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

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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.
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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.

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