With the complete collapse in the US property market due to the subprime mess, there’s been a lot of debate in Australia as to whether the same could or would happen here; Steve Keen has gained attention recently for his fairly apocalyptic predictions of a 40% drop in property prices from their peak. As Peter Martin notes, there are rather contrary views: Macquarie Bank’s Rory Robertson has taken a bet with Steve Keen. In short, Robertson will walk from Canberra to the top of Mount Kosciusko if that occurs. His reasons why it won’t?
We now have a bet, and I expect to record an easy win within two years. That’s because falls in Australia-wide home prices will be limited by our lack of overbuilding, our much more disciplined mortgage market, and – especially – by the RBA’s ability to drive mortgage rates lower (something the Fed until this week had been unable to do; see latter part of chartset, attached).
Critically, the RBA knows that it was 15-20%-plus drops in home prices that poisoned the US and UK banking systems and economies. And so that must not happen here; accordingly, limiting the drop in average home prices is an unstated but obvious objective of increasingly easy RBA policy.
There’s more on this thread on Joshua Gans’ blog about the issue, and it’s interesting to consider the differences and similarities with those two countries. The United Kingdom has, apparently, not seen a huge wave of mortgage defaults, nor huge levels of overbuilding like the USA, but the prices have still cratered. However, Christopher Joye (the boss of Rismark) also points out on that thread some key differences between us and the other two countries:
I agree that the single biggest risk to Australia’s housing market is credit rationing, which is what has hurt the US and UK markets. there is a story in the UK of a FTSE 100 CEO only be able to get access to a 40% LVR loan when buying a home. amongst many other major differences between the US/UK and Aussie markets (including our tiny default rates, the absence of a sub-prime market, and no real credit rationing in the home loan market) is the fact that while in the UK/US most home loans are fixed rate, and therefore do not change in the near-term when central banks cut rates, in Australia aronud 85% of loans are variable rate. This means that are mortgagors immediately benefit when the central bank cuts rates.
Essentially, it’s very difficult to get a loan in the US and UK at the moment, at any price, for anything more than a small fraction of a property’s value. Australian banks are still ready, willing, and able to lend most of the money required to buy a house, even if the non-bank lenders have been finding it difficult.
You may be wondering why it’s so important to keep property prices from falling substantially – wouldn’t cuts in house prices solve the housing affordability issue and tilt the playing field back towards those who don’t presently have housing? Yes, quite possibly. But if property prices fall significantly, all those home owners will start cutting back hard on their spending. And that could make an Australian recession look more like what the UK and US are now experiencing.
What will actually happen is of course anyone’s guess…
Rory Robertson is a helluva clever guy, i’d be inclined to listen to him.
However, there’s been a definite softening in the housing market in my area, it’s not %40 but some back of the envelope calculations make it seem like %10 to %15 in asking prices at least in the last year.
The UK market was completely bonkers though – they had a major market in “flippers” tarting up houses and moving on quickly (same as the US to a certain extent) where that phenomenon was fairly muted here. I reckon the relative absence of flipping is what will keep prices relatively steady as there aren’t huge numbers of desperate sellers with over capitalised houses. Sure, lots of home owners have over capitalised in the renovation boom, but most of them can afford to sit tight.
With absolutely no credentials whatsoever my predictions are –
If the banking system remains in tact then Australian house prices will fall till they are at the historic average of 3 times gross salary. However if the banking system is no longer able to issue mortgages the fall in house prices will be much greater and rental income will be king.
Notes:
do we calculate gross salary using the higher wage or both wages combined
I recall hearing Gerard Minack on Lateline earlier this year predicting up to 50% loss in value in some areas.
My concern with the arguments (that we’re immune from sub-prime problems) is that we compartmentalise debt – that we treat each loan in isolation. Yet, from my experience, quite a lot of people are potentially “sub-prime” – not necessarily on their housing loan – but on overall borrowings: mortgage + margin loans and other credit (credit cards and interest free purchases et al). We also have a situation where, to finance these debts, you pretty well need 2.5 income earners (i.e. two fulltime workers + a little extra (overtime, FTA/FTB, etc)).
So, all it takes is a small ripple and these people collapse like a house of cards. An employer stops overtime. Someone in the household is made redundant. A margin call comes in. The interest free period on that $20K furniture package expires. We’re already hearing murmurs of this happening up here with some of the “well-heeled” who’ve fallen foul of bad financial advice (i.e. leverage everything).
How will this pan out in terms of property prices? Well, I’d be surprised if we get away with 10% but 40% across the board does seem a little extreme (that would mean massive losses in some parts of the country). In my part of the world, I’d guess we’re about 25% overvalued so sliding back to this level might well be in order.
We should also remind ourselves of the naysayers who talked down any suggestion of the markets bursting – despite all of our collective memory saying that it would. No, prices will fall as they’re definately overpriced. So for me, the question is will it lurch past reality before returning or will it be a gradual slide back to where it should be?
What’s worth mentioning here is various measures of house prices.
The only ones worth paying an ounce of attention to are hedonic models – ones that compare like with like.
Some models that are suggesting rather large drops recently are basically little more than aggregations of all house prices, so as investors that entered the market in the early 2000’s recently left the market because of higher debt servicing costs brought about by higher interest rates (and realised a decent capital gain), their cheapish investor properties made up a larger component of the market than usual, dragging down the basic average house price.
Because many house price indexes run or are released quarterly, that issue dragged out over a longer period than when it was actually happening.
The “RP Data-Rismark Hedonic Property Index” is probably one of the better ones to keep an eye on. It get’s published monthly.
What I’m leaning towards thinking is likely (assuming employment holds up relatively well) is flat to small nominal house price growth over the next 6-7 years allowing inflation and wages growth to catch up, reducing the median house price to median income ratio down to something with a high 5 in front of it rather than a 6, 7 or even 8 that we’ve witnessed recently depending on the city.
GoTroppo,
We should also remember that most of the doom and gloomists now chanting “We wuz right!” had predicted 14 of the last 3 financial crisis. Most of them aren’t too dissimilar to the “this time things are different” bull market spruikers.
Except the supply/demand ratio for houses is far from historic averages, so the market will continue to be overpriced until more houses are built, or the population growth slows (given the shift in policies on immigration due to no more ’skills shortage’ this is quite possible).
I think the real estate market will remain stable until the share market recovers and investors start to shift their capital back into it. Given the rapidly falling interest rates, real estate will continue to be an attractive market to investors seeking stability until the appetite for growth and risk return.
These days it’s both.
Don Arthur covered this recently. There is plenty to chew over in his post, which cautions against the “it can’t happen to us” mantra.
Am I the only one who thinks a massive collapse in Australian house prices might have a few upsides?
I’ve got some skin in this game, having just bought an investment flat, positively geared, with the bank very happy to give us everything we wanted and more. My reading (or perhaps fingers crossed hope) is that there will be big variation depending on what and where, and also there remains a strong driver of population growth outside the financial system.
As has been mentioned elsewhere, the way that many home loans in the US are done is different from Australia – the debt from any difference between what you owe and what the house sells for does not follow you. So where there is significant negative equity you might as well sell. Whereas over here you’d only really sell if you had to as the bank will come after you for the rest.
Lefty E @ 8 – I doubt the upsides would come even close to making up for the very big downsides – except for a few cashed up people who can jump in while things are cheap.
Lefty E, it may do. However, one of the arguments going around is that the rise in house prices helped stoke the increase in spending. People felt wealthier as their house was worth more money. This wasn’t necessarily a useful feeling, as the value in your house is only relevant when you die or leave the country (when you’re selling to move house, the one you buy has had the same thing happen to its price as happened to the price of your house).
So, a collapse in house prices – even if nothing else changes – is likely to act as an inhibiting factor for expenditure. Like it or not, consumer spending makes our economy, and a sudden sharp drop in it may break our economy. This would generally be considered a bad thing, as a small drop in expenditure has a disproportionate effect. Money moves around, and creates more money as it does so. If the speed slows, or the amount drops, we see people lose their jobs. Then they’re not spending (as much) money, which in turn leads to more job losses.
I tend to prefer a gradual decline in relative house prices (taking Possum’s comment about ensuring you compare like with like) for most houses, until they reach something resembling affordability. I’m less concerned with what happens to house prices for houses that currently sell for over about $2million.
It’s worth noting that the median wage/house price ratio was slowly creeping towards 4 rather than 3 until the post-1999 surge. It’s also worth noting that we have had quite significant population growth in the last few years, and that this growth has exceeded the development of new homes.
My parents are selling their unit in Melbourne tomorrow, so I’ll let you know how they go. They’re feeling fairly confident right now.
The difficulty is providing continuing support for industries which we can afford long term, while ensuring those that could only be feasible during times of imaginary wealth are cut down.
My suspicion is that Australia is not going to see the drops in house prices that the USA has and will see. Most of the houses in australia are where people live and want to live, our seven and a half capital cities. Yankee Land has over seventy comparable cities. Many of which are dependent on narrow streams of income or, even worse for them, marginal industrial or high risk of being made redundant industrial, streams of income. It only takes a couple of those streams of income to get the shakes and every one goes ‘Holy pit of financial doom Bat Bernanke’.
I’m expecting 10% + or – 2% accross the board over the next two years. Much higher in areas like Bayside Melb and similar that have attracted the silly money over the last 5 years. Also large drops in some of the badly designed and serviced outer suburban developments, with the strong possibility of long term stagnation depending on the development or not of public transport blah blah blah. Much lower in those areas undergoing the transition to higher density living.
Possum @ 5:
That’s very true, but most of the doomsayers are now saying “this way worse than we expected it to be”. What is happening in America at the moment is terrifying. Its completely unprecedented. We will not escape unscathed.
The Robertson vs Keen bet was made at a Vital Issues Seminars and Parliamentary Library Lecture last week. There is a podcast available as well as Steve and Rory’s powerpoint presentations.
Rory opens his comments by noting that Steve Keen is lot smarter than most of critics give him credit for. Before you bag him out, you should at least listen to his talk while watching his PPT presentation. Ditto for Rory’s.
Ian Macfarlane gave a speech at the Lowy institute on Wednesday titled Australia and the international financial crisis which had plenty of food for thought.
In the Q&A session he was asked basically exactly the same question on house prices (at ~33:40 on the mp3), and he was fairly skeptical of the forecasts of 40% falls.
In his speech he lists various financial crises in the last 30 years, and I thought it was particularly interesting when he points out that in the Australian context the crisis in the late 80s – early 90s (the recession we had to have) was worse than the current financial crisis, with various banks and credit unions failing – I had not heard anyone else point this out before.
A few thoughts….
There are a lot of factors that have to be considered when determining a fair value for house prices.
There are demand side factors – interest rates, disposable income growth, people’s expectations of future developments in these variables, migration flows, capital gains concessions, expected capital gains, etc.
On the supply side you also have taxes, planning laws, government infrastructure charges, the expected return from building a home relative to other forms of investment (including the rental yield), etc.
A big factor in Australia is space constraints – there is a nice little RBA paper from 2001 or 2002 that shows that in countries where a larger proportion of the population living in large cities (like Australia), the equilibrium ratio of house prices to disposable income is higher.
With regard to the current environment – Rory’s key point is that in the US there was an enormous increase in residential construction during the housing boom. More generally, housing supply is much more elastic in the US than in Australia. In Australia, estimates suggests that there has been a significant UNDERBUILDING of homes in recent years. Rory argues that the shortage of supply, which is likely to persist, will put a floor under house prices. To me, that seems a reasonable argument.
Keen tends to place more emphasis on what he sees as the unaffordability of housing. Debt-to-income ratios are very high, debt servicing ratios are very high, house price to rent ratios are very high, saving rates are very low, etc. He is also very bearish on the overall economy, so worries that a significant spike in unemployment will cause default rates to increase significantly, and demand for housing to collapse.
What his analysis often leaves out is that financial deregulation (making it easier for households to get loans and reducing liquidity constraints, falling margins on housing loans), together with lower real and nominal interest rates would have been expected to generate a large increase in the demand for housing in Australia. Given that it take supply a long time to catch up with such changes (in densely populated areas supply is effectively fixed), one might expect house prices to have “jumped”, which may then be followed by a long period of more muted growth.
Where he is right I think is to draw attention to the dangers of excessive growth in credit and asset prices, and the way households have reduced their saving out of current income in the belief that rising asset prices represent real savings. the Australian household sector has taken on a lot more risk over the past decade.
As for the likely evolution of the macroeconomy – there is a lot of uncertainty about that. A resonable person could be very bearish – pointing to the awful state of the global economy, falling commodity prices, the vulnerability of the household sector in Australia. But a reasonable person could also be more optimistic – there is a lot more room for policy to be eased in Australia than overseas, the unemployment rate is low, the exchange rate adjustment will help, the financial sector appears more sound than elsewhere.
Who is to say which is right? As an economist, I will fess up to not really knowing. Hence, I feel uncomfortable about taking a strong view on how house prices will evolve over the next few years. If I had to jump one way, it would be to the Rory/Possum side rather than the Keen side.
One final point, a lot of analysts pretend that it is quite easy to model equilibrium house prices. I can assure you it is not. There are enormous standard errors around any estimates. For example, models of fair value suggested that the housing stock was overvalued in Australia 8 years ago! Keen has been warning of a collapse in prices for at least that long.
Sometimes it is best to just admit that we aren’t sure and pay more attention, as a society, to dealing with the problems we have more influence over. IMHO we should be spending more time thinking about the best way to make it easier for the poor to access quality, affordable housing – and how to make sure that it isn’t too difficult for the young to purchase housing in the future. It is almost certainly the case that most of the solutions here will be on the supply side, and not the demand side….
The failures of the Victorian Economic Development Corporation, the State Bank of Victoria, and the Pyramid Building Society were instrumental in the downfall of the Cain/Kirner government, if I recall correctly.
#18:
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Sorry FDB, I don’t know what that means – can you explain?
Sorry, in-joke.
There is an LP rule (honoured as much in the breach &c &c) about limiting comments to three paragraphs.
Mostly I was proud of my special character skillz, and you were the nearest target. As you were.
Ahh…will keep that in mind next time!
That’s the spirit!
In future, run enerything together into rambling chunks of text, without a thought for good writing. Rules are important you know. I actually take this one as a mandatory quota rather than a maximum, which can be a struggle when you’ve only got one sentence worth of material.
Actually, you’re not really likely to be taken to task if your comment is well thought out and well informed, as was yours. Unless some drunken dork has just discovered how to do special characters.
And don’t multiply HTML entities without necessity, FDB. You know that.
Rules are made to be broken. Labor Outsider’s comment is the best summary of this debate I’ve seen yet.
No complaints here about that comment. As long as the signal-to-noise ratio is high, the occasional long comment is fine by me.
I like the way Keen is prepared to put his cards on the table or his money, (or in this case his Inner Sydney apartment) where his mouth is. But he must be still scratching his head on the completed sale.
If my memory serves me corectly, he put his mortgaged apartment in Surry Hills up for auction with a reserve of $540 000 but it was passed in some $20 -30 000 short. Negotiations with the highest bidder continued until a third party came in with the necessary reserve plus some.
He had bought the 2 bedroom Surry Hills unit some 3 – 4 years ago for somewhere in the high 4’s. but with his resolve for having no debt/millstone in the curent crisis, he is now either homeless or renting.
Non-believer Gerard Henderson offered him 40% less than his reserve prior to auction, but the canny Keen held out. My money’s on Robertson walking.
Long run median house prices = 3 x median household income
(Note dimensional consistency)
Nothing else – overbuilding/underbuilding/blah – matters.
Current median house price in Australia = 5-6 x median household income.
Overpricing: 50%
Australia differs from both US and UK in that we had price drops about three years ago, while both those countries were still experiencing big booms. Our interest rate cuts have started earlier than in either of those countries too.
As in the early 1990s, middle-level employees are being sacrificed at the altar of corporate survival. The recently-announced fate of 800 ANZ employees is just one of many of these hollowing out of institutions.
Middle management personnel are the core of the real estate economy. These disemployed folks will be selling their slice of the Australian Dream under nightmare circumstances.
By geometric logic, residential real estate prices in major Australian population centres will inevitably fall significantly.
The one chart that convinced me Steve Keen is onto something
Yeah, yeah, correlation is not causation, but show me another chart as compelling as this one.
Carbonsink, the problem with that chart is that it’s comparing apples with oranges.
GDP is national income. It’s not a problem that your yearly income is less than your debt, as long as you can meet the interest payments.
Think of it this way: would most people have difficulty supporting a mortgage that is 150% of their income? If you earn $50k a year, would a $75k mortgage be a great burden?
And although the line seems to suggest that national debt is accelerating, presumably the financial crisis will cause it to slow down and plateau, since there will probably be less Australians wanting to borrow, and less foreigners willing to lend.
Of course not, but its Keen’s thesis that its the growth in debt that fuels most of the growth during the economy’s “euphoric period”. Eventually debt levels overwhelm the economy, there’s a “Minsky Moment”, sentiment turns dramatically and people start selling assets at firesale prices to pay down debt, which drives the economy into a debt-deflation.
Except its never behaved like that before. What’s happened in the past is debt-to-GDP has either peaked and crashed (e.g. the depressions of the 1890s and 1930s) or dipped briefly then started growing again (e.g. recessions in the 1970s, 1980s and 1990s).
Its entirely possible this could be another “ratcheting up” event, but given the causes and seriousness of this downturn its increasingly likely this will play out more like the 1890s and 1930s than more recent recessions.
Can the authorities engineer a different outcome this time? Perhaps. If the US had entered this crisis in sound financial position then I’d have more confidence. But as we all know, US budget and trade deficits were horrendous before the crisis began, and are now in basketcase territory.
What the Australian authorities do is neither here nor there. If the Yanks mess this up the tsunami is coming (via China) and there’s b*gger all we can do about it.
I think it’s a long bow to say the debt to GDP ratio is meaningless. I know one’s a stock and the other a flow, but over time they show a trend. It seems to me that Keen is either going to be completely right (if we do see our Minsky moment), or largely wrong. There’s not much room for a middle ground.
My feeling is that this slowdown if probably pretty serious, meaning significant layoffs which will have to hit the housing market.
Kynbos, my feeling is that as we become wealthier in terms of per capita GDP we can handle a greater proportionate level of debt, which is not humungous, as explained by Paulus @ 33.
It’s hard to see house prices going down for here in SEQ for any length of time. The Qld Water Commission is planning on a medium scenario where population increases from 2.8 million in 2006 to over 6 million in 2056. The local rag today has a story saying that we need 90 new homes a day for the next 20 years, or an increase of 735,500 dwellings to be built in the region by 2031 as against 1.1 million now.
BTW I received information the other day that according to a leading indicator the economy in SEQ has turned – in the last two weeks. Apparently people are back buying furniture again according to one retail chain. They first noticed the downturn back in March-April when the Reserve Bank was still jacking up interest rates. Now when the MSM is full of doom and gloom and lagging indicators like employment numbers are going to the dogs, people have started buying furniture again, and I’m informed it is not because of insurance claims for houses destroyed in storms.
It might be better than reading tea leaves and if it’s true you read it here first.
Surfers home prices slump 45%
Thanks, CS. Coastal properties are apparently getting hit hard around Australia.
I reckon its the well-heeled selling holiday homes at firesale prices to cover margin calls. Next up will be a crash in the resource states as the big miners shed jobs and slash investment. Then it will go nationwide when unemployment surges next year.
Every single developed economy (and several developing economies) are now in the steepest downturn in 50 years, at a time when the global economy is deeply interconnected. Does anyone seriously believe the RBA pushing on a string, and Kev spraying around a few billion, will magically save Australia from recession?
cs, in Qld our fearless treasurer told us last week we’d have to put up with growth of 3% instead of 4.5%, or thereabouts.
But I’d have to say that there is some very gloomy commentary about the world scene with some well-informed people wondering whether whatever is being done is going to fix it.
I have predicted that in the coming 12 months AUS metro property prices will not fall more than 10% off their 2006 highs.
Likewise I have predicted that in the coming 12 months AUS unemployment will not exceed 7.5%.
OK