After extensive and much appreciated critical feedback on the draft designs, this blog entry showcases the three T-Shirt designs I’m producing for the Walk to Kosciuszko.

Each has the words “I was hopelessly wrong on house prices. Ask me how” as required by the bet. Each also has a graphical answer to the question:

  • Timing;
  • Our Debt Bubble; and
  • Government manipulation of the market in the form of the First Home Owners Grant.

Some blog members have made strong cases for a plain T-shirt, but I will stick with the graph-augmented designs. I entered public debate to make the points that (a) we were in for a serious debt-induced economic crisis; and (b) that conventional economic theory had helped cause this crisis by ignoring the role of credit. I intend using this Walk to continue communicating those messages.

I’ve taken aboard the observations that the distorted text made it harder to read both the text and the graphs, but I am placing the text strategically in each graph to emphasise the message of each T-shirt.

Some bloggers have also argued that I should replace “Walking against Australia’s property mania” with “Walking against Australia’s property bubble”. I am sticking with mania, because I believe that future generations, looking back on this period, will regard it as at least the equivalent–and probably the Master–of previous ages of delusion like the Tulip Mania, the South Sea Bubble, and John Law and the Mississippi Company. Charles Mackay popularised the word “mania” to describe such periods in his masterful Extraordinary Popular Delusions and the Madness of Crowds, and I think that term fittingly describes the period of delusion we are living through.

If the above choices mean that the T-shirts work less well for visual bites on TV and the like, so be it. I would rather see them as historical artefacts first, and communication devices second.

1: Timing

The first T-shirt shows CPI-adjusted house price indices for Japan, the USA and Australia, starting from the common date of June 1986 (the earliest date in the ABS time series for established home prices).

Japan’s real house price index rose by 54% between 1986 and 1991 during its Bubble Economy phase, peaked at 154.75 in February 1991 in the early days of the Bubble’s bursting. By March 2009 had fallen to 63.961–a fall of 58% over 18 years.

When Japan’s Bubble Economy fell into the heap that became known as The Lost Decade–and which is now closer to The Lost Two Decades–there were numerous commentaries that something as absurd as Japan’s bubble could never occur in America, given its much more efficient and transparent financial system. As a well-educated Minskian economist, I scoffed at the time at such reports, but even I didn’t appreciate how accurate my scepticism would prove to be.

The American real estate bubble–which began in 1997 after a period of relatively depressed prices after the 1990s recession–clearly dwarfed Japan’s. Between 1986 and late 2005, American real house prices rose by almost 88%. They then fell 36.5%, before starting to rise again recently–with the US version of Australia’s First Home Owners Grant playing a large role in the turnaround. Though prices have apparently bottomed, there are plenty of arguments to expect this to be only a temporary respite–from the size of the inventory of unsold houses to the approaching wave of defaults by mortgagees whose Alt-A “Option ARM” mortgages are about to reset).

However, both the Japanese and American house price bubbles are pygmies compared to Australia’s bubble. Australia’s still unburst bubble drove the real price of housing to 140 percent above the level of June 1986–that is, real house prices are now 2.4 times what they were in mid-1986 (the peak in real terms is still the pre-First Home Vendors Grant level of January 2008, though the nominal index is now 8 higher percent than then).

2: Our Debt Bubble

The reason that our house price bubble has kept going while other less hardy companions have already popped is the same old same old: debt. The T-shirt itself emphasises the aggregate level of private debt to GDP over the last 150 years, to make the point that this is the biggest debt bubble in our history. The previous two record highs were in 1882 at 104% of GDP, and 1931 at 77% of GDP. Today’s record is 158% as of March 2008.

This comparison actually understates the degree to which our current debt predicament is worse than any previous one, since those previous peaks were affected by deflation: the debt to GDP ratio rose between 1930 and 1931 (and 1890 and 1892) despite falling debt levels, because output and prices were falling faster than debt. In the 1930s, this phenomenon increased the debt to GDP level by about 10 percent over its pre-crisis peak.

We have yet to experience deflation, and yet our current debt level already far exceeds those previous peaks.

Household debt has played a pivotal role in this bubble. The next chart (which won’t be used for a T-shirt) makes that point. Mortgage debt rose fivefold (as a percentage of GDP) between 1990 and today. Without this debt binge, Australia’s private debt to GDP ratio today would be only slightly above the 1930s peak, rather than being twice its level.

The chart also highlights one other important point: a large reason why Australia has had such a mild GFC so far is because Australian households were enticed back into debt by the First Home Vendors Boost, and by the impact of the Government stimulus package upon household disposable incomes.

Households were reducing their mortgage exposure prior to the introduction of The Boost: mortgage debt had peaked at 81.3% of GDP in June 2008, and was trending down prior to the Boost. It then hit a bottom of 80.3% in December 2008 before rising to an all-time high of 86.8 in January 2010.

The change has been less extreme when mortgage debt is measured against Household Disposable Income (HDI), since the Australian government’s stimulus package and the interest rate cuts by the RBA boosted household incomes by almost ten percent last year. As a result, mortgage debt fell only slightly as a percentage of HDI, from 133.6% to 130.3%, and it took longer to fall. But ultimately, even though incomes had been boosted so substantially, the increase in mortgage debt last year finally exceeded the increase in incomes: by January 2010, the mortgage debt to HDI ratio had hit a new peak of 134.2%

The overwhelmingly important reason why this happened is the policy that the Government called the First Home Owners Boost, and which I describe by the more accurate name of the First Home Vendors Boost. As the final T-shirt shows, this is the fifth time in Australia’s recent economic history that the Government has manipulated the property market as a means of stimulating the economy.

3: The First Home Owners Grant

The First Home Owners Grant was first introduced in 1983; while it’s hard to locate discussion on why the grant was introduced (here’s a Hansard link for anyone with more time on their hand than I have to research this), the Grant was introduced when Australia was deep in the recession of the early 1980s, and during the first year of the new Hawke Labor Government. It is therefore likely that then, as now, the Grant was intended to boost economic activity by encouraging the housing market.

That was explicitly the purpose to enhancements to the Grant in 1988, in the aftermath to the Stock Market Crash of the previous year. The 2000 reintroduction of the Grant by the Howard Liberal Government was ostensibly a short-lived boost to the housing sector to get it over the impact of the introduction of the Goods and Services Tax (GST), but it was quickly turned to its customary role of boosting economic activity when a recession was feared in 2001 and the Grant was doubled.

The introduction of the GST is long forgotten of course, but the Grant lived on–and it was then boosted again in September 2008 as part of the Rudd Labor Government’s stimulus package to fight the GFC.

Each time it was introduced, the Grant worked as intended–and it worked not merely because it injected additional Government money into the economy, but also because it encouraged Australians to take on more mortgage debt. Each additional A$1,000 was turned into anything up to an additional $10,000 of buying power, so that while the Buyer got an additional $7,000 from the Government, the Seller (after a very satisfactory auction…) got an additional $30,000 or so from the buyer’s bank.

The Seller then used this money in turn to get a still larger loan from their bank, so that the Grant money was levered at least twice.

This double leverage is a major reason why we have a housing bubble today–and why we had one in 1988, and 2001 before that.

I don’t, like some analysts, blame the housing crisis solely on government policy: for me, the ultimate cause of our housing and financial crises will always be the innate willingness of the financial sector to extend debt. But it is certainly obvious that Government meddling in the housing market has seeded a bubble that the financial sector has then been only too willing to exploit.

As long-time readers know, I railed against this latest manipulation of the housing market when it was first introduced, and again when the scale of take-up of the Boost was first reported. My first post was the only one to draw a response from a Government Minister to any of my writings. Though this reads like a form letter that many critics of this policy may have received, the exchange is still worth reproducing here:

—–Original Message—–
From: Steve Keen [mailto:S.Keen@uws.edu.au]
Sent: Tuesday, 14 October 2008 8:59 PM
To: undisclosed-recipients:
Subject: Debtwatch comment on First Home Buyers Policy
I argue in the attached that doubling the First Home Buyers grant is a continuation of the policies that caused the economic crisis in the
first place.
Associate Professor Steve Keen

From: Plibersek, Tanya[mailto:Tanya.Plibersek@fahcsia.gov.au]
Sent: Thu 16/10/2008 5:19 PM
To: Steve Keen
Subject: RE: Debtwatch comment on First Home Buyers Policy [SEC=UNCLASSIFIED]
Dear Steve

Thanks for your email about the First Home Owners Boost announced by the Prime Minister and Treasurer. I understand the concerns you raise in your email, however, as well as helping Australians into a home of their own, this measure will bring much needed stimulus to the housing market to support the Government’s macroeconomic agenda at a time of serious global uncertainty.

Housing is very important to the Australian economy. Investment in housing accounts for about 6 per cent of the overall economy, and housing is the major source of financial security for millions of Australians and their families.

Expanding support for first home buyers in this fashion is right for the uncertain economic conditions that we now face. It will also help to shore up housing activity in a sector that may otherwise slow. I have attached a fact sheet which provides some more information about the announcement.

Best wishes

Tanya

From: Steve Keen [mailto:S.Keen@uws.edu.au]
Sent:  Thu 16/10/2008 7:05 PM
To: Plibersek, Tanya
Subject: RE: Debtwatch comment on First Home Buyers Policy [SEC=UNCLASSIFIED]

Dear Tanya,

I appreciate your perspective, but I remain of the opinion that this is a misguided policy.

The housing market was seriously over-stimulated by debt-financed speculation in the last one and a half decades, and most of that stimulus did far more to boost price levels and increase unaffordability, than it did to increase supply.

The financial security promised by housing has become financial insecurity in the USA and the UK, and much of the OECD, and it will inevitably prove so for Australia too, which as you are aware has the most expensive housing relative to incomes in the OECD. True security only exists when house prices keep step with incomes. When they rise faster for sustained periods, on the back of even faster increases in debt, the financial wealth created is both fictitious and fragile, as we are now seeing on the daily news.

Part of the reason for Australia’s speculative bubble [I have made a slight grammatical edit here of the original] is the plethora of schemes in Australia which encourage speculation on house prices–from negative gearing, to capital gains tax at half the rate of income tax, the exemption of capital gains on principal residences, and of course the first home buyers scheme.

I would be far happier to see schemes to support renters and strengthen their rights, than yet another to encourage first home buyers into a grossly overvalued market.

Nonetheless I appreciate your email, and would like to keep in contact about this and the broader issues involved in our economic crisis.

Sincerely,
Steve

Now The Boost is behind us, and the evidence is in on its impact. There is no doubt that it stimulated the economy–possibly as much as the rest of the stimulus package and the RBA rate cuts combined. It also stimulated house prices through the roof–and it’s the main reason why I’ll be walking next month.

But it worked by seducing Australians back into debt, since (as I observed in a previous report), house prices can only continue rising compared to incomes if debt continues to rise faster still. This could continue after The Boost if the fire the Government lit in the market was carried on by “investors”–and that was and is certainly the hope expressed both by the Government and the property lobby.

My expectations, and that of many other critics like Adam Schwab, was that the FHVB would boost buyer numbers while it lasted, but cause a slump (in First Home Buyers at least) when it finished because (a) it would drag in many would-be First Home Buyers who would have purchased in later years into purchasing in 2009, thus inflating 2009 numbers at the expense of subsequent years; and (b) it would inflate prices so much that many other would-be First Home Buyers would decide to continue as renters instead.

That’s just from the borrowers side; the surprise move by Westpac to reduce its maximum LVR from 92% to 87% also made me feel that, just maybe, the days of rising leverage driving house prices were coming to an end. That doesn’t sound like much, but it means that a purchaser who had her eye on a $1 million dream home and had the requisite funding prior to the change would now have to find an additional $50,000 in cash to bid the same amount–that’s a 62.5% increase in the deposit required to come up with the asking price wanted by the vendor (from $80,000 or 8% of the purchase price to $130,000 or 13% of the purchase price).

The question then is whether the “investors” who’ve been enticed into the market by the promise of rising prices could outweigh an inevitable fall in the number of First Home Buyers and the start of banks unwinding their excessive leverage beneath house prices.

Preliminary data doesn’t look that crash hot for the property bulls on both these fronts. Both the number and the value of new mortgages took an unprecedented fall once the FHVB expired, as the next two charts show.

So the odds are high that the ending of the FHVB will be one of several triggers for the long overdue bursting of the Australian property bubble–along with the unwinding of excessive housing leverage and the slowdown in the rate of growth of mortgage debt. The FHVB will then turn out to be what I anticipated: a short term success that sets up the conditions for a long term failure, and at the expense of the quarter of a million Australians who were enticed into mortgage debt by this temporarily successful but ultimately irresponsible policy.

For that reason, the T-Shirt I’ll be wearing on day one of The Walk is number 3 above.