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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  • Thanks H4A,

    I’ll post it to the blog in the next few days. I did make a stuff up on that point–I meant 20% over the life of the FHVB–but that’s the sort of thing one does in a live inter­view.

  • My money is on an unex­pected decline in growth and rise in unem­ploy­ment forc­ing him to lower rates later this year Peter.

  • I’ve just browsed this paper so far Robert, but it does look inter­est­ing. I’ll check it out and see if I can add that issue to my analy­sis. I expect it will be a fac­tor in why the debt ride appeared smoother than it should have been though, rather than a totally inde­pen­dent causal fac­tor.

  • At that time Steve, with the utmost of respect, GS will know that the whole global econ­omy has col­lapsed and China is buy­ing no more dirt from Oz and the only game in town is to attract the “hot-money” des­per­ately seek­ing a return and at the low­est risk.

    That appears to be Australia’s name and game at the moment so I am bet­ting he will try to lever­age and amor­tize at the same time. There­fore, in these, the final moments of the global col­lapse, for what rea­son would he reduce rates?

    To stim­u­late SME’s? To stim­u­late exports? To stim­u­late the hous­ing mar­ket? Who is going to buy a house under those con­di­tions? Debt is the issue — as you so well point out.

    I don’t mind being wrong but I don’t see the stated “real” RBA “inde­pen­dence” so well…

    but Yes, I appre­ci­ate your posi­tion but I beg to dis­agree.


  • Hi Steve, you men­tion Demographia, but have you actu­ally done the math to find out whether Demographia’s cal­cu­la­tions for Aus­tralia are cor­rect?

    Since the Demographia sur­vey was released, sev­eral mem­bers of the Aus­tralian Prop­erty Forum have used four sep­a­rate meth­ods and data sources to demon­strate that Syd­ney median house­hold income is much higher than stated by Demograpia… check it out here…

    Demographia Debunked

    And as the blog above shows, they are also using non-com­pa­ra­ble dwelling data across the var­i­ous coun­tries sur­veyed.

    Of course, improv­ing hous­ing afford­abil­ity is an admirable aim, and one that I sup­port myself. But it helps to begin with accu­rate infor­ma­tion.



  • home­s4aussies

    The most thor­ough analy­sis of Aus­tralian house­hold income that I have seen is by the blogsite “Crit­i­cal Influ­ence” in this arti­cle:


    It’s find­ing are con­sis­tent with Demographia.

    It will be extremely inter­est­ing to see what this year’s cen­sus shows for house­hold income. Unfor­tu­nately the data will not col­lected for another 6 months, and not released until some 12 months later again, but it will be quite use­ful to ret­ro­spec­tive stud­ies of our bub­ble well after it has popped.….

  • Muzz

    Another exam­ple of do-good­ing from that era is the fed­eral gov­ern­ment leg­is­lat­ing a cap of 13% inter­est for home mort­gage loans taken out before a cer­tain date. Unthink­able these days. The banks must have had pup­pies!

    Saved my bacon though.

  • Shadow is an infa­mous spruiker so his com­ments can be taken with a large pinch of salt. The only “debunk­ing” Shadow man­aged was in his head. In fact, Raveswei of the Zeta Prop­erty Forum totally debunked Shadow’s poor effort, here:

    Shadow Debunked!

    Also, it’s not just Demographia who have shown Aus­tralia to be over­priced. These charts from The Econ­o­mist show house prices in Aus­tralia are astro­nom­i­cal based on stan­dard price/earnings ratio, and com­pared to most other coun­tries in the world.

    Econ­o­mist Chart Gallery — Aus­tralia Hous­ing Bub­ble

    Rob F.

  • Steve, totally agree with you that a seri­ous crash is over­due. I’m expect­ing it to hit like an express train in Q3 with a very neg­a­tive ABS result, and then prices to decline 40–50% (nom­i­nal) within two years from Q3. Would you agree with that assess­ment or do you have a dif­fer­ent time­frame in mind?

  • home­s4aussies

    Yes, and Prakash Loun­gani of the Inter­na­tional Mon­e­tary Fund (IMF) has pub­lished very sim­i­lar find­ings.…


  • TruthIs­ThereIs­NoTruth

    Hello Steve,

    fig­ure 24 and 25, unless the data is 8 months old, is incon­sis­tent with ABS hous­ing finance (lat­est num­ber released today)


    The credit impulse is com­pelling, what is not clear from the charts is whether the impulse is lagged to employ­ment. If it isn’t I don’t see why falls and rises in employ­ment, caused by exter­nal fac­tors other than debt wouldn’t affect accel­er­a­tion in debt, espe­cially in Aus­tralia, whose econ­omy seems more exter­nally than inter­nally dri­ven.

  • bps

    I used to be amazed (still am) and won­der how on earth peo­ple were afford­ing houses in excess of 500k when I approx­i­mately knew their earn­ings and sav­ings, but lately I have been sur­prised (maybe shouldn’t be so sur­prised) to hear from many that they have inter­est only mort­gages and these are not investors but bought to live in. Are there any sta­tis­tics on this? Surely this has got to have a ceil­ing that we are near­ing.

    Did some google search­ing but can not find any num­bers or sta­tis­tics on this for Aus­tralia, inter­est­ing though this arti­cle from msnbc from 2005 and the good old USA which shows con­cern about the grow­ing pop­u­lar­ity of Inter­est only mort­gages.


    And with the lat­est home loan fig­ures show­ing an increase of 2.1 per­cent in Decem­ber fol­low­ing 2.5 in Novem­ber but the fig­ures includ­ing a bounce largely due to refi­nanc­ing. What does refi­nanc­ing mean Is it bor­row­ers chang­ing the terms of their bor­row­ing; increas­ing to pay of other debts (ATM on their house), con­sol­i­dat­ing debts or pos­si­bly restruc­tur­ing to inter­est only? Inter­ested to know the break­down on new mort­gage fig­ures and if they are being bent and stretched and a cause for con­cern as was in the USA 2005.

  • The Credit Impulse leads employ­ment by 2–3 months, and employ­ment leads GDP by another 2 months in the USA. In Aus­tralia, you are indeed cor­rect: the Credit Impulse lags employ­ment. I expect this is due to the more inter­na­tion­ally exposed nature of the Aus­tralian econ­omy, as you your­self sur­mise. Since my analy­sis is fun­da­men­tally of the global econ­omy and the US as the cen­tral part of that, I take the lead of Credit over employ­ment and GDP as the norm and Australia’s sit­u­a­tion as the aber­ra­tion.

  • I have just done a com­par­i­son of median Mel­bourne house prices to aver­age Aus­tralian dis­pos­able income per house­hold. The com­par­isons over time sup­port the Demographia trends, though the num­bers are of course dif­fer­ent.

    I’ll pub­lish these in a blog entry this week, but to fore­shadow -:) them, the ratio was 1.8 in the 1960s, 2–2.5 in the 1980s, 2.5 in 1997–when I date the cur­rent house price bub­ble from–and is now 5.5.

  • Car­lyle

    I have no doubt that a cor­rec­tion will occur — Jeremy Grantham hits the nail on the head!

    Play­ing dev­ils advo­cate how­ever, the largest Aus­tralian lender (The Com­mon­wealth Bank of Aus­tralia) car­ried out its very own worst case sce­nario late last year. Con­sid­er­ing a 40% drop in real estate, inter­est rates at 14% and unem­ploy­ment at 10% — the losses would expose a loss of $740m. To put in con­text, 0.2% of its book!!
    Unlike the US, the lack of sup­ply for hous­ing in Aus­tralia always out­strips demand. Hous­ing is not being built left, right and cen­tre for the sake of it caus­ing an over­sup­ply…
    Fur­ther­more, no invest­ment banks are involved to the extent of that in the US fuelling growth for growth sake to hit ’ sales tar­gets’ and then bundling and recy­cling them. (I.e. — much greater reg­u­lar­tory over­sight in OZ).

    Debt. Debt is the ele­phant in the room.

  • I fin­ished my piece with the obser­va­tion that every other coun­try that has had a bank­ing cri­sis after a house price crash released sim­i­lar research before­hand about how the crash wouldn’t dam­age the bank­ing sec­tor.

    I expect these stud­ies make the clas­sic mis­take for which the oth­er­wise use­less FCIC report gave a good anal­ogy, as I noted on that blog entry: apply­ing sta­tis­ti­cal tech­niques that assume house price changes are like tosses of a fair coin–one result of Heads has no impact on what the next one will be–when they are more like find­ing slices of mouldy bread in a loaf–one mouldy slice almost cer­tainly guar­an­tees many oth­ers.

  • bret­t123

    740m is actu­ally failry small under those cir­cum­stances.

  • bret­t123

    Steve, I assume once the decline starts you expect it to con­tinue? Wayne Swan has already sug­gested we may get a neg­a­tive quar­ter of growth due to the floods — but then back to growth — if it’s only one quar­ter I’d assume you wouldn’t take this as proof your the­o­ries have come true in Aus?

    Also what does it mean for your the­o­ries if you are wrong? Can we safely say ‘Aus­tralia is dif­fer­ent”?

  • cja

    What’s the impli­ca­tion of this Steve? Does it mean we could still have decel­er­at­ing pri­vate debt with no asso­ci­ated change in unem­ploy­ment? Also, is this affected by which unem­ploy­ment fig­ures source you use?

  • BrightSpark1


    What they have missed is the dynamic sys­tems analy­sis. They are totally unaware of the need to con­sider feed­back effects and how things change with time. Their “worst case sce­nario” is a won­der­land of igno­rance. As Steve says you can not extrap­o­late from sta­tis­tics.

    Also we already have real unem­ploy­ment of about 10% the “less than 5%” mod­i­fied U3 fig­ure that they keep talk­ing about as “unem­ploy­ment” fig­ure is another fraud­u­lent decep­tion.

    Debt is the unsta­ble impro­vised explo­sive device (IED) in the room.

  • ferb

    Inter­est­ing Steve how the extreme views in eco­nom­ics are now becom­ing more main stream.…wont be long now before your views will also take a front seat.


  • @ ferb

    Today’s Heretics are tomorrow’s Con­ser­v­a­tives.
    (the one’s that sur­vive, that it:)

  • Accel­er­at­ing debt gave dou­ble or more the con­tri­bu­tion to aggre­gate demand than it should have done from 1955–2008, and it also redi­rected employ­ment into the unpro­duc­tive FIRE econ­omy. We are going to have a long period now where the credit impulse on aver­age has to sub­tract from aggre­gate demand, and shrink­ing FIRE employ­ment. But the prospect for occa­sional pos­i­tives to the Credit Impulse will gen­er­ate occa­sional appar­ent recov­er­ies on the way down.

  • I expect a fluc­tu­at­ing path down brett–I’ve learnt some­thing from the power of the gov­ern­ment response and the con­cept of the Credit Impulse. But I was always call­ing a Japan­ese future (as Ive just con­firmed while edit­ing Debunk­ing Eco­nom­ics, writ­ten back in 2000) and that remains my base case sce­nario so long as the reduc­tion of pri­vate debt is resisted.

  • I was sur­prised to hear talk of a pos­si­ble tech­ni­cal reces­sion http://www.abc.net.au/lateline/business/items/201102/s3133635.htm