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The Mot­ley Fool’s inter­na­tion­al invest­ing team will be vis­it­ing Aus­tralia for a week start­ing on Feb­ru­ary 15th, meet­ing with more than a dozen domes­tic com­pa­nies to get a feel for what the Aus­tralian stock mar­ket has to offer. If you’d like to get their impres­sions, sign up for their free dis­patch­es here. Their overview piece on the trip itself is enti­tled “One Last Giant Prop­er­ty Bub­ble”.

I’m one of the peo­ple they’ll be inter­view­ing, and as a pre­lude they posed 3 ques­tions to me:

• Is Aus­trali­a’s hous­ing bub­ble big­ger than the one in the US?
• What would trig­ger a cor­rec­tion?
• Who would get hurt the worst?

In my typ­i­cal fash­ion I sup­plied a the­sis when a crib sheet was required, so my answers had to be edit­ed some­what for their site:

The Next Bub­ble Com­ing From Down Under

Here’s the orig­i­nal full-length ver­sion (click here for PDF).

Is Australia’s housing bubble bigger than the one in the US?

The Aus­tralian hous­ing bub­ble is cat­e­gor­i­cal­ly larg­er than the USA’s, though in stan­dard bub­blol­o­gy talk, the main rea­son that it is—that it was far more a pure spec­u­la­tion on prices than the Amer­i­can bubble—is tout­ed as one of the rea­sons that “Aus­tralia is dif­fer­ent” and a crash won’t hap­pen here.

Before I elab­o­rate on that point, here’s the data. The raw data for the US is the Case-Shiller Index, while the recent raw data for Aus­tralia comes from the Aus­tralian Bureau of Sta­tis­tics estab­lished house price index. This has two series—one using 2003-04 as a base year, and the oth­er 1986–87. I com­bine the two to pro­duce a com­pos­ite index from then till now.

For pre-1986 data, I use the num­bers derived by an Aus­tralian aca­d­e­m­ic Nigel Sta­ple­don in his PhD the­sis, which used news­pa­per records to derive series for Syd­ney and Mel­bourne going back to 1860.

Fig­ure 1 com­pares just the recent (post 1986 data), where Case-Shiller’s base year is 2000 and the ABS’s is 2003-04:

Fig­ure 1

Fig­ure 2 puts them to the same base year of 1986. It’s now obvi­ous that nom­i­nal house prices in Aus­tralia have risen far more than in the US since 1986: a fac­tor of six increase, ver­sus a peak of about a 3.5 increase in the USA (which has now fall­en to less than a 2.5 times increase after the US bub­ble burst in 2006).

Fig­ure 2

I also mark on it the begin­ning and end of the Aus­tralian gov­ern­men­t’s con­tri­bu­tion to this Ponzi Scheme, the most recent incar­na­tion of its “First Home Own­ers Scheme”, which gives first home buy­ers a cash grant towards their first pur­chase that is then lev­ered up by a bank loan when they go shop­ping. For this rea­son I call it the “First Home Ven­dors Scheme”, since the real recip­i­ents of the gov­ern­ment largesse are the ven­dors who sell to these new entrants—and they get not mere­ly the gov­ern­ment mon­ey, but the lev­ered amount that the bank­ing sec­tor throws on top of it.

When the “Glob­al Finan­cial Cri­sis” loomed (as the “Great Reces­sion” is called Dow­nUn­der), the then Rudd Labor Gov­ern­ment dou­bled this grant to $14,000 for an exist­ing prop­er­ty and tripled it to $21,000 for a new one, in what they called the First Home Own­ers Boost, and which I nick­named the First Home Ven­dors Boost (FHVB). The Scheme, which began in Octo­ber 2008, was sup­posed to last 8 months but was extend­ed to 14 months because it was “so suc­cess­ful”.

Back to the data. Con­sumer price infla­tion has run at dif­fer­ent speeds in the two economies, so real prices are the best for com­par­isons; Fig­ure 3 deflates the Case-Shiller 20 city index by the US CPI, and the Aus­tralian data by its CPI.

Fig­ure 3

The intrigu­ing aspect of this com­par­i­son is that the two bub­bles tracked each oth­er from 1997 till 2004 (with the Aus­tralian at a high­er lev­el since a mini-bub­ble back in 87–89 that I’ll return to lat­er), and then diverged. The Aus­tralian trend broke first, but then restart­ed just before the US bub­ble final­ly burst. The Aus­tralian bub­ble then broke again in 2008, only to be restart short­ly after by the FHVB. It has recent­ly topped out, with one quar­ter of falling prices (with the nom­i­nal index drop­ping 0.3%), and the lat­est ris­ing by 0.7% (bear in mind how­ev­er that the 0.3% fall for the Sep­tem­ber quar­ter was first shown as a 0.1% increase, and both fig­ures are still sub­ject to revi­sion).

A final long-term com­par­i­son to see just how Aus­tralian and US house prices real­ly com­pare uses Sta­ple­don’s data back to 1890, when the Case-Shiller Index began:

Fig­ure 4

Whether this peri­od marks the begin­ning of the end of the Aus­tralian house price bub­ble will only be clear in hind­sight, but the volatil­i­ty of the index is now extreme, and the impact of the FHVB on it is obvi­ous in Fig­ure 5.

Fig­ure 5

This is not a new phe­nom­e­non: though I appor­tion most blame for the Aus­tralian house price bub­ble to the finance sec­tor, there’s lit­tle doubt that the fuse itself was lit by the gov­ern­men­t’s inter­ven­tions via the First Home Own­ers Scheme, which began in 1983.

‘This Gov­ern­ment was elect­ed … with a com­mit­ment to boost the nation’s econ­o­my … Our hous­ing poli­cies are an essen­tial ele­ment of our nation­al recov­ery strat­e­gy … Our pro­gram is designed to achieve the dual objec­tives of ensur­ing that hous­ing plays a key role in our eco­nom­ic recov­ery and ensur­ing that Aus­tralian fam­i­lies can gain access to ade­quate hous­ing at a price they can afford.

The main ele­ments of our pro­gram are … a new more effec­tive scheme to assist low income home buy­ers — the first home own­ers’ scheme … to get the hous­ing indus­try mov­ing with­out delay we removed the sav­ings require­ment from the exist­ing home deposit assis­tance scheme …’ (from the Hansard record of the First Home Own­ers’ Bill 1983, which gave birth to the First Home Own­ers Assis­tance Scheme)

This scheme has always been used as a means to stim­u­late the econ­o­my, and it’s worked—but in much the same way that an ana­bol­ic steroid will help an ath­lete win a medal: it pumps up the per­for­mance at the event, only to leave the ath­lete with long term health prob­lems in the future. From 1951 until the FHOS was intro­duced in 1983, the aver­age quar­ter­ly increase in house prices was 0.07%—which is sta­tis­ti­cal­ly indis­tin­guish­able from zero, giv­en that the stan­dard devi­a­tion was 1.73%.

Fig­ure 6

After the Scheme was intro­duced, the aver­age quar­ter­ly increase increased by more than a fac­tor of ten to 0.94%, and the volatil­i­ty rose as well. Since there have also been peri­ods where the Scheme was removed and when it was dou­bled, it’s pos­si­ble to drill down fur­ther on its impact—and it’s bleed­ing­ly obvi­ous that it both increased house prices and their volatil­i­ty.

Table 1

Gov­ern­ment inter­ven­tions in this asset mar­ket make it very hard to work out a decent base year from which to com­pare Aus­tralian house prices to those in Amer­i­ca. Pri­or to 1949, the Aus­tralian gov­ern­ment enforced a rental ceil­ing, which kept house prices arti­fi­cial­ly low. Since 1983, it has run the First Home Ven­dors Scheme, which (along with oth­er inter­ven­tions like neg­a­tive gear­ing) kept prices arti­fi­cial­ly high. I take 1970 as the best date for a com­par­i­son of the Aus­tralian and US house price indices, since it’s halfway between when the price spurt caused by the abo­li­tion of the rental con­trol scheme had petered out, and the new regime of keep­ing house prices high took over. So Fig­ure 7 is my pre­ferred series com­par­ing Aus­tralian and US house prices (with the B mark­ing the intro­duc­tion of the First Home Ven­dors Scheme):

Fig­ure 7

As tends to hap­pen at the end of a bub­ble, when prices have been dri­ven far high­er than incomes, spruik­ers have claimed that Aus­tralian house prices are not real­ly high when com­pared to incomes. The Demographia sur­vey’s com­par­i­son of medi­an house prices to medi­an incomes has been dis­par­aged by spruik­ers who hap­pi­ly com­pare medi­an house prices to aver­age incomes, where those aver­age incomes include imput­ed rental returns from own­er-occu­pied dwellings, super­an­nu­a­tion enti­tle­ments that can’t be used to pay mort­gage bills, etc.

This tends to be an inter­minable debate about what should and what should­n’t be includ­ed, so I pre­fer to com­pare the house prices to the broad­est pos­si­ble mea­sure of income: GDP per capi­ta (which under­states the prob­lem because GDP includes imput­ed rental income from own­er-occu­pied dwellings, which of course can’t be used to pay the mort­gage!). Start­ing from the same date, this yields the com­par­i­son of Aus­tralian house prices to income shown in Fig­ure 8, on which basis Aus­tralian house prices are at least 50% over­val­ued, with all of the rise above the long term aver­age occur­ring since first the Howard and then the Rudd gov­ern­ment dou­bled the FHVB in response to fears of a reces­sion.

Fig­ure 8

Anoth­er take on afford­abil­i­ty and whether hous­ing is over­val­ued is to con­sid­er income per house­hold, since it could be argued that the increase in wom­en’s par­tic­i­pa­tion in the work­force since 1970 has meant that two (or more) incomes are being earned per dwelling, mak­ing a high­er price afford­able. Fig­ure 9 com­pares the house price index to house­hold dis­pos­able income per dwelling (using the RBA table G12 for dis­pos­able income and ABS tables 4102 and 87520037 for the num­ber of dwellings).

Fig­ure 9

Spruik­ers claim that there have been sig­nif­i­cant demo­graph­ic shifts, that hous­es now are big­ger and bet­ter than those in 1970 and so on. How­ev­er all of the increase in the house price to GDP per capi­ta index above its aver­age has occurred since 2001 (when Howard dou­bled the FHVB because of fear of a reces­sion), and there has been no real change in Aus­tralian demo­graph­ics since then, as Fig­ure 10 and Fig­ure 11 indi­cate.

Fig­ure 10

Fig­ure 11: The peri­od 2006-10 is the only one where pop­u­la­tion growth exceed­ed growth in dwellings

This is a good point to con­sid­er the usu­al spruik­er case that house prices have risen because demand—driven by ris­ing population—has exceed­ed sup­ply. One of the most reg­u­lar­ly cit­ed jus­ti­fi­ca­tions for this is the Nation­al Hous­ing Sup­ply Coun­cil report, which esti­mates the gap between sup­ply and “under­ly­ing demand”.

’ … 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
+ dwellings required to accom­mo­date peo­ple who are home­less and sleep­ing rough or stay­ing with friends and rel­a­tives
+ dwellings required to house mar­gin­al res­i­dents of car­a­van parks.’ (Nation­al Hous­ing Sup­ply Coun­cil 2010, pages 65–66)

These are legit­i­mate mea­sures of a social need, but they’re not a mea­sure of the mar­ket demand for hous­ing! Fig­ure 12 shows the cor­re­la­tion of changes in the num­ber of Aus­tralians per house with changes in nom­i­nal house prices:

Fig­ure 12

A falling ratio of peo­ple to houses—so that the hous­ing stock was grow­ing more rapid­ly than population—should have meant falling prices accord­ing to the stan­dard “sup­ply and demand” argu­ment. But what about the one brief peri­od where pop­u­la­tion was actu­al­ly ris­ing faster than the hous­ing stock—between 2006 and 2010—and house prices also rose sharply?

Fig­ure 13

Whoops! The cor­re­la­tion is actu­al­ly strong­ly neg­a­tive: minus 0.56. Pop­u­la­tion dynam­ics gave spruik­ers a good sto­ry, but it was­n’t what drove house prices up.

What did instead was debt. Demand for hous­es is not pop­u­la­tion increase: it’s peo­ple with new mort­gage loans. When you look at the rela­tion­ship between new lend­ing and the change in house prices, you final­ly start to see some seri­ous long run cor­re­la­tions (as long as the data makes pos­si­ble, any­way).

Fig­ure 14

The cor­re­la­tion coef­fi­cient here is 0.53—rather bet­ter than the minus 0.06 that applies between change in pop­u­la­tion per dwelling and change in price over 1975–2010—and it improves when the trend of ris­ing mort­gage new debt to GDP is removed. So we’ve had a debt-dri­ven hous­ing bub­ble, just as has the USA, and it’s the dynam­ics of debt that will deter­mine when and how it bursts—not demo­graph­ics.

What would trigger a correction?

Ponzi Schemes ulti­mate­ly fail under their own weight, because they involve pay­ing ear­ly entrants more than they put in, while pro­duc­ing no prof­its with high run­ning expens­es. A debt-financed Ponzi Scheme can how­ev­er appear to work for a long time, because the price of the object of the Scheme—in this case house prices—can rise so long as debt lev­els per house rise faster still.

That was clear­ly the case in Aus­tralia. Prop­er­ty spruik­ers focus on the price increas­es and ignore the debt, but the lat­ter has risen far more than the for­mer: nom­i­nal house prices are up by a fac­tor of 15 over 1976, but debt per house has risen by a fac­tor of 55 (Fig­ure 15).

Fig­ure 15

The turn­ing point in that process appears to be near­by: both debt per dwelling to price (Fig­ure 16) and debt per dwelling to dis­pos­able income (Fig­ure 17) appear to be top­ping out.

Fig­ure 16

Fig­ure 17

Fig­ure 18

This under­scores the fact that, just as in Amer­i­ca, ris­ing mort­gage debt was the real fuel for ris­ing house prices. Though Aus­tralia did­n’t have as wide­spread a Sub­prime phe­nom­e­non as the USA, and many more mort­gages are held on the books of the banks, the lev­el of mort­gage debt actu­al­ly rose faster and high­er in Aus­tralia than in the USA (The ver­ti­cal lines on Fig­ure 19 iden­ti­fy when the First Home Ven­dors Scheme first began—in 1983—and when the recent dou­bling of it ceased—in Jan­u­ary 2010; there is how­ev­er still a $7,000 grant for a first home buy­er).

Fig­ure 19

What will bring this bub­ble undone is its very suc­cess: hav­ing suc­cess­ful­ly dri­ven house prices sky­wards, the cost of entry into the mar­ket is now pro­hib­i­tive so that the flow of new entrants is dry­ing up. Since the Scheme depends on a con­stant flow of new entrants, this alone will bring it unstuck. A gauge of just how dif­fi­cult it is to get into the mar­ket is giv­en by look­ing at the ratio of the aver­age first home loan to the aver­age income—when most first home buy­ers are going to have an income below the aver­age.

The aver­age first home loan has risen four­fold in the last 2 decades, from $75,000 to almost $300,000 (Fig­ure 20).

Fig­ure 20

This rise has far out­stripped increas­es in all incomes, let alone wages, which have lagged increas­es inr pro­duc­tiv­i­ty in Aus­tralia as they have in the USA. In 1992, the aver­age first home loan was 2.5 times the aver­age before tax year­ly wage income. Now it is 5.5 times as much, and it briefly reached 6 times annu­al income dur­ing the fren­zy caused by the Rudd Gov­er­men­t’s dou­bling of the FHVG (Fig­ure 21).

Fig­ure 21

Spruik­ers also claim that this increased debt bur­den just reflects low­er inter­est rates. Even the Gov­er­nor of the Reserve Bank of Aus­tralia made such a claim:

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)

Let’s see how well this argu­ment stacks up against real­i­ty by con­sid­er­ing the ser­vic­ing cost on a typ­i­cal 25-year float­ing inter­est rate mort­gage in Aus­tralia as a per­cent­age of the pre-tax earn­ings of Aus­tralian work­ers.

Fig­ure 22

The result is pret­ty stark: in 1992, ser­vic­ing the aver­age first home loan took under 20 per­cent of the pre-tax income of the aver­age wage earn­er. Now it takes 60 per­cent. Since the aver­age tax rate on work­ers is about 22%, and since pay­ments on your own home can’t be writ­ten off against tax in Aus­tralia, this means that the aver­age wage earn­er would have only 20% of his/her income left for all oth­er expens­es after pay­ing the mort­gage.

Clear­ly it’s no longer pos­si­ble for a sin­gle wage earn­er to buy the medi­an house in Australia—and even a 2 bed­room apart­ment is out of the ques­tion. But what about a couple—what have they got left for expens­es after pay­ing tax­es and the mort­gage?

Back in 1992, this was a dod­dle: pay­ing the mort­gage took just 12 per­cent of the fam­i­ly bud­get. Now it takes 37 per­cent. For those unfor­tu­nate cou­ples who took out a home loan while the FHVB was in oper­a­tion, it takes as much as 42 per­cent of their com­bined after tax income.

Fig­ure 23

So the bub­ble will col­lapse because it has been too successful—and the gov­ern­men­t’s dou­bling of the FHVG has added to this because it encour­aged new entrants who may have wait­ed till 2011 to buy in dur­ing 2009 instead. There are less first home buy­ers enter­ing at the bot­tom of the esca­la­tor (Fig­ure 24), and they are tak­ing out small­er loans, while the trend in oth­er loans is also head­ed down (Fig­ure 25).

Fig­ure 24

Fig­ure 25

So the vol­ume of unsold prop­er­ties is mount­ing and the time to sell is increas­ing. This nor­mal­ly pre­cedes the begin­ning of a down­turn in house prices—since most ven­dors ini­tial­ly refuse to accept offers below their reser­va­tion prices.

One rea­son that is often advanced as to why Aus­tralia won’t suf­fer a US-style hous­ing price crash is that there has­n’t been a huge build­ing boom here. The fac­toid is def­i­nite­ly true; but the obverse inter­pre­ta­tion is that Aus­trali­a’s hous­ing finance has been even more spec­u­la­tive in nature than the USA’s. The frac­tion of total bor­row­ing that has financed invest­ment-ori­ent­ed con­struc­tion ver­sus spec­u­la­tion-ori­ent­ed pur­chas­es of exist­ing prop­er­ties by investors has fall­en from almost 60 per­cent in the mid-80s to under 10 per­cent now. In fact, “investors” in the Aus­tralian mar­ket now invest less than own­er-occu­piers do—though the recent spurt in the frac­tion of own­er-occu­pi­er loans sup­port­ing con­struc­tion from the all-time low of under 8 per­cent to just over 11.5% was prob­a­bly an arti­fact of the tripling of the First Home Own­ers Boost for those build­ing their own home.

Fig­ure 26

In the aggre­gate now, less than 10 cents in every bor­rowed dol­lar builds a new home. This does mean that there isn’t an over­hang of new­ly com­plet­ed prop­er­ties on the Aus­tralian mar­ket. But con­verse­ly, the huge pro­por­tion of “investors” who have bought in sole­ly to achieve cap­i­tal gains means that the investor side of the mar­ket is very frag­ile”: any sus­tained pause in price increas­es means these investors face mount­ing loss­es.

Fig­ure 27

The increase in the num­ber of “investors” rel­a­tive to own­er-occu­piers played a major role in dri­ving up house prices. The rise in “Mum and Dad investors”, as they were termed, saw investor bor­row­ing rise from about 15% of total mort­gages in 1990 to over 30 per­cent since 2000.

Fig­ure 28

Pre­dictably, the rise in “investors” as a pro­por­tion of total bor­row­ing saw rental income top out and begin to fall.

Fig­ure 29

Most “investors” declare loss­es on their income tax (which is sub­sidised by the Aus­tralian scheme known as neg­a­tive gear­ing, where prop­er­ty spec­u­la­tors can write off loss­es on ser­vic­ing rental prop­er­ties against all oth­er income). How­ev­er this ruse is only worth­while if asset price infla­tion more than com­pen­sates for the tax­payre-sub­sidised loss­es made while own­ing a prop­er­ty. So the investor pro­por­tion of the mar­ket is like­ly to add to sup­ply if there is a sus­tained peri­od of flat prices, since their loss­es will mount in the mean­time.

Fig­ure 30

On top of this there are the usu­al “exoge­nous” fac­tors: fur­ther increas­es in inter­est rates by the RBA, and the prospect of a slow­down in Chi­na.

The RBA is con­vinced, by the boom in Chi­na and its neo­clas­si­cal mod­els of the econ­o­my, that capac­i­ty con­straints lie just ahead for Aus­tralia, and that there­fore it has to increase inter­est rates to con­tain infla­tion. This is a clas­sic appli­ca­tion of the “Tay­lor Equa­tion” approach to mon­e­tary pol­i­cy that pret­ty accu­rate­ly defined its behav­ior before and well into the GFC—taking Sep­tem­ber 2007 as the start of the glob­al cri­sis (the US Fed began slash­ing its rate that month).

Fig­ure 31

The recent floods and cyclones in Vic­to­ria and Queens­land are wild­cards that will dri­ve up food prices, and the glob­al bub­ble in com­mod­i­ty prices will also play through, but over­all I expect that the RBA’s expec­ta­tions of infla­tion caused by capac­i­ty con­straints will not pan out—for rea­sons that I expand on below under the Cred­it Impulse. I think they may well put rates up once more, but will then be forced to start cut­ting them.

Chi­na is anoth­er wild­card for Aus­tralia. It is clear­ly the rea­son that our terms of trade, and espe­cial­ly the prices for (and vol­umes of) our exports of min­er­als, are the high­est they have ever been.

Fig­ure 32

I don’t know enough about Chi­na today to make an informed com­ment here, but my feel­ing is that Chi­na’s growth can’t be sus­tained, and that the Chi­nese author­i­ties will do the best they can to secure oth­er sources of min­er­als. Cer­tain­ly I would­n’t advise extrap­o­lat­ing the cur­rent incred­i­ble prices (or vol­umes) for our min­er­als for­ward, which does make Aus­trali­a’s eco­nom­ic per­for­mance par­tic­u­lar­ly sus­cep­ti­ble to a change in our for­tunes with Chi­na.

My focus is on the endoge­nous force: cred­it expand­ing faster than both incomes and asset prices is what drove asset prices up, and the fail­ure of cred­it to con­tin­ue grow­ing faster than income is all that is need­ed to set the reverse process of declin­ing asset prices in train—while leav­ing the debt in place.

The Credit Impulse

The key fac­tor behind not just the prop­er­ty bub­ble, but Aus­trali­a’s appar­ent­ly out­stand­ing per­for­mance dur­ing the Glob­al Finan­cial Crisis—is what Big­gs, Mey­er and Pick chris­tened “The Cred­it Impulse”. In con­trast to neo­clas­si­cal eco­nom­ics, I have a cred­it-ori­ent­ed analy­sis of cap­i­tal­ism in which aggre­gate demand is derived not mere­ly from incomes but from the change in debt. On this basis, the change in aggre­gate demand will reflect both the change in incomes (GDP) and the change in the change in debt: so the accel­er­a­tion or decel­er­a­tion of debt lev­els adds or sub­tracts from the change in aggre­gate demand. This affects both eco­nom­ic per­for­mance and hence employ­ment, and asset price change—since from this per­spec­tive, aggre­gate demand is spent pur­chas­ing both new goods and ser­vices and exist­ing assets.

The col­lapse in the Cred­it Impulse was the fac­tor that made the Great Reces­sion great for the USA. The much small­er col­lapse in the Aus­tralian Cred­it Impulse—and that it turned pos­i­tive again on a year­ly basis n ear­ly 2010—is the pri­ma­ry rea­son why the down­turn was so much milder in Aus­tralia.

Fig­ure 33

The cor­re­la­tion of the Cred­it Impulse with change in employ­ment over the long term is high:

Fig­ure 34

Fig­ure 35

It’s even more marked over the cri­sis itself, though cloud­ed by the impact of mas­sive gov­ern­ment inter­ven­tions via fis­cal pol­i­cy and, in the USA, quan­ti­ta­tive eas­ing. The sever­i­ty of the down­turn in the USA was direct­ly attrib­ut­able to how quick­ly accel­er­at­ing debt gave way to decel­er­at­ing debt, and the decline in the rate of decel­er­a­tion has been a major fac­tor in atten­u­at­ing the cri­sis more recent­ly. Though this sounds para­dox­i­cal and counter-intu­itive, it fol­lows from the log­ic that aggre­gate demand is the sum of GDP plus the change in debt: since the change in aggre­gate demand is the sum of the change in GDP plus the change in the change in debt, a slow­down in how fast debt is falling can actu­al­ly boost aggre­gate demand. That is appar­ent in the US data from mid 2009—when the reces­sion was offi­cial­ly regard­ed as hav­ing end­ed.

Fig­ure 36

The same qual­i­ta­tive phe­nom­e­non applies in Aus­tralia, though with much dif­fer­ent mag­ni­tudes. First­ly the decel­er­a­tion in debt—the change in the Cred­it Impulse from pos­i­tive to negative—was not near­ly as large, and it was reversed more rapid­ly.

Fig­ure 37

How­ev­er the main mech­a­nism for achiev­ing that result—stopping the Cred­it Impulse turn­ing extreme­ly neg­a­tive, and push­ing it back into pos­i­tive territory—was the First Home Ven­dors Scheme. As a result of that Scheme, house­holds did not delever—instead they took on sub­stan­tial­ly more debt, with the mort­gage debt to GDP lev­el ris­ing by 6 per­cent. This more than coun­ter­bal­anced dra­mat­ic delever­ag­ing by the pri­vate sec­tor.

Fig­ure 38

This can’t con­tin­ue, because the house­hold sec­tor is already more indebt­ed than its US coun­ter­part, and the debt ser­vic­ing costs in Aus­tralia are far high­er cour­tesy of our much high­er mort­gage inter­est rates.

Fig­ure 39

The quar­ter­ly data on the Cred­it Impulse implies that this is now turn­ing neg­a­tive again.

Fig­ure 40

This trend is like­ly to con­tin­ue. The arti­fi­cial boost to the rate of growth of mort­gage debt caused by the FHVB is gone, house­holds are indebt­ed beyond any­thing ever seen before, and high inter­est rates are killing con­sumer spend­ing. This in turn will cause a fall in aggre­gate demand that has to be worn by both con­sumer and asset mar­kets. The for­mer effect will con­tribute to ris­ing unemployment—countering the pos­i­tive boost to employ­ment from the Chi­na trade—while the lat­ter will reduce debt-financed demand for hous­ing.

Who would get hurt the worst?

The most obvi­ous losers from a price down­turn will be the buy­ers enticed into the mar­ket by the FHVB, many of whom began with 5% equi­ty and who can there­fore be eas­i­ly thrown into neg­a­tive equi­ty ter­ri­to­ry by even a small price fall.

This won’t lead to “jin­gle mail” defaults in Aus­tralia because our hous­ing loans are full recourse. But since a trig­ger for the down­turn will be a decline in aggre­gate demand as the Cred­it Impulse turns neg­a­tive, unem­ploy­ment will rise—certainly in NSW and Vic­to­ria that don’t direct­ly ben­e­fit from exports to China—and this will cause forced sales, though a less­er rise in bank­rupt­cy sales than in the USA.

Fig­ure 41

The sec­ond obvi­ous group of losers will be the banks them­selves, who have dra­mat­i­cal­ly increased their share of prof­its via the huge increase in mort­gage debt. A decline in mort­gage orig­i­na­tions will reduce their prof­itabil­i­ty, and their sol­ven­cy since mort­gages now con­sti­tute the more than a third of total bank assets and over half of all banks loans.

Fig­ure 42

Fig­ure 43

Aus­tralian banks assert that they are well cap­i­talised and that a down­turn in house prices would have lit­tle impact on their liq­uid­i­ty, let alone their sol­ven­cy. That claim has proven false after the fact of a prop­er­ty price crash every­where else on the plan­et, and I expect Aus­tralia to be no dif­fer­ent.

Fig­ure 44