Competition is not a panacea in banking

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Inquiry into competition within the Australian banking sector

Submission by Associate Professor Steve Keen, School of Economics & Finance, University of Western Sydney;

The Australian Senate's Standing Committee on Economics has established an inquiry into competition in the banking sector, and I was invited by the Committee to make a submission. Click here for the PDF of my submission. The RBA's submission is linked here. All submissions to the inquiry are available here.

Request to submit

I thank the committee for inviting me to make a submission. As noted below, the focus of my submission is point (m) in the terms of reference, "any other related matter", since as I argue below, past attempts to improve banking via increased competition have actually exacerbated the main problem in banking: the tendency for banks to fund speculative bubbles.

Executive Summary

The major problems of the financial sector are macroeconomic and related to the level of debt, rather than microeconomic and related to the price of debt. These are that:

  1. Banks have an innate desire to issue more debt than is good for the economy as a whole, and increased competition tends to exacerbate this tendency rather than control it;
  2. As a consequence of (a), debt has grown inexorably relative to incomes until the financial crisis began. This expansion of debt caused the apparent boom prior to the crisis, while the slowdown in the rate of growth of debt is the predominant cause of the crisis itself;
  3. Banks are lending too much to households and too little to business; and
  4. Lending has been oriented towards financing speculation rather than investment and the working capital needs of business.

Increasing competition once again, without ensuring that lending is restrained relative to incomes, and that it is directed away from households and speculation and towards business and investment, would only exacerbate problems caused by earlier introductions of unbridled competition in the 1980s and 1990s.

The focus of policy on banking therefore needs to shift from the microeconomic issues of the degree of competitiveness and so on to the macroeconomic issues of the impact of debt on the economy. In particular, we need an effective means to control the banking sector's tendency to create too much debt—a tendency that increased competition tends to make amplify rather than attenuate.

The one competitive reform I would suggest is to licence local banks to exclusively lend to small business to provide working capital, where lending cannot be secured against mortgaged property.


Economists and politicians have a tendency to perceive problems in banking as being ones of microeconomics and efficiency, because standard economic analysis regards banking and the level of private debt as having little or no macroeconomic implications.

This belief is reflected in the terms of reference for this inquiry, which has arisen because the general public and the non-bank business sector have been complaining about the impact of the banking sector on their lives and livelihoods. All of the terms of reference, save the catch-all final one of "(m) any other related matter", consider microeconomic topics of such as "(a) … competition, (b) .. products … fees and charges…" and so on. The focus is on competition and the prices of the products that banks provide, rather than on the macroeconomic impact of banks and their fundamental product, which is debt-based money.

I believe that this conventional view is misinformed. Though the microeconomic issues are of some importance, they are trivial compared to the issues of the volume of debt that the banks create, and its effect upon macroeconomic performance and asset prices.

To establish this, I will first review the history of two previous attempts to reform the banking sector by increasing the level of competition. Both of these had only transient impacts upon the price of debt, but caused a lasting increase in the level of debt, and made the Australian macroeconomy even more subject to the deleterious dynamics of debt than it had been previously.

The past failures of increased competition in the finance sector

Recent criticism of banks has focused on the increase in variable mortgage rates by more than the RBA's increase in the cash rate since the "Global Financial Crisis" (GFC) hit in 2008. However, while the margin between mortgage rates and the cash rate has risen compared to post-Wallis Committee levels, it is still below the level that applied prior to the Wallis reforms, which encouraged a substantial expansion in mortgage lending competition by securitised lenders. As Figure 1 indicates, after the economy had recovered from "the recession we had to have", but before the Wallis reforms were introduced, the margin varied between a low of 3 percent and a high of 5. It is now back to 3 percent.

Thus though the margin has increased substantially since the GFC hit (from 1.8 to 3 percent, a 67% increase in 2.7 years), this has only restored margins to what they were prior to the last time the finance sector was reformed to introduce more competition (in line with the recommendations of the Wallis Committee).

Figure 1: Relationship between mortgage rates and RBA cash rate since 1990

Then, as now, increased competition was expected to benefit customers via lower costs. The Wallis Committee described the competitive intent of its reforms in the following way:

The Inquiry has not pursued change for its own sake, but has sought an appropriate balance between achieving competitive outcomes and ensuring financial safety and market integrity. In particular, its recommendations seek to…:

  • ensure that regulation of similar financial products is more consistent and promotes competition by improving comparability;
  • introduce greater competitive neutrality across the financial system;
  • establish more contestable, efficient, and fair financial markets resulting in reduced costs to consumers;
  • provide more effective regulation for financial conglomerates which will also facilitate competition and efficiency; and
  • facilitate the international competitiveness of the Australian financial system.

Precise prediction of the direction and performance of the financial system cannot be made. However, the Inquiry is confident that implementation of its recommendations will place Australia's financial institutions and markets in a strong position to adapt to change and to respond to the ever increasing competitive pressures which lie ahead. (Stan Wallis et al., 1997, p. 2)

The main competitive impact of the Wallis Committee recommendations was to accelerate the growth of securitised lending. As Figure 1 indicates, this did indeed reduce costs for consumers, in terms of the margin between official and market interest rates. But the transient nature of this competitive benefit, the fact that its unwinding coincided with the most severe international financial crisis since the Great Depression, and the public anger at banks today, indicates that competition did not function entirely in the manner expected by the Wallis Committee.

The markup on the cost of funds itself was lowered not so much by an increase in efficiency, as by a diminution of quality, as essential costs were cut in a competitive race for market share—a competition which also increased the aggregate housing loans to GDP ratio.

As the National Director of the Australian Property Institute noted to the House of Representatives hearing into Home loan lending practices and processes, detailed property valuations have been replaced by "drive by" checks that do no more than confirm via a "cursory glance" that a property had a dwelling on it:

what we have seen, particularly from a valuation point of view, is that the asset test that many of the ADIs state they undertake, they quite literally do not undertake. We do not have valuers going out doing asset tests on all loans that are undertaken by financial institutions. Some banks get their own either ex-managers to drive by to see if the actual house exists or we have a lower form of valuation being undertaken.

These days it is getting to the point where you actually have the valuer who would not actually even see if the house or asset existed in the first place. You have a drive-by which is at best a cursory glance to see if there is a property on the lot that has been purchased. (Mr Warner, Standing Committee On Economics Finance And Public Administration, 2007, p. 34)

Similarly, detailed evaluations of the borrower's capacity to service a loan, and a commitment to keep loan repayments below 30% of gross borrower income, were replaced by automated checks that the borrower had sufficient income left after loan repayments to be just above the Henderson poverty line. As APRA's General Manager for Industry and Technical Services, Heidi Richards, told the Committee:

Our research has also confirmed that ADIs have materially increased the maximum amount they are willing to lend to a given borrower. The increase has come about in a shift away from traditional debt-servicing ratios based on simple gross borrower income calculations. In the newer income surplus models borrowers are assumed to continue repaying their mortgage until they reach a minimum level of household expenditure, with these minimum levels often based on poverty level measures.

The traditional rule of thumb was that debt-servicing expenses should amount to no more than 30 per cent of gross borrower income but, based on a review of lending policies that APRA conducted last year, we found that loans with debt-servicing ratios above 30 per cent are now often well within ADIs' policy parameters. (Ms Richards, Standing Committee On Economics Finance And Public Administration, 2007, p. 5)

The lower margins between mortgage rates and the cash rate that consumers temporarily enjoyed between 1997 and 2008 were thus achieved largely through a drop in the quality of the mortgage product. This, and the dramatic increase in the level of debt, allowed loan to valuation ratios to blow out from the conservative 70% of the 1960s and early 1970s to the 97% levels on offer today. This dramatic increase in the size of mortgages relative to incomes (and consequent drop in the initial equity that borrowers have in their properties) has meant an enormous increase in cost of servicing mortgages, despite lower margins. This is the main reason that banks are the subject of such intense public opprobrium today.

At the aggregate level, the drop in mortgage quality caused an explosion in unproductive lending to the household sector, the same phenomenon that in the USA fuelled an apparent boom known as "The Great Moderation", which ended in the financial collapse that American economists now call "The Great Recession". Though the margin between mortgage rates and the cash rate fell by 50 percent relative to 1992 levels, the volume of mortgages rose fourfold (see Figure 2). This increase in the volume of debt relative to GDP is the primary reason that bank profits have increased: had the impact of additional competition only been to affect the margin between the banks' cost of funds and the RBA rate, then bank profits—and therefore the cost of debt to consumers—would be lower today than prior to the Wallis reforms.

Figure 2: A halving of mortgage margins, a fourfold increase in volumes

In the aftermath of the financial crisis, all the securitised lenders have either collapsed, or have been taken over by the four major banks: competition has given way to oligopoly—as it did in the 1980s. Margins on all classes of loans (except those to large businesses) have risen, but only in the case of personal loans are these margins generally higher than applied in the pre-Wallis period. As Figure 3 indicates, though the recent focus has been on the 1.1% increase in the mortgage margin, the margin has risen most aggressively on personal loans—where it is up 3.7%--while the small business loan margin has risen 1.8%.

Figure 3: Margin of average loan rates above RBA rate

Falling margins and rising volumes—too much debt

Competition thus initially reduced margins, only to have them rise once more—so that the benefits of competition proved transient.

The drop in the quality of loan assessment led to an explosion in the volume of debt, most of which financed speculation rather than investment. The lasting impact of the reforms was to sustain the tendency that the banking sector had already demonstrated even prior to the attempts by governments to reform it via increased competition, to increase the level of private debt compared to income. While interest rates have varied wildly and widely over time, the level of debt compared to GDP has risen almost inexorably prior to the Global Financial Crisis—after 20 years of stability between 1945 and 1965 (see Figure 4).

Figure 4: The real reason that banking is a problem today is the blowout in the ratio of debt to GDP

Though the drop in margins was transient, the increase in the volume of debt carried by the housing sector was substantial and, if not permanent, much more enduring: as Figure 5 indicates, whereas it would have taken a mere 2 months of GDP to repay all outstanding mortgage debt in 1990, it would take more than 10 months of GDP to do the same today.

Figure 5: Varying sectoral debt levels over time

This increase in debt could have been productive had it increased the stock of housing, or improved its quality substantially. However though Australian houses have grown dramatically in size—resulting in so-called "McMansions"—the proportion of mortgage debt that has financed construction of new homes has fallen from 60 percent for investors in the late 1980s to barely 5 percent today, while the proportion of owner-occupier loans that financed construction has fallen from 20 percent to about ten percent (see Figure 6; the recent increase was clearly due to the tripling of the First Home Owners Grant for new dwelling construction, and that is now rapidly reversing since the Boost has terminated).

By implication, the vast majority of mortgage finance has financed speculation on the prices of existing properties, driving up house prices without adding to the housing stock of the country.

Figure 6: Percent of housing loans financing construction

Though the increase in prices has made households feel wealthier, the increase in the real debt per house has far exceeded the increase in the CPI-deflated house price index. As Figure 7 shows, though house prices have risen by a factor of 2.5 in real terms since 1977, the CPI-deflated debt level has risen more than 4 times as much. The divergence between the debt level per house and house prices began in 1990—before the Wallis reforms were introduced—but the rate of divergence increased after Wallis encouraged the growth of securitized lending.

Figure 7: Increase in debt per house and house price

Thus even though house prices have risen substantially, household equity in houses has fallen over the last 2 decades—from above 90 percent in the late 1980s to under 70 percent (see Figure 8; the significant rise in the last two years has been caused by the increase in house prices sparked by the First Home Owners Boost). This equity is now extremely dependent on house prices remaining high, since though debt has driven house prices up, debt will not fall if house prices fall.

Figure 8: Value of household assets minus mortgage debt

As equity has fallen, the cost of entering the market has risen. Those who have recently entered the market have had to devote a prohibitive portion of their incomes to servicing their mortgage, while those considering entering must contemplate a daunting level of debt compared to their incomes.

As a result, housing affordability has deteriorated sharply: the claim that many property lobbyists and banks make that it has not is simply absurd. Figure 9 shows the ratio of the average loan taken out by a first home buyer to the average wage, which has risen from just over 2.5 in 1992 to as much as 6 in 2009.

Some commentators have claimed that this rise in the size of mortgages compared to incomes was just a consequence of falling mortgage rates: as rates fell, the level of debt taken on rose, leaving the cost of servicing the debt constant. RBA Governor Glenn Stevens made precisely this claim to the House of Representatives Standing Committee on Economics, Finance and Public Administration in 2007:

The rough statistic that I have quoted many times was that the average rate of interest was about half; that meant you could service twice as big a debt. Guess what? That is exactly what occurred, and that had a very profound effect on asset values. (Glenn Stevens, remarks to the House of Representatives Standing Committee on Economics Finance and Public Administration, 2007, p. 26)

Though there were periods where this was the case, Figure 9 shows that in general this was not true. Debt levels did rise as rates generally fell from 1990-1998, but since then debt levels have almost doubled compared to incomes, while mortgage rates are higher now than then.

Figure 9: Ratio of the average first home loan to the average yearly wage

A focus on the interest costs of debt also understates the problem, since as debt levels rise relative to income the cost of paying down the principal over time rises more than the interest rate cost alone. On this basis it is undeniable that the increase in the volume of mortgages, which was the main lasting impact of increased competition, has made Australians worse off. Figure 10 shows that in 1996, prior to the Wallis reforms, the average first home loan could be serviced with 30 percent of the after tax salary of the average wage earner; today, the figure is 80 percent. It is no longer feasible for a single person on the average wage to buy a dwelling today, and even a couple has to devote more of their take home pay to servicing a mortgage than an individual did just 15 years ago.

Figure 10: 80 percent of the average wage needed to service a first home loan

The deleterious impacts of increased competition in lending to the household sector have clearly outweighed the benefits. The one benefit was that the margin between mortgage rates and the cash rate halved for a decade, but it has now reverted to three-quarters of the pre-Wallis value. Real house prices have doubled, making some households (especially those who own their houses outright) wealthier, but debt has increased fourfold, and in the aggregate household equity in property has fallen.

Competition's history of excess in banking

A similar process applied the previous time that a massive boost to competition was introduced into the financial sector—in February 1985, when Paul Keating persuaded the Hawke Labor Government to introduce not merely 4 foreign banks into the Australian market, but sixteen. Then, lending to the business sector exploded, rising from 33% of GDP to 55% in just 4 years. Much of that lending was unproductive, financing the speculative activities of now acknowledged Ponzi merchants like Alan Bond, Christopher Skase and Laurie Connell.

In the aftermath of the Stock Market Crash of 1987 and the real estate bubble and bust that preceded the 1990s recession, all the foreign banks either withdrew from the market or had their operations taken over by the Big Four—one of which, Westpac, almost collapsed itself in 1992 when it recorded a $1.6 billion loss.

Increased competition in the financial sector has thus failed on two previous occasions to achieve the results its advocates expected. Instead on both occasions, the quality of loan evaluation dropped and the volume of lending increased dramatically, with most of that lending funding speculation rather than investment.

The sector to which the lending was directed varied, as Figure 5 indicates: business debt more than doubled between 1977 and 1987, and then oscillated for the next twenty years, only to explode once more from 2005-2008 (when it funded some productive investment in minerals, but also the "leveraged buyout" frenzy that ended when the stock market crash began). Mortgage debt was constant throughout the late 70s and 80s, but then increased more than fivefold between 1990 and 2010.

The absence of any long term pattern in the sectoral data masks a very clear pattern in the aggregate data. For the first 20 years after WWII, private debt was constant at roughly 25 percent of GDP. From then on, the level of private debt compared to income has risen relentlessly, until a critical turning point was reached in early 2008. From mid-1964 until early 2008, the private debt to GDP ratio grew exponentially, reaching a peak of 157 percent of GDP in mid-2008. As Figure 11 indicates, calling this growth "exponential" is not mere hyperbole: the correlation of the actual ratio to a simple exponential growth rate of 4.2% p.a. is 0.993.

Figure 11: An inexorable increase in debt from 1965 until 2008

The only reason that this correlation is not even closer to a perfect 1 is the existence of two "super-bubbles" in 1972-77 and 1985-1994, and the recent topping-out of the ratio in March 2008. This growth rate was sustained despite significant shifts in regulatory regimes, dramatic volatility in interest rates, and as noted earlier, significant shifts in the sectoral breakup of private debt.

This history should give pause to the current renewed enthusiasm for introducing more competition into the financial sector. If debt—the fundamental output of the banking sector—has grown inexorably despite dramatic changes in the structure of the financial sector and the economy over time, then is there something inherent to banking that leads to unrestrained growth in debt? And if increased competition had unintended deleterious consequences on previous occasions, what might be the consequences of enhancing competition again now, in the aftermath of a financial crisis? Is competition the panacea, as conventional economic analysis argues, or is it to some extent the problem in the financial sector?

Funding bubbles rather than productive enterprise

Banking is clearly a vital function in a market economy, and much of what banks do is essential for commerce: providing working capital to firms, funding investment, enabling consumers to own their homes as an alternative to renting, and so on.

However banking also has potentially damaging consequences if it funds speculative activities rather than genuine investment on a large scale—as I argue that, based on the empirical data, it has. This negative side of banking is unlikely to be constrained by competition—in fact it is likely to be made worse by more competition.

This is because banking differs from commodity production—to which standard "supply and demand" analysis is normally applied—in ways that mean that it has an innate tendency to try to produce as much of its product (effectively, debt that simultaneously creates credit money) as it can entice its customers to take on. The only factor that can prevent this tendency leading to excessive debt levels is a limit to the willingness of its customers to borrow money.

If borrowers base their desired level of lending on either enhancing immediate consumption, or funding activities that may lead to income generation in the future, then debt will generally be constrained to sustainable levels—as occurred during the 1950s and early 1960s. If, however, borrowers go into debt to finance speculation about asset prices, then there is a potential for the level of borrowing to grow out of proportion to incomes and lead to a financial crisis.

An essential side-effect of this process is the creation of an asset price bubble from the positive feedback between rising levels of leverage and asset prices. Asset prices are driven up by debt-financed purchases of assets, and this rise in price entices more borrowers into debt. An increase in debt to income ratios therefore goes hand in hand with an asset price bubble. These bubbles ultimately burst for three main reasons:

  1. Borrowing to buy existing assets adds to the debt burden of society without adding to its income generating capacity. The individuals who profit from rising asset prices are essentially Ponzi speculators whose "enterprise" is fundamentally loss-making. Ultimately they must fail, and this reality is masked only by rising asset prices. As soon as they falter, they are likely to go bankrupt;
  2. Price to income ratios get driven to levels that appear irrational even to insiders, leading to greater volatility, and eventually an asset price crash that ends the bubble; and
  3. The levels of debt that existing speculators and new entrants need to undertake to continue driving the bubble becomes prohibitive compared to their income levels. The borrowing slows down, thus ending the positive feedback process that drives the bubble.

The danger in allowing increased competition in finance, without provisions to ensure that the lending is directed to productive uses, is that the sector's innate tendency to fund Ponzi schemes will be amplified by the pressure of competition.

Competition in the 1980s—the stock market bubble and bust

In retrospect, this is clearly what occurred during the 1980s. The initial bubbles then were in shares and commercial property—though anyone who claimed there was a bubble before October 1987 was widely derided. The stock market bubble then burst spectacularly, as Figure 12 indicates, but in the aftermath, speculation shifted to residential property (thanks in no small measure to the government re-introducing the First Home Owners Grant to ward off a feared recession). Prices rose 36% in real terms between October 1987 and March 1989, and then stagnated in real terms for the next decade.

Figure 12: Stock market bubbles of the 1980s and 2000s

Competition in the 1990s-2000s—housing and share market bubbles

The additional competition from securitized lenders that the Wallis Committee championed has had a similar effect, this time primarily on household debt and speculation on house prices. Increased competition in finance has once again had the deleterious effect of funding speculation rather than productive investment, driving up debt levels and causing asset bubbles in both the share and the property markets.

Predictably, banks have denied that their activities have funded speculative bubbles. With regard to housing, they assert that house prices reflect fundamental forces, on the basis of four propositions:

  1. That the house price to income ratio in Australia is not as high as those who assert that there is a house price bubble claim it to be;
  2. That there is an excess of demand for housing over supply in Australia, reflecting problems with regulation that have prevented the construction of new houses in line with underlying demand;
  3. Strong population growth is driving up prices; and
  4. That Australians have a preference to live near the coast and are willing to pay a premium to do so.

In order to establish my position that the banking sector has once again funded a speculative bubble, I need to consider these arguments in detail. As I show below, none of them stand up to close scrutiny.

No house price bubble (and "Coastal living")

The Commonwealth Bank made the following assertions that combine arguments 1 and 4 above:

  • Australia the 4th least densely settled country in the world—83% live within 50 kms of the coast.
  • Coastal locations demand a premium—Australia's population concentration in capital/coastal cities distorts comparisons to other, more densely settled countries.
  • Australia's capital city house price to income ratio of 5.6 is consistent with coastal city metrics globally (Commonwealth Bank, 2010, p. 4)

These assertions were supported by the table shown in Figure 13:

Figure 13: Commonwealth Bank coastal cities comparison table

This table is a piece of blatant sophistry. Note that there are 2 sources given: Demographia (Wendell Cox and Hugh Pavletich, 2010) and UBS. All of the overseas city data points are taken from the Demographia survey, while all of the Australian cities are derived from UBS research. The differences between the Demographia data for all the cities in this table and the UBS-CBA data are shown in Table 1

Table 1: CBA (Commonwealth Bank, 2010) and Demographia (Wendell Cox and Hugh Pavletich, 2010pp. 36-37) house price ratio comparison

House Price to Income Ratios

Unaffordability Rankings

Country City







Aus-tralia Sydney







Aus-tralia Melbourne







Aus-tralia Brisbane







US San Francisco







US Los Angeles







US New York







Canada Vancouver







UK Bristol-Bath







NZ Auckland







NZ Wellington







The UBS-CBA document thus understates the house price to income ratio for Australian cities by 30 to 38 percent compared to the original Demographia document. It portrays Australian cities as falling in the middle of the range when, according to Demographia, Australian cities are amongst the most unaffordable in the world—in fact in Demographia's comparison of 272 cities around the world, Sydney was the 2nd most expensive, behind only Vancouver.

There are, I believe, two main reasons why the CBA-UBS figures for Australia are so much lower than Demographia's. Firstly, the Demographia survey compares median house prices to median incomes, whereas the CBA-UWS study compares median house prices to average incomes. Since income distribution is skewed, the average income substantially exceeds the median. Secondly, the Australian Bureau of Statistics includes income from property (including the imputed rental income from owner-occupied dwellings) when calculating the average income, whereas the median income relies on wage income only.

Had the CBA-UBS study applied the same transformations to the overseas data, then their figures for those cities would also have been substantially lower than the Demographia figures, and the relative expensiveness of Australian cities compared to coastal cities around the world—let alone land-locked ones—would have been obvious.

Including income from property in the income to which one compares property prices is also an inherently flawed approach: it will understate the price to income ratio when prices are rising (and, conversely, exaggerate the ratio when prices are falling). Property income derives primarily from the change in price, and this will be positive when prices are rising—making income larger than it would otherwise be. Using this data to conclude that there is not a house price bubble is turning a Nelsonian eye to the problem.

When one is not trying to not see a bubble, statistical evidence of it abounds. I will present three measures: the ratio of house prices to disposable income per head; the ratio of house prices to GDP per head; and the gross rental yield on Australian rental properties.

The house price to disposable income data shows a slow upward drift in this ratio from 1960 till 1997 (see Figure 14), and then a takeoff of the ratio since then to ten standard deviations above its mean.

Figure 14: House prices to disposable income--upward trend then bubble since 1997

It could be argued that this series always shows a rising trend, and the acceleration in that trend is not conclusive evidence of a bubble. The house price to GDP per capita calculation, on the other hand, shows no trend between 1953 and 2000, but an explosion in the ratio since 1997 that has taken the ratio from under the mean to more than 7 standard deviations above the mean (see Figure 15). This and several other metrics indicate that (a) the house price bubble began in 1997 and (b) it has driven Australian house prices to a level at least 50% higher than historic levels.

Figure 15: House prices to GDP per capita

The low return on renting in Australia makes it obvious that "investors" in this industry are seeking capital gain rather than income—and are therefore primarily speculators rather than genuine investors (see Figure 16). The rental yield hovered around 3.5 percent—low, but not trivial—between 1998 when records became available, and 1997, when the previous two measures also indicate that the most recent bubble began. Since then the average yields fell to a low of under 2 percent as house prices rose far more than did rents—and the recovery in the ratio to a not quite so abysmal 2.5% was entirely due to the fall in house prices that preceded the Rudd Government's introduction of the First Home Owners Boost.

Figure 16: Rental yields are well below deposit rates, let alone loan rates

Therefore, to put it politely, bank arguments that there is no house price bubble in Australia (and the CBA-UBS table in particular) are duplicitous and misleading—even when one makes an "apples to apples" comparison of Australian house prices to coastal cities overseas, we still have amongst the most expensive housing in the world. But the argument that we should only consider coastal cities is also nonsense.

The proposition that coastal cities command a premium begs the question: compared to what? In countries like the USA, the answer is easy: compared to land-locked cities where the vast majority of the population lives. But in Australia, there is no inland market over which a premium can be charged (apart from Canberra, which, at a price to income ratio of 5.8, is the 228th least affordable city in the world out of the 272 in the on the Demographia survey). In Australia, if you live in a city, then you either live on the coast or in Canberra: there is no non-coastal city market over which coastal cities can command a premium.

"Underlying demand"

The argument that there is an underlying shortage of housing, and that this is why house prices are high, is also easily dismissed. The supply shortage is derived from estimates developed by the National Housing Supply Council.

the Council estimated a gap of around 85,000 dwellings between underlying demand for and supply of housing at 30 June 2008. The Council developed a methodology for measuring the gap based on selected measures of homelessness, including the number of marginal residents of caravan parks and the undersupply of private rental dwellings indicated by the rental vacancy rate. The measures used in the 2008 report were: 2008 gap size =

  • additional private rental dwellings required in 2008 to increase the number of vacant private rental dwellings to 3 per cent of the total private rental stock

These measures—especially the last two—express a social need for additional housing. But they are in no way express a market demand for housing, Frankly, if you believe that house prices are being driven up by either homeless people or "marginal residents of caravan parks", then I have a Bridge or two I'd like to sell you.

Population pressure

The population pressure argument does appear superficially convincing—like any story that gives rise to a Ponzi Scheme—but it is simply not supported by the data. While the assertions that Australia didn't have an overbuilding spree like those in the USA or China, that our population growth rate exceeds the OECD average, and that it spiked recently when house prices were rising sharply are all true, population growth per se bears no correlation to changes in house prices.

Figure 17: Absolute growth levels of population, immigration and dwellings

If the argument that a shortage of new houses relative to population growth is the cause of rising house prices were true, then Australia should have experienced falling house prices between 1955 and 2006—because for this entire period the rate of growth of new dwellings exceeded the rate of growth of population (see Figure 18).

Figure 18: Falling ratio of population to dwellings for all years except 2006-2010

Over the long term, the correlation between population growth and change in house prices is effectively zero. Lagging house price change behind population change—to test the argument that population growth causes price change, but with a lag—does not improve the correlation (see Figure 19). The correlation between change in population and change in house prices remains negative.

Figure 19: There is no correlation between population growth and house prices, even when time lags are considered

Even during the one period when the rate of growth of population exceeded the rate of growth of population, the change in house prices is uncorrelated with the change in population and population density (see Figure 20).

Figure 20: A negative correlation between population and house prices

The simple reason that population change doesn't determine house price movements is that the real market demand for housing is given fundamentally by the number of people who have recently taken out a mortgage, This can vary radically as a proportion of the population, swamping variations in the rate of population growth itself (see Figure 21).

Figure 21: Volatility of new owner occupier loans as percent of population

The two factors that do have a strong causal correlation with changes in house prices are the volume of new lending, and government manipulation of the market via the First Home Owners Grant. The latter will—I hope—be the subject of a separate inquiry one day. The former demonstrates that the key factor in determining house prices is the growth rate of mortgage debt: the correlation is strong (0.56), and new lending leads price change by about 3-6 months (see Figure 22).

Figure 22: The growth in mortgage debt is the key determinant of house price changes

Unregulated banking has financed Ponzi Schemes rather than investment

The data thus clearly shows that, on the two previous occasions where competition in banking was intensified, the result was an increase in lending for speculative rather than productive purposes.

While the boost in lending was taking place, aggregate demand increased—as explained later—which made the economy appear buoyant. But when the buoyant lending came to an end, an economic crisis ensued, since the lending predominantly drove asset prices higher (rather than adding to the level or productivity of assets).

The end result was an increased level of debt compared to income, with little to show for the increased gearing save more expensive assets. That is the main reason why banks are "on the nose" today. To amplify competition a third time, without heeding these lessons of the past, would be a serious mistake.

What we should do instead is:

  1. Properly identify the problems in the sector, rather than assuming that, whatever the problems might be, more competition will fix them; and
  2. Tailor the reforms to the problems, so that there is at least some chance the proposed solutions will make things better rather than worse.

The macro-dynamics of debt

As outlined above, the key problem with the banking sector is that it has created too much debt, and that the majority of this debt has funded speculation rather than productive investment.

This problem has been exacerbated by reforms that have been based on a naïve faith in deregulated markets, but the problem itself is an endemic one, as the historical record attests. As Figure 23 emphasises, the private debt to GDP level today dwarfs anything previously experienced in Australia, but there have also been two previous lesser debt bubbles that both ended in serious Depressions (Chay Fisher and Christopher Kent, 1999).

Figure 23: Australia's private debt to GDP ratio over the very long term

Most economists pay little if any attention to this ratio—and most were therefore caught completely unawares when the Global Financial Crisis hit. By way of contrast, this ratio and its derivatives are crucial to my analysis (Steve Keen, 1995), and to that of the handful of other economists around the world who anticipated the GFC (Dirk J Bezemer, 2009, Dirk J. Bezemer, 2010, Edward Fullbrook, 2010).

An instance of the sanguine way that most economists think about private debt is given by RBA Deputy Governor Ric Battellino's observations on the extraordinary level of household debt as at September 2007 (when it was 94% of GDP):

"The factors that have facilitated the rise in debt over the past couple of decades – the stability in economic conditions and the continued flow of innovations coming from a competitive and dynamic financial system – remain in place. While ever this is the case, households are likely to continue to take advantage of unused capacity to increase debt. This is not to say that there won' t be cycles when credit grows slowly for a time, or even falls, but these cycles are likely to take place around a rising trend. Eventually, household debt will reach a point where it is in some form of equilibrium relative to GDP or income, but the evidence suggests that this point is higher than current levels." (Ric Battellino, 2007, p. 20)

I am not so sanguine, firstly because the historical record shows that when private debt reaches a peak, it does not remain at an equilibrium level but goes into reverse (see Figure 23), and secondly because even if debt did reach "some sort of equilibrium relative to GDP or income", this would cause a large fall in aggregate demand.

This point is not considered by the vast majority of economists because they believe that the level of debt has no impact on macroeconomic outcomes. Ben Bernanke provides a good illustration of this in his dismissal of Fisher's argument (Irv­ing Fisher, 1933) that the Great Depres­sion was caused by “debt-deflation”:

Fisher’ s idea was less influ­en­tial in aca­d­e­mic cir­cles, though, because of the coun­ter­ar­gu­ment that debt-deflation rep­re­sented no more than a redis­tri­b­u­tion from one group (debtors) to another (cred­i­tors). Absent implau­si­bly large dif­fer­ences in mar­ginal spend­ing propen­si­ties among the groups, it was sug­gested, pure redis­tri­b­u­tions should have no sig­nif­i­cant macro­eco­nomic effects. ” (Ben S. Bernanke, 2000, p. 24)

Bernanke’s con­ven­tional argu­ment is false because it ignores the role that changes in debt play in deter­min­ing aggre­gate demand. In the equi­lib­rium per­spec­tive that vir­tu­ally defines con­ven­tional eco­nomic the­ory (known as “neo­clas­si­cal eco­nom­ics”), debt is merely a redis­tri­b­u­tion of spend­ing power from one per­son (the lender) to another (the bor­rower). But in the real world (and in the non-orthodox “Finan­cial Insta­bil­ity Hypoth­e­sis”: Hyman P. Min­sky, 1982), the aggre­gate level of debt can expand or con­tract, and this change in the aggre­gate level of debt does have macro­eco­nomic effects because it alters aggre­gate spend­ing power.

In a nut­shell, aggre­gate demand is the sum of GDP plus the change in debt (Steve Keen, 2009a, c, d), and for this rea­son a sim­ple sta­bi­liza­tion of the debt to GDP ratio can cause a recession.

This can be illus­trated using a sim­ple exam­ple. Con­sider an econ­omy with a nom­i­nal GDP of $1 tril­lion, which is grow­ing at 10% per annum, where half (5%) is real growth and half is infla­tion. The econ­omy also has a pri­vate debt level of $1.25 tril­lion that is grow­ing at 20% p.a. Total spend­ing in the econ­omy that year will there­fore be $1.25 tril­lion, con­sist­ing of $1 tril­lion from GDP and $250 bil­lion from the increase in debt.

Then assume that GDP con­tin­ues to grow at the same rate, so that it is $1.1 tril­lion the year after, and that the rate of growth slows down to 10% per annum—the same speed as the rate of growth of nom­i­nal GDP, so that the debt ratio remains con­stant at 150%, the level it reached in Year 1.

Total aggre­gate demand will there­fore be $1.25 trillion—the sum of the $1.1 tril­lion GDP and the 10% increase in debt from its level of $1.5 tril­lion. This is the same level of nom­i­nal demand as the year before—but since there has been 5% infla­tion, the level of real demand has fallen by $60 bil­lion. This is enough to cause a reces­sion (if the impact is felt entirely by the sale of goods and ser­vices), or a sharp fall in asset prices, or some com­bi­na­tion of the two.

This hypo­thet­i­cal example—summarised in Table 2—is a milder ver­sion of what actu­ally occurred in 2008 and caused the Global Finan­cial Cri­sis. The actual expe­ri­ences of the USA and Aus­tralia are sum­ma­rized in Table 3 and Table 4 respectively.

Table 2: Hypo­thet­i­cal exam­ple of impact of debt to GDP ratio reach­ing equi­lib­rium

Variable/year Year 1 Year 2
Nom­i­nal GDP



Growth rate of nom­i­nal GDP (%)



Real growth rate (%)



Infla­tion rate (%)



Pri­vate debt



Growth rate of pri­vate debt (%)



Change in pri­vate debt



Nom­i­nal aggre­gate demand (GDP + change in debt)



Real aggre­gate demand (in Year 1 terms)



In the USA, the rate of growth of debt did not merely slow but actu­ally turned neg­a­tive: there­fore the change in debt actu­ally sub­tracted from aggre­gate demand, rather than adding to it. But as illus­trated by the hypo­thet­i­cal sit­u­a­tion in Table 2, the mere slow­down in the rate of growth of debt prior to the year end­ing in Jan­u­ary 2010 was enough to start “The Great Reces­sion” in 2008-09.

In the year end­ing in 2008, America’s GDP was $14.34 tril­lion, and the growth in pri­vate debt was $4.04 tril­lion, so that pri­vate sec­tor aggre­gate demand was $18.38 tril­lion. In the year end­ing in 2009, nom­i­nal GDP was slightly higher at $14.35 tril­lion, but the growth in debt was only $1.45 tril­lion (the rate of growth of debt had slowed from 11.1% p.a. to 3.6% p.a.). Pri­vate sec­tor aggre­gate demand was thus $15.8 trillion—a four­teen per­cent fall from the year before.

The increase in gov­ern­ment debt atten­u­ated the fall in total aggre­gate demand to some extent, but this still fell 9% over the year, and America’s asset mar­kets, com­mod­ity mar­kets, and unem­ploy­ment took a huge hit.

The fol­low­ing year saw the slow­down in the rate of growth of debt turn into absolute delever­ag­ing, with pri­vate debt falling by $1.86 tril­lion (falling mort­gage debt con­tributed $220 bil­lion of this). Pri­vate sec­tor aggre­gate demand was thus $12.55 tril­lion, com­pared to $18.38 tril­lion just two years earlier.

Table 3: Delever­ag­ing in the USA

Variable\Year 2006 2007 2008 2009 2010






Change in Nom­i­nal GDP






Change in Real GDP






Infla­tion Rate






Pri­vate Debt






Debt Growth Rate






Change in Debt






GDP + Change in Pri­vate Debt






Change in Pri­vate Aggre­gate Demand






Gov­ern­ment Debt






Change in Gov­ern­ment Debt






GDP + Change in Total Debt






Change in Total Aggre­gate Demand






Mort­gage Debt






Change in Mort­gage Debt






Aus­tralia suf­fered a reduc­tion in aggre­gate demand as well from the slow­down in the rate of growth of pri­vate debt in the year end­ing in 2008. GDP was $1.13 tril­lion, while the increase in pri­vate debt that year was $260 billion—so that pri­vate sec­tor aggre­gate demand was $1.39 tril­lion. GDP grew to $1.24 tril­lion the next year, while the growth of debt slowed sub­stan­tially to $134 bil­lion. The sum was $1.37 tril­lion, slightly less in nom­i­nal terms than the year before.

Table 4: Avoid­ing delever­ag­ing in Aus­tralia

Variable\Year 2006 2007 2008 2009 2010






Change in Nom­i­nal GDP






Change in Real GDP






Infla­tion Rate






Pri­vate Debt






Debt Growth Rate






Change in Debt






GDP + Change in Pri­vate Debt






Change in Pri­vate Aggre­gate Demand






Gov­ern­ment Debt






Change in Gov­ern­ment Debt






GDP + Change in Total Debt






Change in Total Aggre­gate Demand






Mort­gage Debt






Change in Mort­gage Debt






The impli­ca­tions for eco­nomic per­for­mance of exces­sive pri­vate debt

From this debt-driven per­spec­tive, these macro-economic impli­ca­tions of debt are far more impor­tant than the micro­eco­nomic issue of the cost of debt. But since Aus­tralia has appar­ently done so well dur­ing the GFC, these macro­eco­nomic issues have been far less dom­i­nant here than in the rest of the world. It is there­fore impor­tant to con­sider why Aus­tralia dif­fered from the rest of the world: was there some­thing unique about Aus­tralia which meant the GFC didn’t hap­pen here, or are the macro­eco­nomic impli­ca­tions of the GFC still rel­e­vant to us? We can get some guid­ance from com­par­ing the Aus­tralian expe­ri­ence to the US one.

There are three major dif­fer­ences between Aus­tralia and the USA, which in turn are by far the major rea­sons why Australia’s eco­nomic per­for­mance was so much bet­ter than America’s:

  1. While Australia’s debt to GDP level is unprece­dented in its own his­tory, the USA’s is higher still;
  2. Delever­ag­ing as such did not occur in Australia—though this almost guar­an­tees that it will occur in the future; and
  3. Growth in mort­gage debt con­tin­ued, largely under the influ­ence of gov­ern­ment policy.

Were the cur­rent pri­vate debt to GDP ratio unre­mark­able, these fac­tors would be gen­er­ally positive—a handy boost to credit-driven demand would have helped us side­step a reces­sion, with only minor long term con­se­quences. But since pri­vate debt is at unprece­dented lev­els, these short term gains in 2009–2010 imply that a rever­sal of our eco­nomic for­tunes in 2011 is pos­si­ble, if pri­vate sec­tor delever­ag­ing com­mences here. To explain why, I need to pro­vide more detail on each of those three dis­tin­guish­ing fac­tors between the USA and Australia.

Level of Debt

Fig­ure 24 shows both how much greater America’s pri­vate debt level is that Australia’s, and also shows that Amer­ica is rapidly delever­ag­ing now. Thus even though Australia’s debt-driven boost to aggre­gate demand was larger in 2008 than America’s—since pri­vate debt grew 17.2% that year in Aus­tralia, ver­sus 11.1% in the USA—the sheer scale of the USA’s debt com­pared to its GDP means that its depen­dence on ris­ing debt was even more extreme than ours. It also meant that when the debt went into reverse, the depress­ing impact of this was greater for the USA than Australia.

Fig­ure 24: The USA’s pri­vate debt to GDP ratio is sig­nif­i­cantly larger than Australia’s

The rate of change of debt—no delever­ag­ing here

The fun­da­men­tal cause of the GFC was the burst­ing of a global debt bub­ble. With the growth of debt going from pos­i­tive to negative—so that we went from ris­ing debt adding to aggre­gate demand, to falling debt sub­tract­ing from aggre­gate demand (see Fig­ure 25)—what had appeared to be a period of stel­lar eco­nomic per­for­mance gave way to the biggest eco­nomic cri­sis since the Great Depression.

Fig­ure 25: The GFC was the first time the change in debt reduced aggre­gate demand since the Great Depres­sion

Aus­tralia, on the other hand, avoided a seri­ous down­turn because delever­ag­ing was stalled, and in fact turned around—so that ris­ing debt once again added to aggre­gate demand. While Amer­ica and the rest of the world had a deleveraging-driven cri­sis, Aus­tralia avoided the cri­sis by relever­ag­ing on the back of a renewed prop­erty bub­ble (see Fig­ure 26).

Fig­ure 26: Aus­tralia abruptly stopped delever­ag­ing in 2010

Since eco­nomic activ­ity and employ­ment in a mar­ket econ­omy is demand-driven, delever­ag­ing in the USA (and else­where in the OECD) caused a seri­ous reces­sion, while Australia’s relever­ag­ing boosted aggre­gate demand and resulted in it expe­ri­enc­ing only a very mild downturn.

The piv­otal role of the change in pri­vate debt in deter­min­ing eco­nomic activ­ity is eas­ily seen in Fig­ure 27, which cor­re­lates the debt-driven frac­tion of aggre­gate demand with the unem­ploy­ment rate. This fig­ure shows why it is not hyper­bole to com­pare the cur­rent cri­sis to the Great Depres­sion, since this is the only time since then that the debt-contribution to aggre­gate demand has turned neg­a­tive (the appar­ent neg­a­tives in 1945 were due respec­tively to the end­ing of WWII, and a break in the sta­tis­ti­cal series). The cor­re­la­tion with unem­ploy­ment points out the “Ponzi” nature of the US’s eco­nomic per­for­mance in both the Great Depres­sion and recently: when debt grew, unem­ploy­ment fell, and vice versa—with dis­as­trous consequences—when delever­ag­ing struck. In the Great Depres­sion the cor­re­la­tion was –0.76; across the whole of 1955 till now, the cor­re­la­tion was –0.36; and in the last 20 years, when the pri­vate debt has sur­passed the Great Depres­sion level, the cor­re­la­tion was –0.9.

Fig­ure 27: Debt driven-demand and unem­ploy­ment, USA

I’ve used the same ver­ti­cal scales for the Aus­tralian data (Fig­ure 28) as the Amer­i­can to empha­sise both dif­fer­ences and sim­i­lar­i­ties between the two countries.

Firstly, both GDP and the change in debt deter­mine aggre­gate demand, and with its lower level of debt dur­ing the 1950s and 1960s, the debt-driven frac­tion of aggre­gate demand was far less impor­tant in Aus­tralia than in Amer­ica. The cor­re­la­tion over 1955–2010 was 0.25, which is both small and the wrong sign, show­ing that the debt con­tri­bu­tion to demand was swamped by that of GDP—which is the sign of a well-functioning economy.

Sec­ondly how­ever, this dif­fer­ence dis­ap­peared as Australia’s debt to GDP ratio grew expo­nen­tially from 1965. Between 1990 an today, the cor­re­la­tion is sig­nif­i­cant, the cor­rect sign for the causal argu­ment I am mak­ing here, and large at –0.82. So by the time the GFC hit, the debt-driven com­po­nent of aggre­gate demand was almost as dom­i­nant in Aus­tralia as it was in the USA.

Thirdly, we avoided a seri­ous down­turn, not by hav­ing an econ­omy that was fun­da­men­tally dif­fer­ent to the USA’s, but by pre­vent­ing delever­ag­ing. Whereas dur­ing the 1990s reces­sion, absolute delever­ag­ing did occur (and unem­ploy­ment exceeded 10 per­cent) dur­ing the GFC, delever­ag­ing was pre­vented solely because a gov­ern­ment policy—the First Home Own­ers Boost—encouraged Aus­tralian house­holds to go on a debt-binge.

Fig­ure 28: Debt-driven demand and unem­ploy­ment, Aus­tralia

The busi­ness sec­tor, whose debt had been grow­ing strongly in the leadup to the GFC, delev­ered at a faster pace than it did dur­ing “the reces­sion we had to have”, when the debt frac­tion of aggre­gate demand briefly turned neg­a­tive. On the other hand, mort­gage debt rose strongly. Australia’s avoid­ance of delever­ag­ing was there­fore entirely due to the growth in mort­gage debt (see Fig­ure 29).

Fig­ure 29: Debt-driven demand by sec­tor

This growth in mort­gage debt would not have come about with­out the First Home Own­ers Boost (see Fig­ure 30). Prior to that pol­icy being intro­duced, mort­gage debt was on track to fall by about 2% of GDP between mid-2008 and March 2010. Instead, it rose by over 6% of GDP. This effec­tively added $100 bil­lion in debt-financed expen­di­ture to the Aus­tralian economy—a larger boost to aggre­gate demand than either the Rudd Government’s stim­u­lus pro­gram, or the impact on house­hold dis­pos­able income of the RBA’s rate cuts.

Fig­ure 30: The impact of the FHOB on the trend in mort­gage debt

The great dan­ger for the future is that this pol­icy suc­cess in 2008-09 has set Aus­tralia up for a greater pol­icy dilemma in future when the house­hold sec­tor joins the busi­ness sec­tor in delever­ag­ing. That this may already be hap­pen­ing can be seen by con­sid­er­ing the third aspect of pri­vate debt, the “credit impulse”: the impact of the accel­er­a­tion or decel­er­a­tion of debt on the change in aggre­gate demand.

The credit impulse

The fact that aggre­gate demand is the sum of GDP plus the change in debt means that the change in aggre­gate demand is the sum of the change in GDP plus the accel­er­a­tion of debt. Just as the debt con­tri­bu­tion to demand is highly cor­re­lated with the level of employ­ment, the accel­er­a­tion of debt—or the credit impulse, which is defined as the change in the change in debt divided by GDP (Michael Biggs et al., 2010)—is highly cor­re­lated with the change in employment.

In stark con­trast to the assump­tion made by Bernanke and most neo­clas­si­cal economists—that debt only has macro­eco­nomic impli­ca­tions if the dis­tri­b­u­tion of debt affects con­sump­tion (to cite a recent paper by Krug­man, “It fol­lows that the level of debt mat­ters only if the dis­tri­b­u­tion of that debt mat­ters, if highly indebted play­ers face dif­fer­ent con­straints from play­ers with low debt”, Gauti B. Eggerts­son and Paul Krug­man, 2010, p. 3)—the sheer scale of debt, its rate of change, and whether it is accel­er­at­ing or decel­er­at­ing, have very sig­nif­i­cant impacts on the macro­econ­omy. If Bernanke, Krug­man and other neo­clas­si­cals were cor­rect, the cor­re­la­tions between the accel­er­a­tion in debt and the change in unem­ploy­ment should be insignificant.

Instead, the cor­re­la­tion is highly sig­nif­i­cant, large, per­sis­tent, and causal, since it leads changes in employ­ment and GDP by about 3 months. The cor­re­la­tion dur­ing the Great Depres­sion was –0.72; over the whole post-WWII period from 1955 the cor­re­la­tion was –0.59, and since 1990 it was –0.82 (see Fig­ure 31).

Fig­ure 31: Decel­er­a­tion of US debt in the GFC more extreme than in Great Depres­sion

The com­par­i­son of Aus­tralia with the USA dur­ing the GFC con­firms that Aus­tralia had a milder GFC by hav­ing a milder neg­a­tive credit impulse, and by revers­ing it before the USA did (Fig­ure 32).

Fig­ure 32: Australia’s credit impulse was milder and reversed ear­lier than did the USA’s

The size of the neg­a­tive credit impulse in 2008–2010 in Amer­ica was the major cause of the sharp increase in unem­ploy­ment, and the recent improve­ments have been due to the credit impulse turn­ing less neg­a­tive (see Fig­ure 33).

Fig­ure 33: The USA’s large neg­a­tive credit impulse caused a large increase in unem­ploy­ment, since mildly reversed

Australia’s milder reces­sion and current—though appar­ently faltering—recovery has been due to its neg­a­tive credit impulse being smaller than in the USA, and being reversed ear­lier (see Fig­ure 34).

Fig­ure 34: Australia’s smaller neg­a­tive credit impulse meant a smaller down­turn

At a super­fi­cial level, this implies an easy solu­tion to an eco­nomic down­turn: if the econ­omy slows down, encour­age the growth of credit, and the econ­omy will recover. Effec­tively, this is how Aus­tralia and most of the OECD has over­come past reces­sions: by expand­ing the level of pri­vate debt even more and caus­ing a new debt-driven boom to replace the old one.

The prob­lem with this solu­tion is that it nec­es­sar­ily involves a ris­ing level of debt com­pared to income over time. At some point, this will result in a level of debt which is so large com­pared to income that many eco­nomic agents refuse to take on any more debt. The credit impulse there­fore turns neg­a­tive and a major cri­sis ensues—a Depression.

In late 2005, I formed the belief that we had reached such a point in the credit cycle, which is why I went pub­lic with my views that a seri­ous eco­nomic cri­sis was immi­nent (along with a hand­ful of other non-orthodox econ­o­mists; for details see Dirk J Beze­mer, 2009, Dirk J. Beze­mer, 2010, Edward Full­brook, 2010). The occur­rence of the Global Finan­cial Cri­sis, against the expec­ta­tions of the vast major­ity of econ­o­mists, vin­di­cated my analysis.

Australia’s appar­ent avoid­ance of the cri­sis has led to my analy­sis car­ry­ing less weight in Aus­tralia than over­seas. How­ever as out­lined above, Australia’s avoid­ance of a seri­ous down­turn to date has largely occurred because it delayed the process of delever­ag­ing. In effect, we avoided the GFC by recre­at­ing the con­di­tions that caused it: an asset price bub­ble caused by ram­pant lend­ing to the house­hold sector.

Impli­ca­tions for com­pe­ti­tion policy

Attempt­ing to increase com­pe­ti­tion in the bank­ing sec­tor once more could risk con­tin­u­ing this process of an ever-increasing level of debt caus­ing appar­ent pros­per­ity, at the expense of guar­an­tee­ing a future severe deleveraging-driven contraction.

How­ever an equally prob­a­ble out­come, given the exces­sive and unprece­dented level of house­hold debt (higher than that pre­vail­ing in the USA—see Fig­ure 35—and with a much higher debt ser­vic­ing cost—see Fig­ure 36), is that new com­peti­tors will fail to gain a foothold in the mar­ket, because the mar­ket will now shrink rather than expand as the house price bub­ble deflates.

The like­li­hood that the level of house­hold debt will fall is rea­son enough to be less than enthu­si­as­tic about the ben­e­fits of increased com­pe­ti­tion in the bank­ing sector—since in the past this has led to ris­ing lev­els of debt. It is also hard to con­tem­plate how increased com­pe­ti­tion could be con­sis­tent with falling debt volumes—such a phe­nom­e­non is more likely to mean con­sol­i­da­tion in the sec­tor rather than an increased num­ber of play­ers fight­ing over a smaller pie.

Fig­ure 35: Aus­tralian house­hold debt com­pared to GDP is now 5% higher than America’s

Fig­ure 36: Inter­est on mort­gages cost 6.5% of GDP here ver­sus under 4% in the USA

A lack of com­pe­ti­tion, or a lack of control?

The pre­ced­ing analy­sis shows that the prob­lem with bank­ing is not so much a lack of com­pe­ti­tion, as a lack of con­trol over the level of lend­ing. The ques­tion then is whether increased com­pe­ti­tion would pro­vide the con­trol needed over the level of lending.

The his­tor­i­cal record is decid­edly that it will not: as shown above, both pre­vi­ous policy-inspired increases in com­pe­ti­tion caused a blowout in debt lev­els. Com­pe­ti­tion is not the solu­tion to the social and eco­nomic prob­lems caused by the bank­ing sector.

Why then are politi­cians and econ­o­mists rec­om­mend­ing more com­pe­ti­tion for bank­ing? To some degree this is because of they tend to apply the stan­dard “sup­ply and demand” model to banking—and there­fore to argue that if the indus­try is the sub­ject of com­plaints, it must be because it is too monop­o­lis­tic. Unfor­tu­nately how­ever, the “sup­ply and demand” model is a false guide to the oper­a­tions of the bank­ing sec­tor. So too is the “money mul­ti­plier” the­ory of how credit money is cre­ated that is still taught in eco­nom­ics text­books, despite being found to be empir­i­cally false over the last 3 decades.

One of the main rea­sons that the world is now mired in a seem­ingly never-ending series of finan­cial crises is because of the appli­ca­tion of appeal­ing but false mod­els of how bank­ing behaves. It is there­fore impor­tant for policy-makers—like the mem­bers of this Committee—to have an accu­rate under­stand­ing of how the sec­tor they are attempt­ing to reform actu­ally operates.

The con­ven­tional “money mul­ti­plier” model argues that the cre­ation of credit money begins with an injec­tion of government-created “Base Money”, which is then deposited by an indi­vid­ual in a bank account. The bank then retains a por­tion of this—the so-called Reserve Ratio—and lends the rest. A process of re-depositing and re-lending then occurs, at the end of which the total amount of money cre­ated is equal to the Base Money injec­tion divided by the Reserve Ratio.

Were this model accu­rate, then we would find that there was a time lag between the cre­ation of Base Money (M0) and the cre­ation of Credit Money (M2–M0). But in fact the lag has been found to be the other way around: credit money is cre­ated first, fol­lowed by changes in base money. As Nobel Prize win­ners Kyd­land and Prescott put it:

There is no evi­dence that either the mon­e­tary base or M1 leads the cycle, although some econ­o­mists still believe this mon­e­tary myth. Both the mon­e­tary base and M1 series are gen­er­ally pro­cycli­cal and, if any­thing, the mon­e­tary base lags the cycle slightly… The dif­fer­ence of M2 — M1 leads the cycle by even more than M2, with the lead being about three quar­ters. (Finn E. Kyd­land and Edward C. Prescott, 1990, p. 12)

A more real­is­tic per­spec­tive on bank­ing is the “endoge­nous money” the­ory, and its impli­ca­tions are that dereg­u­lated, com­pet­i­tive bank­ing has an innate ten­dency to cause finan­cial crises of the kind the global econ­omy is now expe­ri­enc­ing. As Basil Moore put it, the essence of this model is the obser­va­tion that

In the real world banks extend credit, cre­at­ing deposits in the process, and look for the reserves later” ((Basil J. Moore, 1979, p. 539) cit­ing (Alan R. Holmes, 1969, p. 73); see also more recently (Piti Disy­atat, 2010, “loans drive deposits rather than the other way around”, p. 7)).

This empir­i­cal real­ity makes it easy to under­stand a fun­da­men­tal point: that banks have an innate ten­dency to want to cre­ate as much debt as pos­si­ble, and the only effec­tive stop to this is not com­pe­ti­tion between banks, but insti­tu­tional reforms that limit the will­ing­ness of bor­row­ers to take on debt for spec­u­la­tive purposes.

I have con­structed mod­els of a pure credit econ­omy to illus­trate this point (Steve Keen, 2009a, b, c, d, 2008, 2010); rather than repro­duc­ing these here I have put a model which enables these points to be illus­trated in a dynamic sim­u­la­tion (see Fig­ure 37 for a sam­ple out­put) on my blog at the page The model and mod­el­ing soft­ware can be down­loaded directly from the fol­low­ing link:

Fig­ure 37: Sam­ple out­put from dynamic mod­el­ling pro­gram with vari­a­tions in lend­ing vari­ables

Fig­ure 38 illus­trates the basic insight of this endoge­nous money per­spec­tive: bank income increases if more debt is cre­ated. This ten­dency will not be reduced by increas­ing com­pe­ti­tion: instead, as the his­tor­i­cal record of Aus­tralian bank­ing has illus­trated, an increase in com­pe­ti­tion will often amplify this ten­dency as the com­pe­ti­tion for mar­ket share leads all banks to search out avenues to mar­ket debt.

Fig­ure 38: Bank income increases with faster lend­ing, more rapid money cre­ation, and slower loans repay­ment

The eas­i­est way to do so is to fund spec­u­la­tion on asset prices, since that weak­ens the one effec­tive con­trol on the amount of debt that banks can cre­ate, the will­ing­ness of firms and house­holds to go into debt.

If firms and house­holds limit their bor­row­ing to what they can rea­son­ably antic­i­pate ser­vic­ing from income, then broadly speak­ing debt would not become a prob­lem. Though there will always be firms who bor­row with unre­al­is­tic expec­ta­tions of profit, and prodi­gal house­holds who live beyond their means, by and large these will be periph­eral issues if bor­row­ing is income-based.

But when bor­row­ing becomes based instead on expec­ta­tions of prof­it­ing from ris­ing asset prices (“asset-based lend­ing”), then a pos­i­tive feed­back loop is set up that, almost inevitably, leads to a blowout in debt lev­els and an even­tual finan­cial cri­sis. Ris­ing debt lev­els them­selves drive up asset prices, indi­vid­u­als accept a higher debt to income ratio than they oth­er­wise would in the belief that debt can be repaid from the pro­ceeds of asset sales, and an actual boom is gen­er­ated in the econ­omy as the increase in debt spurs aggre­gate demand. Once such an appar­ent “vir­tu­ous cir­cle” is in train, it is almost impos­si­ble to stop, since vir­tu­ally every­one in soci­ety has an inter­est in its con­tin­u­ance: the banks, stock­bro­kers and real estate agents because their prof­its are higher, the gen­eral pub­lic because they feel wealth­ier as asset prices rise (and some of them do profit from buy­ing and sell­ing on a ris­ing mar­ket), and even the gov­ern­ment because the Ponzi boom gen­er­ated by ris­ing pri­vate debt makes it seem to be a “good eco­nomic manager”.

But the boom must ulti­mately end in a cri­sis, because it dri­ves up debt lev­els with­out adding to the economy’s income-generating capac­ity. Ulti­mately, a level of debt will be incurred that can­not be ser­viced, and the econ­omy will col­lapse into a Depres­sion. I have mod­eled this process in another more tech­ni­cal paper (Steve Keen, 2009d). Two sam­ple out­puts from this model are shown in Fig­ure 39 and Fig­ure 40. With­out asset-based lend­ing, though the debt level rises, it does not get out of hand and cause a crisis.

Fig­ure 39: a debt-financed pure credit econ­omy with­out asset-based lend­ing

With asset-based lend­ing how­ever, spec­u­la­tive lend­ing even­tu­ally pre­dom­i­nates over pro­duc­tive invest­ment and even­tu­ally, after a series of finan­cial cycles, the level of debt over­whelms the economy.

Fig­ure 40: a debt-financed pure credit econ­omy with asset-based lend­ing

Con­clu­sion: the prob­lem is not micro­eco­nomic, and com­pe­ti­tion is not the solution

Since the main prob­lems with the bank­ing sec­tor relate to the amount of debt it gen­er­ates and the macro­eco­nomic prob­lems these cause, the solu­tion lies not with micro­eco­nomic reforms—and espe­cially not with increased com­pe­ti­tion, which exac­er­bates the under­ly­ing prob­lem of exces­sive debt—but with insti­tu­tional reforms and macro­eco­nomic policy.

From the expe­ri­ence of the Great Depres­sion itself, it is clear that reg­u­la­tory reform is not enough to pre­vent bank lend­ing get­ting out of hand. Reforms such as the Glass Stea­gall Act may tem­porar­ily usher in a period of sta­bil­ity. But if the reforms leave open the pos­si­bil­ity of fund­ing asset-price spec­u­la­tion, then banks will do this and in the process, under­mine the reforms. The pub­lic will gain a tem­po­rary ben­e­fit from the lend­ing as it expands eco­nomic activ­ity, bank power will rise with ris­ing debt, and ultimately—as we saw in 1999—the very reforms them­selves will be abolished.

Some­thing more per­ma­nent is required, and it has to, in my opin­ion, tackle the will­ing­ness of bor­row­ers to take on debt, rather than attempt­ing to limit bank will­ing­ness to lend—since I see this as rather like try­ing to stop the tides com­ing in.

I have devel­oped two basic reform ideas, both of which I know I have Buckley’s Chance of hav­ing imple­mented at present—especially in Aus­tralia, since the dom­i­nant per­cep­tion here is that we have in fact avoided the prob­lems that have beset the rest of the world. How­ever unless I put these ideas into cir­cu­la­tion now, there will never be any chance of hav­ing them imple­mented, even when atti­tudes to the finan­cial cri­sis are much more melan­choly than today.

Reform Pro­pos­als

My pro­pos­als are, in one sense, “micro­eco­nomic reforms”, since they are rede­f­i­n­i­tions of fun­da­men­tal com­po­nents of every­day con­tracts rather than grand reg­u­la­tory schemes to con­trol bank­ing, or fis­cal or mon­e­tary pol­icy rec­om­men­da­tions to counter the excesses of the bank­ing sec­tor. How­ever, I am sure they are not the kind of micro­eco­nomic reforms the Com­mit­tee had in mind—and nor are they likely to be adopted.

These pro­pos­als are:

  1. To rede­fine shares so that, when pur­chased from a com­pany, they last indef­i­nitely as they do today, but once they are sold to a sec­ondary pur­chaser, they have a defined life­time of 50 years, after which they expire (I call this a Jubilee Share pro­posal); and
  2. To base lend­ing for prop­erty on the rental income (actual or imputed) of the prop­erty being pur­chased, and to limit the debt that can be secured against a prop­erty to ten times its annual rental income.

The object of both reforms is to make lever­aged spec­u­la­tion on asset prices much less likely than it is today.

The vast major­ity of trades on share mar­kets are of spec­u­la­tors sell­ing to other spec­u­la­tors, with val­u­a­tions osten­si­bly based on the net present value of expected future div­i­dend flows, but in real­ity based on the “Greater Fool” prin­ci­ple, where ris­ing debt funds the Greater Fool. If instead shares on the sec­ondary mar­ket pro­vided div­i­dends for up to 50 years, but after that date had a value of zero, it is far less likely that share pur­chases would be under­taken with bor­rowed money. Val­u­a­tions would then be actu­ally based on con­ser­v­a­tive esti­mates of future div­i­dend flows up until expiry, lead­ing to much less volatile share prices and much less speculation.

Such a change would also encour­age cap­i­tal for­ma­tion via the share mar­ket, since the only means to secure a per­pet­ual div­i­dend flow would be to pro­vide money directly to a com­pany via an ini­tial pub­lic offering.

The prop­erty reform would break the pos­i­tive feed­back loop that cur­rently exists between lever­age and prop­erty prices: prices rise because some bor­row­ers are will­ing to take on more lever­age to trump other bor­row­ers, and the increased lever­age dri­ves prices up, feed­ing back into the leverage-price bub­ble process.

With this reform, all would-be pur­chasers would be on equal foot­ing with respect to their level of debt-financed spend­ing, and the only way to trump another buyer would be to put more non-debt-financed money into pur­chas­ing a property.

Though I know there is no prospect of these reforms being adopted, I nonethe­less rec­om­mend that Sen­a­tors at least pon­der them. The Global Finan­cial Cri­sis is not going away any time soon, because its fun­da­men­tal cause is still with us—an exces­sive level of pri­vate sec­tor debt, gen­er­ated by a finan­cial sec­tor that was hap­pier fund­ing Ponzi Schemes than it was doing the more dif­fi­cult work of financ­ing pro­duc­tive invest­ment. Only when the intractabil­ity of the cri­sis with­out fun­da­men­tal reforms becomes appar­ent, will pro­pos­als like these that actu­ally go to the heart of the prob­lem be considered.

In the mean­time, I expect that mis­taken ideas—such as that the prob­lem is exces­sive mar­gins rather than exces­sive debt, and that addi­tional com­pe­ti­tion will solve this problem—are more likely to be pro­posed by Inquiries such as this one. I remain opposed to unstruc­tured attempts to increase com­pe­ti­tion in the bank­ing sec­tor, but there is one com­pet­i­tive reform that I would sup­port: intro­duc­ing lenders whose sole pur­pose is to pro­vide small busi­ness with work­ing cap­i­tal. At present, small busi­ness is being squeezed by higher loan mar­gins more than all other sec­tors, and much small busi­ness lend­ing is actu­ally secured against and based on the prop­erty owned by small busi­ness own­ers, rather than on their busi­nesses and cash flows,as it should be.

A com­pet­i­tive reform that encour­aged lend­ing to this sector—to finance actual busi­ness activity—would be worth­while. Any other approach that relied sim­ply on increased com­pe­ti­tion to fix the sector’s ills would either fail to work—given the cur­rent exces­sive level of debt—or make our prob­lems worse.


Bat­tellino, Ric. 2007. “Some Obser­va­tions on Finan­cial Trends.” Reserve Bank of Aus­tralia Bul­letin, Octo­ber 2007, 14–21.

Bernanke, Ben S. 2000. Essays on the Great Depres­sion. Prince­ton: Prince­ton Uni­ver­sity Press.

Beze­mer, Dirk J. 2009. ““No One Saw This Com­ing”: Under­stand­ing Finan­cial Cri­sis through Account­ing Mod­els,” Gronin­gen, The Nether­lands: Fac­ulty of Eco­nom­ics Uni­ver­sity of Groningen,

Beze­mer, Dirk J. 2010. “Under­stand­ing Finan­cial Cri­sis through Account­ing Mod­els.” Account­ing, Orga­ni­za­tions and Soci­ety, 35(7), 676–88.

Biggs, Michael; Thomas Mayer and Andreas Pick. 2010. “Credit and Eco­nomic Recov­ery: Demys­ti­fy­ing Phoenix Mir­a­cles.” SSRN eLi­brary.

Com­mon­wealth Bank. 2010. “Aus­tralian Res­i­den­tial Houses and Mort­gages: Cba Mort­gage Book Secure,” Syd­ney: Com­mon­wealth Bank of Australia,

Cox, Wen­dell and Hugh Pavletich. 2010. “6th Annual Demographia Inter­na­tional Hous­ing Afford­abil­ity Sur­vey,” Demographia,

Disy­atat, Piti. 2010. “The Bank Lend­ing Chan­nel Revis­ited,” BIS Work­ing Papers. Basel: Bank of Inter­na­tional Set­tle­ments, 35.

Eggerts­son, Gauti B. and Paul Krug­man. 2010. “Debt, Delever­ag­ing, and the Liq­uid­ity Trap: A Fisher-Minsky-Koo Approach,”

Fisher, Chay and Christo­pher Kent. 1999. “Two Depres­sions, One Bank­ing Col­lapse,” Reserve Bank of Aus­tralia Research Dis­cus­sion Papers. Syd­ney, NSW, Aus­tralia: Reserve Bank of Aus­tralia, 54.

Fisher, Irv­ing. 1933. “The Debt-Deflation The­ory of Great Depres­sions.” Econo­met­rica, 1(4), 337–57.

Full­brook, Edward. 2010. “Keen, Roubini and Baker Win Revere Award for Eco­nom­ics,” E. Full­brook, Real World Eco­nom­ics Review Blog. New York: Real World Eco­nom­ics Review,

Holmes, Alan R. 1969. “Oper­a­tional Con­traints on the Sta­bi­liza­tion of Money Sup­ply Growth,” F. E. Mor­ris, Con­trol­ling Mon­e­tary Aggre­gates. Nan­tucket Island: The Fed­eral Reserve Bank of Boston, 65–77.

House of Rep­re­sen­ta­tives Stand­ing Com­mit­tee on Eco­nom­ics Finance and Pub­lic Admin­is­tra­tion. 2007. “Ref­er­ence: Reserve Bank of Aus­tralia Annual Report 2006,” Perth: Hansard,

Keen, Steve. 2009a. “Bail­ing out the Titanic with a Thim­ble.” Eco­nomic Analy­sis & Pol­icy, 39(1), 3–24.

Keen, Steve. 2009b. “The Dynam­ics of the Mon­e­tary Cir­cuit,” S. Rossi and J.-F. Pon­sot, The Polit­i­cal Econ­omy of Mon­e­tary Cir­cuits: Tra­di­tion and Change. Lon­don: Pal­grave Macmil­lan, 161–87.

Keen, Steve. 1995. “Finance and Eco­nomic Break­down: Mod­el­ing Minsky’s ‘Finan­cial Insta­bil­ity Hypoth­e­sis.’.” Jour­nal of Post Key­ne­sian Eco­nom­ics, 17(4), 607–35.

Keen, Steve. 2009c. “The Global Finan­cial Cri­sis, Credit Crunches and Delever­ag­ing.” Jour­nal Of Aus­tralian Polit­i­cal Econ­omy, 64, 18–32.

Keen, Steve. 2009d. “House­hold Debt-the Final Stage in an Arti­fi­cially Extended Ponzi Bub­ble.” Aus­tralian Eco­nomic Review, 42, 347–57.

Keen, Steve. 2008. “Keynes’s ‘Revolv­ing Fund of Finance’ and Trans­ac­tions in the Cir­cuit,” R. Wray and M. Forstater, Keynes and Macro­eco­nom­ics after 70 Years. Chel­tenham: Edward Elgar, 259–78.

Keen, Steve. 2010. “Solv­ing the Para­dox of Mon­e­tary Prof­its.” Eco­nom­ics: The Open-Access, Open Assess­ment E-Journal, 4(2010–31).

Kyd­land, Finn E. and Edward C. Prescott. 1990. “Busi­ness Cycles: Real Facts and a Mon­e­tary Myth.” Fed­eral Reserve Bank of Min­neapo­lis Quar­terly Review, 14(2), 3–18.

Min­sky, Hyman P. 1982. Can “It” Hap­pen Again? : Essays on Insta­bil­ity and Finance. Armonk, N.Y.: M.E. Sharpe.

Moore, Basil J. 1979. “The Endoge­nous Money Stock.” Jour­nal of Post Key­ne­sian Eco­nom­ics, 2(1), 49–70.

National Hous­ing Sup­ply Coun­cil. 2010. “National Hous­ing Sup­ply Coun­cil 2nd State of Sup­ply Report,” H. Depart­ment of Fam­i­lies, Com­mu­nity Ser­vices and Indige­nous Affairs, Can­berra: Aus­tralian Government,

Stand­ing Com­mit­tee On Eco­nom­ics Finance And Pub­lic Admin­is­tra­tion. 2007. “Round­table on Home Loan Lend­ing Prac­tices and Processes,” Can­berra: Proof Com­mit­tee Hansard,

Wal­lis, Stan; Bill Beer­worth; Jeff Carmichael; Ian Harper and Linda Nicholls. 1997. “Final Report of the Finan­cial Sys­tem Inquiry,” Trea­sury, Can­berra: Aus­tralian Gov­ern­ment Pub­lish­ing Service,

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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66 Responses to Competition is not a panacea in banking

  1. goidcc says:

    Thanks for the detailed arti­cle. About your pro­posal for reforms: How about we just limit the mar­gin accounts that are used to spec­u­late on stock mar­kets or raise the mar­gin requirments and down pay­ments for mort­gage loans. These two sim­ple con­di­tions will itself limit the spec­u­la­tion. I think set­ting up expi­ra­tion date on stocks is basi­cally mak­ing stocks behave like bonds with higher default risk.


  2. Steve Keen says:

    I’m think­ing in a 50 year time frame goidcc: reforms like that will work, and then be eas­ily abol­ished because they did work. Look at what hap­pened to Glass-Steagall. We need some­thing that out­lives the mem­ory of those who expe­ri­enced the cri­sis itself. That’s why I think any lesser reforms are wor­thy but … won’t last.

  3. alainton says:


    I think that this posts gives too lit­tle atten­tion to the issues con­cern­ing the elas­tic­ity of sup­ply of hous­ing. You are right in stat­ing that the key dri­ver is mort­gage lend­ing; but for a mort­gage to exist houses must exist. What mat­ters is the ratio of expan­sion in mort­gage lend­ing (in real terms) to the expan­sion in the dwelling stock. If both rise in tan­dem with­out spec­u­la­tive excess there can be no hous­ing asset price bubble.

    There are three unusual aspects of the hous­ing mar­ket that need to be incor­po­rated into your model. Firstly new hous­ing, like money, is endoge­nous, to expand sup­ply a third party, a landowner, must develop it, and obtain devel­op­ment finance prior to a house­holder pur­chaser obtain­ing finance. Sec­ondly hous­ing mar­kets are not clear­ing in a down­turn, if some­one lives in a house and does not have to move for employ­ment or other pur­poses then they wont put the house on the mar­ket, they will hold out on expec­ta­tions of long run house price increases. Sim­i­larly devel­op­ers of prop­er­ties not reliant on loan financ­ing wont nec­es­sar­ily sell or rent at rock bot­tom prices — they will sit things out in many cases leav­ing newly com­pleted houses empty, the same with bank repos­sessed houses (there is plenty of empir­i­cal evi­dence of this in china and dubai, and ire­land — ghost estates and ghost cities). In these cases first time buy­ers from newly formed house­holds have a dis­pro­por­tion­ate impact on house prices. What mat­ters is not pop­u­la­tion increase per se but house­hold increase. House­holds have been increas­ing in many coun­tries despite falling pop­u­la­tion lev­els because of divorce, aging etc. etc.

    Finally for the work­ing age pop­u­la­tion the expan­sion of hous­ing in an area will be lim­ited by the amount and wages of employ­ment in the houses catch­ment area. If employ­ment is high paid in an area and hous­ing sup­ply lim­ited then house prices will rise and hous­ing devel­op­ers in that area will make super prof­its. It is the per­ceived abil­ity of hous­ing devel­op­ers to make these super prof­its that feeds hous­ing con­struc­tion and mort­gage lend­ing, of course exces­sive sup­ply and exces­sive lever­age can result in the herd instinct.

  4. Steve Keen says:

    Agreed that there wouldn’t be a bub­ble with­out spec­u­la­tive excess Andrew, but my point was that there has been spec­u­la­tive excess.

    The elas­tic­ity of sup­ply turns up in how, gen­er­ally speak­ing, the rate of growth of dwellings has matched pop­u­la­tion growth plus demo­graphic change. I would think that the prop­erty spruik­ers are the ones who under­es­ti­mate this elas­tic­ity rather than me–they’re for­ever explain­ing the increase in prices on rigidi­ties in sup­ply, after all.

    The capac­ity of sell­ers not to sell does make prop­erty dif­fer­ent to shares for instance, where a mar­gin loan will com­pel sell­ing given a suf­fi­cient price drop. This does give it dif­fer­ent, slower dynamics–which is why my expec­ta­tion of a 40% price fall was always over a 10–15 year time period.

  5. cja says:

    Where do you think the Credit Impulse is head­ing for Aus­tralia?
    I found this arti­cle (also here) from about a month ago where Deutsche Bank are quoted as saying:

    A more use­ful mea­sure is the accel­er­a­tion or decel­er­a­tion in credit growth as it tracks the eco­nomic cycle much more closely. We call this the credit impulse and it cur­rently points to above trend con­sumer demand growth.

    Are they talk­ing non­sense, or is it likely to have stalled since then?

  6. Steve Keen says:

    Hi cja,

    Those Deutsche Bank econ­o­mists were the ones who actu­ally iden­ti­fied and mea­sured the Credit Impulse before I did–my own cau­tion on whether there could be a close cor­re­la­tion between a first and sec­ond deriv­a­tive in eco­nomic data undid me here.

    But what those ana­lysts don’t con­sider is the aggre­gate debt to GDP and its impact as a limit on the credit impulse. For the credit impulse to remain pos­i­tive, ulti­mately the debt to GDP ratio has to rise. That, I believe, ain’t going to hap­pen. The more recent data than they were using shows this too–the last 3 months worth of the credit impulse have been neg­a­tive. I’ll cover this early next year.

  7. cja says:

    Awe­some. I was try­ing to do this in Excel, but it made my head hurst and I prob­a­bly had the wrong data any­way. I’ll wait will the new year!

  8. jonnow says:

    Hi Steve, I enjoyed the thor­ough paper.

    I want to ask, how did you deter­mine that Aus­tralia escaped depres­sion because of the first home owner boost? While it is true that Aus­tralia avoided delever­age by going back to bub­ble con­di­tions, I would like to hear more of your argu­ment on why it worked. After­all, you were con­vinced dur­ing the GFC that recov­ery would be stalled if the gov­ern­ment inter­vened the way they did.

    The stan­dard global response to the GFC was to avoid delever­ag­ing by cut­ting bank fund­ing costs and rein­flate spec­u­la­tive mar­kets. Aus­tralia was no different.

    Being a “risky coun­try” we could not cut our inter­est rates. We couldn’t print money due to our weak cur­rency and for­eign denom­i­nated debt. We did not bail out trou­bled busi­nesses as the US did with banks and motor com­pa­nies. We could not turn to invest­ment banks to prop up the mar­ket. We didn’t give out tax cuts and con­ces­sions other than first home buyers.

    Sure we guar­enteed deposits / bank debt and handed out some free money. But that was far from the efforts of other countries.

    So the ques­tion should be why did Aus­tralia suceeded while oth­ers failed?


  9. Steve Keen says:

    Hi Jon­now,

    I hope I’ve answered this query with the lat­est blog post, which com­pares the dynam­ics of credit in Aus­tralia and the USA. It really does come down to the First Home Ven­dors Boost, with­out which we would have hit delever­ag­ing ter­ri­tory, as they have in the USA.

  10. peterjbolton says:

    Dur­ing my expo­sure to the Euro­pean bank­ing sector’s insides some 15 years ago, I was repeat­edly faced with the com­mon fact to the numer­ous banker insid­ers with whom I had rela­tion­ships with, that the whole of the Euro­peans larger banks were all tech­ni­cally bank­rupt and deep in col­lu­sion with their national lead­ers and the game and the order of the day (every­day), not to save the banks but to cover up this state of affairs and to save the bankers col­lec­tive necks. Lead­er­ship, of course, all — were more than co-operative due to another fact, that the con­di­tion of bank­ruptcy had come about by their nefar­i­ous “pol­icy” mak­ing and dip­ping into the slop pot… of cap­ture banking.

    My posi­tion has been for many years, since this time, that bank­ing is a seri­ally dan­ger­ous and deadly polit­i­cal tool that does not respond to com­pe­ti­tion — at all, but on the con­trary, cap­tures and cor­rupts social val­ues and which always dri­ves soci­ety into sig­nif­i­cant bloody dis­as­ters — which are always paid for by the cur­rent and future pro­duc­tive work­force. IOW, it is by far worse than a Ponzi scheme as it has been now described by so many; it is indeed a preda­tory sin­gle minded deadly syco­phan­tic par­a­site that con­sumes human val­ues and pro­duc­tiv­ity whilst being dressed in expen­sive suits and couched in warm and polit­i­cal cor­rect lan­guage; it is per­va­sive and ubiq­ui­tous and indeed wel­come — with eager antic­i­pa­tion, into all cor­ners of brood­ing con­tem­pla­tions of power.

    In other words, it is mans’ worst enemy and that which resides within… pre­tend­ing and feed­ing and has a life of its own; the vam­piric alien.

    Swan has shown this past week that he is indeed hav­ing his strings pulled by those that he says are to be con­tained — my words. Now RBA has yes­ter­day announced a new mech­a­nism to top up those all pow­er­ful 4 pil­lars of Aussie her­culean strength with a slop fund for … the Min­ski Moment and / or ‘just in case’. So much for the ill-termed and mis-named “fifth pil­lar”, which never was.

    From Wik­ileaks we get the following:

    Mon­day, 17 March 2008, 18:27
    C O N F I D E N T I A L LONDON 000797
    EO 12958 DECL: 03/17/2018
    Clas­si­fied By: AMB RTUTTLE, rea­sons 1.4 (b) and (d)

    1. Since last sum­mer, the nature of the cri­sis in finan­cial mar­kets has changed. The prob­lem is now not liq­uid­ity in the sys­tem but rather a ques­tion of sys­temic sol­vency, Bank of Eng­land (BOE) Gov­er­nor Mervyn King said at a lunch meet­ing with Trea­sury Deputy Sec­re­tary Robert Kim­mitt and Ambas­sador Tut­tle. King said there are two imper­a­tives. First to find ways for banks to avoid the stigma of sell­ing unwanted paper at dis­tressed prices or going to a cen­tral bank for assis­tance. Sec­ond to ensure there’s a coor­di­nated effort to pos­si­bly recap­i­tal­ize the global bank­ing sys­tem. For the first imper­a­tive, King sug­gested devel­op­ing a pool­ing and auc­tion process to unblock the large vol­ume of finan­cial invest­ments for which there is cur­rently no mar­ket. For the sec­ond imper­a­tive, King sug­gested that the U.S., UK, Switzer­land, and per­haps Japan might form a tem­po­rary new group to jointly develop an effort to bring together sources of cap­i­tal to recap­i­tal­ize all major banks.

    Sys­temic Insol­vency Is Now The Problem


    Just to repeat: sol­vency or “Insol­vency” is the prob­lem which is of no sur­prise to me at all.

    Eric Hoffer’s mag­nif­i­cent and reveal­ing work ‘The True Believer” grants us (who­ever reads any­more) real insights as to why we just fol­low flawed par­a­digms (Kuhn) to bliss­ful con­sen­sual social sui­cide; Long Live the King — which in a qual­i­ta­tive sim­plic­ity sug­gests that 1), we just don’t care, 2). we don’t dare inquire, and 3). we do not have the nec­es­sary intel­li­gence to be that which we think we are, ie, homo sapien sapien. Or, we just want des­per­ately to belong to some­thing con­sen­sual, no mat­ter what, but not, of sen­tience or thought.!

    Please note that the 1st. global rev­o­lu­tion has begun and appro­pri­ately this rev­o­lu­tion is ulti­mately about being informed, being aware and being sen­tient; sup­posed and the­o­ret­i­cal human con­di­tions, and attrib­utes. All facts must fit the the­ory espe­cially anom­alous facts for a the­ory to be some­where in the vicin­ity of being ready for adop­tion as a Maxim.

    As such, the real­ity is that this global sys­temic cri­sis (GSC) is a bank­rupted “lead­er­ship” cri­sis, where “lead­er­ship” has decid­edly and absolutely failed to lead the loyal, gullible and trust­ing to higher ideals, val­ues and sci­en­tific pur­suits and Prin­ci­ples but have instead, cho­sen to lead the World unknow­ingly and con­sen­su­ally back into bar­baric devo­lu­tion — aided and abet­ted by that ancient cor­rup­tive tool of ‘Cap­ture Bank­ing’ and prim­i­tive “force” instilled through fear.

  11. peterjbolton says:

    And, from Kris Sayce of Mon­day Morn­ing today: (Facts tend to upset… some)

    NAB Execs Admit Bank Was In Trou­ble
    Fri­day 17th Decem­ber, 2010 — Mel­bourne, Aus­tralia
    By Kris Sayce
    NAB Execs Admit Bank Was In Trou­ble
    Mar­ket News This Week

    You’ve got your eye on a stock — but you’re not sure if it’s the right time to buy it…

    You’re hold­ing another stock that just went up — or down — sig­nif­i­cantly… but you don’t know whether it’s time to sell…

    The solu­tion to both of these dilem­mas will become a lot clearer once you’ve watched this video (turn on your speakers)


    If you haven’t found the time to read the tran­scripts from the Sen­ate eco­nom­ics select com­mit­tee I sug­gest you find the time.
    Sim­ply because com­ments from two National Aus­tralia Bank [ASX: NAB] exec­u­tives con­firm — that’s right, con­firm — every­thing we’ve writ­ten about NAB’s secret bailouts in 2008 and 2009.

    You can down­load the tran­script by click­ing here.

    We told you the banks need the loans because they faced a mas­sive liq­uid­ity and sol­vency problem.

    Our crit­ics said we were talk­ing rub­bish. That we had finally lost our marbles.

    They tried to say NAB was just being cheeky. That is was snaf­fling Fed­eral Reserve loans on the cheap. They said NAB did what any back should do, take the oppor­tu­nity to bor­row low and lend high.

    We coun­tered the argu­ment by explain­ing how bank bor­row­ing works. How banks have to roll over debt on a reg­u­lar basis. If there’s a prob­lem with rolling the debt over, then, well, it can leave a bank in the lurch.

    We showed you how NAB and West­pac [ASX: WBC] had stood hunched shoul­der to hunched shoul­der with other trou­bled banks. Banks such as Royal Bank of Scot­land, Lloyd­sTSB, Citibank and ABN Amro.

    Believe me, the admis­sion I’ll show you in a moment is dyna­mite. It’s an admis­sion straight from the horses’ mouths. That the Aus­tralian bank­ing sys­tem was in dire trou­ble in late 2008.

    Yet where is the Aus­tralian main­stream press on this story?

    Good ques­tion. Nowhere. The main­stream press con­spired with the banks and reg­u­la­tors to sweep the secret loans scan­dal under the car­pet. And now they’ve done the same with the Sen­ate com­mit­tee statements.

    To be hon­est, the incom­pe­tence of the main­stream press doesn’t sur­prise us. We’d waited a cou­ple of days for the tran­scripts to be posted to the Hansard web­site (Hansard is the offi­cial record of par­lia­men­tary debate).

    Until then, like you, we had to rely on what the main­stream press had reported. And what did they focus on? Of course, they focused on the easy stuff… banks’ inter­est mar­gins, bank fees, exec­u­tive pay lev­els… the sort of stuff that’s easy for the jour­nal­ism cadets to get their teeth into.

    I mean, the bomb­shell I’ll reveal to you today isn’t the sort of thing the sea­soned finance hack would touch with a barge­pole. Why? Because the sea­soned finance hack doesn’t want to ruin his chances of an invite to the next bank­ing din­ner party.

    Or the chance to inter­view a top bank­ing exec­u­tive. That’s more impor­tant to them than uncov­er­ing a story that proves the fragility of the bank­ing system.

    Although to be fair, even if they did want to report on it, chances are their edi­tor would exer­cise a veto and cut out all the juicy stuff.

    So, when we read the tran­script, guess the first thing your edi­tor did. Go on, guess.

    What’s that, you can’t? Think harder. Think how annoy­ing we can be… that’s right, we fired off another email to our pals at the ASX. I won’t reprint it here, instead I’ll expand on what I wrote to them.

    Remem­ber some of the pre­vi­ous ban­ter we had with the ASX folks. They told us the ASX didn’t have the power to request infor­ma­tion from a com­pany. Not unless there was an unex­plained price movement.

    We told them their ver­sion of ASX Rule 3.1 was wrong. The ASX did have the power to request addi­tional infor­ma­tion from the banks. Not only did they have the power, but that they should do so immediately.

    Fun­nily enough, two weeks since the US Fed­eral Reserve released the extra­or­di­nary details of NAB and Westpac’s secret loans and the ASX is still sit­ting on it.

    The ASX con­tin­ues to con­spire with NAB and West­pac to keep the mar­ket unin­formed about secret loans that pre­vented two of Australia’s banks from going bust. I don’t know about you but I’d think that was some­thing the ASX would want an expla­na­tion on.

    Yes, I’ve been crit­i­cised for my com­ments on the seri­ous­ness of these loans. I’ve been told on more than four occa­sions (five I think… maybe six) that Australia’s banks were nowhere near going bust.

    Well, it turns out your edi­tor was right. But don’t just take my word for it. In a moment I’ll show you what two top execs at NAB — one of them the top dog — told the Sen­ate com­mit­tee about the finan­cial con­di­tion of the banks in 2008 and 2009.

    But first, Money Morn­ing reader Paul sent us this timely reminder of the spin put out by the bank­ing indus­tries pup­pet mouth­piece, the Aus­tralian Bankers’ Asso­ci­a­tion (ABA) in Octo­ber 2008:

    The Aus­tralian Bankers’ Asso­ci­a­tion (ABA) is con­cerned that recent announce­ments by the Fed­eral Gov­ern­ment to guar­an­tee deposits and whole­sale fund­ing are being char­ac­terised as the Aus­tralian banks hav­ing been ‘bailed out’.

    This is false

    No bank deposits have been at risk. Bank deposits are safe — with or with­out the government’s guarantee.

    Aus­tralian banks and the reg­u­la­tory frame­work have been suc­cess­ful. Unlike in the UK, Europe and the USA, no taxpayer’s money has been allo­cated to sup­port an Aus­tralian bank. Aus­tralian banks are very strongly cap­i­talised and con­tinue to hold assets that are of good credit quality.”

    It’s inter­est­ing the ABA would say that, because one year prior to that state­ment West­pac had grov­elled to the US Fed­eral Reserve for USD$1 bil­lion. And one month later NAB would need to raise bil­lions of dol­lars on the Aus­tralian Secu­ri­ties Exchange.

    As NAB direc­tor of finance Mark Joiner told the Sen­ate committee:

    There were two peri­ods dur­ing the cri­sis when our credit rat­ing was on neg­a­tive watch. If we dropped out of the AA sta­tus, then the cost of funds and our access to funds inter­na­tion­ally would have been severely altered.”

    Despite that, the ABA claimed Australia’s banks were “strongly cap­i­talised”. So “strongly cap­i­talised” that the NAB had to raise $6 bil­lion on the mar­ket plus another USD$4.5 bil­lion in secret from the US Fed.

    That doesn’t sound very strong to me.

    But right there, in Mr. Joiner’s state­ment is the pre­cise rea­son why the NAB grabbed the secret loan money from the US Fed­eral Reserve. Not because it was try­ing to make a few extra bucks, but because the bank was on a neg­a­tive credit watch.

    The bank execs knew that if the mar­ket knew just how tight the bank’s bal­ance sheet was, the bank would have lost its AA credit rat­ing. Here are Mr. Joiner’s com­ments to the Sen­ate committee:

    There were two peri­ods dur­ing the cri­sis when our credit rat­ing was on neg­a­tive watch. If we dropped out of the AA sta­tus, then the cost of funds and our access to funds inter­na­tion­ally would have been severely altered. Then our abil­ity to sup­port the econ­omy in the ways we described before—staying open for busi­ness and pre­dictable for customers—would also have gone. We would have had to freeze our bal­ance sheet growth and the like. While you prob­a­bly do not want obscene amounts of prof­itabil­ity out of your bank­ing sys­tem, it is good for every­body to have a strong bank­ing sys­tem that sup­ports a degree of eco­nomic self-determination and flexibility.”

    See, with­out these bailouts Mr. Joiner admits it would have been hard for the bank to stay open for business.

    Yet just like the secret loans, you didn’t hear about this state­ment in the main­stream press. They didn’t seem to think it was impor­tant enough.

    But that wasn’t all, NAB CEO Cameron Clyne backed up his finance direc­tor. Here’s what Mr. Clyne told the committee:

    As we went to the cri­sis, we were in a sit­u­a­tion where obvi­ously, quite appro­pri­ately, investors and pru­den­tial reg­u­la­tors were seek­ing us to hold greater cap­i­tal. We had to go to the mar­kets. We went to the mar­kets in Novem­ber 2008 and in July 2009 and raised about $6 bil­lion in equity. We effec­tively had to absorb that and suf­fer the drop in return on equity. Had we tried to main­tain the same return on equity on the addi­tional $6 bil­lion in cap­i­tal, prices would have been sub­stan­tially higher. I do con­test the fact that we main­tained return on equity. We most cer­tainly did not.”

    There you have it. Australia’s banks were on the edge. It needed the cap­i­tal raised on the mar­ket, plus US Fed­eral Reserve secret loans in order to make it.

    Think about it. Think about the other bailouts the banks received — the first home­buy­ers grants, the whole­sale guar­an­tee, the deposit guar­an­tee… but still it wasn’t enough to prop up NAB and Westpac.

    They needed more. These two “strongly cap­i­talised” banks needed the secret Fed loans. Plus top-up loans from the Reserve Bank of Aus­tralian (RBA), which itself received USD$53.5 bil­lion from the US Fed.

    Yet all the while the ABA yapped that “Aus­tralian banks are very strongly cap­i­talised and con­tinue to hold assets that are of good credit quality.”

    We now know that to be false. A strongly cap­i­talised bank­ing sys­tem doesn’t need a raft of gov­ern­ment and cen­tral bank bailouts. It cer­tainly doesn’t need secret loans from a for­eign cen­tral bank.

    But even now, the reg­u­la­tors are spin­ning the same yarn. We printed this com­ment on Wednes­day by RBA assis­tant gov­er­nor Guy Debelle:

    The RBA par­tic­i­pated in the swap line [with the US Fed­eral Reserve] to help dis­trib­ute US dol­lars into this time zone… It did not reflect any issue with the Aus­tralian bank­ing system’s own need for US dol­lars. The funds pro­vided under the swap line were cheaper than the extremely wide mar­ket price at the time. As a result, Aus­tralian based banks availed them­selves of this and in a num­ber of cases on-lent the funds to banks in other jurisdictions.”

    We thought about his state­ment some more after we sent it to you. The way Debelle car­ries on he’s mak­ing out that Amer­ica and Aus­tralia were play­ing doc­tor and nurse to the sick global bank­ing system…

    That Aus­tralia was fine. Our banks were sim­ply being good doc­tors by help­ing out others.

    He’s mak­ing the RBA and the banks out to be the Dr. John For­rest and Matron Grace Scott of the bank­ing world. In real­ity they’re no more than the Den­nis Jamieson and Ada Sim­mons of banking.

    But con­sid­er­ing the mag­ni­tude of the admis­sion, how did the good Sen­a­tors’ respond?

    Fol­low­ing Mr. Clyne’s reply, Sen­a­tor Hur­ley continued:

    All right. Let us talk about the most recent rate rise above the RBA cash rate.”

    What?! Handed on a plate an admis­sion that Australia’s banks were in dire trou­ble in 2008 and 2009, and the hap­less Sen­a­tor blabs on about the lat­est inter­est rate decision.

    end extract.

  12. portoalet says:

    Hi Steve,

    How much debt can Aus­tralia take? Have you done any mod­el­ing?
    So far you “only” com­pare Aus­tralia to USA in terms of ‘pri­vate debt to GDP’ ratio and maybe use USA ‘pri­vate debt to GDP’ ratio as a guide to tell whether Aus­tralia has reached max­i­mum pri­vate debt to GDP ratio.

    I sus­pect the max­i­mum ‘pri­vate debt to GDP’ ratio is sim­i­lar to that for the USA, but how do you model this?

    Also I do think that your pro­pos­als will not be lis­tened to (who likes them?), but the more impor­tant reform is to make the gov­ern­ment stop bail­ing out finan­cial insti­tu­tions (read: nation­alise loss, pri­va­tise profit) when the tide turns (it’s a when not an if any­more based on your exten­sive research).

  13. Steve Keen says:

    I was asked this last week por­toalet, and this was the answer I gave:

    Hi yrebrac,

    And sev­eral oth­ers who’ve posed a sim­i­lar ques­tion. Firstly there is no hard and fast num­ber, but the ulti­mate limit is not “debt ser­vice equals income” but “debt ser­vice equals dis­pos­able income”. If ser­vic­ing your debt leaves you below sub­sis­tence, then you will fail financially.

    Clearly no eco­nomic sys­tem as a whole gets to that level–though many indi­vid­u­als do. The feed­back from some fail­ing to the over­all dynam­ics of a Ponzi Scheme start­ing to col­lapse is some­thing that involves not only aver­ages but also sto­chas­tic issues–in fact this is one area where some econo­physics analy­sis could be very useful.

    Hav­ing said that, in my own sim­u­la­tions (which include real­is­tic ratios of wage to non-wage income and model only cap­i­tal­ists bor­row­ing and there­fore hav­ing to ser­vice debt), the level at which break­down occurs is roughly com­pa­ra­ble to the non-financial sec­tor debt lev­els for the US and Aus­tralia right now: roughly 175% of GDP.

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