio was in January 2008. So on this measure, Australia’s house price bubble did go off the boil a bit in 2004, but it went right back on again in 2006. Rather than our house price adjustment starting before America’s, on this price to income comparison our bubble continued well after the acknowledged bursting of the US bubble in mid-2006.
Secondly, rather than the current value being just a smidgin above the 93-09 average, it’s 27% above it–and it’s one third higher than the “long term average” from 1987 till now.
So which ratio is more valid here–one derived prior to the payment of interest (Richards), the other derived after it? A case could be made for either: if you’re contemplating buying a house, then you’re contemplating taking on a interest payment burden (and principal repayment burden) that you don’t currently have; but on the other hand, you might be substituting rental payments (out of disposable income) for interest+principal payments.
So it could be seen as a judgment call as to which to use–in which case, for objective presentation of the data, you should present both.
Or perhaps use a few more indicators to decide which one, on balance, gives the more accurate picture. For example, here’s the ratio of the median house price index to GDP per head. It is currently 25% above the 86-08 average, and the second peak in early 2008 is 1.65% higher than its 2004 predecessor.
It’s also no secret that income has been massively skewed in favour of profits rather than wages in the last few decades. So how about a comparison of the house price index to average weekly wages (ABS 630203, Column J), which is a fairer analysis of how expensive housing is for the average family of workers?. This is currently 43% above the 86-08 average:
There are those pesky Twin Peaks again, and once more the second (in March 2008) is higher than the 2004 one the RBA prefers to see as the peak of the housing bubble–this time a substantial 9% higher, reflecting the continuing erosion in workers’ incomes over the last decade.
Certainly, it’s not possible to make a conclusive statement that 2003-04 marked the peak of the Australian house price bubble, as RBA officials have done on many occasions, nor can it be said that household affordability is now back at the “long term average”.
Which raises the next question: just how “average” was the 1986-2009 period, in the long sweep of Australian history?
House Prices over the really long term
The ABS has only maintained a comprehensive index of Australian house prices since mid-1986–a time when the hills were alive to the sound of Alan Bond and Christopher Skase. House prices rose 60% in the first three years of the index, far above the rate of inflation at the time. They then stalled for the next few years before more than tripling over the next 17 years–again, a rate of growth that far exceeded the rate of inflation. This 30-year-plus experience of continuously rising prices has helped shape the belief that house prices “always” rise faster than consumer prices.
But “always” is a much longer time span than a mere 30 years–something Robert Shiller appreciated when he and Karl Case developed the index of US house prices now known as the Case-Shiller Index. The key comparison Shiller makes is between house prices and consumer prices; this is the premiere indicator of the American market, and there it’s clear that the bubble has popped.
If we take a 25 year view, like that which Richards used in his paper, it could be argued that the fall in the index has almost brought the real price of American housing back to the average. Having plateaued at a value of 217 between 2005 and 2007, it has now fallen to 138, which is just 11% above the 85-09 average.
But if we look at the really long term–over the whole data set from 1890 till now–it’s apparent that the American market has some way to fall before it hits the average: even though it has already fallen 30% from its peak, it still has another 46% to go, if the real price of housing is constant over the long term.
That’s an if to which Shiller gives an emphatic “yes” to, based partly on his own data–which shows no trend to rising real house prices prior to the current bubble that clearly began in 1997–and partly on a yet longer term series still: the “Herengracht Index” that shows the real price of housing on a famous canal in Amsterdam over the three and a half centuries from 1628 till 1970. This index has at times risen for extended periods–such as over the 7 decades between 1814 and 1887 when the real price of a house on the Herengracht Canal rose almost fourfold. Anyone born at the beginning of that period could have easily been persuaded that house prices “always” rise faster than consumer prices.
But over the long term, there is no trend. For the next 7 decades, house prices tended down in real terms: the index fell 55% from the 1887 peak to be 40% below the long term average of 198 in 1951, when yet another upward trend occurred.
Could a similar proposition apply to Australia? Dr Nigel Stapledon set out to answer this question in his PhD, where he observed that:
The period since the early 1970s has been one in which house prices have risen quite significantly by any measure with the median capital city house prices in Australia having risen on average 3% per annum in real terms in the period 1970-2006. While the rises in Australia have been above the average for developed countries, the picture is similar in most OECD economies and Australia is by no means unique.
The question that can be asked is whether this period is unique for housing? Eichholtz (1997) has constructed a long term series for Amsterdam in Holland which spans the period 1628-1973. The broad picture that his time series paints is one of prices essentially showing no trend for three centuries, with cycles related to the economic events. Against that long term perspective the post 1970 rise in house prices in Holland stands out. But one city is probably not convincing…” (Stapledon 2007, p. 1)
Stapledon’s key data table gave the median capital city house price in current dollars, 2005 dollars, and 2005 dollars deflated by 0.6% p.a. to reflect increasing house quality. In the following graph I take Stapledon’s CPI and quality deflated index, extended to today using the last 2 years of ABS data deflated by the CPI. I then set the value to 100 in 1890 to enable easy comparison with the Case-Shiller real house price index for the USA.
One inference from this graph is that the recent Australian house price bubble began earlier at much the same time as the USA’s (1997), but began from an already higher base that can be dated back to the 1987 Stock Market Crash.
At that time, the Australian index was only marginally higher than the USA’s–132 for Australia versus 120.5 for the USA, a 10% difference. But the 25% fall in the Australian stock market on Black Tuesday ended the Antipodean flirtation with stocks, and we piled right back into our favourite speculative play: bricks and mortar. Most of the money borrowed by Australian households for speculative purposes then drove up house prices, whereas Americans spread their leveraged dollars between stocks and houses.
As a result, Australian house prices absorbed most of the speculative excess of the last thirty years, driving them to 3.5 times the long term average versus “just” twice the average in the USA.
Of course, it could be true that, as the property lobby keeps asserting, Australia is “different”, and trends that don’t exist elsewhere in the world rule in the land of the marsupials. Especially since virtually everyone now describes this crisis as “the worst since the Great Depression, it would have helped if the RBA had referred to this publicly available data when preparing its own comparison of current house prices to “long term” trends.
The Never-Ending UnderSupply Story
Richards did express some scepticism here on behalf of the RBA that Australia’s undersupply of housing was as marked as some commentators claim, but he still came down on the side of this widely shared belief:
“Whatever the true shortfall of dwellings, we can say with some confidence that our housing market is relatively tight. This can be contrasted with the US market which many observers characterise as having been subject to overbuilding during their housing boom. And the relative tightness of the Australian housing market is one factor that will support home-building in the period ahead.”
Curiously, one group that does not share this belief is Hometrack, the local branch of the UK housing intelligence research group. Just days after Richards’ speech, it released a press release in which it stated that:
the widely quoted views of many property market commentators who believe that Australia’s current building levels are not enough to meet the future demand for housing, may be based on inaccurate data calculations.
“Our analysis indicates Australia may already have an excess of housing. We estimate there are at least 10 million dwellings in Australia compared with ABS data showing occupied dwellings of 8.3 million. The extra one to two million dwellings consists of a mixture of housing awaiting sale or development, vacant dwellings, second homes, and abandoned homes,” he said.
He went on to say that the ABS method for calculating the ratio of people per dwellings is based on ABS census data which in turn is based upon occupied dwellings. However, he said, Hometrack analysis which is based on postal address data indicates that Australia’s current level of housing relative to its population is in line with other Anglo economies.
Following on from this, Darcy said that when looked at in the context of population growth, total residential building approvals have been running above demand.
“This points to a build-up of excess stock of housing over the past six years, despite the gap between building approvals and demand narrowing over recent months,” he said.
“The concern is that business and government decisions regarding the residential housing market in Australia are being made based on demand assumptions that differ from the actual behavior of the housing market. There will always be examples of areas with an undersupply, but it’s not clear from the data that we have an overall shortage relative to future demand.”
Similar views have been expressed on contrarian blog sites like Bubblepedia, Homes4Aussies, etc.; this is the first time this claim has been made by a commercial property research group. The claim that there are up to 2 million unoccupied houses in Australia may appear extreme, but that is the size of the gap between the number of houses that the ABS says are occupied (8.3 million) and the 10,150,000 street addresses in Australia Post’s PAF database. However, many of these are business addresses, holiday homes and the like. On the other hand, the ABS found that 800,000 private dwellings were unoccupied on Census Night 2006–close to Hometrack’s bottom estimate of 1 million unoccupied dwellings in 2009.
So how valid is Hometrack’s claim? One way to assess this is to look at the growth of population in Australia, and compare it to the growth in the number of dwellings. If this ratio was substantially above the ABS estimate of the average number of persons per occupied dwelling, then the undersupply thesis would be confirmed and Hometrack would be off-track.
Whoops. Over the period 1985-2009, an average of 1 residential dwelling was built per 1.75 new Australians, and only in the last 3 months has the rate of new building fallen behind population growth. This build rate is well in excess of the current ABS ratio of 2.55 persons per occupied dwelling. Only if 30% of new dwellings involved the demolition of existing properties–an improbably high number–would the rate of supply of new dwellings be running behind the rate of growth of population.
Far from having an undersupply of housing, Australia may well have a substantial oversupply. It’s just that no-one is living in many of them.
So what could these unoccupied residences be? Holiday homes? Some, of course, but surely not all of them. It is far more likely that many of these include “housing awaiting sale or development,” and “vacant dwellings”, as Hometrack put it.
A very likely cause of this large stock of unoccupied homes is Australia’s system of negative gearing. Most “investors” build houses not for the rental income, but for capital gains, and rental returns in Australia are now so low that for many investors, the drawbacks of renting–damage to property, having to manage tenants, etc.–are not worth the rental income. Better to keep the property off the rental market, and claim the loss against tax. The under-supply of housing to the rental market, and the alleged shortage of properties for sale, could be a perverse result of Australia’s peculiar property development laws.
This implies that the market dynamics could turn out to be very different than those who believe there is an oversupply expect. If prices start to fall substantially, then many owners who have kept their properties off the market may be motivated to bring them out of mothballs. The “undersupply” of both rental properties and houses for sale could thus evaporate, and rather than supply issues putting a floor beneath house prices, they could well pull the rug out from underneath them instead.
A final issue considered only tangentially by Richards, but vital to the question of whether “the forces of supply and demand” will prop up Australian house prices, is leverage.
Exit, Stage Down
In defending the dominant view that Australian house prices are justified by supply and demand, Richards observed that:
“the relatively high level of housing prices in Australia is to a large extent a reflection of demand and the collective decisions of households. That is, housing prices have not been set at high levels by some external force. They are at their current levels because buyers in aggregate – with their incomes, preferences, access to finance, and other influences – have been willing to pay those prices.” (Richards; emphasis added)
This is a fairly typical piece of neoclassical economic thinking: prices reflect the interaction of supply and demand, and are therefore justified. In most markets, there’s not much wrong with this way of thinking; but there’s something unique about housing. You don’t take out a loan to buy the groceries, but you do to buy a house. What therefore will happen to demand if lenders become less willing to provide “access to finance”?
While the boom was on, loan to valuation ratios (LVRs) were rising; now they are falling as credit standards tighten. Though average LVRs are of the order of 50%, it’s the marginal LVR that matters, since that’s the source of leverage for new buyers. Accurate data on this isn’t easily available, but the impact of a drop in leverage can be dramatic. A fall from 95% to 90% in the maximum LVR a lender approves will halve the amount of money that a buyer can bid for a property.
Economists who apply a standard “supply and demand” mindset to analysing the property market seem to consider that demand can shift “left and right” as the volume of buyers falls and rises with time; but they seem to ignore that the “demand curve” for housing can shift up and down as well, in response to the willingness of lenders to increase or decrease their LVRs. A substantial fall in LVRs to new buyers could thus reduce the price that would-be buyers can offer, even if there was a physical shortage of properties.
Conclusion: Safe as Houses?
The data in support of the belief that Australian house prices will not suffer during the forthcoming recession is therefore nowhere near as conclusive as Richards’ speech implies. The price index might well be driven higher in coming months by the artificial stimulus imparted by the doubling of the First Home Buyers Grant (see FHB Boost is Australia’ s “ Sub-prime Lite”); but the downside risks to Australian house prices could be every bit as big as those that apply in other OECD nations.
Australia is not therefore justified in being “relaxed and comfortable” about house prices, despite the RBA’s assurances to the contrary.
This would not be an issue were the RBA simply another property market advocate: it’s common practice for both sides of the property market to quote data that supports one side and ignore the other. However, the RBA is not supposed to take sides in this debate, but instead to set monetary policy in the best interests of Australia as a whole.
I have argued consistently that, in common with Central Banks throughout the world, the RBA has failed in this task because it has followed an economic philosophy–known as “neoclassical economics”–that is fundamentally flawed. But this is something that, in some ways, the RBA can’t really be held accountable for: its economists are simply a product of academic economics departments around the world, and since these are dominated by neoclassical economists, most graduates are not going to know that there is any other way to think about the economy.
However when it comes to statistics, the RBA should play the role of honest broker rather than advocate. Its monthly Bulletin Statistical Tables provide a valuable resource. I believe its time would be better spent in developing robust, long term statistics on the housing market than in presenting selective data like that given in this speech.
END OF COMMENTARY
Comments on Data
The latest set of figures imply that the Great Deleveraging is well and truly underway. Aggregate private debt rose by a mere $326 million in the last month, with only mortgage debt turning in a positive–and were it not for the FHB Boost, the aggregate debt level would certainly have fallen.
Table One
Table Two
While debt levels have to fall, this process will necessarily cause a dramatic blowout in unemployment. Since our economy became so utterly debt-dependent, the contribution that rising debt makes to aggregate demand has come to dominate changes in economic activity and unemployment. The recent “larger than expected” increase in unemployment will become a recurrent phenomenon this year, as the change in debt starts to reduce aggregate demand rather than increase it.
In this respect, we are not so much different to the USA as merely running behind it in time. The explosion in unemployment that has virtually doubled unemployment there in the last two years will occur here, and possibly at an even faster rate.
As in the USA, what the authorities are interpreting as a liquidity crisis is actually a solvency crisis. Debt levels are now so high that the only way is down, and there are no other groups who can be encouraged to take on yet more debt and thus pull us out of this crisis as household borrowing did when it brought “the recession we had to have” to a close.
Now the only way forward is via deleveraging, and the great danger is that this will occur in a climate of falling prices–deflation–as well as falling output. This process could drive aggregate debt to GDP levels even higher–as it is now doing in the USA: there the ratio of debt to GDP is rising sharply, even though the rate of increase of debt has dropped. Fisher’s Paradox–that the attempt to reduce debt levels can actually cause debt levels to rise–is now with us once more. The world is paying a terrible price for listening to Milton Friedman and ignoring Irving Fisher and Hyman Minsky.
To add further to my comments about the Fujitsu/JP Morgan study, one thing it does not take account of is the quality of housing that the first home buyer is purchasing over time. (Because it just compares the average FHB loan with rents, and median house prices are not factored in.)
Towards the end of my recent paper I plotted the ABS median price series versus the ABS average FHB loan size (for Brisbane).
For simplicity I’ve uploaded it here –
http://www.geocities.com/homes4aussies/loangap.gif
From 1997-2001, the gap between the
average first home buyer loan and the median price was consistently close. Through this period the median home was around 20-40% more than the average first home buyer loan.
A first home buyer taking on the average loan in this period was able to afford the median home if they had a deposit in the range of 25-35%. With houses one-third the current price – it was a deposit of around $40,000. Specifically, from 1997 to 2001 the deposit required was equivalent 1 to 1.5 times the average annual wage.
Not all would have had such a deposit, but we can assume that from 1997-2001 a great majority of first home buyers were buying median-equivalent homes or very close to it.
By March 2008 the median home was over 80% more than the average first home buyer loan! And a first home buyer taking out the average first home buyer loan and purchasing the median priced home needed a deposit of $210,825 which was almost 4 times the annual average salary !!
Of course we know over that period first home buyer LVRs have been rising. So, whereas before the bubble a good proportion of FHBs would have been buying a median equivalent, very, very few are now even though they have higher LVRs.
So, when we take account of the lessening quality of FHB housing compared to the general stock, affordability is still worse than what the Fujitsu/JP Morgan study suggests (which wasn’t particularly good in any case).
Some good calls Evan.
In terms of supply. I believe supply plays a very small part in the price determination of houses. Supply is used by the HIA, planners and property industry to get their way.
Since 2003 construction has been falling and prices have been rising (reasonably slowly except for WA and QLD). So on the surface one could conclude that a slow growth in supply leads to rising price.
But in November ’07 the buyers started disappearing and prices started falling. There is no way that supply rose dramatically around that period causing prices to fall. On the contrary, supply was growing more slowly, which should have caused prices to rise.
Demand trumps supply by 9 to 1 (my made up numbers) every time. If the buyers get into a frenzy the prices rise whether there is supply or not. In fact the price rises create supply. “My house is not for sale, but if the price is right, everything’s for sale”. Has anyone heard that before?
Ask Brettforhomes what has happened to demand in Brisbane. He has the numbers to show that the volume of sales has crashed by at least 70%.
Demand sets price. Supply follows a long way behind.
Demand is driven by sentiment. Supply follows sentiment by the same forces.
Hi Everybody,
In case you are not aware, the RBA publishes some interesting charts the day after each meeting (today):-
http://www.rba.gov.au/ChartPack/output_expenditure_activity_fincon.pdf
Page 1
* GDP – Annual rate now approaching zero
Page 2
* Household Consumption and Income (1996-now) – Consumption is at a historic low, whereas disposable income is now at a historic high. This tells me that people are are really scared and are hoarding money or paying off their loans as fast as they can.
* Consumer Sentiment (1990-now) – consumer sentimate is now as low as it was 1993.
Page 3
* Household Debt and Interest as percentage of household disposable income (1984-now)- From 15% interest has now dropped to 13%, which is still very high from a historical perspective. Debt (Steve are you there?) has only just started to drop after peaking at 170%.
Page 4
* AFFORDABILITY (1994-now) – Has improved significantly since the reduction of interest rates, but is still at historically LOW LEVELS.
* Established house prices – Just starting to turn down so it looks like we have a way to go!
http://www.rba.gov.au/ChartPack/share_markets.pdf
Page 3 (this one is for you Bullturnedbear)
* P/E Ratios and Dividend yields for world and Australia stockmarkets (1975-now) – Australian P/Es have dropped to where they were in the 70s & 80s. Australian dividend yields have now climbed to the highest level in 34 years (around 7%) or possibly longer as that’s as far back as the chart goes!
Just a note on AFFORDABILITY:- This is actually “Home Loan Affordability” and since it is still low, this tells me interest rates need to go down further and if the banks stop passing on the RBA rate cuts then the only way affordability will rise is if house prices fall as predicted by Steve, homes4aussies etc. Also, if the current level of interest rates have reached the level of wholesale funding then the banks are unlikely to pass much more on to us even if the RBA continues lowering rates. In other words, we may have now hit the wall on interest rates and as a result a UK or US style housing collapse may be on its way?
Dear Chris,
Perhaps my language confused you. My comparison was of “rate of new dwellings (flow) to rate of new people (flow).”
Re: “Your chart has the ratio of persons per occupied dwelling as a flat line from 1985 to 2010. This is extremely unlikely.”
The wiggly line was the year on year data Chris. The flat line was the average over the 25 years.
Yes, I know. Austrians were much more likely to spot the crisis than neoclassicals, and they emphasise disequilibrium, but they don’t do so in a way that “operationalises” it–except for Schumpeter, whom for some reason most self-described Austrian economists don’t regard as “one of them”.
I’ve put off doing a detailed critique of them for the same reason that I haven’t taken on some sub-species of Marxist economists–such as the “Temporal Single System” lot. Firstly there’s only so much time in one lifetime; secondly, I’d rather develop an alternative analysis than get bogged down in yet more critiques.
So many one day when I have some spare time…
That’s true reason, and I have a chart looking at the real rate of interest which is scarier still than the nominal one. Then 1990 drops off the radar as a period of stress, and the only times that compare to now are the 1890s and the 1930s, when deflation of up to 10% p.a. made the real interest repayment burden slightly higher than it is today.
I’m working on making my data presentation and graphing systematic for the book I’m now working on, and when that’s ready I’ll finally maintain a graphs page–and a data page with the help of some blog members.
Hi All
Please see this article from a Nobel Laureate no less suggesting a closer link to house prices and consumer debt to today’s crisis and to the Great Depression. This doesn’t seem to have been something mainstream economics has discussed openly before (that I have seen).
Cheers
http://online.wsj.com/article/SB123897612802791281.html#printMode
Unfortunately Vernon Smith is not mainstream flash,
Even though he was awarded the Nobel Prize. He was one of the first to develop “Behavioural Economics”, and is one of those mavericks outside the neoclassical fold who is occasionally awarded a Nobel. Others like him include Gunnar Myrdal, Amartya Sen (to some degree), Herbert Simon, Bertil Ohlin, Wassily Leontief, and Simon Kuznets.
Steve writes:
A major reform we need to introduce is to strengthen tenants’ rights, and get longer term leases becoming commonplace here.
I respectfully disagree on the second point. I doubt that I would ever advise someone enter into a long fixed term tenancy agreement. When you start a tenancy, the landlord is most likely an unknown quantity, with no reputation or brand to protect; and if you need to move, breaking a long fixed term can be a very expensive pain in the bum.
A better way to provide security to tenants would be to remove landlords’ ability to give notices of termination without grounds. This would be no great loss for the majority of landlords who give notices only where they have a good reason for doing so, but it would be a great benefit for the peace of mind of tenants.
I entirely agree on the first point. Renting shouldn’t be awful. The NSW government is currently considering the first comprehensive review of tenancy laws in 20 years – it is not too late to contact your local MP and tell them that you’ll vote for the party that gives tenants a better deal.
More about tenancy law reform here:
http://www.tenants.org.au/publish/policy-law-reform/index.php
cheers
Chris M
homes4aussies,
From Stapledon’s data, have you managed to create an estimate of how great a percentage of property price deflation is required for Australia to return to long-run averages? How much property “paper” wealth is likely to be destroyed?
flash and Steve Keen
I suggest the article:
http://online.wsj.com/article/SB123897612802791281.html#printMode
shows Steven Gjerstad and Vernon Smith are neoclassical thinkers, because they appear to treat each bubble in isolation, much like an external shock, as an independent event. For example they questioned:
“But what sparks bubbles? Why does one large asset bubble — like our dot-com bubble — do no damage to the financial system while another one leads to its collapse?”
The reason is clear: Greenspan prevented that last bubble, as well as several bubbles before it, from running its natural course, which would have been a decent recession. He prevented a proper bust by re-inflating it through loose monetary policy (1% Fed fund rate for more than a year). The result is the current deflating housing (and credit) bubble which is the last of the sequence of bubbles starting at least since the 1987 crash, after which the Fed fund rate has trended down continuously from more than 10% to now effectively 0%.
In a sense, it has been one continuous bubble for more than 20 years. The current bubble could be the culmination, the final bubble to end this sequence of bubbles. But it may not be, if the Bernanke helicopter of cash succeeds, though it is looking more and more likely to be. If Bernanke does succeed, then the next bubble would boggle the mind.
The search for something special about this bubble by Gjerstad and Smith really misses the point that it is a historical process of credit expansion and not an isolated historical accident, per neoclassical economics. The postponement of the day of reckoning has to culminate in a total collapse, which by definition must involve the most number of people and hence the households and the consumers. To say it is a “great consumer debt crash” is to state the obvious.
Reason, you obivously havent read many of my previous posts. I clearly come down on the side of the Behaviourial economics. I do, and I’m sure others also find it interesting that many of those who have had some insight into the current mess are from the Austrian school of thought, I do agree with you that some of these “Austrians” are a bit out there and clearly dont have all the answers. I’m not sure you could call Peter Schiff or Marc Faber “full of holy scripture and unshakeable belief backed by limited evidence”.
Far from being a radical Austrian, I think a revised economic theory is clearly needed, this may include many of the advances made in other areas of study like psychology and engineering. This new theory may also contain some of Benoit Mandelbrots wisdom and suggest reading the (mis) behaviour of markets. To who I owe my successful risk management career to.
I agree with others, that there must be something lacking with the current economic theory if someone like Alan Greenspan couldnt see the US housing bubble.
I suggest you watch Risky Business from the ABC program Catalyst, to really understand which side of the fence I sit.
I was recently reading The place of Mises’s Human Action in the development of modern economic thought by Joseph Salerno. Mr Salerno seems to have a problem with Schumpeter’s favourable view of the Walrasian general equilibrium theory. Googling around, I also found a recent blog post by an Austrian entitled Was Schumpeter an Austrian?. This goes on to talk about Minsky also but it’s hard to follow for a layman.
Since you’re a “student” of Minsky, perhaps it makes sense that you like Schumpeter because Minsky was his student. I’ve heard Austrian’s say that they like his exposition on Entrepreneurship.
That’s perhaps a little unfair. Have the “Temporal Single System” Marxists forewarned of the current crisis? The Austrian economists did see this crisis coming. You fail to mention them on your about page refer to other commentators who foresaw the crisis. You speak of the Austrian’s here with what appears to be some disdain. You may know that their theories are flawed but to myself and other laypersons the Austrian explanation of the business cycle makes a lot of sense. The Rothbardian solution of abolishing central banking, outlawing fractional reserve banking and instituting “free banking” is also fairly natural (but much debated). This view is supported by an ethical framework of personal and economic freedom (built up from natural rights). It all seems very plausible to the layman. Perhaps particularly to the prudent saver who sees that prudent savers are protected in such a system (and reckless companies are allowed to fail).
It would be very useful to at least one interested “observer”. We’re all economists these days as we all have skin in the game
. We are all trying to understand this crisis and protect ourselves and our loved ones from it. Perhaps you could bullet point your main objections to the Austrian School so that those of us who are enticed by their theories can be on the lookout for the flaws.
Well put Drew.
Agree entirely Lyonwiss. I’m putting a post together on that topic in fact. I trace the bubble back to 1987, in the sense that had there not been Fed intervention then, the preceding debt bubble would have burst at only Great Depression levels. Instead the Greenspan rescues have let debt levels get twice that high, at least.
Smith is not quite a neoclassical thinker, but as I’ve come to realise from meeting a number of those who’ve become non-orthodox “from within”, so to speak, he hasn’t strayed far enough from the neoclassical mould.
But also allow that this was a newspaper piece. I expect there is some more systematic thinking behind Smith’s argument, but not the sort of thing that can be expressed in a targetted newspaper column.
“You may know that their theories are flawed but to myself and other laypersons the Austrian explanation of the business cycle makes a lot of sense.”
Yes, I suppose if you ignore the reality of banking, assume that bankers will not act as capitalists (and so not seek profits by extending credit), assume that, unlike every other market, the credit market can be in equilbrium, and so on, then, yes, I suppose it could make a lot of sense…
http://anarchism.pageabode.com/afaq/secC8.html
Nor should we forget that von Hayek LOST the business cycle debates of the 1930s. First Sraffa and the Kaldor destroyed his arguments (the later did so twice). That is part of the reason why the “Austrian” theory was shunted into the sidelines, where it has remained ever since.
“It not only proved to be vulnerable to the Cambridge capital critique . . . , but also appeared to reply upon concepts of equilibrium (the ‘natural rate of interest’, for example) that were inconsistent with the broader principles of Austrian economic theory.” (J.E. King, A history of post Keynesian economics since 1936, p. 230)
“The Rothbardian solution of abolishing central banking, outlawing fractional reserve banking and instituting ‘free banking’ is also fairly natural (but much debated).”
So “natural” that no economy has ever tried it. Those economies which did approximate “free banking” were pretty unstable, for example 19th century America. As for “outlawing” fractional reserve banking, really? How would that be done? Why would any private defence company take the costs onto itself of strictly regulating an industry so?
“This view is supported by an ethical framework of personal and economic freedom (built up from natural rights).”
Nope, supported by an ideological love of private property which ignores the obvious fact that private property can restrict personal freedom, all built up from an abstract set of assumptions which (by happy coincidence) led to the desired conclusions. Just like his economic ideology…
http://anarchism.pageabode.com/afaq/secF1.html
“It all seems very plausible to the layman.”
And not remotely plausible to, say, anyone familiar with the genuine anarchist tradition or who has some idea how a real economy works.
Iain
http://www.anarchisfaq.org.uk
Thanks for the comments.
When I read the Smith and Gjerstad article It seemed like it was the first time I had read that the Great Depression was perhaps related to consumer debt involved in real estate rather than stock market speculation and business debt. I expect it was a combination of the two (consumer debt in the stock market and real estate as well as business debt) but the emphasis in that article was certainly different to others I had read. If this is true, that the real estate consumer debt component of the Great Depression has been forgotten or down played over the decades perhaps this explains why the real estate credit bubble was ignored by at least Greenspan?
Steve, do you think your graphs support a real estate bubble in the 1920s with consumer debt ?
I am one of a few but growing number of people who believe that people like Hugh Pavletich, Wendell Cox, Oliver Marc Hartwich, and Alan Moran have the key to this problem and we are ignoring tham at our peril. For the benefit of those who haven’t followed the argument, here is what I insist you should check out.
Wendell Cox and Ronald Utt: “Don’t Regulate the Suburbs: America Needs a Housing Poliicy that Works”.
http://www.heritage.org/Research/SmartGrowth/bg2247.cfm
Alan Moran: “The Tragedy of Planning: Losing the Great Australian Dream”
http://www.ipa.org.au/library/MORANPlanning2006.pdf
Those who insist that factors other than land use rationing, such as taxation treatment of housing, are responsible for housing bubbles, should look at page 54 onwards, (page 61 of the PDF) where Moran gives analysis charts of these factors accross a number of countries that have exerienced housing bubbles.
Oliver Marc Hartwich and Alan Evans: “Unaffordable Housing: Fables and Myths”
http://www.policyexchange.org.uk/images/publications/pdfs/pub_38_-_full_publication.pdf
On page 17 is a graph of previous house price bubbles in the UK. The UK just happens to have had land use rationing decades ahead of everyone else. They have also had house price bubbles decades ahead of everyone else; they just never got the connection.
Oliver Marc Hartwich and Alan Evans: “Bigger Better Faster More: Why Some Countries Plan Better Than Others”
http://www.policyexchange.org.uk/publications/publication.cgi?id=47
Germany has policies of funding local government which are powerful incentives to development and construction. Consequently, Germany has not had a house price bubble other than in a few locales where local anti-development sentiment was strong enough to survive the cost impact of consequent loss of funding. They have had a nationwide 1990’s construction boom and subsequent depressed property prices which are frequently misinterpreted as a “bubble”. They do not, however, have huge increases in household debt backed by the “faery gold” of house price inflation, and subsequent wipeout of equity bringing the whole banking and finance system down. Germany can honestly say that the impact on their economy is spillover from outside their borders. Just about no other country can say that, including NZ and Australia.
I badly wish for more evidence than this, but this is pretty conclusive to my mind.
Why property price bubbles, nearly everywhere, at this time? There have been numerous periods of monetary looseness in the past which have led to bubbles in the share market. I would argue that every potential property bubble in the past was spiked in time by construction booms, other than in the UK, obviously. But the 1980’s and 1990’s were marked by the advancement of environmentalism and urban limits and planning and land use rationing. Just as environmentalist mismanagement of forestry policy has finally had to be blamed for unprecendentedly destructive forest fires in California and Australia, it is high time that the true blame for the housing bubble crises was directed that way also.
I also insist that a property price bubble will get underway against all other obstacles, because of land rationing policies alone. Alan Moran’s comparisons are conclusive that CGT’s and other taxation treatments made no difference. I would argue that land rationing policies could cause property price bubbles even under a gold standard. Think about this. All that is required is for prices to be unable to be relieved by supply, and mania to do the rest. The (temporary) gains for speculators in such a bubble will naturally be more attractive than virtually any other investment. The starving of productive capital of investment, as a result of the bubble, will indirectly contribute to the bubble’s ultimate collapse. This is because of the effect on incomes, of productivity being affected adversely.
Did the famous tulip bubble not take place under a gold standard?
When a housing price bubble gets underway, Reserve Banks increasingly find themselves “holding a tiger by the tail”. Raising the base interest rate will depress PRODUCTIVE activity which is already being depressed by the diversion of investment into real estate. But the demand for finance for the housing bubble will have been having an upward effect on interest rates anyway. Meanwhile, the cashing-out of increased house owner “equity” will have been driving consumption, which will not have been resulting in increased productivity either.
But a lower base interest rate, in the absence of other seriously depressing effects, will immediately have a highly volatile effect. NZ did not get this effect like the USA did, as our Reserve bank did not “do a Greenspan” any time there was a clamour for lower interest rates. In a way, we can thank them for that, but on the other hand, a housing bubble will inflate and blow up regardless, it will just blow up quicker under the low interest rate scenario. That is what we desperately need to avoid now; we desperately need to avoid tracking the US experience any further.
As I intimate above, NZ is thus far avoiding the highly volatile response to lower interest rates that was experienced in the USA, at least partly because we are already up to our eyeballs in debt even under the higher interest rate scenario, and partly because there are other depressive factors at work, like the rest of the world imploding around us………
But what would Bollard and Co hope to achieve by “stimulating the economy”, Greenspan style, with lower interest rates? All we would be doing, is tracking the USA from 2001 onwards, only we would be starting from a very much worse position regarding our debt and the inflated prices of our houses.
The biggest favour the National government could do our economy now would be to just let the builders loose on whatever land anyone anywhere will sell them, and let low interest rates combine with LOW HOUSE PRICES and small mortgages, to leave as many income earners as possible with as much REAL discretionary income to spend, as possible.
(Sorry, I am obviously a New Zealander, my comments do apply to Australia in some ways too, as readers will understand).
Please excuse me, what I am doing here is pasting arguments I have made recently on “Interest.Co.NZ”.
One of the problems in trying to control a housing bubble by the base interest rate (Greenspan didn’t even believe there WAS a housing bubble in the USA) is that not only is the housing bubble not based on the other fundamentals of the economy, it is de-linked from them. In some cases, the fundamentals are being driven by the housing bubble; like consumption being driven by people cashing out home “equity”, rather than by incomes. As long as house prices cannot be brought down by the building trade and free availability of land, bubbles will occur and will blow up eventually. The OCR will seem to have played a role in so far as the bubble has been inflating more rapidly when the OCR is low, and possibly bursting at some point when the OCR is raised, but meanwhile everything else in the economy will have been pushed completely out of kilter. Incentives to save, what to invest in, productivity, wages…….
The fundamentals should drive house prices and the fundamentals should also drive what the Reserve Bank does with the OCR.
The global crash problem in a nutshell; investment in productive capital was siphoned off into a speculative bubble in real estate.
Previous speculative bubbles have been mainly confined to financial markets. Why? There is a certain limitation on “supply” of business, in the shares of which speculation can take place. Such bubbles ultimately pop, and investors lose, in a matter of hours.
Speculative bubbles do not take place in commodities for which supply responds to demand. What Austrian economists call malinvestment can occur when production is boosted to meet demand that is not “real”, but damaging as this is, it is nowhere near as damaging as speculative bubbles are in their own right. What some people call a “housing bubble”, where a lot of cheap homes are built as in Texas recently, is really “malinvestment”. In these conditions, prices of all real estate is actually kept low because of the over-supply; that is not a “bubble”. Left to itself, these over-supply situations would be limited in their consequences as the suppliers would quickly adjust to the reality of lack of sales, and demographics and migration and economic reality (affordability) would ultimately take care of the empty homes. But price bubbles just carry on and on inflating until they reach the point where the economy cannot sustain them, by which time catastrophe is the unavoidable consequence.
Why did speculative price bubbles not take place in real estate before this particular time? The simple reality is that land supply was not restricted to the same extent or for as long as was required for bubbles to get underway. An interesting exception I can point you to, is the UK. The UK has been experiencing severe housing price bubbles since way back in the 1960’s; the obvious consequence of their much earlier adoption of anti-development land use restriction policies.
Allowing these bubbles to occur in real estate is an economic error of an order of magnitude of difference to bubbles in financial markets which the small proportion of people with money to burn enter voluntarily, and the fortunes that are made on paper and wiped out do not leave huge economy-distorting amounts of debt behind them.
Not so housing. Housing affects everybody. The total sums of money are not only much larger than the sharemarket, the debt that remains when the values on paper collapse is an order of magnitude larger and affects a high proportion of the population. Nor does the bubble burst in a matter of hours, with values quickly resetting at realistic levels; denial and paralysis besets the whole economy for years.
Productive capital gets starved of investment both coming and going: both as the bubbles were inflating and as they deflate. This is grave in its implications.
Did ANYONE have the wisdom to see this coming? I’ll tell you what, precious few have even got the wisdom today to see that this is “what happened” and what “is happening” still.
First, we need “domestic savings”. It wasn’t “domestic savings” that were going into buying houses, it was borrowing – debt – created by monetary inflation.
We need to be prepared to utilise resources, and utilise them efficiently. We need to make it less hassle and less risky and just plain less unpopular to be in business and make money. We need to reduce if not abolish corporate tax; we need to abolish the employment grievance shakedown industry and wind back the holiday and maternity leave and so on that we thought in the years 1999-2008, that our economy could afford. And we need to wind back the toxic combination of the RMA (Resource Management Act) and the anti-development powers bestowed on councils that are responsible for the double whammy of restricting productive investment and allowing house prices to bubble by interfering with supply, and also wind back the fee gouging by councils.
Our economy could NOT afford it in reality even then. THIS assessment, which I have just read, is exactly applicable to our situation; I have been looking for a long time for this sort of assessment:
http://www.dailyreckoning.co.uk/economic-forecasts/the-mystery-of-britains-missing-recession.html
Fred Harrison: “The Mystery of Britain’s Missing Recession”
EXCERPT:
(You could change “Gordon Brown” to “Michael Cullen” and it would still be true)
“…..If the business cycle had played out in the way that we would have predicted on the basis of historical trends, the price of houses would have deflated in 2001-2. This would have been the outcome of a mid-cycle recession. Instead, under Gordon Brown’s stewardship, the residential sector was allowed to bubble. This set new benchmarks for prices: the next housing bubble would have to inflate to stupendous levels before finally collapsing and driving the economy into the Depression of 2010.
But in the meantime, Britain’s consumers were on a spending spree. They borrowed like there was no tomorrow to finance the purchase of luxury goods, holidays in exotic locations, new cars, and improvements to their homes. Following the election of New Labour in 1997, consumption grew faster than output, with retailers sucking in imported goods to make up the difference. Between 1999 and 2001, consumption grew exactly twice as fast as Gross Domestic Product (GDP). Unsecured consumer debt rose at an annual average rate of nearly 11% over the five years to 2004. While Gordon Brown preened himself with declarations about his virtuous ‘prudence’ in handling the nation’s public finances, he sanctioned private bingeing that undermined the culture of thrift……”
PhilBest adds:
While Michael Cullen preened himself about fiscal prudence, NZ consumers went on a spending spree that artificially inflated our GDP and our business turnover and profits and the government’s taxation revenue. We SHOULD in reality, going by what was happening to NZ’s productive capital and productivity, have been in recession already and tightening our belts and the government should have been cutting wasteful spending, not embarking on new binges; and the government should also have been freeing up the productive sector, not imposing new burdens on it.
Interest rates need to be decided by the interaction between the willingness of people to save and the demand for productive capital.
The interference with this that results from housing bubbles (and any other speculative bubbles) is what is destroying modern economies today, even leaving aside the issue of whether the central banks can get the OCR’s right.
A bubble develops through expectation of returns. Those expectations cannot be dampened by interest rates. Interest rates that would dampen a housing bubble, would kill productive business off in the process. That is why Reserve Banks are “pushing on a string” as long as housing issues are unresolved.
As Hugh has pointed out, the correct term for building lots and lots of houses, is a “boom” rather than a “bubble”.
The effect of the two different things on the issues at hand, are quite different.
We definitely are in agreement about the need to get investment going in the direction of productive activity. But in the light of the huge “pluses” that result from affordable housing, I would be prepared to simply ignore the occaisional building of “too many” new homes; in fact, the effects of prices being too high are so much more serious, that I think a little bit of oversupply would be the “best” sign to look for at all times; it would show that the market is not being interfered with in the direction of rationing.
A price “bubble” drives itself to the level at which it collapses, only through mechanisms that will ensure economy-wide destruction in its wake. But a construction “boom” rapidly undermines the reason for its own existence, it is self correcting.