Today’s figures for the fall in house prices over the last quarter and year were larger than the usual bull-side pundits expected: a 1.7% fall for the quarter (versus the 0.5 percent median prediction of 17 economists surveyed by Bloomberg) and 0.2% fall for the year (versus expectations of a 1.6% gain for the year by the same group of economists, according to Chris Zappone’s article).
I wonder if the same economists will now assert that declining immigration and/or population is behind the fall? After all, population growth and a supply shortage relative to population growth were the reasons they gave for a rise in prices in the first place—surely the same argument must work in reverse?
In fact, as I’ve argued ad nauseam on this blog and elsewhere, the real explanation for rising house prices was rising credit. To be more precise, what drives the change in house prices is the acceleration of mortgage debt.
This is an empirical extension of the argument I’ve made about the role of credit in the macroeconomy—for background, see these three posts on Deleveraging, Australian Debt, and Australian banks and house prices). In a credit-driven economy, aggregate demand is the sum of income plus the change in debt—and therefore the change in aggregate demand is the sum of the change in income plus the acceleration of debt, a phenomenon dubbed “The Credit Impulse” (Michael Biggs et al., 2010).
In the past I’ve correlated this with changes in employment, and shown that the rapid change from accelerating to decelerating debt was the cause of the Great Recession (or the Global Financial Crisis, as it’s called in Australia). But the Credit Impulse affects asset prices too—since we use credit not merely to purchase newly produced goods, but also to buy existing assets. Today, I’ll take a look at the correlation of the Credit Impulse with change in Australian house prices, and compare this to the property spruiker’s argument that population growth and supply constraints justify Australia’s astronomical house prices.
This correlation is the “smoking gun” in the Australian property debate.
Not only does the acceleration in debt correlate with changes in house prices—the correlation of the acceleration in all private credit with change in house prices is 0.28, and the correlation of acceleration in mortgage debt with change in house prices is 0.58—the acceleration in debt also leads changes in house prices by about 3 to 6 months.
How about the correlation of changes in population—and the ratio of population to dwellings—with changes in house prices?
Not only are these demographic factors far less volatile than house prices—and than media and popular obsession with them would imply—their correlation with changes in house prices is actually negative. The correlation of change in house prices with change in population since 2000 is ‑0.34, and the correlation with change in population per dwelling is even worse, at ‑0.41.
The picture gets worse when you consider leads and lags: the correlation of population and population density 6 months ahead of price changes is lower than the contemporaneous correlation, and in either direction—leading or lagging—the correlation is negative.
Population dynamics—even immigration dynamics—have nothing to do with house prices. What determines house prices is not the number of babies being born, or immigrants—illegal or otherwise—arriving, but the number of people who have taken out a mortgage, and the dollar value of those mortgages.
For changes in house prices, what matters is the acceleration of mortgage debt, and that’s why the First Home Vendors Boost was instrumental to the turnaround in house prices in 2009: it turned a nascent deceleration in mortgage debt into an acceleration once more. That acceleration has now run out and deceleration has resumed–and house prices have started to tumble as a result.
The fact that the Credit Impulse leads changes in house prices also gives some indication of where future prices are likely to go. The mortgage Credit Impulse shown above is for the acceleration in mortgage debt over a year: the change in the change in mortgage debt compared to the previous year. This brings in an inevitable lag in the series—matched by the lag in the change in house price data, which also shows the change in house prices over the previous year—so that the turning points in each series line up in the graph: lows in the mortgage credit impulse are associated with lows in house price change, and vice versa. With the mortgage credit impulse still headed south, and leading falls in house prices by 3–6 months, that implies that there are at least two more quarters of negative house price movements coming up.
Of course, there could always be a change in government policy that entices people back into debt—as the First Home Vendors Boost did in 2008. However, governments might huff and puff to try to keep the house price bubble inflated—as the Victorian Government is doing in its current budget, with its supposed boost to First Home Buyers that in reality is a support scheme for Victorian house prices—but the likelihood of the little piggies rushing back into the straw house of debt is minimal, when Australian mortgage debt is already at levels that dwarf those in the USA. The Australian house price bubble is over.
Biggs, Michael; Thomas Mayer and Andreas Pick. 2010. “Credit and Economic Recovery: Demystifying Phoenix Miracles.” SSRN eLibrary.