Steve Keen’s Debtwatch No. 33 April 2009: Lies, Damned Lies, and Housing Statistics

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“Lies, damned lies, and sta­tis­tics” is part of a phrase attrib­uted to Ben­jamin Dis­raeli and pop­u­larised in the Unit­ed States by Mark Twain: “There are three kinds of lies: lies, damned lies, and sta­tis­tics.” The state­ment refers to the per­sua­sive pow­er of num­bers, the use of sta­tis­tics to bol­ster weak argu­ments, and the ten­den­cy of peo­ple to dis­par­age sta­tis­tics that do not sup­port their posi­tions. (Wikipedia)

Two recent speech­es by the RBA sup­port­ed the con­tention that Aus­tralian house prices are no longer over­val­ued, that mort­gage repay­ment costs have returned to his­toric aver­ages, that Aus­tralia is suf­fer­ing a hous­ing short­age, and there­fore that the Aus­tralian hous­ing mar­ket should not expe­ri­ence the cat­a­stroph­ic falls that are now com­mon­place across the OECD–and espe­cial­ly in the USA.

Ric Bat­telli­no’s speech to the Urban Devel­op­ment Insti­tute of Aus­tralia (An Update on the Econ­o­my and Finan­cial Devel­op­ments) gave no data, but was opti­mistic about the future prospects of the hous­ing sec­tor. The data sup­port­ing this opti­mism was sup­plied in a speech by Antho­ny Richards to the 4th Annu­al Hous­ing Con­gress (Con­di­tions and Prospects in the Hous­ing Sec­tor).

Though Richards acknowl­edged that prices had fall­en some­what in 2008, he empha­sised that this was less than had been expe­ri­enced over­seas. He also hypoth­e­sised that our mar­ket would not suf­fer sim­i­lar falls in the future:

there are a num­ber of rea­sons to think that out­comes here might remain bet­ter than else­where. These relate both to the role of pol­i­cy in respond­ing to the down­turn and the con­sol­i­da­tion of house­hold finances that has occurred in Aus­tralia since our hous­ing boom slowed ear­li­er in this decade, around the end of 2003.

Two key pieces of evi­dence Richards pre­sent­ed were the fol­low­ing graphs. The first com­pares cur­rent mort­gage repay­ments to a “long run aver­age” that was based on data from June 1986 until now.

On this indi­ca­tor, a house pur­chase is cur­rent­ly about 15% more afford­able than the long term aver­age (the dot on the graph esti­mates cur­rent afford­abil­i­ty after recent rate cuts).

The sec­ond graph shows the ratio of the medi­an dwelling price to house­hold dis­pos­able income, again with a com­par­i­son to the aver­age (this time from 1993 till now).

From this per­spec­tive, hous­ing was not quite as afford­able when com­pared to his­toric aver­ages as the above mea­sure implies, (since the for­mer includes the impact of today’s very low inter­est rates where­as the lat­ter does not). But it was still only mar­gin­al­ly above the his­tor­i­cal aver­age, and Richards sur­mised that the ris­ing trend up till 2003 may have reflect­ed the tran­si­tion to a low­er infla­tion envi­ron­ment:

In addi­tion to mort­gage rates, the sec­ond deter­mi­nant of stan­dard afford­abil­i­ty mea­sures is the ratio of hous­ing prices to income. At present, this ratio remains slight­ly above its aver­age over the low-infla­tion peri­od (Graph 3). Of course, there may be good rea­sons for it to have expe­ri­enced a trend increase over recent decades as the econ­o­my adjust­ed to a struc­tur­al shift to low­er infla­tion.

Richards’ over­all con­clu­sion was that, on the sta­tis­tics, Aus­tralian house prices were not over­val­ued,

… it is note­wor­thy that the hous­ing price to income ratio has declined sig­nif­i­cant­ly since its peak in late 2003. Over the peri­od since end 2003, nation­wide house prices have grown on aver­age by 4 per cent per annum, ver­sus annu­al growth of 14 per cent in the pri­or five-year peri­od. And the growth rate of house prices in the past five years has been well below the 8 per cent aver­age annu­al nom­i­nal growth in house­hold dis­pos­able incomes.

So the price-income ratio, a fre­quent­ly used –  but crude –  mea­sure of hous­ing price val­u­a­tion sug­gests that any over­val­u­a­tion of hous­ing prices has eased sig­nif­i­cant­ly since the Aus­tralian hous­ing boom slowed sig­nif­i­cant­ly in late 2003. Since then, house­holds have had sig­nif­i­cant income growth, but that growth has flowed only to a mod­est extent into hous­ing prices.

Richards expressed some reser­va­tions about the degree of under­sup­ply of hous­ing in the Aus­tralian mar­ket, but over­all agreed with the com­mon assess­ment that the rel­a­tive short­age of hous­ing sup­ply would place a floor under the Aus­tralian mar­ket, in con­trast to the over­sup­ply sit­u­a­tion in the USA:

“What­ev­er the true short­fall of dwellings, we can say with some con­fi­dence that our hous­ing mar­ket is rel­a­tive­ly tight. This can be con­trast­ed with the US mar­ket which many observers char­ac­terise as hav­ing been sub­ject to over­build­ing dur­ing their hous­ing boom. And the rel­a­tive tight­ness of the Aus­tralian hous­ing mar­ket is one fac­tor that will sup­port home-build­ing in the peri­od ahead.”

His con­clu­sion sup­port­ed the belief that, even though a reces­sion will occur, the hous­ing sec­tor will not suf­fer price falls like those that are com­mon­place over­seas, nor will prob­lems with hous­ing exac­er­bate the reces­sion itself. If any­thing, the hous­ing sec­tor should boost the wider econ­o­my rather than drag it down:

First, the recent sig­nif­i­cant falls in the cash rate are hav­ing pos­i­tive effects on the econ­o­my and the house­hold sec­tor, and have con­tributed to a sig­nif­i­cant improve­ment in house­hold cash flows and in mea­sures of hous­ing afford­abil­i­ty for peo­ple pay­ing mort­gages or con­tem­plat­ing home own­er­ship. Sec­ond, although home-build­ing is like­ly to remain weak in the near term, there are a num­ber of fac­tors which should sup­port activ­i­ty over the medi­um term, pro­vid­ing stim­u­lus to the broad­er econ­o­my. Final­ly, when one looks at the behav­iour of the house­hold sec­tor over the past five years –  in par­tic­u­lar the trends in hous­ing prices, and house­hold income, spend­ing and bor­row­ing –  it is evi­dent that there has been a sig­nif­i­cant degree of con­sol­i­da­tion since the hous­ing boom slowed in 2003. This will reduce the vul­ner­a­bil­i­ty of the house­hold sec­tor in the cur­rent slow­down.

Richards analy­sis, along with Bat­telli­no’s implic­it endorse­ment of its con­clu­sions, was picked up by com­men­ta­tors like Alan Woods in “Hous­ing dam­age won’t be dras­tic” (The Aus­tralian, April 03):

Now, of course, we have the worst glob­al reces­sion since the ’30s and an inter­na­tion­al cred­it cri­sis, but an author­i­ta­tive analy­sis last week by Antho­ny Richards, the Reserve Bank of Aus­trali­a’s res­i­dent hous­ing expert, high­lights sev­er­al impor­tant rea­sons for expect­ing Aus­tralian hous­ing prices to per­form bet­ter than in many oth­er coun­tries.

Woods was reas­sured by the report­ed fall in “the ratio of hous­ing prices to income, … Richards says this sug­gests any over­val­u­a­tion of hous­ing prices in the boom years also has eased sig­nif­i­cant­ly”, and his qual­i­fied endorse­ment of the argu­ment that house prices will be buoyed here by “the gap between hous­ing sup­ply and demand as a result of a rapid­ly grow­ing pop­u­la­tion.” How­ev­er on the lat­ter point, Woods not­ed that “a short­age of hous­ing has­n’t stopped a crash in prices in Britain”.

Over­all, while he empha­sised that Richards’ speech pro­vid­ed “an impres­sive list of pos­i­tives”, he felt that the reces­sion would still come out trumps: “the most like­ly out­come is at best a peri­od of stag­nat­ing house prices, with a real risk of a fall, albeit a far more mod­est one than in the US and Britain.”

Now, in the spir­it of Ben­jamin Dis­raeli, let’s take a slight­ly more crit­i­cal look at the numbers–starting with the com­par­i­son of the medi­an house price to income.

House Prices to Income

The foot­note to Richards’ Graph 3 states that the fig­ure used for aver­age house­hold dis­pos­able income was “after tax and before the deduc­tion of inter­est pay­ments”. This is curi­ous, since the RBA’s own mea­sure of house­hold dis­pos­able income is after the deduc­tion of inter­est pay­ments (see RBA Bul­letin Table G12 and the Notes).

The aver­age line Richards drew on Graph 3 is also curi­ous, since it is an aver­age since 1993. This may reflect how long a time series for the medi­an house price that the RBA got from the Real Estate Insti­tute of Aus­tralia, but it would not have tak­en much effort to com­bine this with the ABS’s medi­an house price indices and pro­vide a house price to dis­pos­able income cal­cu­la­tion that went back to 1987. That is done in the next Figure–using index num­bers since I don’t have access to the REIA’s medi­an house price data.

This Fig­ure paints a very dif­fer­ent pic­ture of the cur­rent house price to income ratio.

First­ly, there are now “twin peaks”: unlike the RBA’s mod­i­fied house price to dis­pos­able income  ratio that peaked in 2004 and clear­ly fell there­after, the high­est val­ue of this ratio was in Jan­u­ary  2008. So on this mea­sure, Aus­trali­a’s house price bub­ble did go off the boil a bit in 2004, but it went right back on again in 2006. Rather than our house price adjust­ment start­ing before Amer­i­ca’s, on this price to income com­par­i­son our bub­ble con­tin­ued well after the acknowl­edged burst­ing of the US bub­ble in mid-2006.

Sec­ond­ly, rather than the cur­rent val­ue being just a smidgin above the 93–09 aver­age, it’s 27% above it–and it’s one third high­er than the “long term aver­age” from 1987 till now.

So which ratio is more valid here–one derived pri­or to the pay­ment of inter­est (Richards), the oth­er derived after it? A case could be made for either: if you’re con­tem­plat­ing buy­ing a house, then you’re con­tem­plat­ing tak­ing on a inter­est pay­ment bur­den (and prin­ci­pal repay­ment bur­den) that you don’t cur­rent­ly have; but on the oth­er hand, you might be sub­sti­tut­ing rental pay­ments (out of dis­pos­able income) for interest+principal pay­ments.

So it could be seen as a judg­ment call as to which to use–in which case, for objec­tive pre­sen­ta­tion of the data, you should present both.

Or per­haps use a few more indi­ca­tors to decide which one, on bal­ance, gives the more accu­rate pic­ture. For exam­ple, here’s the ratio of the medi­an house price index to GDP per head. It is cur­rent­ly 25% above the 86–08 aver­age, and the sec­ond peak in ear­ly 2008 is 1.65% high­er than its 2004 pre­de­ces­sor.

It’s also no secret that income has been mas­sive­ly skewed in favour of prof­its rather than wages in the last few decades. So how about a com­par­i­son of the house price index to aver­age week­ly wages (ABS 630203, Col­umn J), which is a fair­er analy­sis of how expen­sive hous­ing is for the aver­age fam­i­ly of work­ers?. This is cur­rent­ly 43% above the 86–08 aver­age:

There are those pesky Twin Peaks again, and once more the sec­ond (in March 2008) is high­er than the 2004 one the RBA prefers to see as the peak of the hous­ing bubble–this time a sub­stan­tial 9% high­er, reflect­ing the con­tin­u­ing ero­sion in work­ers’ incomes over the last decade.

Cer­tain­ly, it’s not pos­si­ble to make a con­clu­sive state­ment that 2003-04 marked the peak of the Aus­tralian house price bub­ble, as RBA offi­cials have done on many occa­sions, nor can it be said that house­hold afford­abil­i­ty is now back at the “long term aver­age”.

Which rais­es the next ques­tion: just how “aver­age” was the 1986–2009 peri­od, in the long sweep of Aus­tralian his­to­ry?

House Prices over the really long term

The ABS has only main­tained a com­pre­hen­sive index of Aus­tralian house prices since mid-1986–a time when the hills were alive to the sound of Alan Bond and Christo­pher Skase. House prices rose 60% in the first three years of the index, far above the rate of infla­tion at the time. They then stalled for the next few years before more than tripling over the next 17 years–again, a rate of growth that far exceed­ed the rate of infla­tion. This 30-year-plus expe­ri­ence of con­tin­u­ous­ly ris­ing prices has helped shape the belief that house prices “always” rise faster than con­sumer prices.

But “always” is a much longer time span than a mere 30 years–something Robert Shiller appre­ci­at­ed when he and Karl Case devel­oped the index of US house prices now known as the Case-Shiller Index. The key com­par­i­son Shiller makes is between house prices and con­sumer prices; this is the pre­miere indi­ca­tor of the Amer­i­can mar­ket, and there it’s clear that the bub­ble has popped.

If we take a 25 year view, like that which Richards used in his paper, it could be argued that the fall in the index has almost brought the real price of Amer­i­can hous­ing back to the aver­age. Hav­ing plateaued at a val­ue of 217 between 2005 and 2007, it has now fall­en to 138, which is just 11% above the 85–09 aver­age.

But if we look at the real­ly long term–over the whole data set from 1890 till now–it’s appar­ent that the Amer­i­can mar­ket has some way to fall before it hits the aver­age: even though it has already fall­en 30% from its peak, it still has anoth­er 46% to go, if the real price of hous­ing is con­stant over the long term.

That’s an if to which Shiller gives an emphat­ic “yes” to, based part­ly on his own data–which shows no trend to ris­ing real house prices pri­or to the cur­rent bub­ble that clear­ly began in 1997–and part­ly on a yet longer term series still: the “Heren­gracht Index” that shows the real price of hous­ing on a famous canal in Ams­ter­dam over the three and a half cen­turies from 1628 till 1970. This index has at times risen for extend­ed periods–such as over the 7 decades between 1814 and 1887 when the real price of a house on the Heren­gracht Canal rose almost four­fold. Any­one born at the begin­ning of that peri­od could have eas­i­ly been per­suad­ed that house prices “always” rise faster than con­sumer prices.

But over the long term, there is no trend. For the next 7 decades, house prices tend­ed down in real terms: the index fell 55% from the 1887 peak to be 40% below the long term aver­age of 198 in 1951, when yet anoth­er upward trend occurred.

Could a sim­i­lar propo­si­tion apply to Aus­tralia? Dr Nigel Sta­ple­don set out to answer this ques­tion in his PhD, where he observed that:

The peri­od since the ear­ly 1970s has been one in which house prices have risen quite sig­nif­i­cant­ly by any mea­sure with the medi­an cap­i­tal city house prices in Aus­tralia hav­ing risen on aver­age 3% per annum in real terms in the peri­od 1970–2006. While the ris­es in Aus­tralia have been above the aver­age for devel­oped coun­tries, the pic­ture is sim­i­lar in most OECD economies and Aus­tralia is by no means unique.

The ques­tion that can be asked is whether this peri­od is unique for hous­ing? Eich­holtz (1997) has con­struct­ed a long term series for Ams­ter­dam in Hol­land which spans the peri­od 1628–1973. The broad pic­ture that his time series paints is one of prices essen­tial­ly show­ing no trend for three cen­turies, with cycles relat­ed to the eco­nom­ic events. Against that long term per­spec­tive the post 1970 rise in house prices in Hol­land stands out. But one city is prob­a­bly not con­vinc­ing…” (Sta­ple­don 2007, p. 1)

Sta­ple­don’s key data table gave the medi­an cap­i­tal city house price in cur­rent dol­lars, 2005 dol­lars, and 2005 dol­lars deflat­ed by 0.6% p.a. to reflect increas­ing house qual­i­ty. In the fol­low­ing graph I take Sta­ple­don’s CPI and qual­i­ty deflat­ed index, extend­ed to today using the last 2 years of ABS data deflat­ed by the CPI. I then set the val­ue to 100 in 1890 to enable easy com­par­i­son with the Case-Shiller real house price index for the USA.

One infer­ence from this graph is that the recent Aus­tralian house price bub­ble began ear­li­er at much the same time as the USA’s (1997), but began from an already high­er base that can be dat­ed back to the 1987 Stock Mar­ket Crash.

At that time, the Aus­tralian index was only mar­gin­al­ly high­er than the USA’s–132 for Aus­tralia ver­sus 120.5 for the USA, a 10% dif­fer­ence. But the 25% fall in the Aus­tralian stock mar­ket on Black Tues­day end­ed the Antipodean flir­ta­tion with stocks, and we piled right back into our favourite spec­u­la­tive play: bricks and mor­tar. Most of the mon­ey bor­rowed by Aus­tralian house­holds for spec­u­la­tive pur­pos­es then drove up house prices, where­as Amer­i­cans spread their lever­aged dol­lars between stocks and hous­es.

As a result, Aus­tralian house prices absorbed most of the spec­u­la­tive excess of the last thir­ty years, dri­ving them to 3.5 times the long term aver­age ver­sus “just” twice the aver­age in the USA.

Of course, it could be true that, as the prop­er­ty lob­by keeps assert­ing, Aus­tralia is “dif­fer­ent”, and trends that don’t exist else­where in the world rule in the land of the mar­su­pi­als. Espe­cial­ly since vir­tu­al­ly every­one now describes this cri­sis as “the worst since the Great Depres­sion, it would have helped if the RBA had referred to this pub­licly avail­able data when prepar­ing its own com­par­i­son of cur­rent house prices to “long term” trends.

The Never-Ending UnderSupply Story

Richards did express some scep­ti­cism here on behalf of the RBA that Aus­trali­a’s under­sup­ply of hous­ing was as marked as some com­men­ta­tors claim, but he still came down on the side of this wide­ly shared belief:

“What­ev­er the true short­fall of dwellings, we can say with some con­fi­dence that our hous­ing mar­ket is rel­a­tive­ly tight. This can be con­trast­ed with the US mar­ket which many observers char­ac­terise as hav­ing been sub­ject to over­build­ing dur­ing their hous­ing boom. And the rel­a­tive tight­ness of the Aus­tralian hous­ing mar­ket is one fac­tor that will sup­port home-build­ing in the peri­od ahead.”

Curi­ous­ly, one group that does not share this belief is Home­track, the local branch of the UK hous­ing intel­li­gence research group. Just days after Richards’ speech, it released a press release in which it stat­ed that:

the wide­ly quot­ed views of many prop­er­ty mar­ket com­men­ta­tors who believe that Aus­trali­a’s cur­rent build­ing lev­els are not enough to meet the future demand for hous­ing, may be based on inac­cu­rate data cal­cu­la­tions.

“Our analy­sis indi­cates Aus­tralia may already have an excess of hous­ing.  We esti­mate there are at least 10 mil­lion dwellings in Aus­tralia com­pared with ABS data show­ing occu­pied dwellings of 8.3 mil­lion. The extra one to two mil­lion dwellings con­sists of a mix­ture of hous­ing await­ing sale or devel­op­ment, vacant dwellings, sec­ond homes, and aban­doned homes,” he said.

He went on to say that the ABS method for cal­cu­lat­ing the ratio of peo­ple per dwellings is based on ABS cen­sus data which in turn is based upon occu­pied dwellings. How­ev­er, he said, Home­track analy­sis which is based on postal address data indi­cates that Aus­trali­a’s cur­rent lev­el of hous­ing rel­a­tive to its pop­u­la­tion is in line with oth­er Anglo economies.

Fol­low­ing on from this, Dar­cy said that when looked at in the con­text of pop­u­la­tion growth, total res­i­den­tial build­ing approvals have been run­ning above demand.

“This points to a build-up of excess stock of hous­ing over the past six years, despite the gap between build­ing approvals and demand nar­row­ing over recent months,” he said.

“The con­cern is that busi­ness and gov­ern­ment deci­sions regard­ing the res­i­den­tial hous­ing mar­ket in Aus­tralia are being made based on demand assump­tions that dif­fer from the actu­al behav­ior of the hous­ing mar­ket. There will always be exam­ples of areas with an under­sup­ply, but it’s not clear from the data that we have an over­all short­age rel­a­tive to future demand.”

Sim­i­lar views have been expressed on con­trar­i­an blog sites like Bub­ble­pe­dia, Homes4Aussies, etc.; this is the first time this claim has been made by a com­mer­cial prop­er­ty research group. The claim that there are up to 2 mil­lion unoc­cu­pied hous­es in Aus­tralia may appear extreme, but that is the size of the gap between the num­ber of hous­es that the ABS says are occu­pied (8.3 mil­lion) and the 10,150,000 street address­es in Aus­tralia Post’s PAF data­base. How­ev­er, many of these are busi­ness address­es, hol­i­day homes and the like. On the oth­er hand, the ABS found that 800,000 pri­vate dwellings were unoc­cu­pied on Cen­sus Night 2006–close to Home­track­’s bot­tom esti­mate of 1 mil­lion unoc­cu­pied dwellings in 2009.

So how valid is Home­track­’s claim? One way to assess this is to look at the growth of pop­u­la­tion in Aus­tralia, and com­pare it to the growth in the num­ber of dwellings. If this ratio was sub­stan­tial­ly above the ABS esti­mate of the aver­age num­ber of per­sons per occu­pied dwelling, then the under­sup­ply the­sis would be con­firmed and Home­track would be off-track.

Whoops. Over the peri­od 1985–2009, an aver­age of 1 res­i­den­tial dwelling was built per 1.75 new Aus­tralians, and only in the last 3 months has the rate of new build­ing fall­en behind pop­u­la­tion growth. This build rate is well in excess of the cur­rent ABS ratio of 2.55 per­sons per occu­pied dwelling. Only if 30% of new dwellings involved the demo­li­tion of exist­ing properties–an improb­a­bly high number–would the rate of sup­ply of new dwellings be run­ning behind the rate of growth of pop­u­la­tion.

Far from hav­ing an under­sup­ply of hous­ing, Aus­tralia may well have a sub­stan­tial over­sup­ply. It’s just that no-one is liv­ing in many of them.

So what could these unoc­cu­pied res­i­dences be? Hol­i­day homes? Some, of course, but sure­ly not all of them. It is far more like­ly that many of these include “hous­ing await­ing sale or devel­op­ment,” and “vacant dwellings”, as Home­track put it.

A very like­ly cause of this large stock of unoc­cu­pied homes is Aus­trali­a’s sys­tem of neg­a­tive gear­ing. Most “investors” build hous­es not for the rental income, but for cap­i­tal gains, and rental returns in Aus­tralia are now so low that for many investors, the draw­backs of renting–damage to prop­er­ty, hav­ing to man­age ten­ants, etc.–are not worth the rental income. Bet­ter to keep the prop­er­ty off the rental mar­ket, and claim the loss against tax. The under-sup­ply of hous­ing to the rental mar­ket, and the alleged short­age of prop­er­ties for sale, could be a per­verse result of Aus­trali­a’s pecu­liar prop­er­ty devel­op­ment laws.

This implies that the mar­ket dynam­ics could turn out to be very dif­fer­ent than those who believe there is an over­sup­ply expect. If prices start to fall sub­stan­tial­ly, then many own­ers who have kept their prop­er­ties off the mar­ket may be moti­vat­ed to bring them out of moth­balls. The “under­sup­ply” of both rental prop­er­ties and hous­es for sale could thus evap­o­rate, and rather than sup­ply issues putting a floor beneath house prices, they could well pull the rug out from under­neath them instead.

A final issue con­sid­ered only tan­gen­tial­ly by Richards, but vital to the ques­tion of whether “the forces of sup­ply and demand” will prop up Aus­tralian house prices, is lever­age.

Exit, Stage Down

In defend­ing the dom­i­nant view that Aus­tralian house prices are jus­ti­fied by sup­ply and demand, Richards observed that:

“the rel­a­tive­ly high lev­el of hous­ing prices in Aus­tralia is to a large extent a reflec­tion of demand and the col­lec­tive deci­sions of house­holds. That is, hous­ing prices have not been set at high lev­els by some exter­nal force. They are at their cur­rent lev­els because buy­ers in aggre­gate –  with their incomes, pref­er­ences, access to finance, and oth­er influ­ences –  have been will­ing to pay those prices.” (Richards; empha­sis added)

This is a fair­ly typ­i­cal piece of neo­clas­si­cal eco­nom­ic think­ing: prices reflect the inter­ac­tion of sup­ply and demand, and are there­fore jus­ti­fied. In most mar­kets, there’s not much wrong with this way of think­ing; but there’s some­thing unique about hous­ing. You don’t take out a loan to buy the gro­ceries, but you do to buy a house. What there­fore will hap­pen to demand if lenders become less will­ing to pro­vide “access to finance”?

While the boom was on, loan to val­u­a­tion ratios (LVRs) were ris­ing; now they are falling as cred­it stan­dards tight­en. Though aver­age LVRs are of the order of 50%, it’s the mar­gin­al LVR that mat­ters, since that’s the source of lever­age for new buy­ers. Accu­rate data on this isn’t eas­i­ly avail­able, but the impact of a drop in lever­age can be dra­mat­ic. A fall from 95% to 90% in the max­i­mum LVR a lender approves will halve the amount of mon­ey that a buy­er can bid for a prop­er­ty.

Econ­o­mists who apply a stan­dard “sup­ply and demand” mind­set to analysing the prop­er­ty mar­ket seem to con­sid­er that demand can shift “left and right” as the vol­ume of buy­ers falls and ris­es with time; but they seem to ignore that the “demand curve” for hous­ing can shift up and down as well, in response to the will­ing­ness of lenders to increase or decrease their LVRs. A sub­stan­tial fall in LVRs to new buy­ers could thus reduce the price that would-be buy­ers can offer, even if there was a phys­i­cal short­age of prop­er­ties.

Conclusion: Safe as Houses?

The data in sup­port of the belief that Aus­tralian house prices will not suf­fer dur­ing the forth­com­ing reces­sion is there­fore nowhere near as con­clu­sive as Richards’ speech implies. The price index might well be dri­ven high­er in com­ing months by the arti­fi­cial stim­u­lus impart­ed by the dou­bling of the First Home Buy­ers Grant (see FHB Boost is Aus­tralia’ s “ Sub-prime Lite”); but the down­side risks to Aus­tralian house prices could be every bit as big as those that apply in oth­er OECD nations.

Aus­tralia is not there­fore jus­ti­fied in being “relaxed and com­fort­able” about house prices, despite the RBA’s assur­ances to the con­trary.

This would not be an issue were the RBA sim­ply anoth­er prop­er­ty mar­ket advo­cate: it’s com­mon prac­tice for both sides of the prop­er­ty mar­ket to quote data that sup­ports one side and ignore the oth­er. How­ev­er, the RBA is not sup­posed to take sides in this debate, but instead to set mon­e­tary pol­i­cy in the best inter­ests of Aus­tralia as a whole.

I have argued con­sis­tent­ly that, in com­mon with Cen­tral Banks through­out the world, the RBA has failed in this task because it has fol­lowed an eco­nom­ic philosophy–known as “neo­clas­si­cal economics”–that is fun­da­men­tal­ly flawed. But this is some­thing that, in some ways, the RBA can’t real­ly be held account­able for: its econ­o­mists are sim­ply a prod­uct of aca­d­e­m­ic eco­nom­ics depart­ments around the world, and since these are dom­i­nat­ed by neo­clas­si­cal econ­o­mists, most grad­u­ates are not going to know that there is any oth­er way to think about the econ­o­my.

How­ev­er when it comes to sta­tis­tics, the RBA should play the role of hon­est bro­ker rather than advo­cate. Its month­ly Bul­letin Sta­tis­ti­cal Tables pro­vide a valu­able resource. I believe its time would be bet­ter spent in devel­op­ing robust, long term sta­tis­tics on the hous­ing mar­ket than in pre­sent­ing selec­tive data like that giv­en in this speech.

END OF COMMENTARY

Comments on Data

The lat­est set of fig­ures imply that the Great Delever­ag­ing is well and tru­ly under­way. Aggre­gate pri­vate debt rose by a mere $326 mil­lion in the last month, with only mort­gage debt turn­ing in a positive–and were it not for the FHB Boost, the  aggre­gate debt lev­el would cer­tain­ly have fall­en.

Table One

Table Two

While debt lev­els have to fall, this process will nec­es­sar­i­ly cause a dra­mat­ic blowout in unem­ploy­ment. Since our econ­o­my became so utter­ly debt-depen­dent, the con­tri­bu­tion that ris­ing debt makes to aggre­gate demand has come to dom­i­nate changes in eco­nom­ic activ­i­ty and unem­ploy­ment. The recent “larg­er than expect­ed” increase in unem­ploy­ment will become a recur­rent phe­nom­e­non this year, as the change in debt starts to reduce aggre­gate demand rather than increase it.

In this respect, we are not so much dif­fer­ent to the USA as mere­ly run­ning behind it in time. The explo­sion in unem­ploy­ment that has vir­tu­al­ly dou­bled unem­ploy­ment there in the last two years will occur here, and pos­si­bly at an even faster rate.

As in the USA, what the author­i­ties are inter­pret­ing as a liq­uid­i­ty cri­sis is actu­al­ly a sol­ven­cy cri­sis. Debt lev­els are now so high that the only way is down, and there are no oth­er groups who can be encour­aged to take on yet more debt and thus pull us out of this cri­sis as house­hold bor­row­ing did when it brought “the reces­sion we had to have” to a close.

Now the only way for­ward is via delever­ag­ing, and the great dan­ger is that this will occur in a cli­mate of falling prices–deflation–as well as falling out­put. This process could dri­ve aggre­gate debt to GDP lev­els even higher–as it is now doing in the USA: there the ratio of debt to GDP is ris­ing sharply, even though the rate of increase of debt has dropped. Fish­er’s Paradox–that the attempt to reduce debt lev­els can actu­al­ly cause debt lev­els to rise–is now with us once more. The world is pay­ing a ter­ri­ble price for lis­ten­ing to Mil­ton Fried­man and ignor­ing Irv­ing Fish­er and Hyman Min­sky.