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Wednesday, March 31, 2010

Steve Keen, on his way to Mt. Kosciuszko, outlines threat to Australia's housing bubble

Growing like Topsy
by Steve Keen
March 31, 2010

My Walk to Mt Kosciuszko is no longer a solitary affair: at last count, I will have a dozen companions for the entire distance, and another 16 joining me for at least one day.

One of those coming for the entire trip is the Commentary Editor from Business Spectator, Rob Burgess. Rob will report from and on the Walk on a daily basis, covering it both as a news story, and as the basis for a discussion of the wider issues facing business and economics in the uncharted terrain of the supposedly ‘post-GFC’ world.

The others joining me on the trek are doing so not just for the scenery, but because they too believe that Australia’s economic policy has become beholden to maintaining house prices at unsustainable levels. Despite government rhetoric (and some action) about improving home affordability, the First Home Vendors Boost did far more to make houses more unaffordable than the government’s minor actions in the opposite direction. The other walkers are joining me to bring attention to the absurdity of managing the Australian economy by making it impossible for people to afford houses in their own country.

But though The Walk will have a political protest at its core, it is not party partisan: our call here is “A Plague on Both Your Houses”. Whatever else might change if Tony replaces Kevin, one thing that won’t change is a sky-high house price policy, since both sides of politics in Canberra (not to mention the commercial Banks and their economists) have become convinced that the major reason the GFC occurred was that house prices fell.

This is true in the same sense that jumping off a cliff is painless—it’s hitting the ground at its bottom that hurts. The real cause of the GFC wasn’t falling house prices per se, but the mortgage debt that drove them higher as households took part in a speculative bubble. The rising debt level was, in effect, climbing the mountain in the first place: deleveraging was jumping off it.

The only way to prevent a financial crisis is not to climb the mountain in the first place: to stop debt being taken on for speculative reasons. But instead politicians the world over encouraged households to do precisely that, in the misguided belief that financial engineering was a road to wealth. Instead, it was the road to debt penury.

Once that debt has been accumulated, trying to stop house prices falling is like keeping Wily Coyote stationary in midair after he’s fallen off a cliff with an anvil attached to his legs: he’ll stay there for a moment, but after a while, it’s “Hello Terra Firma”.

House prices rose in America and the rest of the OECD because households took on bucketloads of mortgage debt, and they fell because households stopped taking on more debt. The fall in house prices was a symptom of households ending the leveraging game: it was coincident with the crisis, it made it worse because the collapse in house prices and the rise in insolvencies made banks insolvent, but the real problem was that households had got into too much debt.

So how does Australia keep house prices high? By encouraging households to get into yet more debt. The next chart shows what happened to the household debt ratios (both to disposable income and to GDP) before and after the First Home Vendors Boost.

The rise against GDP is far more dramatic than against household disposable income because other government policies—the stimulus package itself and the RBA’s 4% cut in interest rates—boosted disposable income dramatically last year (but even so, mortgage debt is now a higher proportion of household disposable income than before the GFC). The Boost-inspired house price bubble was financed by households adding another 6% of GDP to their already unprecedented debt burden, when prior to The Boost they were on track to reduce mortgage debt by about 3% of GDP in 2009.

We’ve avoided hitting the ground of deleveraging by climbing to a higher cliff.

1 comment:

  1. Australia's housing market is a time bomb. It is grossly over valued and the government have been doing everything in their power to keep the game going. They have had a sizeable grant for first time buyers. Though when they have sucked in all the potential first time buyers what will hold the market up? I have heard the usual affordability excuses and the fact that there is a shortage of homes in the country. By some figures there are as many as 200 000 homes needed but by other figure that there are nearly a million unoccupied properties. One must be wrong and very wrong.

    Australia is in the same mess as Ireland, in that its banks are heavily reliant on foreign hot money to fund these homes. Once these homes start to lose value the banks will start to post horrendous losses, and the whole financial edifice in Australia will collapse.

    Once the housing market collapses the rest of the economy will slump as consumers try and reduce debts or save to replace loses. Both will cause a contraction in the economy. Steve is right that falling house prices is not the problem. It is the debt that is attached to that property that is the problem. If you have no mortgage then a loss of $100 000 off the value of the property is meaningless. Banks everywhere have lent excessively at every higher levels of loan to value. They need a growing property market to restore the safety margin.

    Agreed the only solution is not to get on the debt escalator in the first place. The problem with that in many occasions is that those banks have access to cheap interbank money and this distorts incentives. If countries limit mortgage funding to those organisations that are excluded from interbank markets and can only fund mortgages from depositors savings it would mean that the mortgage market might tighten up. It would require bigger deposits, and less risk in future. It would keep the house price in line with the general inflation rate. It would also keep savings rates higher during booms because they would still need to fund mortgages.