It’s the leverage, stupid

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So I’m walk­ing to Kosciusko–now that the ABS Estab­lished House Price Index has cracked its Sep­tem­ber 2008 peak of 131 to reach an all-time high of 134.4 (as of Sep­tem­ber one year lat­er). This renewed bub­ble reversed the trend of falling nom­i­nal house prices that had dropped the index to a low of 123.8 in March 2009.

This lev­el of price volatility–down 5.5% in 6 months, only to rise 8.5% in the sub­se­quent six months–almost match­es the stock mar­ket’s man­ic-depres­sive per­for­mance.

Though you’d see no men­tion of it if it you only read Chris Joye (“Keen con­cedes defeat”), the main fac­tor behind the revival of the bub­ble is what is for­mal­ly known as the  First Home Own­ers Boost (FHOB), but what is more accu­rate­ly described as the First Home Ven­dors Boost. As at the end of September–the date of the lat­est ABS house price data–171,000 appli­cants had received this $7,000 bribe. Since many are cou­ples, more than 1 per­cent of Aus­trali­a’s pop­u­la­tion has leapt into the prop­er­ty mar­ket pool at the behest of a gov­ern­ment stim­u­lus.

So how has a mere $1.2 bil­lion injec­tion of gov­ern­ment mon­ey dri­ven the aver­age house price up by 8% in six months? By the “mag­ic” of lever­age: the typ­i­cal First Home Buy­er (FHB) took that $7,000 to the bank and lever­aged it up to anoth­er $40–50,000, which then was hand­ed over to the First Home Ven­dor (FHV) as cold, hard cash.

The FHV then took that extra $40–50,000 and lever­aged it to an addi­tion­al $200,000-$250,000, which meant that that new place which had been just out of reach pri­or to the FHOB was now well with­in range. Com­pet­ing with oth­er lucky recip­i­ents of gov­ern­ment and bank largesse, he drove up the price of that mid­dle to upper tier house by an addi­tion­al $100,000 or more.

The aggre­gate impact of this gov­ern­ment entice­ment into pri­vate debt was that Aus­tralian house­holds reversed the delever­ag­ing process that had begun in late 2008, and as a result the mort­gage debt to GDP ratio, which had been falling, began to rise once more. The FHOB has led to Aus­tralians tak­ing on an addi­tion­al $50 bil­lion of mort­gage debt. That “demand” fac­tor, far more than any oth­er, is why I’ve lost the sec­ond half of Rory’s bet with me.

Nor­mal­ly I regard the “ceteris paribus” assump­tion of con­ven­tion­al eco­nom­ic the­o­ry as a copout–in a mar­ket econ­o­my every­thing is con­nect­ed to every­thing else, and you can’t assume that, for exam­ple, a fir­m’s out­put can change with­out affect­ing the mar­ket price. But I think I’m enti­tled to ask the “ceteris paribus” ques­tion here: what would have hap­pened to house prices had the gov­ern­ment not spiked the mar­ket with the FHVB? I some­how doubt that Rory would be crow­ing today had that irre­spon­si­ble pol­i­cy move not been made.

In fact, there’s a good argu­ment that we would­n’t be hav­ing a prop­er­ty bub­ble here at all, were it not for the First Home Buy­ers pol­i­cy. I’m not one for mak­ing argu­ments sole­ly on sta­tis­ti­cal correlations–I’m only too aware of the “cor­re­la­tion isn’t cau­sa­tion” argument–but I think I can also spot a smok­ing gun when I see one.

Pri­or to the FHB, though real house prices were ris­ing, so was real house­hold dis­pos­able income. Then add two dollups of the FHB–one its intro­duc­tion as a “tem­po­rary” mea­sure to get us over the shock of the GST in 2000, the oth­er its dou­bling to boost the econ­o­my dur­ing the brief 2001 recession–and off go real house prices rel­a­tive to real house­hold dis­pos­able income.

Last year, as the mar­ket starts to head back towards par­i­ty between house prices and incomes again, Rudd throws in anoth­er tem­po­rary dou­bling (of this tem­po­rary mea­sure that is now almost a decade old), and off goes the house price bub­ble once more.

In the main, I’ve been a crit­ic of bank­ing prac­tices as the under­ly­ing cause of the Glob­al Finan­cial Cri­sis. But I also believe that the cri­sis would have occurred long ago (in 1987) and been far less severe if gov­ern­ments and Cen­tral Banks had­n’t attempt­ed to res­cue the sys­tem from its own fol­lies. The First Home Own­ers is a clas­sic gov­ern­ment fol­ly, and its dou­bling last year is the main rea­son I’ll be walk­ing to Kosciusko some time in April 2010.

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