Regarding Australia I still don’t understand why a “lovely 1 bedroom unit in Ashfield” , “Living area and bedroom are very sunny and airy, 1 car space.” should be priced at >$240000. Is it really the permanent equilibrium price?

In regards to the lag, my vote is with the difference in time between the peak and eventual bursting of the housing bubbles in the US and AU. In the US, the peak occurred in 2006 Q2. In AU, the data seems to indicate the peak occurred around 2008 Q1-Q2.

It was the property price deflation in the US that eventually started the financial problems they are currently suffering from. Now that the AU property bubble is now deflating, I don’t think it will take too long for property price deflation to knock over the AU banking and financial systems. When that occurs, then we will be faced with the devastation that is happening over there.

I’ve read quite a few articles about the desperation that is hurting the people in the US. One of the major problems is that the US has a very skimpy social welfare state while at the same time, its extensive corporate welfare state is enlarging to unseen proportions.

“The U.S. government and the Federal Reserve have spent, lent or committed $12.8 trillion, an amount that approaches the value of everything produced in the country last year, to stem the longest recession since the 1930s.”

http://www.bloomberg.com/apps/news?pid=20601087&sid=armOzfkwtCA4

I’ve found that the economists Dean Baker and Michael Hudson have probably the best ideas when it comes to solving the property crisis. Their articles are definitely worth reading.

I already asked that question in the past – what would be required to artificially push the system from the deflationary trajectory back to the growing bubble trajectory?
What is the sensitivity of the system to external stimuli during the switchover phase?

Couldn’t we imagine the bubble for 5 years more? Why didn’t it burst 5 years ago?

I would like to add the following:

The government has prevented the mortgage debt bubble from deflating by FHOG. On top of that there were money handouts used often to increase the margin for future debt repayments and lubricating the system.

If prices of houses are prevented from falling the system is in a kind of pseudo – “equilibrium”. How long this will last nobody knows. There is no extra financing of consumption from the Ponzi speculation however there is no drop in the demand due to the rush to repay the debt. There is no “wealth destruction” due to falling prices of assets – spiraling out of control, driving the demand further down and bankrupting the banking system.

This might be the real meaning of aggregated variables used in the model created by Steve. I am still very far away from having enough intuitive knowledge of the processes in the economy to start modeling them on my own (if I am ever able to). But I have a feeling that a more realistic model which could be used to forecast the dynamic behaviour of the system when external stimuli are applied may need to work at a different level of granularity – not on a macro-scale but on a meso-scale.

Now let’s imagine even more desperate measures to prevent the bubble from collapsing – the ban on repossessions (effectively already in place in Australia), creating artificial demand at the lower end of housing market by replenishing the pool of social housing assets and what sounds ridiculous – a tax on early mortgage repayments. Do you think we cannot imagine that?

We should never underestimate the willingness of politicians to fiddle with the system.

However I agree that these measures can only work to some extent and once the bubble really starts bursting it’s all over – nobody will be able to push it back to the other trajectory.

“If we get out of this crisis with only a mild downturn, and the recovery is not based on a return to increasing debt to GDP ratios, then I will be forced to take a much more critical look at my fundamental analysis.”

I for one have found Steve’s past explanations for a severe deflationary depression quite convincing and I still hold that belief.

Why is Australia still so much better off than countries overseas?

I think at least the follwing factors (probably more):

1) As you indicate, the money poured into the economy has ‘postponed the evil moment’.
2) Whilst the debt is still huge, asset values have not yet fallen sufficiently to expose the problem.
3) Social mood has been up-beat, following the initial signs that property values are not falling so much and we pin great hopes in China saving our exports.
4) The stockmarkets have been bullish re-igniting a belief that the worst is over.
5) Traditionally in Australia there is a delay time before we follow overseas trends.

However, I think it’s a temporary holiday, because:

1) The government cannot keep feeding unlimited moneys into the economy for ever.
2) High debt caused the problem in the first place, it must be resolved by bringing down the debt.
3) As you have shown so convincingly our housing is amongst the most unaffordable in the world and must fall. China has been stockpiling metals and iron ore, not supported by demand, so soon there will be dramatic cutbacks in their orders.
4)During the Great Depression the stock market in the US had several bull runs (one by as much as 52%), yet overall the market fell by a massive 89% during this period. What we see now is just history repeating.
5)As things turn worse again overseas the social mood here will also change and it will need only a small ‘quake’ for the tidal wave to hit us.

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Thanks, and yes, on behalf of most of the site here I expect you are right: the Australian data isn’t yet as severe as that in the USA, Europe and Japan, and that does perplex us. There’s also the standard human response to discount information that doesn’t account with your world view, and I’m the first to admit I’m human on that front, even if I try to be more sceptical than the standard economist.

However there are also data reliability issues that we have been aware of ever since the 2008 budget when the ABS’s funding was recklessly cut, and the ABS responded firstly by reducing its sample size by 24%, and then later by sacking (and since being forced to reinstate) about 150 staff. So I had some expectations of unreliable data.

The data is also massively contradictory. I don’t know whether Evan spotted it for the PoolRoom, but Tim Colebatch (I think) in The Age on Tuesday reported on the huge discrepancy between the Production, Expenditure and Income versions of the recent quarterly GDP figure: the first showed GDP falling by about 1.5% in the quarter; the last two showed an increase of about 0.5%. That is an enormous difference, far bigger than the usual statistical discrepancy.

The unemployment data is also surprisingly benign–at the moment.

My main response is still to accept my analysis of the economy’s dynamics, and ask what I haven’t sufficiently factored in to explain why the deterioration in unemployment hasn’t been as sharp as I expected. A major issue here could be the sheer scale of the government response to date–the $42 billion plus the rest amounting to about a 4% boost to the economy in the short term (though some of course dissipated in debt repayment and lots lost offshore in imports). My usual calculations of the debt contribution to demand have omitted the increase in government debt; I will factor those into the July Debtwatch and see what change that makes (the measure is also approximate only of course–hypothesising that all extra debt represents a matching increase in monetary demand when part if compound interest and part also is non-bank debt that doesn’t increase demand).

If we get out of this crisis with only a mild downturn, and the recovery is not based on a return to increasing debt to GDP ratios, then I will be forced to take a much more critical look at my fundamental analysis. But I still expect that the comparatively mild figures we are seeing for Australia reflect the different nature of our linkages to the global economy than for the rest of the OECD (and hence a time lag between our situation and the USA of about a year), and the size of the government stimulus to date counteracting the initial downturn–again with the advantage of taking palliative action a year before the USA, in effective timing terms.

You asked how I arrived at my number. Firstly as I said before there is a lot of guess work in the calculation, so it is a bit ‘rubbery’, nevertheless here goes. In view of your comment Outback about earlier numbers being more relevant, I used the CBA annual report (AR) for June 2007 (before the effects of the GFC). I also chose the CBA because (as I understand it) they have a higher proportion of residential mortgages than the other banks.

I also used information from the APRA Insight One publication, published in 2008, but referring to data for 2006 (APRA).

The AR shows Residential loans as $190,337 million (note 13) and SHF as $24,444 million (balance sheet). Note 13 also shows years to maturity in 3 ranges (1 year, 2-5 years and 6 years+); 80% of the amount has 6 or more years to maturity. Here comes my main guess: mortgages often go for 30 years or more, so the average time to maturity for these loans could be any number between 6 and 30, but highly unlikely at either extreme; for the 80% of the loans at the longer end I chose 9 years, which is probably at the short end. But pick any number of years around that mark and the conclusion is not that different.

With the earlier years thrown in, overall the average (weighted)length becomes 8.4 years (say 8 years). Eight years ago the average house prices were 50% cheaper than in 2007. So a bank that issued a loan at 80% of collateral value 8 years ago would in 2007 have a loan only 40% of latest collateral value; in other words the price of a house would have to fall by 60% before there is a shortfall on the loan.

The APRA publication states that on average 30% of bank loans have mortgage insurance, meaning the insurer will pay the bank for any shortfall (as long as the insurer does not go broke), so assuming CBA fits this average and 30% of its loans are insured it would not lose any money on this part of the loans.

APRA also states that the average loan to value ratio on which the loans are initially based is 67%, with the largest group (just over a quarter of all loans) in the 75 to 80% LVR range, with the second largest (just under one-fifth of all loans) the under 50% LVR group.

Using the above data I made this calculation:

$190,337 minus $57,000 (30% loans with mortgage insurance) = $133,337.
Initial property values at 67% LVR = $199,000
Average property values 2007, 8 years later (double) = $398,000.
Loan to asset values in 2007 (133337/398000) = 34%.

Even if we used an original LVR of 80% the LVR on latest housing prices is still only 40%. If we go one step further and also shorten the average age of loans to only 6 years (obviously far too short), the LVR on latest prices is 45%.

This only focussed on residential mortgages and I realise that business loans may also be under threat, derivatives could incur losses and I am not clear what other traps there may be in off-balance sheet items?

BTB, you may be right about the quality of SHF and maybe all the numbers in the banks’ accounts aren’t worth the paper they are written on; but that is another story. Maybe I have overlooked something important in these calculations, I’m not a banking expert, if so please let me know.

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