This Time Had Better Be Different: House Prices and the Banks Part 2

Flattr this!

Click here for this post in PDF

Figure 1

In last week’s post I showed that there is a debt-financed, government-sponsored bubble in Australian house prices (click here and here for earlier installments on the same topic). This week I’ll consider what the bursting of this bubble could mean for the banks that have financed it.

Betting the House

For two decades after the 1987 Stock Market Crash, banks have lived by the adage “as safe as houses”. Mortgage lending surpassed business blending in 1993, and ever since then it’s been on the up and up. Business lending actually fell during the 1990s recession, and took off again only in 2006, when the China boom and the leveraged-buyout frenzy began.

Figure 2

Regular readers will know that I place the responsibility for this increase in debt on the financial sector itself, not the borrowers. The banking sector makes money by creating debt and thus has an inherent desire to pump out as much as possible. The easiest way to do this is to entice the public into Ponzi Schemes, because then borrowing can be de-coupled from income.

There’s a minor verification of my perspective in this data, since the one segment of debt that hasn’t risen compared to GDP is personal debt—where the income of the borrower is a serious constraint on how much debt the borrower will take on. As much as banks have flogged credit cards, personal debt hasn’t increased as a percentage of GDP.

On the other hand, mortgage debt has risen sevenfold (compared to GDP) in the last two decades.

Figure 3

The post-GFC period in Australia has seen a further increase in the banking sector’s reliance on home loans—due to both the business sector’s heavy deleveraging in the wake of the crisis, and the government’s re-igniting of the house price bubble via the First Home Vendors Boost in late 2008. Mortgages now account for over 57 percent of the banks’ loan books, an all-time high.

Figure 4

They also account for over 37% of total bank assets—again an all-time high, and up substantially from the GFC-induced low of 28.5% before the First Home Vendors Boost reversed the fall in mortgage debt.

Figure 5

So how exposed are the banks to a fall in house prices, and the increase in non-performing loans that could arise from this? There is no way of knowing for sure beforehand, but cross-country comparisons and history can give a guide.

Bigger than Texas

A persistent refrain from the “no bubble” camp has been that Australia won’t suffer anything like a US downturn from a house price crash, because Australian lending has been much more responsible than American lending was. I took a swipe at that in last week’s post, with a chart showing that Australia’s mortgage debt to GDP ratio exceeds the USA’s, and grew three times more rapidly than did American mortgage debt since 1990 (see Figure 13 of that post).

Similar data, this time seen from the point of view of bank assets, is shown in the next two charts. Real estate loans are a higher proportion of Australian bank loans than for US banks, and their rise in significance in Australia was far faster and sharper than for the USA.

Figure 6

More significantly, real estate loans are a higher proportion of bank assets in Australia than in the USA, and this applied throughout the Subprime Era in the USA. The crucial role of the First Home Vendors Boost in reversing the fall in the banks’ dependence on real estate loans is also strikingly apparent.

Figure 7

Never mind the weight, feel the distribution

The “no bubble” case dismisses this Australia-US comparison on two grounds:

  • most of Australia’s housing loans are to wealthier households, who are therefore more likely to be able to service the debts so long as they remain employed; and
  • housing loans here are full-recourse, so that home owners put paying the mortgage ahead of all other considerations..

Bloxham made the former claim in his recent piece:

However, there are other reasons why levels of household debt should not be a large concern. The key one is that 75 per cent of all household debt in Australia is held by the top two-fifths of income earners. (Paul Bloxham , The Australian housing bubble furphy, Business Spectator March 18 2011)

Alan Kohler recounted an interesting conversation with “one of Australia’s top retail bankers” a couple of years ago on the latter point:

There is some ‘mortgage stress’ in the northern suburbs of Melbourne, the western suburbs of Sydney and some parts of Brisbane, but while all the banks are bracing themselves for it and increasing general provisions, there is no sign yet of the defaults that are bringing the US banking system to its knees.

We often see graphs showing that Australia’s ratios of household debt to GDP and debt to household income had gone up more than in the United States. So, while the US is deep into a mortgage-based financial crisis, it is surely a cause for celebration that Australia has not seen even the slightest uptick in arrears.

“Please explain,” I said to my dinner companion. Obviously, low unemployment and robust national income, including strong retail sales until recently, have been the most important part of it. But on the other hand, the US economy was doing okay until the mortgage bust happened; it was the sub-prime crisis that busted the US economy, not the other way around.

Apart from that it is down to two things, he says: within the banks, “sales” did not gain ascendancy over “credit” in Australia to the extent that it did in the US; and US mortgages are non-recourse whereas banks in Australia can have full recourse to the borrowers’ other assets, which means borrowers are less inclined to just walk away. (Alan Kohler, “Healthy by default“, Business Spectator August 21, 2008; emphases added)

Kris Sayce gave a good comeback to Bloxham’s “most of the debt is held by those who can afford it” line when he noted that “two-fifths of income earners is quite a large pool of people”:

In fact, it’s nearly half the income earners. Is that number any different to any other economy? You’d naturally think the higher income earners would have most of the debt because they’re the ones more likely to want it, need it or be offered it.

So with about 11.4 million Australians employed, that makes for about 4.6 million Australians holding over $1.125 trillion of household debt – remember total household debt is about $1.5 trillion. That comes to about $244,565 per person.

Perhaps we’re not very bright. But we’re struggling to see how that makes the popping of the housing bubble a “virtual impossibility.” (Kris Sayce, “Are Falling House Prices “Virtually Impossible”?“, Money Morning 18 March 2011)

The best comebacks to Alan Kohler’s dinner companion may well be time itself. Impaired assets (See Note [1]) did hit an all-time low of 4.1% of Bank Tier 1 Assets and 0.2% of total assets in January 2008, but by the time Kohler and his banker sat down to dinner, impairment was on the rise again. Impaired assets have since reached a plateau of 25% of Tier 1 capital and 1.25% of total assets—and this has occurred while house prices were still rising. Despite the pressure that full-recourse lending puts on borrowers, this is comparable to the level of impaired assets in US banks before house prices collapsed when the SubPrime Boom turned into the SubPrime Crisis (see Table 2 on page 10 of this paper).

Figure 8

Since real estate loans are worth roughly 7 times bank Tier 1 capital—up from only 2 times in 1990—it wouldn’t take much of an increase in non-performing housing loans to push Australian banks to the level of impairment experienced by American banks in 2007 and 2008.


Figure 9

The level and importance of non-recourse lending in the US is also exaggerated. While some major States have it, many do not—and one of the worst performing states in and since the Subprime Crisis was Florida, which has full recourse lending.

Finally, the “never mind the weight, feel the distribution” defence of the absolute mortgage debt level has a negative implication for the Australian economy: if debt is more broadly distributed in Australia than in the USA, then the negative effects of debt service on consumption levels are likely to be greater here than in America. This is especially so since mortgage rates today are 50% higher here than in the USA. Interest payments on mortgage debt in Australia now represent 6.7% of GDP, twice as much as in the USA. It’s little wonder that Australia’s retailers are crying poor.

Of course, the RBA could always reduce the debt repayment pressure by reducing the cash rate. But with the margin between the cash rate and mortgages now being about 3%, it would need to reduce the cash rate to 1.5% to reduce the debt repayment burden in Australia to the same level as America’s.



Figure 10

So if America’s consumers are debt-constrained in their spending, Australian consumers are even more so—with negative implications for employment in the retail sector.

Compared to the USA therefore, there is no reason to expect that Australian banks will fare better from a sustained fall in house prices. What about the comparison with past financial crises in Australia?

This time really is different

There are at least three ways in which whatever might happen in the near future will differ from the past:

  • On the attenuating side, deposit insurance, which was only implicit or limited in the past, is much more established now; and
  • If the banks face insolvency, the Government and Reserve Bank will bail them out as the US Government and Federal Reserve did—though let’s hope without also bailing out the management, shareholders and bondholders, as in the USA (OK, so call me an optimist! And if you haven’t seen Inside Job yet, see it);

On the negative side, however, we have the Big Trifecta:

  • The bubbles in debt, housing and bank stocks are far bigger this time than any previous event—including the Melbourne Land Boom and Bust that triggered the 1890s Depression.

I’ll make some statistical comparisons over the very long term, but the main focus here is on several periods when house prices fell substantially in real terms after a preceding boom, and what happened to bank shares when house prices fell:

  • The 1880s-1890s, when the Melbourne Land Boom busted and caused the 1890s Depression;
  • The 1920s till early 1930s, when the Roaring Twenties gave way to the Great Depression;
  • The early to mid-1970s, when a speculative bubble in Sydney real estate caused a rapid acceleration in private debt, and a temporary fall in private debt compared to GDP due to rampant inflation;
  • The late 1980s to early 1990s, when the Stock Market Crash was followed by a speculative bubble in real estate—stoked by the second incarnation of the First Home Vendors Boost; and
  • From 1997 till now.

I chose the first four periods for two reasons: they were times when house prices fell in real (and on the first two occasions, also nominal) terms, and bank share prices suffered a substantial fall; and they also stand out as periods when an acceleration in debt caused a boom that gave way to a deleverage-driven slump, when private debt reached either a long term or short term peak (compared to GDP) and fell afterwards. They are obvious in the graph of Australia’s long term private debt to GDP ratio.

Figure 11

They also turn up as significant spikes in the Credit Impulse (Biggs, Mayer et al. 2010)—the acceleration of debt (divided by GDP) which determines the contribution that debt makes to changes in aggregate demand (See Note [2]).

The Credit Impulse data also lets us distinguish the pre-WWII more laissez-faire period from the “regulated” one that followed it: credit was much more volatile in the pre-WWII period, but the trend value of the Credit Impulse was only slightly above zero at 0.1%.

Figure 12

The Post-WWII period had much less volatility in the debt-financed component of changes in aggregate demand, but the overall trend was far higher at 0.6%. This could be part of the explanation as to why Post-WWII economic performance has been less volatile than pre-WWII, but it also indicates that rising debt has played more of a role in driving demand in the post-War period than before.

Ominously too, even though the post-WWII period in general has been less volatile, the negative impact of the Credit Impulse in this downturn was far greater than in either the 1890s or the 1930s.

Figure 13

One final factor that also separates the pre-WWII data from post-WWII is the rate of inflation. The 1890s and 1930s debt bubbles burst at a time of low inflation, and rapidly gave way to deflation. This actually drove the debt ratio higher in the first instance, as the fall in prices exceeded the fall in debt. But ultimately those debts were reduced in a time of low inflation.

The 1970s episode, on the other hand, was characterized by rampant inflation—and the debt ratio fell because rising prices reduced the effective debt burden. Whereas the falls in real house prices in the 1890s and the 1930s therefore meant that nominal prices were falling even faster, the 1970s fall in real house prices mainly reflected consumer price inflation outstripping house price growth. The 1990 bubble also burst when inflation was still substantial, though far lower than it was in the mid-1970s.

Today’s inflation story has more in common with the pre-WWII world than the 1970s. Our current bubble is bursting in a low-inflation environment.


Figure 14

Now let’s see what history tells us about the impact of falling house prices on bank shares.

The 1880s-1890s

This was the bank bust to end all bank busts—just like WWI was the War to end all wars. Bank shares increased by over 75% in real terms as speculative lending financed a land bubble in Melbourne that increased real house prices by 33% (Stapledon’s index combines Sydney and Melbourne, so this figure understates the degree of rise and fall in Melbourne prices). The role of debt in driving this bubble and the subsequent Depression is unmistakable: private debt rose from under 30% of GDP in 1872 to over 100% in 1892, and then unwound over the next 3 decades to a low of 40% in 1925.

The turnaround in debt and the collapse in house prices precipitated a 50% fall in bank shares in less than six months as house prices started to fall back to below the pre-boom level.

Figure 15

The excellent RBA Research paper “Two Depressions, One Banking Collapse” by Chay Fisher & Christopher Kent (RDP1999-06) argues fairly convincingly that the 1890s Depression was a more severe Depression for Australia than the Great one—mainly because there were more bank failures in the 1890s than in the 1930s. The severity of the 1890s fall in bank shares may relate to the higher level of debt in 1890 than in the 1930s—a peak of 104 percent of GDP in 1892 versus only 76 percent in 1932 (the peak this time round was 157 percent in March 2008).

The correlation of the two series in absolute terms is obvious (the correlation coefficient is 0.8), and the changes in the two series are also strongly correlated (0.42).


Figure 16

The 1920s-1940s

The 1920s began with the end of the great deleveraging that had commenced in 1892. Real house prices rose by about 25 percent in the first two years—though mainly because of deflation in consumer prices—and then fluctuated down for the next four years before a minor boom. But the main debt-financed bubble in the 1920s was in the Stock Market.

Figure 17

There was however still a crash in bank shares after house prices turned south in early 1929. It was not as severe as in 1893, and of course coincided with a collapse in the general stock market (I can’t give comparable figures because of the different methods used to compile the two indices—see the Appendix). But still there was a fall of 24% in bank shares over 7 months at its steepest, and a 39% fall from peak to trough—preceded by a 25% fall in house prices.

Figure 18

Bank shares also tracked house prices over the 20 years from the Roaring Twenties boom to the beginning of WWII: the correlation was 0.44 for the indices, and 0.47 for the change in the indices.

Figure 19

The 1970s

The 1970s bubble was the last gasp of the long period of robust yet tranquil growth that had characterized the early post-WWII period. The peculiar macroeconomics of the time—the start of “Stagflation”—clouds the house price bubble picture somewhat (I discuss this in the Appendix), but there still was a big house price bubble then, and a big hit to bank shares when it ended.

This was Australia’s first really big debt-financed speculative bubble, which most commentators and economists seem to have forgotten entirely. Its flavor is well captured in the introduction to Sydney Boom, Sydney Bust:

Sydney had never experienced a property boom on the scale of that between 1968 and 1974. It involved a frenzy of buying, selling and building which reshaped the central business district, greatly increased the supply of industrial and retailing space, and accelerated the expansion of the city’s fringe. Its visible legacy of empty offices and stunted subdivisions was matched by a host of financial casualties which incorporated an unknown, but very large, contingent of small investors, together with the spectacular demise of a number of development and construction companies and financial institutions. The boom was the most significant financial happening of the 1970s and the shock waves from the inevitable crash were felt right up to 1980. It was an extraordinary event for Sydney, and for Australia.(Daly 1982, p. 1)

House prices rose 40 percent in real terms from 1967 till 1974, and then fell 16 percent from 1974 till 1980. Bank shares went through a roller-coaster ride, following Poseidon up and down from 1967 till 1970, and then rising sharply as the debt-bubble took off in 1972, with a 31 percent rise between late 1972 and early 1973. But from there it was all downhill, with bank shares falling 35 percent across 1973 while house prices were still rising.

But when house prices started to fall, bank shares really tanked, falling 54 percent in just seven month during 1974.

Figure 20

However, the extreme volatility of both asset and commodity prices, and the impact of two share bubbles and busts—the Poseidon Bubble of the late 1960s and the early 1970s boom and bust—eliminated the correlation of bank share prices to house prices that applied in the 1890s and 1930s: the correlation of the indices was -0.46 and of changes in the indices was -0.01.

Figure 21

The 1980s

“The recession we had to have” remains unforgettable. That plunge began with Australia’s second big post-WWII speculative bubble, as Bond, Skase, Connell and a seemingly limitless cast of white-shoe brigaders established the local Ivan Boesky “Greed is Good” church—with banks eagerly throwing money and debt into its tithing box.

It would have all ended with the Stock Market Crash of 1987, were it not for the government rescues (both here and in the USA) that enabled the speculators and the banks to regroup and throw their paper weight into real estate.

Figure 22

Having plunged 30 percent in one month (October, of course), bank shares rocketed up again, climbing a staggering 54 percent in 11 months to reach a new peak in October 1988, as speculators and the second incarnation of the First Home Vendors Grant drove house prices up 37 percent over just one and a half years. Bank shares bounced around for a while, but once the decline in house prices set in, bank shares again tanked—falling 40 percent over 11 months in 1990.

Figure 23

The positive correlations between the indices and their rates of change which had been swamped by the high inflation of the early 1970s returned: the correlation of the indices was 0.45 and the correlation of their rates of change was 0.42.

Figure 24

Which brings us to today.

From 1997 till today

I have argued elsewhere that the current bubble began in 1997, but the debt-finance that finally set it off began far earlier—in 1990. The fact that unemployment was exploding from under 6 percent in early 1990 to almost 11 percent in early 1994 was not, it seems, a reason to be restrained in lending to the household sector. It was far more important to expand the marketing of debt, and since the business sector could no longer be persuaded to take more on, the virgin field of the household sector had to be explored. Mortgage debt, which had flatlined at about 16 percent of GDP since records were first kept, took off, increasing by 50 percent during the 1990s recession (from 1990 till the start of 1994), and ultimately rising by 360 percent over the two decades—from 19 percent of GDP to 88 percent—with the final fling of the First Home Vendors Boost giving it that final push into the stratosphere.

Figure 25

By 1997 the sheer pressure of rising mortgage finance brought to an end a period of flatlining house prices, and the bubbles in both house prices and bank shares took off in earnest.

The rise in bank shares far outweighed the increase in the overall share index (the two indices are now comparable, whereas for the longer series they were compiled in different ways). Bank shares rose 230 percent from 1997 till their peak in 2007, versus a rise of only 110 percent in the overall market index.

The increase in house prices also dwarfed any previous bubble: an increase of over 120 percent over fifteen years.

Bank shares and house prices both tanked when the GFC hit: house prices fell 9 percent and bank shares fell 61 percent. But thankfully the cavalry rode to the rescue—in the shape of the First Home Vendors Boost—and both house prices and bank shares took off again. House prices rose 17 percent while bank shares rose 60 percent (versus a 45 percent rise in the market) before falling 12 percent after the expiry of the FHVB.

Figure 26

The correlation between bank shares and house prices is again positive: 0.51 for the indices and a low 0.1 for the change in indices over the whole period, but 0.46 since 2005.

Figure 27

So now we are on the edge of the bursting another house price bubble. What could the future bring?

When the bubble pops…

There are several consistent patterns that can be seen in the past data.

Firstly, house prices and bank shares are correlated. There was one aberration—the 1970s—but that was marked by peculiar dynamics arising from the historically high inflation at the time. Generally, bank shares go up when house prices rise, and fall when the fall. Partly, this is the general correlation of asset prices with each other, but partly also it’s the causal relationship between bank lending, house prices, and bank profits: banks make money by creating debt, rising mortgage debt causes house prices to rise, and rising house prices set off the Ponzi Scheme that encourages more mortgage borrowing. The bubble bursts when the entry price to the Ponzi Scheme becomes prohibitive, or when early entrants try to take their profits and run.

Secondly, the fall in the bank share price is normally very steep, and it occurs shortly after house prices have passed their peaks. Holding bank shares when house prices are falling is a good way to lose money—and conversely, if you get the timing right, betting against them can be profitable. That’s why Jeremy Grantham—and many other hedge fund managers from around the world—are paying close attention to Australian house prices.

Thirdly, house prices and bank shares are driven by rising debt, and when debt starts to fall, not only do house prices and bank shares fall, the economy also normally falls into a very deep recession or Depression. This is the crucial role of deleveraging in causing economic downturns, including the serious ones where debt falls not just during a short cycle prior to another upward trend, but in an extended secular decline.

There is also one cautionary note about the current bubble: though history would imply that there is a very large downside to bank shares now, it’s also obvious that bank shares fell a great deal in 2007-09, so that much of the downside may already have been factored in.

However, on every metric: on the ratio of debt to GDP, on how much that ratio rose from the start of the bubble to its end, on how big the house price bubble was, and on how much bank shares rose, this bubble dwarfs them all.

Debt to GDP

The 1997 debt to GDP ratio started higher than all but the 1890s bubble ended, and the bubble went on long after all the others had popped.

Figure 28

Though the actual debt to GDP ratio today dwarfs all its predecessors, in terms of the growth of debt from the beginning of the bubble, it has one rival: the 1920s.

Figure 29

However this is partly because of deflation during the early Great Depression: deflation ruled from 1930 till 1934, and the debt to GDP ratio rose not because of rising debt, but falling prices. Though the increase in debt in the final throes of the Roaring Twenties was faster than we experienced, over the whole boom debt grew as quickly now as then, and it has kept growing for four years longer than in the 1920s. Even though the ratio is falling now, it’s because debt is now rising more slowly than nominal GDP: we still haven’t experienced deleveraging yet (unlike the USA).

House Prices

The rise in prices during this bubble again has no equal in the historical record.

Figure 30

Bank Shares

Bank shares are also in a class of their own in this bubble, even after the sharp fall from 2007 till 2009. In terms of how high bank share prices climbed, this bubble towers over all that have gone before, and even what is left of this bubble is still only matched by the biggest of the preceding bubbles, the 1890s and the 1970s.

Figure 31

It’s a long way from the top if you’ve sold your soul

Bank lending drove house prices sky high, and the profits banks made from this Ponzi Scheme dragged their share prices up with the bubble (and handsomely lined the pockets of their managers).

It’s great fun while it lasts, but all Ponzi Schemes end for the simple reason that they must: they aren’t “making money”, but simply shuffling it—and growing debt. When new entrants can’t be enticed to join the game, the shuffling stops and the Scheme collapses under the weight of accumulated debt. There are very good odds that, when this Ponzi Scheme collapses and house prices fall, bank shares will go down with them.



Between 1954 and 1974, unemployment averaged 1.9 percent, and it only once exceeded 3 percent (in 1961, when a government-initiated credit squeeze caused a recession that almost resulted in the defeat of Australia’s then Liberal government, which ruled from 1949 till 1972). Inflation from 1954 till 1973 averaged 3 percent, and then rose dramatically between 1973 and 1974 as unemployment fell.

This fitted the belief of conventional “Keynesian” economists of the time that there was a trade-off between inflation and unemployment: one cost of a lower unemployment rate, they argued, was a higher rate of inflation.

But then the so-called “stagflationary” breakdown occurred: unemployment and inflation both rose in 1974. Neoclassical economists blamed this on “Keynesian” economic policy, which they argued caused people’s expectations of inflation to rise—thus resulting in demands for higher wages—and OPEC’s oil price hike.

Figure 32

The latter argument is easily refuted by checking the data: inflation took off well before OPEC’s price hike.

Figure 33

The former has some credence as an explanation for the take-off in the inflation rate—workers were factoring in both the bargaining power of low unemployment and a lagged response to rising inflation into their wage demands.

Figure 34

The Neoclassical explanation for why this rise in inflation also coincided with rising unemployment was “Keynesian” policy had kept unemployment below its “Natural” rate, and it was merely returning to this level. This was plausible enough to swing the policy pendulum towards Neoclassical thinking back then, but it looks a lot less plausible with the benefit of hindsight.

Figure 35

Though inflation fell fairly rapidly, and unemployment ultimately fell after several cycles of rising unemployment, over the entire “Neoclassical” period both inflation and unemployment were higher than they were under the “Keynesian” period. So rather than inflation going down and unemployment going up, as neoclassical economists expected, both rose—with unemployment rising substantially. On empirical grounds alone, the neoclassical period was a failure, even before the GFC hit.

Table 1

Policy dominance Keynesian Neoclassical
Years 1955-1976 1976-Now
Average Inflation 4.5 5.4
Average Unemployment 2.1 7

There was a far better explanation of the 1970s experience lurking in data ignored by neoclassical economics: the level and rate of growth of private debt. As you can see from Figure 32, private debt, which had been constant (relative to GDP) since the end of WWII, began to take off in 1964, and went through a rapid acceleration from 1972 till 1974, before falling rapidly.

The debt-financed demand for construction during that bubble added to the already tight labor market, and helped drive wages higher in both a classic wage-price spiral and a historic increase in labor’s share of national income—which has been unwound forever since.

Figure 36

Inflation, higher unemployment that weakened labor’s bargaining power, anti-union public policy and an approach to wage-setting policy that emphasized cost of living adjustments but ignored sharing productivity gains, all contributed to that unwinding.

The share market indices

The bank share index used in this post was compiled by combining 3 data sources. Working backwards in time, these were:

  • The S&P’s ASX 200 Financials Index (AXFJ) from May 2001 till now;
  • A composite formed from the prices for the 4 major bank share prices that matches the value of the Financials Index from 2000 till May 2001; and
  • Data from the Global Financial Database from 1875 till 2000, which in turn consists of three series:
    • “Security Prices and Yields, 1875-1955,” Sydney Stock Exchange Official Gazette, July 14, 1958, pp 257-258 (1875-1936), together with D. McL. Lamberton, Share Price Indices in Australia, Sydney: Law Book Co., 1958; and
    • The Australian Stock Exchange Indices, Sydney: AASE, 1980; and
    • Australian Stock Exchange Limited, ASX Indices & Yields, Sydney: ASX, 1995 (updated till 2000)

From a perusal of the GFD documentation and a comparison of the Banking and Finance index to the broader market index, it appears that the bank index is a straight price index pre-1980, whereas the GFD’s data for the overall market is an accumulation index till 1980 and a price index after that. These inconsistencies make it impossible to compare the two over the very long term, but the movements in each at different time periods can be compared (and the comparison is also fine from 1980 on).

Figure 37


[1] The notes to Table B05 state that “‘Impaired assets’ refers to the aggregate of a reporting bank’s non-accrual and restructured exposures, both on- and off-balance sheet, plus any assets acquired through the enforcement of security conditions. Off-balance sheet exposures include, inter alia, commitments to provide funds that cannot be cancelled or revoked and the credit equivalent amounts of interest rate, foreign exchange and other market-related instruments.”

[2] One of the many issues that distinguishes my approach to economics from neoclassical economists is my focus on the role that changes in debt play in aggregate demand. Neoclassical economists wrongly ignore the role of aggregate level of debt because they see debt as simply a transfer of spending power from one agent to another—so that there is no change in aggregate spending power if debt rises.  This is the reason that Bernanke gave for ignoring Fisher’s “debt deflation” theory of the Great Depression (Fisher 1933):

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

And it’s the explicit assumption that Krugman uses in his recent paper on the Great Recession:

Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth — one person’s liability is another person’s asset. (Krugman and Eggertsson 2010, p. 3)

This shows their ignorance of the capacity for the banking sector to create spending power “out of nothing”, and thus create spending power in the process. I cover this topic in detail in these posts ( and


Bernanke, B. S. (2000). Essays on the Great Depression. Princeton, Princeton University Press.

Biggs, M., T. Mayer, et al. (2010). “Credit and Economic Recovery: Demystifying Phoenix Miracles.” SSRN eLibrary.

Daly, M. T. (1982). Sydney Boom, Sydney Bust. Sydney, George Allen and Unwin.

Fisher, I. (1933). “The Debt-Deflation Theory of Great Depressions.” Econometrica
1(4): 337-357.

Krugman, P. and G. B. Eggertsson (2010). Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo approach [2nd draft 2/14/2011]. New York, Federal Reserve Bank of New York & Princeton University.

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.
Bookmark the permalink.

140 Responses to This Time Had Better Be Different: House Prices and the Banks Part 2

  1. ak says:

    If anyone thinks that “austerity” works, Greece is the best example what happens next.

  2. sirius says:

    Australia gets a mention. The issue of Copyright.

    Watch from 15 mins in and pay attention to what is said at about 16 mins.

    (I thought this and the previous section starting at 12:43 (“boing boing”) were dull until it get to a certain point and then…well listen to what is said)

    Do you see what is happening ?

  3. Steve Keen says:

    That’s an interesting call brett.

    On one level–and the one I worry most about–getting out of an economic slump by igniting an asset price bubble is what got us into this mess in the first place. had the 1987 Stock Market Crash not led to the Greenspan Put, we’d have had a minor Depression back then that would have seen debt levels soon fall below the near Great Depression levels they had reached–given the relatively high inflation at the time.

    Instead we had numerous further asset bubble driven recoveries and Puts until we ended up here.

    However each of those has involved debt rising relative to GDP, and as you point out in Australia the avoidance has occurred with an overall fall in debt to GDP–because the increased leverage by the household sector was partially offset by a reduction in debt by the business sector, plus growth in GDP reduced the debt to GDP ratio even though aggregate debt levels continued to rise.

    Overall I still see this as “kicking the can down the road”, as Lyonwiss put it recently. We now have house prices 18 percent higher than they reached in 2008, simply courtesy of the FHVB, thus making the potential fall in house prices still greater than it would have been without the policy. The downside potential of that implies a greater problem in the near future than we would have had had the bubble unwound back in 2008. And household debt is now 8% higher (relative to GDP) than it would have been; business debt is lower as you point out, which offsets this. But household debt is more intractable, and may extend the depressing impact of a crippled credit sector. As I’ve said before, businesses can get out of debt by going bankrupt, sackign the workers, and stopping investment. Bankruptcy is painful for households, they can’t sack the kids, and they can reduce but can’t stop consumption.

    I would have been much happier with the government’s stimulus package had it not included the FHVB; I supported it at the time except for that detail, which I attacked. If it hadn’t been there, about $100 billion less would have been injected into the economy over 18 months, which would have meant a substantial increase in unemployment, though not on the same scale as in the USA. That would have been a better outcome for the long term than what it did: I’ve always argued that we can’t reverse decades of bad economic momentum without pain, and that was a pain avoidance strategy rather than a pain minimisation one.

  4. slaphappy says:

    Hi Steve

    In 2008 if the FHOG contributed $100 billion to aggregate debt would’nt the bulk of it gone to a productive purpose i.e record numbers of new home starts
    and as such increased the total housing stock.

    One could only assume that in its absence the RBA would have had to cut 100/150 basis points further to accomodate growth only for that growth to be speculative growth on what was the existing housing stock.

    It could be argued that without this measure (21kFHOG) that in 2011 house prices could have been a lot higher than they currently are.

  5. Steve Keen says:

    Gawd no slaphappy!

    The bulk of it went into existing house prices: 90% of loans now buy existing properties, not new ones.

    I’ll check the data later, but there was only a slight uptick in new house construction due to the 21K component for new homes. If the government really wanted to boost that, then it would abolish the FHVB on existing properties but maintain it on new ones–something that the Centre will be campaigning for when it’s up and running.

  6. slaphappy says:


    ABS8750 shows a pretty big spike in new home starts corresponding with the introduction of the 21k FHOG.

  7. DrBob127 says:

    “slight uptick” VS “pretty big spike”

    Anyone have time to find the numbers?

  8. Steve Keen says:

    I’ll check the numbers tomorrow DrBob, and compare them to expenditure on existing homes.

  9. aus_ed says:

    Hi Steve,

    Biggs, Myer, Pick credit impulse is quite an interesting concept. However, after reading their paper in full a question started to intrigue me – how does it relate to “house price bubble”, “excess mortgage credit” and incoming “drop in property prices of 40%”?

    My understanding of BMP credit impulse concept is that there is a correlation between change in change of credit and GDP. It is not causal, as the authors stress, so one does not necessarily cause the other. But it is a possible explanation of “phoenix miracles”, that is, credit-less recoveries where GDP starts to grow with no growth in stock of credit because mere reduction in the speed of deleveraging has a positive effect on the economy. There is no reference in the paper to property prices at all…

    Therefore, it seems, applying the concept to current situation in Australia, one can draw conclusions only about the economic recovery. That is, after a period of significant deleveraging during the GFC (much more severe than 1991 and even 1929 according to your graphs) credit impulse turned positive, indicating return to economic growth. It is reflected in rising GDP figures in recent quarters. So, it is a good news… Am I missing something obvious? Appreciate your advice.

  10. Tel says:

    Back when the Olympics were in Sydney I was renting a 2BR terrace in the city for $280 per week, now the same sort of thing is $600 per week (that’s 7% PA). In 1998 petrol was hovering around 70c per liter, now it sits at $1.50 (that’s 6% PA). Same story if you catch the bus or the train. It’s taken a bit longer than 12 years for electricity to go from 10c /kwh up to 20c /kwh which (also 6% PA). Anyone buying groceries knows what a small package you carry away for $50 these days.

    You expect me to believe that inflation has been sitting around 3% for the last decade or more? Of course I don’t believe it. Inflation is tax by stealth, no way is any government about to advertise the fact, they always jig the figures to downplay inflation.

    Buying a family home is the only way regular folks can protect their savings from inflation, and when rents are increasing at 7% it makes sense to pay 7% interest on your mortgage — you are just breaking even.

    Whats more, inflation expectations in the community are massive. We have had the US govt printing money to deliberately devalue their dollar (and soft-default on Chinese lenders), we have existing inflation in China and it’s only a matter of time before the Euro goes the way of money printing as well. What’s more we have the neo-Keynsians and “Modern Monetary Theory” fruit loops out there saying that you can print all the money you like and it never causes inflation. Those people can’t be told, they have no sense of reality. So I bought a house knowing that it is overpriced but also knowing that a Labor government is guaranteed to inflate away my loan. Print all the money you like!

  11. schism_jism says:

    Hi Steve,

    another stellar posting. I have a quick question regarding the stagflation evident in 70’s australia – does the credit impulse factor explain the phenomenon globally at that time? I was also wondering if your modelling gives us a clue as to what are the implications of full employment on the level of debt an economy can sustain, without going ponzi?

  12. Steve Keen says:

    It certainly appears to for Australia, and tomsome degree the USA Tom. The credit accelerator, as I prefer to call it now, was the strongest ever that year in Australia. Then it collapsed, ushering in the period of low growth, while the wage push and then oil price momentum continued in, giving us the low growth, high inflation combination.

  13. Pingback: Australia: There goes the neighbourhood | Credit Writedowns

  14. Pingback: The Debtwatch Manifesto | Steve Keen's Debtwatch

  15. Buddy Rojek says:

    @ Aziz “The least unfair way of doing this would seem to be the modern debt jubilee advocated by Steve Keen — print money, and instead of pumping it into the financial system as per QE, use it to write down a portion (say, $6,000) of each person’s debt load, and send out cheques up to an equal amount to those who are not indebted.”

    This is a start but does not address moral hazard. I proposed a similar idea to keen, but instead of writing off debts, TAXPAYERS through the “Tax Office/IRS etc” receive their Taxes back as lump sum payments of say Monthly or quarterly installments. This boost in GDP via Consumption will flow to the most utilised goods and services, and the various businesses on the receiving end will appropriately invest. As Government debt is quite high, capital rationing will occur and only the best “Shover Ready” projects will get the go ahead, and Contractor Tenders would be much more scrutnised. We would get the best value for our Tax Dollars. The psychological boost to getting “free Money” which it really is not will jolt Consumption.

    The increased availability of work and overtime will allow the Borrowers in Debt to pay down their debt based on “Contractual Honour” The people who were too stupid to plan ahead, bought too big a house or flash a car, will be tagged as “Bankrupted” accordingly. It will be a good lesson for society.

    When the economy is actually working again, Tax rates can be adjusted accordingly to “Harvest” dollars out of the system and reduce inflation pressures. Using Monetary policies does not work. It is too blunt a method to stimulate demand. I used to think the Central Banks had the best interests of society, but now I am not so sure. I think Monetary policy in its current form is ineffectual and downright dangerous. For example the Reserve Bank of Australia was raising raites during the GFC, and now the Australian Property market is collapsing. Hard. They wanted to take the heat out of the house market, but what they have done now is cause possible panic. Too many people are invested in Property in Australia. The Reserve Bank Governors knew what they are doing. I am sure their connected cronies will be buying up houses on the cheap.

    It seems a little too convenient for me.

Leave a Reply