Why Australia's housing balloon is shot

The figures released this week by the ABS showed that the fall in house prices over the last quarter and year was larger than the usual bull-side pundits expected: a 1.7 per cent fall for the quarter (versus the 0.5 per cent median prediction of 17 economists surveyed by Bloomberg) and 0.2 per cent fall for the year (versus expectations of a 1.6 per cent gain for the year by the same group of economists.

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, 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”.

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.

Figure 1
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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 three to six months.

How about the correlation of changes in population, and the ratio of population to dwellings, with changes in house prices?

Figure 2
image

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 six 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.

Figure 3
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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 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 three to six months, that implies that there are at least two more quarters of negative house price movements coming up.

Figure 4
image

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.

Steve Keen is Associate Professor of Economics & Finance at the University of Western Sydney and author of Debunking Economics and the blog Debtwatch.

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I agree with you Steve as well (See Why Australia's housing balloon is shot, May 3). Prices are slowly but surely decreasing. If the RBA has to raise interest rates sooner rather than later than that will absolutely kill the property market. First Home buyers will be stuffed and I don't think all the stimulus in the world will convince them to jump in and buy like last time.
The cost of living is certainly headed higher and with the Fed in America transfering inflation to many parts of the world through their stimulus policies I see strong headwinds ahead. The top end of the property market is certainly coming off the boil the fastest.
Government is the problem. Free markets should rule but they don't in Australia because the government always steps in and changes the rules (See Why Australia's housing balloon is shot, May 3). They can keep changing the rules to keep housing inflated. Probably because the big four banks will get smashed if they don't.
Steve, I am sure I am not the only one who is curious... do you see a 40 per cent correction in the headwinds off the back of a 1.7 per cent fall for the quarter? (See Why Australia's housing balloon is shot, May 3.)
It seems to me that more people want to be right than want to be happy. Why do "experts" seem so obsessed with talking the property market down, and why do you need to see the glass constantly as half empty? Do you really want to see 70 per cent of Australians financial security (wealth) nearly halved?
So the only thing that will save housing prices (who will think of the children!) is for government to effectively bankrupt our economy and younger generation by propping prices up.
I really don't know what to think of this country and its politicians, it just seems absolutely insane.
Assuming we do get another baby boomer/speculator pararchute scheme (FHOG) my only hope is that younger people second time around won't be suckered into the deathtrap that is currently home ownership in this country (See Why Australia’s housing balloon is shot, May 3).
In response to Stuart Jones (See 'Happy with high house prices', Conversation contribution, May 3):
An owner of a house is not immediately richer when their property goes up in value, as that is what is called 'paper wealth'. So all these people have had their houses value since 2004 cannot all sell at once, so therefore the capital gain they have made is not realised until they sell their property... and as you have seen, now that everyone is catching on to this, we see a lot of houses for sale and no buyers.
So we should be happy to see house prices fall, just like we should be happy to see grocery prices fall and fuel prices fall, and so on. If people have borrowed too much money end up in trouble, so be it... nothing Steve Keen predicts will happen has no bearing on that issue (See Caught in a property trap, May 3).
In response to the article Why Australia's housing balloon is shot (May 3):
Point 1: Economists are not trying to talk the housing market down. They are merely commentating on how investing works in all markets these days – that is, in bubbles. Its a statement of fact, not an effort to be negative.
Point 2: Its not the demand and supply of houses that's the issue. Its the demand and supply of credit (an input to the process of buying a house). If person X can no longer borrow the sums required then who cares what the demand and supply of houses are?
Point 3: When bubbles burst and the government or central bank steps in to help markets out they do so at the expense of (i) you and your future generations paying high tax to service government borrowings; (ii) exceptionally low interest rates which screw up your currency, meaning items such as TVs and any overseas travel you do become expensive. (iii) The asset price depreciates anyway as lending regulations tighten up and people have lower disposable incomes. Just ask the people of London who have high immigration, low supply of housing but whose house prices have been cut by at least 10 per cent and more to come, currency depreciated by over 25 per cent, mass unemployment and now a 50 per cent tax rate and inflation running over 4 per cent so the government can inflate away its debts. What is ironic that people still comment on the fact that there was only 10 per cent drop, when this is a nominal figure (not inflation adjusted).
The point is that you and your future generations pay for it in the end – even if you think your nominal house prices have held up. The longer the government and RBA try to inflate house prices the worse the bust will be. So if they observe and learn from overseas markets they should have no interest in re-inflating this already flogged beast.
I agree with Steve (See Why Australia’s housing balloon is shot, May 3).
If credit is not available or very expensive, then sales will drop (at least speculative sales) and the market will be gone. So many other markets experience credit crises and shattered house prices.
Stuart Jones wrote: "Steve, I am sure I am not the only one who is curious... do you see a 40 per cent correction in the headwinds off the back of a 1.7 per cent fall for the quarter?" (See 'Happy with high house prices', Conversation contribution, May 3).
Good question! First, let's look at the bet. The bet that Steve made was that house prices would fall 40 per cent from peak to trough over a 10 to 15 year period.
Let's now look at the maths. Giving Steve the benefit of the full term of the bet, 15 years equals 60 quarters. So let's pop 60 quarters into the relevant formula for a decaying asset, and find out by how much per quarter the asset would need to depreciate in order to have fallen 40 per cent at the end of 15 years. Wow! Only 0.85 per cent per quarter. For it to fall 40 per cent over only ten years – 1.3 per cent per quarter.
So, the answer to your question, in terms of the actual bet made, is that yes, a 40 per cent drop over 10-15 years at a quarterly rate of 1.7 per cent is a mathematical certainty.
Stuart then asked: Do you really want to see 70 per cent of Australians financial security (wealth) nearly halved? Answer: No, I don't think he wants to see it – he's simply pointing out the simple fact that it will probably happen. Don't shoot the messenger.
I might also add that the "wealth" to which Stuart refers is probably similar to the "wealth" held by the clients of Bernie Madoff.
Steve, can you please explain something to me? The house I bought in 1975 for $32,000 is now worth $500,000. If it drops by 40 per cent it will be worth $300,000. I thought it was supposed to be worth $32,000 – or is it really still going to be worth $268,000 more than I paid for it? Does that mean I don't have to lie awake at night worrying that buying a house back in 1975 has ruined my life? Because y'know it sounds like buying property does that kind of thing to some (See Why Australia's housing balloon is shot, May 3).
Steve, you have been predicting a 40 per cent price crash for Australian homes for years and your prediction is still far, far away from becoming a reality (See Why Australia’s housing balloon is shot, May 3).
By the time your prediction of a 40 per cent price drop does occur (if ever), myself, and many other owner-occupiers with mortgages, will have paid off our mortgage by then!
So why does the Australian government support the housing industry? It's simple, the Australian economy is a pyramid and supporting the base of that pyramid is the housing industry (See Why Australia's housing balloon is shot, May 3).
Consider this back of envelope calculation. Suppose if the average household was 2.5 persons and the home they lived in was worth $360,000 then we are talking about a market worth $2,400,000,000,000 – aka $2.4 trillion. The purpose of the biggest economic sector in Australia is putting a roof over the heads of our citizens. If it were to collapse then the economy may follow with dire consequences. That is why it deserves support.
Any talk about a home being a home and not an investment is nonsense... it is an asset and ipso facto an investment.
I agree (See Why Australia’s housing balloon is shot, May 3), but also would not dismiss importance of temporary and permanent residents whether they be immigrants, workers, international students and their dependents, they are all renters and/or buyers.
Like many commentators and vested interests who have aggressively dismissed Keen's views and predictions (to point of personal attacks), one could say it merely exemplifies both the extremely short term horizons of Australians, and our religious obsession with property (and investment).
Compounded further by a lack of timely, valid and reliable data, not that "mumbo jumbo" provided by property industry and media which focusses upon the sport of auctions and clearance rates, whilst ignoring increasing stock coming onto the market which will never go to auction in the first place.
Population growth has stalled, and if people were aware of how many less international students are considering Australia (Curtin predicts their enrolments to drop 50 per cent over three years), they would not even think about property.
But lets hope it's a slow deflation.
There is another factor of rising house prices that you have not discussed and that is: housing prices increase due to quick succession of ownership (See Why Australia’s housing balloon is shot, May 3).
In the past a household remained in the home for 30 years or more. Recently the turnaround was as quick as 3 - 5 years in many areas. Although you have correlated this to increased mortgage debt it isn't necessarily so aligned. However it is aligned to the fact that each successive seller wants to make a profit.
After taking into account the cost of stamp duty, estate agent selling fees and settlement costs, plus the original purchase price, obviously the property price will increase whether it is to cover increased mortgage debt or simply to provide the seller with a profit.
Property value is determined by supply and demand so therefore there is no "bubble" it is simply a shift in control from the seller to the buyer.
The reason Australians remain confident in the property market despite media doom and gloom stories is not because of the full recourse provisions of lending but because they actually value the security of home ownership - even if it has a "lower price value".
Most home owners don't buy with the intention of gaining capital value; they buy for more emotional reasons.
Perhaps an extra factor to consider in this spiral (See Why Australia’s housing balloon is shot, May 3)? - Baby Boomers are on the move out of their bigger nests and/or liquidating property "assets" which may also be contributing to the oversupply of properties on the market, thereby further depressing values.
Australian property needs to do one of three things - halve in price, double the rental prices, or have interest rates at two per cent or less - to revert back to global standards. It is a HUGE bubble (See Why Australia’s housing balloon is shot, May 3).
My London property is worth exactly the same as my Australian property yet brings in double the rent, which means that the cashflow covers the mortgage. While Australian rental prices cannot cover even half of my Australian mortgage payments. This means that Australians are paying too much initially, and also too much to the banks. This is not sustainable, and must fall. God knows how much of the average person's salary is now just going to service a mortgage these days!
This is a frightening prospect, and Australian is hanging on by its fingernails.
The dynamics of the Australian and US property markets are completely different (See Why Australia's housing balloon is shot, May 3). To name just a few differences, 106 per cent (of purchase) non recourse loans at 1.99 per cent were given in the US to people with no or bad credit. Also there was an oversupply of 2 million houses. I could go on and on.
If every day you wake up and say something bad is going to happen eventually you will be right. It seems to me that Steve still thinks wishing for something will make it so (See Why Australia's housing balloon is shot, May 3).
I lived and invested through many of the European and UK examples of housing crashes used by Steve as examples of the terror we face. And my memory is that they were all very short crises of confidence that never seemed that bad at the time. House prices in my opinion can only ever cause you pain in the very short term. Long term, though, you cannot lose. The mortgage that appears frightening today will be less than your credit card bill 20 years from now.
Wow, a 1.7 per cent decline over a quarter! Perhaps Steve could tell us an asset category that is not subject to such massive declines... Those who argue that housing does not contribute to National GDP should try sleeping under a bridge and still going to work the next day (See Why Australia's housing balloon is shot, May 3).
Steve, you note that the "change in aggregate demand is the sum of the change in income plus the acceleration of debt" (See Why Australia’s housing balloon is shot, May 3). I like your analysis of the second element, but what about the first element that is income?
No doubt income in Australia is rising greatly thanks to the resource boom (the RBA keeps reminding everyone of that). Also, how about analysing the instrument that is used to measure the value of homes? There could be, like you say, a bubble in home and credit values but the bubble could reside in the money to measure it (the Australian dollar for Australia), so many other elements when priced in Australian dollars give you similar chart pattern. Maybe it is better to use something like gold to price credit growth and home prices
Between 1989 and 1994 house prices fell in Australia by up to 70 per cent in some suburbs and around 40 per cent in most. In the property bust of the 1890s almost every bank in the sovereign state of Victoria went out of business lending into the property bubble.
Why does everyone think it cannot happen again if it has happened before?
Claiming some sort of victory on a 0.2 per cent fall? Virtually everyone (RBA, the big four banks, private forecasters) have repeatedly stated that the current mortgage rates will deaden the housing market for years. Prices will be flatish, but no huge decline like Keen has now been forecasting for about four years now (See Why Australia’s housing balloon is shot, May 3).
That's a good thing given the over-investment in Australian property, but it's a gigantic leap away from the catastrophe Steve Keen has continually forecast.
Let's also remember some specific Steve Keen predictions that we can test. Keen predicted that Australian interest rates will probably be zero by 2010”. Plus Australia was heading for a depression, the slump will last for 10 years if we're lucky, unemployment will rise to 10 or 15 per cent and could go to 20 per cent.
Hooray hooray.
Yet another affirmation of the difference between a short term decision for political benefit and long term economic ramifications.
Makes us all wonder why they were ever linked (See Why Australia’s housing balloon is shot, May 3).
The housing bust has already happened in many parts of Australia, just like the US. The more populous cities in the US have held up in prices, the same will occur here.
Some regional areas have and are already 30-70 per cent below prices from a few years ago. Have a look at tourism boom town Agnes Water, in Queensland, people selling blocks of land for a half to third of their last high selling price of five years ago. That is an example of tourism regional area in Qld. There are many regional areas that have already suffered good size falls.
Anyway, short term it does not matter if prices go down, as the good times with commodity prices will be with us for the next decade at least (See Why Australia’s housing balloon is shot, May 3).
Everything is a cycle and the trick to investing is where you get in during the cycle and then out, and for most people out is more important otherwise you make good gains quickly but then no gains for many years.
As the old saying goes: 'a recession is just the redistribution of wealth from those who thought they knew what they were doing, to those who do know what they are doing.'