A Bubble of Ludicrous Pettifoggery

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By Philip Soos

Recent­ly, Aus­tralian prop­er­ty ana­lyst Ter­ry Ryder, in an arti­cle on Prop­er­ty Observ­er, voiced com­plaints about hous­ing bub­ble advo­cates. His issue is “wait­ing for some­one who sub­scribes to the bub­ble the­o­ry to actu­al­ly define it. So far, nobody has. The term implies that some­thing has been over-inflat­ed and will burst.” Of course, Steve Keen has already done so in his volu­mi­nous and crit­i­cal work reach­ing back for over a decade.

If Mr. Ryder has dif­fi­cul­ty in find­ing some­one who has con­struct­ed an accu­rate def­i­n­i­tion of an asset bub­ble, the work of the late U.S. post-Key­ne­sian econ­o­mist Hyman Min­sky is rec­om­mend­ed read­ing. Min­sky devel­oped a the­o­ry called the ‘finan­cial insta­bil­i­ty hypoth­e­sis,’ the­o­ris­ing that finan­cial mar­kets are not very effi­cient and con­tin­u­al­ly mis­al­lo­cate sub­stan­tial amounts of cred­it into asset mar­kets, cre­at­ing pyra­mid schemes or bub­bles (Min­sky called them Ponzi schemes, named after the fraud­ster Charles Ponzi).[1]

He defined three types of finance: hedge, spec­u­la­tive and Ponzi. Hedge finance: income flows from an asset are suf­fi­cient to pay down both prin­ci­pal and inter­est on the debt used to finance the asset pur­chase, and asset prices are based upon fun­da­men­tal or intrin­sic val­ue. Spec­u­la­tive finance: income flows cov­er only inter­est repay­ments, not loan prin­ci­pal, requir­ing debt to be con­tin­u­al­ly rolled over from the cur­rent time peri­od to the next. Busi­ness­es or indi­vid­u­als may expe­ri­ence finan­cial stress, but it is not wide­spread and fun­da­men­tals val­u­a­tions are kept large­ly in check. Ponzi finance: income flows cov­er nei­ther prin­ci­pal nor inter­est repay­ments. This leaves asset own­ers com­plete­ly reliant upon esca­lat­ing cap­i­tal val­ues in order to real­ize sub­stan­tial cap­i­tal gains at sale to meet the cost of prin­ci­pal and inter­est. Prices are com­plete­ly delinked from fun­da­men­tal val­u­a­tions at this stage, result­ing in an asset bub­ble.

Sim­ply put, if gross rental income pays down nei­ther inter­est nor prin­ci­pal repay­ments of mort­gage debt on aggre­gate (includ­ing oth­er prop­er­ty-relat­ed costs) and is sus­tained over a num­ber of years, a hous­ing bub­ble exists by this def­i­n­i­tion. Even bet­ter, there is plen­ty of evi­dence to show that the res­i­den­tial prop­er­ty mar­ket is cur­rent­ly expe­ri­enc­ing said bub­ble. The fol­low­ing fig­ure shows a long-term hous­ing price index for Aus­tralia, adjust­ed for infla­tion and qual­i­ty.

Fig­ure 1: Aus­tralian Medi­an Cap­i­tal Cities Hous­ing Price Index 1880–2011, 1880=100[2]

The 1996–2010 peri­od is eas­i­ly the largest boom on record. This mete­oric surge in hous­ing prices, how­ev­er, is not proof in itself of a bub­ble; more evi­dence is need­ed. Data from the Aus­tralian Tax Office shows that, on aggre­gate, res­i­den­tial prop­er­ty investors have been run­ning sub­stan­tial net income loss­es since 2000-01. The same would hold true con­cern­ing own­er-occu­piers and imput­ed rental incomes.

Fig­ure 2: Res­i­den­tial Prop­er­ty Investor Net Rental Income 1993–94 – 2009–10[3]

The rea­son for these sus­tained net income loss­es is the com­bi­na­tion of gen­er­al run­ning costs with inter­est and prin­ci­pal repay­ments, as shown in the next fig­ure.

Fig­ure 3: Deduc­tions and Repay­ments as % of Gross Rental Income 1993–94 – 2009–10[4]

In 2009-10, the neg­a­tive­ly geared cohort, who com­prise 63% of the res­i­den­tial prop­er­ty investor mar­ket, are pre­car­i­ous­ly posi­tioned under a stag­ger­ing amount of mort­gage debt. The fol­low­ing fig­ure shows a break­down by income tax brack­et.

Fig­ure 4: Deduc­tions and Repay­ments as % of Gross Rental Income 2009–10[5]

The rea­son why costs out­weigh gross income is because Aus­tralians have bur­dened them­selves with the largest house­hold debt increase in his­to­ry to engage in an orgy of res­i­den­tial prop­er­ty spec­u­la­tion.

Fig­ure 5: House­hold Debt as % of Nom­i­nal GDP 1861–2011[6]

In con­clu­sion, Minsky’s finan­cial insta­bil­i­ty hypoth­e­sis helps to inte­grate the occur­rences of why hous­ing prices and the pro­por­tion of house­hold debt to the econ­o­my (GDP) have boomed while net income loss­es are sus­tained. That Australia’s res­i­den­tial prop­er­ty mar­ket has resem­bled Ponzi finance for the last ten years is noth­ing short of aston­ish­ing (longer if count­ing 2010-11 and 2011-12 as there is a sub­stan­tial lag in mak­ing tax data avail­able). The mar­ket would have col­lapsed dur­ing the glob­al finan­cial cri­sis in 2008 were it not for a fresh First Home Owner’s Boost (FHOB) re-inflat­ing hous­ing prices to a new, high­er peak.

Although Mr. Ryder claims that bub­ble advo­cates are “pub­lic­i­ty-seek­ers” and “shal­low, lazy and like the sound of their own voic­es”, out­bursts of ludi­crous pet­ti­fog­gery should not deter the pre­sen­ta­tion of sound evi­dence.


[1]. Min­sky, Hyman P. (1992). “The Finan­cial Insta­bil­i­ty Hypoth­e­sis,” Work­ing Paper No. 74, Levy Eco­nom­ics Insti­tute of Bard Col­lege, New York.; Min­sky, Hyman P. (2008). Sta­bi­liz­ing An Unsta­ble Econ­o­my, 2nd Edi­tion. Unit­ed States: McGraw-Hill.

[2]. Sta­ple­don, Nigel D. (2007). “Long Term Hous­ing Prices in Aus­tralia and Some Eco­nom­ic Per­spec­tives,” PhD The­sis, Uni­ver­si­ty of New South Wales.

[3]. ATO Tax­a­tion Sta­tis­tics 2001-02 through to 2009-10.

[4]. ATO Tax­a­tion Sta­tis­tics 2001-02 through to 2009-10.

[5]. ATO (2012; per­son­al com­mu­ni­ca­tion).

[6]. RBA (2012; per­son­al com­mu­ni­ca­tion).

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