A Motley Crew interview on Australian House Prices

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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

Stats Before FHOS After FHOS All Data Dur­ing FHOS Between FHOS periods When FHOS doubled
Mean 0.07% 0.94% 0.47% 2.17% 0.25% 3.10%
Min –5.53% –3.73% –5.53% –2.26% –2.26% –0.92%
Max 3.91% 7.86% 7.86% 7.86% 2.95% 4.93%
Std. Dev. 1.73% 2.17% 1.99% 2.71% 1.26% 1.83%
Count 131 110 241 25 51 7

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

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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92 Responses to A Motley Crew interview on Australian House Prices

  1. ak says:


    This analy­sis is very impres­sive and I agree with the con­clu­sions. I believe that effects of run­ning out of cheap oil (trig­ger­ing spec­u­la­tive price bub­bles like in 2007) might finally pop our bub­ble as the risk of cost-push infla­tion will hold inter­est rates high and at the same time cor­po­rate prof­its will suf­fer. This may hap­pen quite soon — in the next few years.

    The US fears that Saudi Ara­bia, the world’s largest crude oil exporter, may not have enough reserves to pre­vent oil prices esca­lat­ing, con­fi­den­tial cables from its embassy in Riyadh show.”


    They are even send­ing their Amer­i­can KGB offi­cials to China to cut a global deal — will it work? I doubt…

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  3. mattnz says:

    Great arti­cle thanks Steve.

    I think you meant Mot­ley Fool, instead of 80’s rock­ers Mot­ley Crew.


  4. Steve Keen says:

    That was delib­er­ate Matt, and the MF guys approved it!

    I’m being inter­viewed (well, over din­ner) by seven of them in a cou­ple of weeks, and that’s quite a crew…

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  6. Muzz says:

    Hi Steve,

    Greet­ings from the outer rim of your blog mem­ber­ship galaxy.

    I have one very minor pedan­tic quib­ble: You use cap­i­tals when nam­ing the First Home Own­ers Scheme that began in 1983, and this gives the impres­sion that it’s the cor­rect name — it isn’t. It was called the First Home Own­ers Assis­tance Scheme. I only know this because I was a ben­e­fi­ciary and still have the paper work. I thought it worth cor­rect­ing in case some­body wants to search for infor­ma­tion on it.

    Sadly, this is prob­a­bly the great­est con­ti­bu­tion to the blog that I can muster (c;

  7. Steve Keen says:

    That’s not bad Muzz–I know it’s impor­tant to get the detail right. I’ll amend the entry now for posterity’s sake.

  8. Steve Keen says:

    PS Can you scan and send the paper­work my way?

  9. TruthIsThereIsNoTruth says:

    so you are pro­vid­ing infor­ma­tion to over­seas spec­u­la­tors so they could profit from a fall in the Aus­tralian hous­ing market?

  10. Muzz says:

    Actu­ally Steve, I owe you an apol­ogy. In dig­ging out the papers I dis­cover that both terms were used in the cor­re­spon­dence. Unfor­tu­nately the one on top of the pile was HFOAS. I guess either might be cor­rect, but your mem­ory tips the bal­ance in favour of FHOS. I hope the edit­ing hasn’t been too much rig­ma­role for you.

    I’ll email scans to you later today (WA).

    Do you remem­ber Keat­ing (as trea­surer) scrap­ping neg­a­tive gear­ing on invest­ment prop­er­ties? This must have been about 1984–85. It lasted only a short time and it would be inter­est­ing to read about the ruc­tions in the press of the time. I remem­ber it because it exactly cor­re­sponded with the only period that I rented out a prop­erty. I’m pretty sure it lasted less than a year.

  11. pacham12 says:

    Enjoy read­ing your work and agree with a lot of your analy­sis. I cur­rently live in the US and gave been fol­low­ing the Aus­tralian hous­ing mar­ket for the past 7 years. The two fac­tors that I grav­i­tate towards to explain some of the growth are as fol­lows:
    1. Inter­est rate reduc­tions since the 1980’s — I believe this as fueled con­sid­er­able growth in Aus­tralian prop­erty prices over the last 25 years. Mov­ing from 18% to 7% sig­nif­i­cantly increases the amount some­one can bor­row. I esti­mate that this accounts for about 120% of the prop­erty price increase over the past 25 years.
    2. Per­sonal Income tax reduc­tions that hap­pened around 2004. I’m not liv­ing in Aus­tralia so I haven’t expe­ri­enced this directly how­ever the reduc­tions in fed­eral income tax appear sig­nif­i­cant. I recall in the 90’s that as soon as reached an income of $50k you were taxed at about 48 cents on the dol­lar. I esti­mate that income tax reduc­tions could have increased prop­erty prices around 25% since 2004.
    I agree with you that prop­erty prices are over val­ued in Aus­tralia, how­ever I sus­pect that unless inter­est rates rise dra­mat­i­cally or the tax code reverts to 1990’s level, then the crash may not be as severe as here in the US.
    Inter­ested to hear your thoughts.

  12. Steve Keen says:

    I think you over­state the impact of rate cuts on caus­ing the bub­ble Paul, but I agree that the poten­tial to cut mort­gage rates here has a lot to do with the ease with which the bub­ble can be revived. I do expect the RBA to reverse direc­tion this year and reduce rates, once both the bub­ble bursts and the impact of a neg­a­tive Credit Impulse starts to push up unemployment.

  13. Steve Keen says:

    I’m call­ing the data as I see it TININT; always have, always will.

  14. cyrusp says:

    Pro­fes­sor Keen, could I ask why you use and trust gov­ern­ment sta­tis­tics for infla­tion, pro­duc­tiv­ity and unemployment?

    In your speeches you some­times bring up the fact that the U-3 unem­ploy­ment sta­tis­tics in the US is dodgy — and you even refer to shad­ow­stats as pro­duc­ing more real­is­tic stats.

    But then you casu­ally men­tion things like this in your thesis:

    This rise has far out­stripped increases in all incomes, let alone wages, which have lagged increases inr [sic] pro­duc­tiv­ity in Aus­tralia as they have in the USA.”

    Accord­ing to shad­ow­stats again, pro­duc­tiv­ity has been falling in the US for the past 2 decades. Any rise in the offi­cial stats was due to “method­olog­i­cal gimmicks”:


    It’s sim­i­lar to the infla­tion sta­tis­tics which have again been manip­u­lated by substitution/hedonics/removing or down-weighting house and land prices — which sug­gests that the “great mod­er­a­tion” never actu­ally hap­pened — it was just sta­tis­ti­cal gim­mickry all along.

    I’m curi­ous why econ­o­mists insists on using these obvi­ously flawed num­bers in their mod­els when all it results in is a case “garbage in — garbage out”.

  15. Steve Keen says:

    It’s the pub­lished data cyrusp; I keep track of other data as well–including Roy Morgan’s unem­ploy­ment data for Aus­tralia, and Shadowstats–and occa­sion­ally pub­lish posts based on them too when the diver­gence becomes extreme. But to engage with the stan­dard debate I have to ref­er­ence the offi­cial data, even if it is dodgy.

  16. cyrusp says:

    Thanks for the answer. As an engi­neer I find all of this very strange. I guess that’s why they they call it the ‘dis­mal science’ :)

  17. Muzz says:

    An inter­est­ing dif­fer­ence between this ear­lier FHOS and later ones is that the full amount was not avail­able as a lump sum. There were three options that ranged from hav­ing it all in monthly pay­ments to hav­ing about 60% in a lump sum and the rest in monthly payments.

  18. Steve Keen says:

    It is indeed! Def­i­n­i­tions and sta­tis­tics are highly cor­rupted in this field. We have noth­ing like an atomic stan­dard of measurement.

  19. Muzz says:

    That “mini bub­ble” in ’87-’89 might look mini on the graph but it was HUGE. I sold a prop­erty in ’89 for two and a half times what I paid in ’84, and all of that increase came in the last two years. I felt very, very lucky that I had got into the mar­ket before the bubble.

    I’ve since blown all my real estate oppor­tu­ni­ties. I would be a much wealth­ier per­son now if I’d kept that place and sim­ply sat on my back­side and sub­sisted some­how. Down­grad­ing the abode so that I could study for a degree and build a career was finan­cially a mistake.

  20. cja says:

    This is twist­ing my melon. ‘Offi­cial’ fig­ures say unem­ploy­ment is flat at 5% whereas Roy Mor­gan says it’s risen yet again to 7.9%.

    Any­one know what’s going on here, because this is start­ing to look dodgy to me…

  21. peterjbolton says:

    Inter­est­ing and rel­e­vant post today by Deep T at:

    I have learned this day from you Steve: that the Aus­tralian gov­ern­ment Pol­icy did in fact inten­tion­ally and deter­min­is­ti­cally bias bank­ing towards the res­i­den­tial sec­tor for its socio-economic dynamic growth vehi­cle . Too bad, but def­i­nitely a good ‘polit­i­cal’ strategy.

    If we, Aus­tralia, which still remains a truly and legally, British Colony to this day, (I have just vis­ited Par­lia­ment House in Can­berra ACT, so I have this first hand) had learnt any­thing from the British, we would have learnt to invest, one way or another, into the capi­tol costs of infra­struc­ture (real infra­struc­ture) where the pri­vate sec­tors would freely and will­ingly invest in the exten­sion of same and thereby, stim­u­lat­ing growth while build­ing a nation. The British were good at this once.

    Aus­tralian Pol­icy, has clearly not invested, but spent, ie con­sumed in spend­ing heav­ily in the ‘com­forts’ for today, ie, not “invest­ment” for the future and accord­ingly, which is not the Prime Func­tion of gov­er­nance, under most def­i­n­i­tions. Hence, the total break­down of the socio-economic model which is gain­ing rapidly across the oceans of the Globe as this par­a­digm of inept gov­er­nance, is spent.

    Invest­ment’ explic­itly implies a future tense.
    Com­fort, sug­gest merely spend­ing, albeit in Moral Haz­ard in the present tense.

    Aus­tralia has become totally reliant on for­eign invest­ment (plus dig­ging holes, in the main part) to such an extent, that the whole coun­try is now at full risk by a Sov­er­eign debt col­lapse, through res­i­den­tial pur­suits by over-leveraged banks, and sim­i­lar to other nations around the World. But, not only has the aver­age Aus­tralian sub­si­dized this polit­i­cal pur­suit, ie, con­tin­u­ally, he/she has been taxed at every cor­ner of the square along the road, which includes the increases in infla­tion­ary tax­a­tions on the polit­i­cal model neces­si­ties of bal­loon­ing and rapid house price increases beyond afford­abil­ity. Plus all the direct costs of the con­se­quences of same.

    Then we have bank­ing bailouts and guar­an­tees, tax­payer RMBS pur­chases, higher inter­est rate loan require­ments, (due to the neces­sity to pay out higher inter­est rates on for­eign deposits), mort­gage insur­ance and trans­ac­tion charges and taxes, bal­looned rates, insur­ances and other fees, other charges to ensure that the lender bankers in the mas­sively lever­aged credit cre­ation for res­i­den­tial lend­ing, func­tion “risk-free” (ARM mort­gages), we have tax­payer full risk “prime– senior– enti­tle­ment” to the com­ing col­lapse in bank oper­a­tions — just like Ire­land, fully com­mit­ted, by those of the Policy.

    Lit­tle to no rea­son­able lend­ing invest­ment in loans for SME’s linked to infra­struc­ture, have left Aus­tralia and Aus­tralians fully naked to total risk per­pe­trated by ill-founded polit­i­cal Pol­icy and bank­ing entan­gle­ment activ­ity (“Moral Haz­ard”). Aus­tralia has no man­u­fac­tur­ing per se, few skill sets, and lit­tle ambi­tion to do any­thing but dig holes for for­eign mar­kets and for­eign share­hold­ers, live in over-priced houses owned by Banks and get drunk on Fri­day nights. Some future.

    I ask, where is the “lead­er­ship” in this menagerie?

    Ho hum

  22. sirius says:


    I agree with what you wrote but I would go even fur­ther. Do you remem­ber when I said “We are ask­ing the wrong questions?”.

    I shall say a lit­tle here. This “money” sys­tem (which in fact it is not) works by enslav­ing one group/country to pro­vide a “wealth­ier” lifestyle for another.

    The “beauty” of the sys­tem is that there is an anonymity between the 2 parts — the “money” sys­tem itself.

    Thus the “well to do” live in their “ivory tow­ers” not hav­ing to be con­cerned or bear the respon­si­bil­ity if their taxes are spent on buy­ing guns to kill oth­ers, used to impov­er­ish other nations to such an extent that we have organ traf­fick­ing, child pros­ti­tu­tion or a bunch of other ills.

    The ones in their “ivory tow­ers” mock the impov­er­sished and say “there there what a shame” all the time while the very “invest­ments” are used to facil­i­tate this.

    The impov­er­ished mean­while are too weak to do any­thing (much) about it.

    I can give you specifics. (I have stud­ied this for many years now). When I under­stood how this money sys­tem (which is con­stantly mor­ph­ing) worked I realised that with­out its reform this process was absolutely going to con­tinue on unabated.

    Many peo­ple are so both­ered about them­selves that they don’t see it or refuse to see it.

    You taled about “forces”. I can plot the waves of credit and how it fil­ters down and its effects.

    The thing about it all is that I owe Pro­fes­sor Keen a huge debt because it was through his work that I was able to tie it all together.

    I am not talk­ing about Utopia here. It is incon­ceiv­able to have a “per­fect world” but we are very far from that (and I sur­mise this is not meant to be the case any­way — but what do I know of that?).

    With Sys­tem Dynam­ics I can also model the “Human Response” and pre­dict cer­tain out­comes (funny that). Although I could not tell you that Egypt would erupt, I could over the last year as each new event took place imag­ine how “the forces” would play out and cause some dis­lo­ca­tion or event. Given what is con­tin­u­ing to hap­pen this need­less stu­pid­ity seems set to continue.

    The “prob­lem” that I have with all this (and it has always been a “prob­lem” for me) is that it is the inno­cents who suf­fer while the guilty go free.

    That (unfor­tu­nately for me any­ways) is the world that we live in.

    I can­not believe what passes as “news” or “debate” on the Tele­vi­sion (I rarely can bring myself to watch any). How­vere the illu­sion is very effec­tive and works for most people.

    Of course some peo­ple sim­ply do not believe a sin­gle word that gov­ern­ment says any­way but it is lit­tle con­se­quence for those liv­ing in the “ivory tower” land.

    I would fin­ish this with two things which I am sure most will not under­stand at all and likely will com­pletely misunderstand…

    1) I love “God” (And I am most def­i­nitely not some “reli­gious nut­ter” — never was and never will be — and I find it extrador­di­nary that I would ever issue those words to myself let alone in public).

    2) I respect my neighbour

    p.s. I never received an email from you

  23. sirius says:


    Typos — the obvi­ous one, “taled”, I meant “talked”

    A lit­tle
    The “prob­lem” is not the banks it is “us”.
    (I am sure you will appre­ci­ate what I am say­ing here).

  24. sirius says:

    I thought “gov­ern­ment” involved “free-speech”. Whoops no it doesn’t — if you don’t say what you are told (or say noth­ing) then out you go…

    “Hours later, chief sec­re­tary to the trea­sury Danny Alexan­der con­firmed on live tele­vi­sion that Lord Oakeshott had stepped down by “mutual con­sent”.


    Then of course

    “Shadow chan­cel­lor Ed Balls said Lord Oakeshott had paid the price for “telling the truth”. “”

    Funny that but Balls he hasn’t. One thing is very clear. The party in oppo­si­tion always reverse their words when they are in “power”.

    The process nowa­days is so bla­tant and clear to see that it is “comical”.

    It is clear that “change” is inevitable.

  25. Mich says:

    I don’t think the banks will lose. All over the world this group is trans­fer­ring the (unre­al­ized) losses to the tax­pay­ers, pen­sion funds.. any­one but them­selves, with help from the peo­ple we trust to run the gov­ern­ment and funds etc on our behalf. And we let them do it.

    In fact the whole deflation/inflation issue doesn’t mat­ter any­more, gov­ern­ments have taken on or are guar­an­tee­ing the “assets”. Higher taxes, pen­sion costs and/or lower value of money, saver or bor­rower; we pay.

    The banks will be fine. Well well, how lucky.

    I keep won­der­ing why econ­o­mists ignore crime, legal­ized or nor, a major fac­tor in the econ­omy now imho.


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