Housing Prices Article by Steve Keen

From: Linda-Jane Debello [mailto:linda@ljgrealestate.com.au]
Sent: Wednesday, 18 January 2012 10:12 AM
To: 'Linda-Jane Debello'
Subject: Housing Prices Article by Steve Keen

07

Australian House Prices—again

By Steve Keen on January 7th, 2012 at 3:36 pm

Posted In: Debtwatch

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Mortgage debt is by far the largest component of debt in Australia today—government debt, which is the focus of political debate, is trivial by comparison (a quick caveat though—finance sector debt may be larger again than mortgage debt, ifthis claim, sourced from Morgan Stanley, is accurate—since it shows Australia’s aggregate private debt ratio as almost equal to the USA’s).

Figure 1

 

The household debt to income ratio may have topped out now, after growing fivefold in the last two decades. Figure 2 shows the ratio of household debt to disposable income, which peaked at 149% of disposable income back in late 2008. Despite the enticement into debt given by the First Home Vendors Boost, aggregate household debt never exceeded this pre-Boost peak as a percentage of disposable income, since the fall in personal debt outweighed the rise in mortgage debt.

Figure 2

This huge rise in household debt compared to income has more than offset the falls in interest rates that occurred since the 1990s. The perennial argument from property spruikers that the rise in debt has simply been a rational reaction to the fall in interest rates is pure bunkum—especially when you take a less-than-myopic look at the data, and consider mortgage rates back in the 1960s, which were well below today’s rates (see Figure 3).

Figure 3

This comparison stands even when inflation is taken into account. The average real mortgage rate in the relatively low-inflation 1960s was 3 percent—a full percent below the low inflation level of the last decade (see Figure 4). Why wasn’t mortgage debthigher back then, if the increase since the 1990s was a “rational response to lower interest rates”?

Figure 4

I date the Australian house price bubble from 1988, when it was spiked by the reintroduction of the First Home Owners Scheme by the Hawke Government in reaction to the Stock Market Crash of 1987 (the Scheme works by encouraging would-be buyers to take on mortgage debt, and then hand the leveraged sum over to the vendors—which is why I prefer to call it the First Home Vendors Scheme [FHVS]). It then really took off in 2001, when Howard doubled the Grant in response to a feared recession (see Figure 5, which combines Nigel Stapledon’s long term indexwith the ABS data from 1976 on; “Hawke” and “Howard” respectively mark the re-introduction of the grant in 1988 and Howard’s doubling of it in 2001), though it was already running hot again from 1997 when—without any additional help from the government—the financial sector had enticed Australians to go from a 50% to a 70% mortgage debt to GDP ratio (at a time of rising interest rates).

Figure 5

The combination of higher rates and much higher debt levels means that paying the mortgage is taking far more out of the family purse than it used to do back in the pre-Housing Bubble years. Readily available data from the RBA shows that interest payments on household debt are five times as high as they were back in the 1970s.

The RBA data for mortgage debt only start in 1976; in the spirit of countering spruiker myopia, I’ve estimated pre-1976 mortgage debt as 30% of total debt, from the RBA’s long-term data (the average from 1977-1980 was 31%). Interest payments on mortgage debt are as much as ten times as high now as in the 1960s (see Figure 6).

Figure 6

Spruikers also prefer to ignore the fact that debt has to be repaid, and focus on the interest payments alone. In the past mortgages been paid off after 5-7 years via the resale of the property, but that will be a lot more difficult in future as house prices fall. Figure 7 shows household debt service as a percentage of disposable income with mortgage debt being repaid over 25 years and personal debt over 10. On this basis, there has been a twelve-fold increase in the proportion of family income that has to be devoted to servicing mortgages since 1970. Even compared to the high interest days of 1990, mortgage debt service is now 2.5 times as burdensome.

Figure 7

There is clearly no capacity for debt service to take a larger slice of the family income pie, which in turn is taking the wind out of the housing market. Spruikers happily make a “supply and demand” argument about why house prices have risen, but obsess about regulation-impaired supply and equate demand with population growth. In fact, demand for housing doesn’t come from population growth: it comes from the growth in the number and value of mortgages. That growth rate in fact peaked back in 2004, and it has been trending down ever since: the First Home Vendors Boost merely delayed this process without stopping it.

Figure 8

That in turn is the main factor driving house prices down—just as rising mortgage debt drove prices up, falling mortgage debt is driving them down. As I’ve explained elsewhere, the causal factor behind asset prices is not just rising but acceleratingdebt. This is an extension of my basic proposition that macroeconomic analysis must include the role of credit—which is ignored by conventional neoclassical economics. In a credit-driven economy, aggregate demand is the sum of incomes plus the change in debt, and this monetary demand is expended buying commodities and claims on existing assets—basically, shares and property.

Part of demand for housing thus comes from income—the focus of the property spruikers—and part comes from the increase in mortgage debt—which they ignore.

 

Figure 9

For prices to rise, demand must also be rising, and this requires not merely rising mortgage debt but accelerating debt. Of course variations in income (and variations in supply too) can play a role, but in the overwhelmingly speculative, overly-leveraged market that Australian housing has become, accelerating mortgage debt trumps the lot (see Figure 10).

Figure 10

This is especially so since such a large percentage of buyers are so-called investors—”so-called” because a better description is speculators. Actual investors aim to make a profit out of the income flow generated by an investment. Australia’s property “investors” instead lose money on their rental income, and hope to recoup the loss as capital gains via a later sale. With the days of house prices rising faster than incomes well and truly over, this percentage of the market could drop back to pre-1990s levels.

Figure 11

Both sources of demand are now falling strongly from the artificial boost given by Rudd’s spin of the FHVS sauce bottle.

Figure 12

One of the world’s last and greatest house price bubbles is thus finally ending.

Figure 13

Discussion (77) ¬

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1.    Bob Carver

January 10, 2012 at 4:05 am | #

What is the point of having a PDF link that doesn’t work? I have yet to see any of these “membership” links actually work! All it does is ask me to login. I login and get to a generic page. I try the link again and it asks me to login again! What a crock!

2.    Ericopoly

January 10, 2012 at 4:15 am | #

The housing supply situation in the USA is no longer one of overbuilding in the boom years. Today it is one of below-trend household formation. To verify this just count the number of housing units constructed over the past 12 years and subtract out approximately 3 million homes (about 250k per year destroyed). And actually if you look at census statistics on home ownership in the US we’re now at historically low levels of owner-occupier for the demographic below the age of 65. The headline owner-occupier number is skewed by the 80% ownership rate of the age 65+ demographic (and our population is aging). So we actually have positive fundamentals in the US if we could just get some damned job creation. That’s a bit of a chicken and egg too given how we have so many jobs tied to home construction. So there you have it — we still have falling prices despite not having an overbuilding problem. It’s a problem with household formation rates being low, due to high unemployment.

One proposed method of boosting household formation rates in the USA is VISIT-Act:
http://lee.senate.gov/public/index.cfm/press-releases?ID=7d71bb4f-3752-4e86-af5f-85ecc9c0c142

3.    Steve Keen

January 10, 2012 at 6:08 am | #

Sorry Bob, Ill check what’s going wrong for you there.

4.    Steve Keen

January 10, 2012 at 6:18 am | #

Hi Bob,

According to the records in my WordPress database, you are a “Free Subscriber”. If you have paid–which I also couldn’t find a record of, but systems sometimes stuff up–then let me know and I’ll fix things up. But if not, what’s happening is a function of the “Clayton’s” membership scheme on this blog back in September 2011. Blogs, papers, old PDFs and the like are still accessible, but from then on new downloads are restricted to paying members, with a minimum fee of $2 a year:

http://www.debtdeflation.com/blogs/2011/09/01/debtwatch-still-free-but/

There is an additional hassle at the moment that I haven’t had time to fix: the site has recently been ported to a new ISP for higher reliability (and the cost of this service is one of the things now being covered by membership revenues rather than out of my own pocket), and in the transfer at least one page went missing–the one to enable old “Free Subscriber” members to upgrade. So if any of the 12,500 Free Subscribers wish to upgrade, at the moment the only option is to sign up via the “New Member Registration” link with a new user name.

5.    Ericopoly

January 10, 2012 at 8:39 am | #

The weird thing about the USA is that when they want municipalities to have cheap access to credit they make the interest income from municipal bonds tax-exempt. This lowers the market interest rate to lower the cost of funding for municipal projects.

Then when they want lower mortgage rates they just follow a similar taxation strategy right? Of course not, instead we have the Fed buying up bonds hoping that will drive the rate down. The easiest and most targeted method of immediately making mortgages cheaper would of course be making the income from mortgage bonds tax exempt. But why not make a simple problem complex?

We could easily push through a debt jubilee if it were coupled with tax cut on mortgage interest income. The banks/investors holding such bonds would get a rise in after-tax income that would be offset by a partial principle forgiveness.

You could do this without hurting the banks.

6.    Aus_ed

January 10, 2012 at 12:50 pm | #

C’mon AMH, lighten up. Life is good! Why you hate property so much? It’s just an investment class as any other… you can’t get emotional with investments otherwise it can lead to unreasonable decisions.

BTW, thanks for referencing that post. Points one and two I made are more valid than ever (for example, read excellent comments from Ericopoly). And regarding point 3, even Steve took my comment to heart and now this blog has a disclaimer. Look at the bottom of this page! And support for anti negative gearing crusade has disappeared from the front page – in favour of Adsense ads 

 .

Philip, I am simply saying that you are trying to compare change in price of an asset to change in the cost of renting it. Hence, apples and oranges. More relevant comparison is how much rental costs changed over time in relation to changes in costs of buying the house (ie. mortgage payments, the most significant and highly variable component), not the house price itself. The logic is that people need accommodation over the period of 40-60 years. They can choose to rent or buy their own home. There is an annual cost of each of the option and that is the only relevant cost for comparisons.

Please consider this real life examples:

1. June 1987, median Sydney price $104K, avg mortgage rates 15.5%: cost $16,120 pa

2. June 2011, median Sydney price $586K, avg mortgage rate 7.8%: cost $44,304 pa (or 2.7 times 1987 cost)

1. June 1987, median Sydney rent 2b $7,540 pa

2. June 2011, median Sydney rent 2b $23,400 pa (or ~ 3.1 times 1987 cost)

That is what the graph indicates independently, based on ABS statistics. This is not a prediction. This is not a speculation. This is a historical reality… why is it so difficult for some to accept it?

7.    Ericopoly

January 10, 2012 at 3:50 pm | #

This summer I took a look at properties in Sacramento, CA. We looked at multifamily properties (4 unit) that are fully occupied by long term tenants at below-market rents. The current gross rental yield on those properties was 16%.

Our 30 year fixed rates are down to less than 4% now! Contemplate that for a moment. 16% gross rental yield, 4% financing rate, and yet these properties are still depreciating! It’s just nuts.

The Shiller numbers just don’t show what’s going on in some areas. You can drown in a lake that only 1 millimeter deep on average.