Room for Debate: Could an Australian housing bubble be forming?

Room for Debate: Could an Australian housing bubble be forming?
Room for Debate: Could an Australian housing bubble be forming?

Glenn Stevens is right – there will not be an Australian property crash, as there is no bubble: Terry Ryder

One of many reasons there will be solid price growth in Australian property markets this year is that current prices are at sensible levels.

Australian house prices make sense in an international context, based on the relationship between household incomes and typical prices. They make even more sense when you factor in culture and tradition, elements economists can’t put into an equation but important nevertheless.

Reserve Bank Governor Glenn Stevens does not think Australian house prices are unreasonably high and does not believe they will drop. Nor does he agree that we have a price bubble.

A transcript of a recent interview with the Australian Financial Review shows that AFR editor-in-chief Michael Stutchbury and economics editor Alan Mitchell (why did it take two senior execubots to interview one public servant?) worked pretty hard to get Stevens to agree that Australia was vulnerable to a US-style collapse in property values – but they were unsuccessful.

I’m always curious as to why doomsayers expect Australia to follow the pattern of the United States, to the exclusion of all other countries. Why would one of the strongest markets on the planet follow the example of the worst?

The impression created by bad journalism is that most of the nations of the world suffered a US-style collapse in prices, and Australia was one of the few to unreasonably resist the trend.

In fact, only a handful of countries had property crashes: the United States, Ireland, Spain and, to a lesser extent, the UK. Those declines happened for specific reasons. In the US these included a recessed economy, high unemployment, a major oversupply of dwellings and an unregulated lending sector (pretty much the opposite of Australia on every count).

The vast majority of nations, even some with weak economies, have escaped decimation of their property values. Many have continued to show growth since the onset of the GFC. Australia is, in fact, reacting in line with most of the world’s nations.

In his interview with the poorly researched AFR boffins, Stevens repeated his consistent position that Australian house prices are high but relative to other countries they are not overpriced.

“When you put if fully into international perspective – that is, you don’t just compare us with the US but compare us with a whole range of countries – it’s actually a lot harder to make the case that we’re grossly overpriced and due for a crash,” he said.

“We’ve been around this level of house prices/incomes for 10 years. It’s taking a long time to burst if it’s a bubble. So, I’m not so much concerned about a crash.”

However, Stevens said he would be concerned if there was another major rise in prices, such as increase of 10% to 20% seen in some recent years.

“We have seen some gain in house prices over the past year or so, which is reversing a little bit of an earlier decline. That doesn’t trouble me. I think that’s probably part of the cyclical transmission mechanism working.

“But it would be, I think, troubling if you saw a return to very strong 10-20% persistent rates of growth of housing prices, especially if that was accompanied by a return of rising leverage.

“I don’t think that’s going to happen, by the way.”

Stevens, it seems, shares my view that house prices are at comfortable levels relative to incomes and that we will see solid growth in the near future, without a return to boom levels – with the exception of selected markets with specific dynamics, such as Darwin and Gladstone.

Terry Ryder is the founder of and can be followed on Twitter.



Philip Soos responds: Australian housing prices are nowhere near sensible, and a housing bubble could be forming

As mainstream opinion would have it, Australia’s housing prices are solidly based upon fundamental valuations or intrinsic value. This position was repeated yet again by Terry Ryder, in an article on Property Observer, claiming “current prices are at sensible levels”. This view is the stance of the Australian government, central bank, Treasury, the FIRE (finance, insurance and real estate) sector, much of academia, and a legion of commentators, economists and analysts.

Ryder cites RBA governor Glenn Stevens, who is on the record saying the residential property market is not experiencing a bubble. For anyone who has followed the global property market over recent years, it is difficult not to notice that central bankers are possibly the least reliable and most incompetent of all economists when it comes to identifying asset bubbles. Their record is truly terrible, for not only completely missing trillion-dollar bubbles that formed in their own backyard but they have continually put effort into denying these bubbles exist.

Although Ryder believes Australia is different from the US in regards to the relative economic conditions and property markets (more on this below), in one aspect Australia is similar: central bankers at the RBA and Federal Reserve have gone on the record to deny that a housing bubble exists in their countries. In the US, concerns were continually raised before 2006 about the risk of a property bubble. Unfortunately, such concerns were dismissed as nonsense, with these dismissals emanating from all quarters.

This reached truly ludicrous proportions in the US with its two leading economists and central bankers, Ben Bernanke and Alan Greenspan. In October 2005, Bernanke, then chairman of the President’s Council of Economic Advisers, testified before the Congressional Joint Economic Committee, claiming “price increases largely reflect strong economic fundamentals, including robust growth in jobs and incomes, low mortgage rates, steady rates of household formation, and factors that limit the expansion of housing supply in some areas.”

A few months before Bernanke’s testimony, Alan Greenspan, the then chairman of the Fed, testified before the same Congressional committee,detailing a similar analysis to Bernanke. In his testimony, Greenspan noted “Although a ‘bubble’ in home prices for the nation as a whole does not appear likely, there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels. … Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications.”

As with the dot-com bubble, the vast majority of economists missed and/or denied the existence of a bubble on the stock market, and did it again with the housing bubble. Just 12 out of 15,000 professional economists in the US publicly warned of this $8 trillion-dollar Ponzi scheme. This was noted by Dirk Bezemer, a Dutch economist at the University of Groningen, identifing twelve economists who picked both the collapse of the housing bubble and GFC, in a study that is well worth reading (disappointingly, economist John Talbott who wrote two books in 2003 and 2006 predicting the eminent collapse of the bubble was explicitly not included).

Central bankers cannot identify these epic asset bubbles for two primary reasons: lousy economic theory and an unwillingness to take responsibility. The former revolves around a non-empirical form of economics that is taught in universities and practiced in government and industry. This is called “equilibrium economics” and is associated with the neoclassical school of economic thought. It teaches, using many unrealistic assumptions, that markets operate in equilibrium – a state in which economic resources are put to their most efficient use.

Many of these assumptions are patently absurd: all firms are the size of lemonade stands, people can see into the infinite future, know all information about all markets, firms borrow at the same rate of interest, that money, credit and debt does not exist, and so on. It is similar to an astronomer who constructs a model of the solar system without a sun, moons and gravity. If NASA were to attempt another moon landing using such a deficient model, the space shuttle would never leave the planet.

This worldview assumes, because markets operate efficiently, assets are almost always priced correctly – so bubbles cannot occur. Neoclassical theories of equilibrium price statics, rational expectations, efficient markets hypothesis, capital assets pricing model, utility, and so on are doctrines with slim to non-existent empirical backing.

This economic theory does not reflect reality, as has been accurately detailed by economist Steve Keen’s book Debunking Economics and numerous other sources. If it did, why are so many countries generating the largest asset bubbles in their respective histories after undergoing reforms of privatisation and deregulation?

The latter reason is simple: if a central bank warned about a housing bubble as it was forming, the market would react by changing its attitude from greed to panic, typical of the pathology of boom bust mania. Economists in the central bank are considered the foremost authority on the economy, so when they speak, everyone listens. This institution’s most powerful influence upon the economy is not the ability to print money or adjust the interest rate, but its loudspeaker.

For instance, if the Fed had warned about a bubble forming in the housing market in 2002, and put time and effort into ensuring that everyone heard the message, the market would have collapsed then as property investors would act to protect themselves by selling assets (ensuring a collapse in capital values) and refusing to take up more debt (thus hurting bank profitability). This would have plunged the economy into a recession, though not of the severity the US is currently experiencing after letting the bubble run the course through to its peak in 2006.

Central bankers would have copped the blame for the financial and economic fallout, which would not endear them to political and economic elites, or the general population. Economists in the central bank are not going to put their substantial six-figure salaries and secure job placements on the line, including being subject to an immense amount of flak from the FIRE sector, for correctly stating the perfectly obvious that anyone with a modicum of knowledge of the financial and real estate markets would realise.

The majority of economists, especially those prominently placed in institutions like the RBA, Treasury, universities, the banking, financial and real estate industries, reject the notion that a bubble exists in the residential property market. This is unsurprising, given the poor track record of establishment economists in identifying asset bubbles and crises.

The Dot-Com bubble that formed in the stock market during the late 1990s and the GFC of 2008 are but two examples where the vast majority of economists missed the obvious, even though some did accurately predict these events and attempted to warn the public of impending danger. Thus, the analysis and commentary of mainstream economists, especially those within leading policy-making positions, tell us little about the future of the housing market and general economy, and their unwavering optimism should be greeted with a great deal of scepticism.

Ryder goes on to claim the US housing market was sunk by “a recessed economy, high unemployment, a major oversupply of dwellings and an unregulated lending sector (pretty much the opposite of Australia on every count).” The first two reasons are back to front. The bursting of the $8 trillion-dollar bubble caused the ‘Great Recession’ and subsequent high unemployment.

A collapse in demand from a formally strong private sector (including an external account deficit) and combined with the US government’s attempted austerity, pushed the US economy into recession. It is the bursting of asset bubbles that cause recessions and high rates of unemployment, not the other way round.

That the US had a major oversupply of dwellings was obvious to the mainstream only after the bubble had burst. Meanwhile vested interests constantly claimed there was a considerable shortage of dwellings. The shortage argument, however, is not new. Every country that has suffered through a housing boom and crash in recent years had so-called ‘experts’ claiming prices were based upon fundamental valuations due to dwelling shortages.

Take the US as a case study. Leading institutions such as the Federal Reserve, National Association of Realtors, California Building Industry Association and Harvard University’s Joint Center for Housing Studies produced sophisticated studies to show that the housing boom was caused, in part, by dwelling shortages. These studies were authored by professors, PhDs, and businesspeople, all with extensive knowledge and experience but with conflicts of interest that could fill a small book.

Their expertise was as illusory as the shortage when the housing market crashed. In this way, Australia is not different because there is no housing shortage here. High housing prices are not set by the forces of supply and demand but by banks’ willingness to lend, which leads to the next issue.

The leading cause of the US housing bubble was a privatised and deregulated financial system lending absurd amounts of credit to every Tom, Dick and Harry that would take it, regardless of their financial standing. This gave rise to the term ‘ninja’ loan, borrowers with no income, no job and no assets.

Loose credit was used to speculate on the property market, generating easy profits until the bubble peaked and then collapsed the financial sector in 2008. As early as 2004, the FBI testified before Congress that there was a significant amount of fraud taking place around the banks’ lending to borrowers. These concerns were dismissed by the Bush administration.

Similar to the US, Australia has a deregulated and liberalised financial sector, having undergone numerous reforms during the 1980s and 1990s, ending the government’s heavy involvement in ownership and management during the social democratic period of the 1950s to 1970s. Unsurprisingly, the amount of credit the banking sector extended to all parts of the private sector has increased dramatically. Mortgage debt has more than quadrupled from 19% of GDP in 1990 to 84% in 2012 to a higher level that of the US at its peak.

According to Denise Brailey, the president of the Banking & Finance Consumers Support Association, an organisation dedicated to protecting the public against predatory financiers, there is some evidence to suggestmortgage fraud is far more widespread than previously thought. Having worked in this field for the last 20 years, criminologist Brailey has seen first-hand the financial and social wreckage wrought by a multitude of scams and predatory lending.

Brailey provided testimony before the Senate Economics References Committee alleging wide-scale fraud from banks to brokers. While her testimony, which covers the period of 2008 to the present, was largely about low- and no-doc loans, her claims extend into the mainstream of full-doc mortgages.

Certainly, the public would know more if the ATO, ASIC and APRA bothered to look into these cases of fraud, but just like the US, regulators have been captured by the finance industry, unwilling to upset bankers and their allies in political office. Only time will reveal the extent of fraud that has taken place.

Ryder quotes Stevens about the apparent stability of the house price to income ratio for around a decade. I personally took an interest in the statistics used to construct this ratio, but my data request was refused by the RBA on the grounds of commercial confidentiality. Eventually, I managed to extract the household income part of the equation (denominator) through a Freedom of Information Act, as this had been constructed using ABS data (the numerator was constructed using data from APM).

It was easy to see why Stevens believed the ratio had not changed for 10 years: the RBA measure of household income was severely inflated, to the point that the median household was ‘earning’ $97,000 in early 2010 (the last year that data was provided). This unrealistically high level of household income deflated the ratio.

ABS survey data estimates household income to be no higher than $74,000, a significant difference. Economists Leith van Onselen and Cameron Murray carefully backtracked through the National Accounts data to reveal the extra artifacts that the RBA had inserted into the household income figure to inflate it.

In summary, Australia does share some uncanny similarities with the US in the period before its housing market collapsed. Central bankers denied there was a bubble, the economy was apparently strong, there were never-ending reports of a dwelling shortage, bank lending is at historical levels, housing prices were also historically high, regulators were asleep at the wheel and reports of lending fraud surfaced. A weak economy and high unemployment only occurs after the housing market sinks.

Probably the only aspect of Ryder’s article that is accurate is when the question is asked of why a comparison between Australia is the US is considered legitimate. Ultimately, the most accurate assessment is based upon Australia’s current internal economic conditions. The second-best comparison is between Australia’s current and historical trends. Comparisons with other countries comprise an interesting academic exercise that can tell a useful story, but this is not needed to assess the health of Australia’s property markets.

Philip Soos is a researcher at the School of International and Political Studies at Deakin University.


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