This Time Had Bet­ter Be Dif­fer­ent: House Prices and the Banks Part 1

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Before the US house price bub­ble burst, its banks and reg­u­la­tors claimed (a) that there wasn’t a bub­ble and (b) that, if house prices did fall, it wouldn’t affect the sol­vency of the banks.

The same claims are now being made about Aus­tralian house prices and Aus­tralian banks. On the for­mer point, Glenn Stevens recently remarked that:

There is quite often quoted very high ratios of price to income for Aus­tralia, but I think if you get the broad­est mea­sures coun­try-wide prices and coun­try-wide mea­sure of income, the ratio is about four and half and it has not moved much either way for ten years.

That is higher than it used to be but it is actu­ally not excep­tional by global stan­dards.
(SMH March 16th 2011)

On the lat­ter, APRA con­ducted a “stress test” study of Aus­tralian banks in 2010, with the stresses includ­ing a 30% fall in house prices over 3 years:

Table 1: APRA Stress Test Table, APRA Insight 2010/2, p. 9

2009/10 2010/11 2011/12
GDP growth (%) (-3.0) 2.1 3.5
Unem­ploy­ment (%) 9.8 10.8 10.7
House Price Growth (%) (-11.8) (-12.1) (-1.7)
Com­mer­cial office prop­erty growth (%) (-21.5) (-9.4) 1.5

APRA’s con­clu­sion was:

The main results of the stress-test for the 20 ADIs, taken as a group, are as fol­lows:

  • none of the ADIs would have failed under the down­turn macro­eco­nomic sce­nario;
  • none of the ADIs would have breached the four per cent min­i­mum Tier 1 cap­i­tal require­ment of the Basel II Frame­work; and
  • the weighted aver­age reduc­tion in Tier 1 cap­i­tal ratios from the begin­ning to the end of the three-year stress period was 3.1 per­cent­age points. (APRA Insight 2010/2, p. 10)

So there’s noth­ing to worry about then? No bub­ble to pop, and no prob­lems for the banks if house prices fall any­way? In this post I’ll con­sider the argu­ment that there is no bub­ble because changed eco­nomic fun­da­men­tals jus­tify Australia’s rel­a­tively high house prices. In the next I’ll con­sider what the pop­ping of the bub­ble could mean for Aus­tralian banks.

Prices

Glenn Stevens’ claim that the house price to income ratio was “about four and a half” was almost cer­tainly rely­ing on research by Ris­mark. Ris­mark MD Chris Joye recently asserted that the house price ratio in Aus­tralia was 4.6, and though he con­ceded this was some­what high, he argued that it was jus­ti­fied by changes to eco­nomic fun­da­men­tals. He ridiculed the claim, made by The Econ­o­mist on the basis of a com­par­i­son of house prices to rents, that Australia’s house prices are 56% over­val­ued:

The Econ­o­mist does not ques­tion whether the old hous­ing ratios might be non­sen­si­cal to today’s home own­ers as a result of:

  • Fun­da­men­tal changes in the struc­ture of the econ­omy wrought by the fact that inter­est rates over the past 15 years have, on aver­age, been 43 per cent lower than inter­est rates in the 15 years that pre­ceded that period;
  • The fact that aver­age infla­tion since the mid­dle of the 1990s has been 55 per cent lower than infla­tion in the 15 years prior; or
  • The fact that the rise of two-income house­holds and the female par­tic­i­pa­tion rate in con­cert with a near halv­ing in the nom­i­nal cost of debt might have trig­gered a once-off upward increase in house­hold pur­chas­ing power, and hence hous­ing val­u­a­tions… (Chris Joye, A prop­erty bub­ble long shot, Busi­ness Spec­ta­tor March 25 2011)

For­mer RBA staffer and now HSBC econ­o­mist Paul Blox­ham was equally adamant: Aus­tralian house prices are a tad high, but they are jus­ti­fied by changed eco­nomic fun­da­men­tals over the last 15 years:

… a large struc­tural adjust­ment that occurred in the Aus­tralian hous­ing mar­ket between 1997 and 2003… involved lower inter­est rates, bet­ter-anchored infla­tion expec­ta­tions, and increased avail­abil­ity of hous­ing credit. With­out some rever­sal of these struc­tural changes – which is a vir­tual impos­si­bil­ity – we do not expect Aus­tralian hous­ing prices to fall…

Since late 2003 the dwelling price to income ratio has been broadly sta­ble at between 3.5 and 4.5 and has aver­aged 4 (see chart)…

We view the risk of a sharp fall in hous­ing prices as very low. (Paul Blox­ham, The Aus­tralian hous­ing bub­ble fur­phy, Busi­ness Spec­ta­tor March 18 2011)

Fig­ure 1: Rismark’s Dwelling Price to Income Ratio Chart

In other words, this time is dif­fer­ent.

They would say that, wouldn’t they?

The “this time is dif­fer­ent” argu­ment asserts that lower inter­est rates, lower infla­tion and higher income per house­hold (and more income earn­ers per house­hold) means that though the house prices to income ratio might higher than before, it’s noth­ing to worry about.

Tell that to a would-be first home buyer who’s con­tem­plat­ing tak­ing out a mort­gage. In 1992, the aver­age mort­gage for a First Home Buyer was $ 71,500. It is now $274,000.

Fig­ure 2: Aver­age First Home Mort­gage and Mort­gage Inter­est Rate

The “no bub­ble” argu­ment asserts that this has been coun­ter­bal­anced by the fall in inter­est rates—which were 12% then and are 7.8% now. So the aver­age first home buyer’s mort­gage is 3.8 times higher than it was two decades ago, while inter­est rates are 2/3rds what they were then. Does one—along with changes in income and demographics—counterbalance the other?

Not on your life: the increase in debt and debt ser­vic­ing has far out­stripped all the fac­tors that Joye and Blox­ham rely upon to argue that Australia’s house prices are not in a bub­ble.

I want to make this case slowly, so that you can see each step in the argu­ment, so let’s first look at the weekly inter­est and loan repay­ments on a typ­i­cal 25-year First Home hous­ing loan. Back in 1992, the weekly inter­est bill was $165; now it is $420—2.5 times as high. Repay­ments were $174; now they are $490—2.8 times as high.

Fig­ure 3: Inter­est up 2.5 times, repay­ments up 2.8 times


So have incomes risen suf­fi­ciently to mean that this almost three­fold increase in debt ser­vic­ing costs over 20 years is no big deal?

Not if you’re a wage earner! Aver­age before tax wages have risen from $505 a week in 1992 to $996 a week at the end of 2011—so they have almost dou­bled. Using an aver­age tax rate of 28%, that gives the aver­age wage earner $777 after tax a week today, ver­sus $394 back in 1992.

Fig­ure 4: Aver­age wages have risen by 97% since 1992

While wages have risen, the 2.8 times increase in loan repay­ments means that mort­gage pay­ments on an aver­age first home loan have gone from tak­ing 40 per­cent of after-tax income of the aver­age worker in the 1990s to 64 per­cent now—after reach­ing a peak of 74 per­cent in late 2008 before the RBA slashed inter­est rates (the ratio fell to 53 per­cent, and it would have fallen fur­ther had the First Home Ven­dors Boost not caused house prices to sky­rocket again).

In the early 1990s, a young wage earner could aspire to financ­ing a house pur­chase using his or her income alone. Now, that’s out of the ques­tion.

 

He’s a (young) Working Class Man Renter…

This is what the “no bub­ble” pro­po­nents don’t get: high house prices have become a class and age issue. If you’re a young “work­ing class man” on the aver­age wage, you can no longer afford to enter the hous­ing mar­ket in Australia—since the aver­age first home loan would con­sume over 60 per­cent of your after-tax wage.

Even if you’re a “young work­ing class cou­ple”, the cost of ser­vic­ing a mort­gage from wage income alone is pro­hib­i­tive. In the 1990s, a cou­ple (where both earned the aver­age wage) had about 80% of their income free for other costs after pay­ing the aver­age First Home mort­gage. The rapid esca­la­tion in house prices after Howard dou­bled the First Home Own­ers Grant in 2001 drove this down to under 65 percent—and most wage-earn­ing cou­ples sim­ply don’t have that much head­room in their bud­gets. They can’t pay the rates, the food bill, the petrol, and the edu­ca­tion fees, with less than three quar­ters of their after-tax income.

Fig­ure 5: Max Headroom–disposable income after pay­ing the mort­gage plum­mets as prices rise

Faced with this level of poten­tial debt-ser­vic­ing costs, young would-be house-buy­ers are giv­ing up on the dream of home ownership—and its atten­dant night­mare of debt peon­age. They’re also sign­ing up in droves to call for a polit­i­cal cam­paign against house prices by GetUp: see the Anti-FHOG, Anti-Neg­a­tive Gear­ing, and Buy­ers Strike cam­paign sug­ges­tions (and read David Llewellyn-Smith’s excel­lent piece on it in the Fair­fax press too).

A “Buy­ers’ Strike”, whether orga­nized or not, is what will end the Ponzi Scheme of debt-inflated house prices, because like all Ponzi Schemes it only con­tin­ues to work so long as new entrants out­weigh those try­ing to cash out.

Those who are try­ing to cash out—existing house own­ers who are sell­ing as spec­u­la­tors, or sell­ing to real­ize a paper cap­i­tal gain and upgrade to a more expen­sive house, or sell­ing an invest­ment prop­erty to fund their retirement—are now sell­ing into a dwin­dling mar­ket.

The first effect of this imbal­ance between demand and sup­ply is an increase in the time to sell, and in the num­ber of unsold prop­er­ties on the mar­ket. The sec­ond effect is a mod­er­ate fall in prices, once sell­ers who have to sell real­ize that they have to take a hair­cut. The third effect in Aus­tralia may well be an increase in sales by prop­erty spec­u­la­tors, if they see their cap­i­tal gains dimin­ish­ing the longer they hold on to their “invest­ments”.

The Scheme could be kept alive by a reduc­tion in inter­est rates to entice new buy­ers into the market—Australia’s float­ing rate mort­gages make it much eas­ier for the Cen­tral Bank to manip­u­late mort­gage rates here than in the USA—but even there, there’s a limit. To get mort­gage pay­ments back to 20% or less of the after-tax income of a cou­ple earn­ing the aver­age wage— with­out mort­gage lev­els falling, and hence house prices falling—the mort­gage inter­est rate would need to fall to 3%. This would require the RBA to drop its cash rate to zero from its cur­rent level of 4.75 per­cent.

Even if it does do that, it will take a very long time to do so—remember that Australia’s Cen­tral Bank was still rais­ing inter­est rates well into the GFC (it increased the cash rate to 7.25% in March 2008, and only start­ing cut­ting it in Sep­tem­ber when the cri­sis was already a year old). Mort­gages and house prices will have plenty of time to fall before that hap­pens.

Fig­ure 6: Australia’s Cen­tral Bank rate is almost 5% higher than the USA’s

This raises two ques­tions: how much could house prices fall, and what could be the impact of a fall on the financiers of this Ponzi Scheme: the banks?

I’ll con­sider the sec­ond ques­tion in a post next week; for now let’s do some­thing the “no bub­ble” crowd reg­u­larly refuse to do, and con­sider long-term data on house prices and incomes.

Fighting Magoo-nomics with long-term data

I some­times feel like I’m fight­ing Mr Magoo when I debate the non-bub­ble set: they choose a short-term data set and then tell me that what I’m pre­dict­ing can’t hap­pen because it has never hap­pened before. Yet there is long-term data to show that it has hap­pened before. They either ignore it, or find rea­sons to dis­miss it because it doesn’t meet their qual­ity stan­dards.

This is self-serv­ing. Older data will almost always not meet mod­ern stan­dards, sim­ply because it is old and, in most cases, sta­tis­ti­cal prac­tices have improved over time (one obvi­ous excep­tion to this is gov­ern­ment report­ing of unem­ploy­ment and infla­tion, where stan­dard have been dropped for polit­i­cal expediency—see Roy Morgan’s fig­ures on the actual unem­ploy­ment rate in Aus­tralia, and John Williams’ “Shad­ow­stats” infor­ma­tion on actual unem­ploy­ment and infla­tion in the USA). But the data exists, and unless it is out by a huge mar­gin, the infor­ma­tion it con­tains is worth con­sid­er­ing.

Joye’s points above about inter­est and infla­tion are a case in point here: “inter­est rates over the past 15 years have, on aver­age, been 43 per cent lower than inter­est rates in the 15 years that pre­ceded that period… aver­age infla­tion since the mid­dle of the 1990s has been 55 per cent lower than infla­tion in the 15 years prior”. That’s all true—but if you look back fur­ther in time, inter­est rates and infla­tion were lower in the 1960s than they are today. In the 1970s, though inter­est rates were higher than today, they were lower than the rate of infla­tion, so that the real inter­est rate was neg­a­tive.

Time Period Nom­i­nal Mort­gage Rate Infla­tion Rate Real Mort­gage Rate
1960–70 5.37 2.43 2.94
1970–80 8.62 9.76 –1.13
1980–95 12.71 6.69 6.02
1995–2011 7.55 2.78 4.77

If Joye and Bloxham’s “struc­tural changes mean this time is dif­fer­ent” case was valid, then mort­gages and house prices should have been higher rel­a­tive to incomes in the 1960s than today (let along the 1970s!) because inter­est rates and infla­tion were much lower then than now.

And were they? Here we have to do some detec­tive work, to com­bine the very brief ABS time series on house prices (which starts in 2002) with longer term house price esti­mates for Syd­ney and Mel­bourne put together by Nigel Sta­ple­don of UNSW (which starts in 1880 and ends in 2005). Though put together with very dif­fer­ent method­olo­gies, the over­lap is good for the 3 years they share in common—especially for Mel­bourne.

Fig­ure 7: Two meth­ods for esti­mat­ing house prices with com­pa­ra­ble results

It’s also pos­si­ble to derive an implied ABS median house price for Syd­ney and Mel­bourne by com­bin­ing the ABS’s median house price index data—which goes back to 1986—with its price data from 2002 on. Stapledon’s data also fits this series very well—again, espe­cially for Mel­bourne.

Fig­ure 8: They’re also con­sis­tent over the last 25 years when com­bined with ABS Index data

Given this close cor­re­spon­dence, I’m will­ing to use Stapledon’s data as a rea­son­able guide to what median house prices were before the ABS began col­lect­ing house price index data.

Fig­ure 9: Esti­mated median prices for Syd­ney and Mel­bourne using Stapledon’s data till 1986 and ABS after­wards

Now we can com­bine this data with ABS and RBA data on dis­pos­able incomes, pop­u­la­tion and the num­ber of dwellings to see how the ratio of house prices to dis­pos­able income has fared over time.

Fig­ure 10: A tripling of house prices com­pared to incomes over the last 50 years

There are var­i­ous prob­lems with this com­par­i­son:

  • It com­pares median house prices to aver­age incomes, and there­fore under­states the median to median (or aver­age to aver­age) com­par­i­son by about 25 per­cent;
  • The ABS Index only cov­ers free-stand­ing houses, thus over­stat­ing (prob­a­bly also by about 25 per­cent) the median price level by omit­ting cheaper apart­ments;
  • It doesn’t account for dif­fer­ences in aver­age dis­pos­able incomes by city, thus over­stat­ing the ratio for Syd­ney and Mel­bourne, but under­stat­ing it for the other cities.

But over­all it’s a rea­son­able guide to some­thing we des­per­ately need more infor­ma­tion on, and the over-time com­par­isons are valid. An aver­age-income house­hold could have pur­chased the median house in Syd­ney with less than 2 years of dis­pos­able income in 1960; it now takes over 6 years—and at the peak, it took 8 years.

What’s more, the ser­vic­ing cost of this debt was lower in the 1960s than it has been for the last decade, because mort­gage rates were 30% lower back then.

So much for Stevens’ claim that “the price to income for Aus­tralia … is about four and half and it has not moved much either way for ten years”. The myopic focus of “no bub­ble” com­men­ta­tors on the last 10 years of data ignores a bub­ble that, since 1985, has dou­bled the rel­a­tive cost of buy­ing a house. Since the early 1960s, when the old­est Baby Boomers were buy­ing their first prop­er­ties, it has tripled the cost.

To restore the house price to income ratio that applied in 1985, before this bub­ble really took off, house prices would have to fall by 50 per­cent com­pared to incomes.

The final refuge of bub­ble deniers is a claim that I’ve heard much less of in recent years—after the US Bub­ble clearly burst in 2006—but which is still worth address­ing: that house prices always rise faster than con­sumer prices over the long term. The best empir­i­cal retort to this is the price index com­piled for Amsterdam’s most expen­sive canal from 1628—just before the Tulip Craze began—till 1973. There were lengthy peri­ods where prices gen­er­ally went down in real terms, and equally lengthy peri­ods where they went up. It was pos­si­ble to be born when a long term slump began, and die at a mature age believ­ing that house prices always fall; and ditto for believ­ing, from your own expe­ri­ence, that they always rise. But over the very long term, there is no trend.

Fig­ure 11: Ams­ter­dam prices; booms and bust over 350 years, but no trend

Driving Miss Bubble

There were two main dri­vers of this bub­ble: a finan­cial sec­tor that makes money by cre­at­ing debt, and a gov­ern­ment sec­tor that has (to some extent unwit­tingly) used asset price manip­u­la­tion as a cheap means to stim­u­late the econ­omy.

The impact of the gov­ern­ment is obvi­ous when you over­lay the First Home Own­ers Grant over the house price to income data.

Fig­ure 12: The FHOG lifts prices and stokes the debt-dri­ven econ­omy

Sta­tis­ti­cally, its impact sticks out like a sore thumb as well. Between 1951 and when the FHOG was first intro­duced (in 1983), the aver­age quar­terly change in real house prices was 0.07 percent—or effec­tively zero. After it, the aver­age quar­terly change was just shy of 1%. When the Scheme was in oper­a­tion (it was not in oper­a­tion dur­ing the 1990s), the rise was 2% per quar­ter; on the two occa­sions when the Grant was dou­bled, real house prices rose by 3 per­cent per quar­ter.

Nor­mal Stats Before FHOS After FHOS All Data Dur­ing FHOS Between FHOS peri­ods When FHOS dou­bled
Mean 0.07% 0.95% 0.47% 2.17% 0.26% 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% 1.27% 1.83%
Count 131 108 240 25 50 7

On all but one occa­sion, the Grant was used as a macro­eco­nomic tool—a cheap way of boost­ing the econ­omy dur­ing a down­turn, whether actual or feared (the one other time—when Howard revived it in 2000—it was as a “tem­po­rary” sup­port to the build­ing indus­try when the GST was intro­duced; that tem­po­rary sup­port has now lasted almost 12 years).

The Grant works because the rel­a­tively small gov­ern­ment grant is lev­ered not once, but at least twice. Firstly the First Home Buyer’s bor­row­ing capac­ity is boosted by the lender’s Loan to Val­u­a­tion Ratio—so $7,000 to the bor­row­ers becomes some­thing north of $50,000 for the ven­dors with today’s sky-high LVRs. Then the ven­dors use the addi­tional cash they received as increased deposits for their next pur­chase.

The banks are happy to fund this process, because they make money by cre­at­ing debt, and are there­fore always look­ing for avenues by which it can be cre­ated. When bor­row­ing is based upon expected future income, or even aimed at fund­ing con­sump­tion today, cre­at­ing addi­tional debt is hard. But if bor­row­ers can be per­suaded that there’s money to be made by bor­row­ing money and spec­u­lat­ing on asset prices, there is—for a while—an easy means to cre­ate more debt.

Ever since 1990, that’s been the secret to both the house bub­ble and the prof­itabil­ity of Aus­tralian banks. They’ve made their money by financ­ing Australia’s prop­erty bub­ble; they started to do so the moment the pre­vi­ous spec­u­la­tive bubble—the one that gave us Alan Bond and Christo­pher Skase—died out; and, though the spin is that the USA had irre­spon­si­ble lend­ing while Australia’s lenders were pru­dent, mort­gage debt grew three times more rapidly in Aus­tralia than in the USA, and reached a peak 18 per­cent higher than the USA’s.

Fig­ure 13: Aus­tralian banks have been respon­si­ble lenders? Com­pared to whom?

The growth of this debt is what really drove house prices higher, and now that our mort­gage debt to GDP ratio is start­ing to turn, so too are our house prices—just as in the USA.

Fig­ure 14: Ris­ing debt drove the US bub­ble up, and slow­ing debt caused it to burst

The only thing that delayed this process in Aus­tralia was the last gasp of the First Home Ven­dors Scheme under Rudd, which turned a nascent decline in Australia’s mort­gage debt to GDP ratio into a final fling of the debt bub­ble. Had the trend con­tin­ued, the mort­gage debt to GDP ratio would have fallen about 2 per­cent. Instead it rose over 6 per­cent, inject­ing about $100 bil­lion of addi­tional debt-financed spend­ing into the Aus­tralian econ­omy. It was a major fac­tor in Australia’s appar­ently good per­for­mance dur­ing the finan­cial cri­sis, but as one my blog­gers remarked, it worked by “kick­ing the can down the road”.

Fig­ure 15: The same dynamic is play­ing out in Aus­tralia, though delayed by the FHVB

We all know what hap­pened to the US finance sec­tor after the US house price bub­ble burst. In the next post I’ll con­sider what could hap­pen to Aus­tralian banks as our bub­ble ends.

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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  • ricky bobby

    ” Aus­tralian devel­op­ers do not make abnor­mal prof­its on hous­ing pro­duc­tion”

    What would be abnor­mal prof­its any­ways??
    Maybe they would have higher prof­its if they didn’t pay staff so much and need­lessly fly around and go to lunches. My wife works for a listed prop­erty devel­oper and she tells me what every­one makes at her job and it’s a joke. Even recep­tion­ists and PAs do pretty good. Had peo­ple on con­tracts clear­ing over 1-2k a day and she said they just wan­dered around doing much of noth­ing. Under­stand­able for the tal­ent and divi­sions that bring in money…but almost every­one does well there.…except for the recent and upcom­ing redun­dant folks. I can’t speak a sin­gle word about another prop­erty devel­oper in Australia…but I can speak for one, and the pay per level of expertise/productivity is exces­sive.

  • ak

    BB,

    I fully agree with Steve. There is very lit­tle util­ity value added by build­ing houses as big as an apart­ment block. They are only very sophis­ti­cated “invest­ment vehi­cles”, enabling to increase the long posi­tion on the hous­ing mar­ket.

    Cur­rently built houses are as over­sized as dinosaurs imme­di­ately before extinc­tion.

    Please com­pare the house I used to live as a kid (3 storeys, 11 apart­ments, we lived in a crammed one-bed­room flat):

    http://maps.google.com.au/maps?hl=en&ie=UTF8&ll=54.454225,18.551693&spn=0.000504,0.001592&t=h&z=20

    to mod­ern one-two storey houses in a “cheap”, “work­ing class”, “first home owner” sub­urb of The Ponds (these houses are sold for $450k-600k)

    http://maps.google.com.au/maps?hl=en&ie=UTF8&ll=-33.71484,150.911694&spn=0.000721,0.001592&t=h&z=20

    I dare to say we can eas­ily cram 3 fam­i­lies into these mon­strous houses and it will be still a plenty of room for any­one (I am not say­ing that these houses are designed to house sev­eral fam­i­lies but this is a sep­a­rate issue). About 20-30sqm per per­son is enough.

    Please look at this com­par­i­son:
    http://news.bbc.co.uk/2/hi/uk_news/magazine/8201900.stm

    We have a very seri­ous over­sup­ply of hous­ing if we look at the issue from the ratio­nal “util­ity max­i­miza­tion” point of view.

  • TruthIs­ThereIs­NoTruth

    After watch­ing ‘Inside Job’ last night I find Aus­tralia-US com­par­i­son a bit sad, com­i­cal and insult­ing all at the same time. There are plenty of sim­i­lar­i­ties, but there are much more sig­nif­i­cant dif­fer­ences.

    There is no doubt both house price and debt lev­els are high in Aus­tralia, but to be pro­ject­ing those facts in the same light as the hous­ing cri­sis in the US and dis­miss­ing counter argu­ments into the ‘this time is dif­fer­ent’ or ‘Aus­tralia is dif­fer­ent because it’s got kan­ga­roos’ bucket is steer­ing away from real insights.

    The ques­tion I would be ask­ing based on the facts is how is it that Aus­tralia man­aged to get to these high lev­els of mort­gage debt with­out the fraud and poor lend­ing stan­dards. Same absolute level of debt does not mean the same com­po­si­tion of that debt, which is a more sig­nif­i­cant fac­tor in assess­ing the risk of a debt induced finan­cial cri­sis.

    Argu­ing whether there is a bub­ble or not in Aus­tralia is an argu­ment about the def­i­n­i­tion of bub­ble argued by peo­ple on the oppo­site extreme ends of the eco­nomic sen­ti­ment spec­trum.

    By the way, lat­est fig­ures show around a 5% drop in hous­ing finance and a 30k+ increase in jobs and unem­ploy­ment down to 4.9%

  • pb

    Hi Bb
    Hasnt Steve replied to this ques­tion stat­ing that it is not the devel­op­ers who are the ben­e­fi­cia­ries of the bub­ble , but the gov­ern­ment through taxes and banks through inter­est earn­ings. Now since you always argue that every coun­try is dif­fer­ent , how is it that Aus­tralia is not dif­fer­ent in its bub­ble char­ac­ter­is­tics, that to exam­ine the bub­ble in this case the bal­ance sheet of the gov­ern­ment has to be exam­ined.

    You your­self have already said that the gov­ern­ment is the key player here, if they lower their taxes or sub­sidise the sup­ply side then we shall the prices of houses drop.

  • ecoN­um­bers

    Good work.
    The only prob­lem I found is miss­ing demand/supply side in this com­par­i­son – the untold story that makes sig­nif­i­cant dif­fer­ence. If there is a real short­age with no abil­ity from sup­ply side to fix that and avail­able credit to fund new pur­chases, prices could stay high for­ever or even go up slightly regard­less of high his­tor­i­cal lev­els or price to income ratio. On the other hand if area is flooded with prop­er­ties and there is no credit to fund pur­chases prices would go down even if already on low lev­els.
    Prices in most of USA at the peak of the bub­ble were not extremely high, not high com­pared to his­tor­i­cal lev­els or com­pared to any place in Aus­tralia. Still prices fell sig­nif­i­cantly across the coun­try (even in the famous no bub­ble cities such is Atlanta). In most of USA prices didn’t fall because they were high com­pared to income, they fell because credit became unavail­able and there was an over­sup­ply of prop­er­ties on the mar­ket. Prices in Phoenix (big bub­ble city) were only $240K or 5 times median income they fell almost 70% to 1.6 times median income. Atlanta, city with no prior sig­nif­i­cant price growth had just slightly lower house price $220k and the same ratio of 5 – prices fell 28%. 

    With price to income ratio of 5 and inter­est rates at only 6% (30 year fixed) in 2007, clearly unaf­ford­abil­ity was not the rea­son for the fall. The ini­tial rea­sons for the fall were over­sup­ply and weaker demand (big indebt­ness — no abil­ity to increase the debt). This was accel­er­ated by even big­ger over­sup­ply (investors tyring to cash in) and col­lapse of demand (credit freeze and higher unem­ploy­ment).
    In Aus­tralia, sit­u­a­tion is worse. The whole coun­try is in the bub­ble; banks are in a worse posi­tion (more exposed to res­i­den­tial hous­ing debt), over­sup­ply of prop­er­ties huge (in most of cities higher than in Nevada or Ari­zona), larger share of prop­erty spec­u­la­tors and peo­ple equally indebted with no sav­ings. The only thing that is keep­ing our bub­ble up is faith, strong belief that prices will go up and we will all be mil­lion­aires.

    At one point, for any rea­son, belief will dis­ap­pear and house of cards will fall. Sadly, price will be huge and paid even by peo­ple not respon­si­ble for it cre­ation – our chil­dren.

    Cheers,

    Raveswei

    http://popping-bubble.blogspot.com/

    I know how frus­trat­ing is to explain obvi­ous things to grown up peo­ple but …

  • Philip

    ecoN­um­bers,

    Good overview. While the com­par­i­son between Aus­tralian states and the most bub­ble-inflated states of the US does not prove any sort of cor­re­la­tion, it does pro­vide some more evi­dence that Aus­tralia has suf­fered an over­build­ing epi­demic.

    This might inter­est you: http://bubblepedia.net.au/tiki-index.php?page=OverbuildingByLocation

    Earth­shar­ing Aus­tralia, a sub­sidiary of Pros­per Aus­tralia, pro­duced a report in 2009, ana­lyz­ing water usage across the sub­urbs of Mel­bourne (Australia’s 2nd largest city). There are an enor­mous num­ber of empty pri­vate dwellings across Mel­bourne.

    A sim­ple overview: http://www.earthsharing.org.au/wp-content/uploads/Earthsharing_Vacancies_In_Melbourne_Report.pdf

    In more detail: http://www.earthsharing.org.au/wp-content/uploads/IW2LH_09_final.pdf

  • sir­ius

    Bub­ble bub­ble “pop”…

    Por­tu­gal calls for EU finan­cial bail-out
    http://www.bbc.co.uk/news/business-12993318

    Peston said res­cue loans could amount to as much as 80bn euros ($115bn; £70bn).”
    Now could some­body tell me where the the $115 bn comes from ? 🙂 (rhetor­i­cal).

    I would really like to know “who” is on the “other side” of all of this credit???

    Trea­sury may bor­row fed­eral retire­ment funds in debt emer­gency
    http://www.federaltimes.com/article/20110405/BENEFITS02/104050306/1001

    and just to make sure the debt ceil­ing gets raised ??
    US gov­ern­ment shut­down looms amid bud­get brinkman­ship

    The White House is draw­ing up detailed plans to shut down the fed­eral gov­ern­ment from Sat­ur­day that would sus­pend an esti­mated 800,000 employ­ees and dis­rupt hun­dreds of ser­vices rang­ing from pro­cess­ing of tax returns to the clo­sure of national parks, senior Obama admin­is­tra­tion offi­cials said.”
    http://www.guardian.co.uk/world/2011/apr/06/us-government-shutdown-looms-budget

  • slaphappy

    Hi Steve —

    I am a bit curi­ous as to the use of ABS 6302003 col­umn J as the basis for your analy­sis. This series includes casual, part-time and junior wages.

    ABS 6302003 col­umn I ( F/T adult earn­ings) show stronger wage growth.

    Col­umn J 08/94 $538 05/10 $977

    Col­umn I 08/94 $662 05/10 $1300

    The income tax bur­den on F/T adult earn­ings has declined from 22.44% to 20.90% and not the 28% used in your analy­sis.

    F/T earn­ings 94/95 $34424
    $7726 tax ( $3060 + .34 each $ over 20700) 22.44%
    net $26698

    F/T earn­ings 09/10 $67600
    $14130 tax ( $4350 + .30 each $ over 35000) 20.90%
    net $53470

    In 1994 mort­gage hold­ers required 35.95 % ($9600) of there after tax income ($26698) to serice 80k at 12%.

    In 2010 mort­gage hold­ers required 37.29 % ($19967) of there after tax income ($53470) to ser­vice 275k at 7.25 %.

    An increase of 1.34% in mort­gage costs for adult full time work­ers hardly seems like a buu­ble.

  • sir­ius

    I did not know this but appar­ently the US Gov. has had “shut­downs” before…

    “Nine shut­downs occurred between 1980 and 1995, and none lasted longer than three full days.””

    http://money.cnn.com/2011/04/04/news/economy/shutdown_faq/index.htm?iid=EL

  • sir­ius

    tanks in the streets?”

    “The Obama admin­is­tra­tion has warned law­mak­ers that they must raise the country’s cur­rent debt limit of $14.29 tril­lion before May 16 or risk “cat­a­strophic” con­se­quences, accord­ing to Trea­sury Sec­re­tary Tim Gei­th­ner. In fact, Gei­th­ner said Tues­day, the con­se­quences of default would make the recent finan­cial cri­sis appear “mod­est in com­par­i­son.”””

    http://blogs.abcnews.com/politicalpunch/2011/04/geithner-says-failure-to-raise-debt-limit-would-make-recent-financial-crisis-look-modest-in-comparis.html

    Deja-Vu?

  • sir­ius

    Last one for today.

    100 “big ones”
    http://news.bbc.co.uk/1/hi/7832601.stm

  • sir­ius

    Are We It Yet ?


    The Pound declined against the Euro yes­ter­day, after a report from the Office of National Sta­tis­tics unex­pect­edly showed that UK indus­trial pro­duc­tion declined in Feb­ru­ary. Over the past quar­ter, the improve­ment in man­u­fac­tur­ing out­put, due pri­mar­ily to a weak Pound, has been the cor­ner­stone of the eco­nomic recov­ery, but the report will fuel con­cerns that the route back to growth will be a bumpy one.

    Man­u­fac­tur­ing out­put **dropped 1.2% from the pre­vi­ous month**, despite ini­tial esti­mates of a 0.4% increase, while reports ear­lier this week revealed that **UK ser­vice sec­tor growth expanded way beyond fore­casts**. The result will dampen spec­u­la­tion of an increase in UK inter­est rates with the Bank of Eng­land very unlikely to raise rates this lunchtime hav­ing waited all of this time for the first quar­ter GDP num­bers. ”

    From a cur­rency exchange com­pany.

  • mahaish

    “”The Obama admin­is­tra­tion has warned law­mak­ers that they must raise the country’s cur­rent debt limit of $14.29 tril­lion before May 16 or risk “cat­a­strophic” con­se­quences, accord­ing to Trea­sury Sec­re­tary Tim Gei­th­ner. In fact, Gei­th­ner said Tues­day, the con­se­quences of default would make the recent finan­cial cri­sis appear “mod­est in com­par­i­son.””””

    con­gress has rocks in its brains sir­ius,

    this whole talk of rais­ing the debt ceil­ing is mean­ing­less if they just removed the no over­draft pro­vi­sions as far as trea­sury spend­ing is con­cerned.

    trea­sury doesnt need to issue any debt since the fed moved to inter­est rate tar­get­ing by decree.

    get rid of the debt ceil­ing, its totally unecessery .

    these char­ac­ters dont under­stand their own mon­e­tary sys­tem, and its just more evi­dence of the failed eco­nomic right non­sense about unbacked trea­sury spend­ing being infla­tion­ary due to it being high pow­ered money, when we can argue quite rea­son­able that it doesnt really mat­ter if a debt instru­ment is cre­ated or not as far as its infla­tion­ary nature is con­cerned since the com­po­si­tion of liq­uid­ity is only being effected.

    its not whether a debt instru­ment is cre­ated that is impor­tant as far as infla­tion is con­cerned, but the total level of the deficit, and the pri­vate sec­tors abil­ity to pro­duce goods and ser­vices for a par­tic­u­lar level of deficit.

    even if we take the most char­i­ta­ble inter­pre­ta­tion of US unem­ploy­ment data, we are a long way off from full employ­ment , and the eco­nomic right con­veneintly skips the bit about the fact that its propo­si­tions about infla­tion only hold true at full employ­ment con­di­tions, and they con­stantly keep mov­ing the bar as far as what con­sti­tutes full employ­ment.

  • sir­ius

    Trump this…
    http://www.msnbc.msn.com/id/21134540/vp/42469716#42469716

    (Well worth watch­ing IMHO)

  • sir­ius

    @mahaish

    trea­sury doesnt need to issue any debt since the fed moved to inter­est rate tar­get­ing by decree.”

    Money” con­sists of sev­eral con­stituent parts.

    Money equates to oblig­a­tion. Both a cur­rent oblig­a­tion (as in now at this moment) and/or future oblig­a­tion.

    Issu­ing money with­out some sort of “check and bal­ance” has proven his­tor­i­cally to be cat­a­strophic. (I am think­ing of the French Assig­nats here but there are other exam­ples).

    When “money” is issued with­out debt it is not money. “Some­thing done a lit­tle is good, some­thing done to excess is bad”.

    The prob­lems that we see are due to “some­thing that is done to excess is bad”.

    Com­pletely decou­pling entirely is surely dis­as­trous.

    This is just a base from which to begin because with­out a solid base one can not build any­thing.

    For those who have not read about “Peak Oil” I was reminded of it again today…

    peak oil primer — looks good
    http://www.energybulletin.net/primer.php

    http://viableopposition.blogspot.com/2011/02/peak-oil-inconvenient-truth.html
    Note what one com­menter said…
    ”“Anony­mous said…
    You Amer­i­cans have had decades to sort out your gas guz­zlers, but with atten­tion deficits and bird brains you learned noth­ing, you think 30mpg is being green! Well you‘ve stuffed your­selves big time now and pissed it all away, ps it will be a long 100 year decline fac­ing you now. Try eat­ing less as well.
    ””

    I would not have used these words but we more than a mon­e­tary or fis­cal bud­get to bal­ance.

  • sir­ius

    I cor­rect my sentence..I meant to write..

    I would not have used those words but we have more of a prob­lem than just a mon­e­tary or fis­cal bud­get to bal­ance. Being adults would sug­gest that we need to act respon­si­bly.

  • sir­ius

    Apolo­gies for the pro­fu­sion of posts today (there seems to be a lot of threads in progress at the moment)…

    Don­ald Trump is mad as hell
    http://www.youtube.com/watch?v=jAVWpeYiRa4&feature=player_embedded#at=412

    Mr Trump says he “under­stands eco­nom­ics”. I believe that he believes that he under­stands eco­nom­ics.

    So cou­ple this along with other things that he said in the inter­view and this really makes me feel very uneasy for the future. (I con­sider his diag­no­sis some­what unsound but I do appre­ci­ate that he is shrewd and would not nec­es­sar­ily “reveal all” any­way).

    I think that some here may be think­ing “what has this got to do with Aus­tralia?”. My answer..“a lot”

    I have no doubt that Mr Trump has cer­tain qual­i­ties and is famil­iar with some Wall Street processes…
    Watch from 3:10 on the 2nd video down on the page
    http://market-ticker.org/akcs-www?post=183376

    Of course may Trump may not become Pres­i­dent so…

    Once again apolo­gies. I leave you to pon­der on this one.

  • mahaish

    the long term value of the cur­rency sir­ius,

    has very lit­tle to do with whether trea­sury issues a bond or not,

    and more to do with whether the cit­i­zens of the coun­try have jobs to go to at rea­son­able incomes.

    the wage level is a de facto peg for the cur­rency

    ulti­mately how we value the eco­nomic poten­tial of our cit­i­zens deter­mines the value of the coun­tries cur­rency,

    if we dont value our selves, we cant expect oth­ers to see any value in our endeav­ours,

    and i dont see how imposs­ing a totally unnec­es­sary inter­est bur­den on the sys­tem helps things.

  • Hi Slaphappy,

    I have about 1500 data sources that I drag in auto­mat­i­cally for analy­sis in a sin­gle Math­cad file; the over­all sys­tem is a dog’s break­fast in structure–which is why there are vol­un­teer efforts to develop an online acces­si­ble data­base instead–and I spec­i­fied the orig­i­nal ABS files this time just to let peo­ple know where the info is com­ing from.

    I’ll check out the alter­na­tive you suggest–and I’ve just noticed that amongst my set of ABS files I have a pre­de­ces­sor to that file that takes the data back to 1983!

    I agree that that change isn’t much, but (hav­ing not looked at the time trend yet) I won­der whether it shows the same pat­tern as I show in that graph of a sud­den dete­ri­o­ra­tion start­ing in 2002.

    Also, while that’s not much, what it shows is that more than all of the increase in dis­pos­able income caused by falling tax rates has been cap­tured by the finance sec­tor as increased mort­gage pay­ments. That is still my point: a fall in tax rates that should have caused an increase in dis­pos­able income instead allowed the finance sec­tor to cap­ture more of house­hold income.

    This of course doesn’t affect fig­ure 10–which still shows an almighty bub­ble.

  • bb

    Hi Steve (and AK),

    Thanks for your com­ments and thoughts. Since I know how busiy you are that is always appre­ci­ated.

    AK has brought this issue up in the past (over sized houses) and I have replied in the past on this issue but could well have been lost in prior post­ing.

    The issue of over­build­ing (indi­vid­ual houses) in some respects is real, but is bal­anced some­what by the dra­matic reduc­tion in plot sizes (land).

    In the old days (1950–1970) some stan­dard blocks of land were 1/4 acre. That is about 1000sqm. Today, sites range from 400-600sqm. So while house sizes have increased (in NLA) land sizes have halved.

    So while prior gen­er­a­tions had a big back­yard to play cricket, todays gen­er­a­tions have a Home Office, or maybe seper­ate bed­rooms.

    So it’s not all one way.

    Sec­ondly, lets put Over­build­ing into con­text. The aver­age NEW house today is around 280sqm up from 220sqm a few decades ago. Know­ing is costs $500/sqm (cost) to develop land and $1000 per sqm for build (cost) the dif­fer­ence between a 280sqm house and 220sqm house is 11%. So assum­ing there is no util­ity for the extra 60sqm, houses could be 11% over val­ued relatve to cost.

    How­ever, after giv­ing up a back­yard, I would argue there is some util­ity in a larger home. But I admit that is a mat­ter of opin­ion.

    Finally, lets look at the US. If we want to make com­par­i­sions on debt/GDP house sizes, etc, lets also look at the fac­tors of pro­duc­tion. I have posted below the aver­age return on cap­i­tal (ROC) for the US hous­ing devel­oper builder Lennar from 2000–2005 (as the bub­ble formed).

    For com­par­i­sion, have used the same method­ol­ogy to caclu­late the ROC for Aus­tralian listed devel­op­ers — Stock­land (land) and Mir­vac (build). If Aus­tralia is expe­ri­enc­ing a US style bub­ble, why the diver­gence. Is it just dif­fer­ent in Aus­tralia?

    The chart high­lights stark dif­fer­ences between Aus­tralian and the US. IMO this is the ele­phant in the rooms for the bub­ble the­o­rists.

  • bb

    ” Aus­tralian devel­op­ers do not make abnor­mal prof­its on hous­ing pro­duc­tion”

    What would be abnor­mal prof­its any­ways??

    —————
    Hi Ricky Bobby,

    A good ques­tion — lots af aca­d­e­mic papers on this, so I sus­pect SK could give a bet­ter answer on the exact def­i­n­i­tion of abnor­mal or “eco­nomic” prof­its.

    How­ever in the spirit of being “roughly right” rather than being “pre­cisly wrong” check out the chart I just posted. If will give a feel for the dif­fer­ences between Aus­tralia and the US.

  • bb

    Hi Bb
    Hasnt Steve replied to this ques­tion stat­ing that it is not the devel­op­ers who are the ben­e­fi­cia­ries of the bub­ble , but the gov­ern­ment through taxes and banks through inter­est earn­ings

    ——–

    Hi Pb,

    I must have missed that post.

    Based on this state­ment, clearly the eco­nom­ics profit in the US went to cap­i­tal provi­dors, whereas in Aus­tralia excess returns have (par­tially) gone to gov­er­ment.

    So If I read this com­ment cor­rectly, the bub­ble theoists assume Aus­tralia IS dif­fer­ent to the US.

  • bb

    Ricky Bobby,

    I found a link which may be of inter­est.

    http://www.calculatedriskblog.com/2010/12/building-costs-after-bust.html

    It basi­cally says since the bub­ble burst the cost to build in the US has fallen from US$900 per sqm to roughly US$650 per sqm.

    That com­pares to US$1000 per sqm in Aus­tralia.

    How­ever the US$650 per sqm build in the US is pred­i­cated on unskilled labour cost of US$60 per day. In Aus­tralia it is A$112 per day (based on 7.5 hour day).

    http://www.netlawman.com.au/info/minimum-wages-australia.php

    So US house build­ing is cheaper than Aus­tralia. This is because US labour is cheeper.

    So, if you want US style house prices, you need to argue for US style labour mar­ket reforms.

    I pre­fer the Aus­tralian Sys­tem.

  • Steve, you wrote quite a bit here. I think you hit the nail on the head. The biggest fac­tor is the amount of debt com­pared to income on the home. How can the occu­pant make the debt go away? Not too eas­ily when the ratio is 450% of income. To put in per­spec­tive, it would take all the sav­ings one had for 18 years, if they were sav­ing 25% of their income. There is more said, as the money used to finance a home come out into the econ­omy and stim­u­lates spend­ing. Thus, when the bub­ble bursts, eco­nomic activ­ity goes with it. 

    Robert Prechter worked up a prin­ci­pal, where in every­thing but assets, peo­ple buy more when the price is lower. But, in assets, when prices start ris­ing, peo­ple buy more. Rarely is it buy low, sell high, but instead buy high and sell higher. Much of the bad lend­ing is bailed out by ris­ing prices. The prob­lems is that once prices peak, which prices of every­thing peaks, then the inter­est in buy­ing more dis­ap­pears and the bad loans are exposed. More liq­ui­da­tion brings more prop­erty on the mar­ket and the rea­son peo­ple were buy­ing in the first place, ris­ing prices, dis­ap­pears.

    Aus­tralia has used a faulty method to bub­ble prices, the restric­tion of land use. Where I live, in Texas, we didn’t have the bub­ble other areas had because there wasn’t a restric­tion on the amount of land avail­able. I know in many ways Amer­i­can sub­ur­bia is waste­ful, but the idea of lim­it­ing con­struc­tion to force up home prices only feeds more money to the bankers. Every bub­ble is fed by bank­ing and the higher prices go, the more cloudy the idea that prices could actu­ally fall. Thus, lend­ing looks like a free lunch, as does tak­ing on more debt. When these hous­ing bub­bles start, there is a large sup­ply of exist­ing hous­ing tha has lit­tle or no debt. Not when they end. Every­one is caught in the debt vise.

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