Australia Faces Its Demons

[JonoP]

It's the influx of overseas capital that I wonder about. The place we sold went for cash to a pom.

Ummmm, yesssss......

All those 'cashed up' punters from the UK, Ireland, the US etc. Coming over here and spending the massive profits they secured from the sale of their properties back home?

Or maybe it is all those ‘cashed up’ Indian students that are coming over here to do hair dressing courses?

Anyhow, it does not really matter. The point is that banks in Australia make more mortgages each month than banks in the UK. Yet Australia only has one third of the population. That is deeply weird.

[South Lorne]

The point is that banks in Australia make more mortgages each month than banks in the UK. Yet Australia only has one third of the population. That is deeply weird.

...they are in an ever inflating housing bubble...we are in a slow crash....they will have lots of mewing which increases remortgaging ....we have nothing to mew....

[aussieboy]

Ummmm, yesssss......

All those 'cashed up' punters from the UK, Ireland, the US etc. Coming over here and spending the massive profits they secured from the sale of their properties back home?

Or maybe it is all those ‘cashed up’ Indian students that are coming over here to do hair dressing courses?

Anyhow, it does not really matter. The point is that banks in Australia make more mortgages each month than banks in the UK. Yet Australia only has one third of the population. That is deeply weird.

"Doesn't really matter". Thus spake Zarathustra.

Anyone with out there with any actual experience of or information on this? I know that a lot of Aussie ex-pat money from Asia is coming in along with the Asian investors themselves directly.

[South Lorne]

"Doesn't really matter". Thus spake Zarathustra.

Anyone with out there with any actual experience of or information on this? I know that a lot of Aussie ex-pat money from Asia is coming in along with the Asian investors themselves directly.

...a bubble is a bubble ...and will most likely end in tears...origin of funds will not matter.....

[JonoP]

"Doesn't really matter". Thus spake Zarathustra.

Anyone with out there with any actual experience of or information on this? I know that a lot of Aussie ex-pat money from Asia is coming in along with the Asian investors themselves directly.

BUYERS are deserting the housing market at a pace that threatens a slump in housing prices and a risk to the economic outlook.

The number of new housing loans approved by the banks dropped 5.6 per cent to a 10-year low in February, after a similarly sharp drop in the previous month, The Australian reports.

The Queensland floods were not to blame, because the number of new housing loans fell in all states. Among the biggest falls was a 10.1 per cent drop in New South Wales.

The buyer retreat comes as the stock of unsold houses mounts. Figures compiled by property analysts SQM Research show there are now 356,600 properties on the market, which is almost 50 per cent more than a year ago.

"It is clear now that the sudden drop in finance approvals in the new year is not to do with the flooding, but is rather due to the Reserve Bank's interest rate rise in November, which was the straw that broke the camel's back," SQM chief executive Louis Christopher said.

He said the fall in the demand for housing was more severe than occurred during the global financial crisis and should erode house prices by more than 5 per cent.

Mr Christopher said reported auction clearance rates of between 50 and 60 per cent in the major capitals could not be believed, since the results of half the houses put up for auction each weekend are not recorded. Agents with unsuccessful auctions have an incentive not to report them.

The slump threatens to undermine Budget calculations for the Government, which is counting on a rapid return to growth in the next financial year.

The number of loans for new homes slumped 12 per cent in February and has dropped almost 36 per cent in the past three months. Home building is a key economic sector influencing both the health of manufacturing and consumption.

Read more: http://www.news.com.au/money/property/buyer-retreat-spells-slump-in-home-prices/story-e6frfmd0-1226035067289#ixzz1InDb8zMc

[South Lorne]

The slump threatens to undermine Budget calculations for the Government, which is counting on a rapid return to growth in the next financial year.

The number of loans for new homes slumped 12 per cent in February and has dropped almost 36 per cent in the past three months. Home building is a key economic sector influencing both the health of manufacturing and consumption.

..sounds like a Gordon Brown moment ...

[wherebee]

There is a LOT of inherited wealth coming online in Australia, from what I see. Many 3 generation immigrants have grandparents and parents who had no debt, own houses outright, have large cash assets to boot, and as they start to die off that money is going to be a nice fillup to Gen X,Y, and the like.

As I have said before, until China sneezes I cannot see Australia having a cold. The strong currency helps - even if your wages have stayed flat for three years, your spending power on the internet from US or UK has increased by almost 50%.

[aussieboy]

...a bubble is a bubble ...and will most likely end in tears...origin of funds will not matter.....

[South Lorne]

...'tis but 'the dawning of the day'......

[Tiger Woods?]

It's the influx of overseas capital that I wonder about. The place we sold went for cash to a pom.

Given the current exchange rates, I just don't get it. Aussie houses no longer look cheap relative to the USD/GBP etc.

[JonoP]

There is a LOT of inherited wealth coming online in Australia, from what I see. Many 3 generation immigrants have grandparents and parents who had no debt, own houses outright, have large cash assets to boot, and as they start to die off that money is going to be a nice fillup to Gen X,Y, and the like.

As I have said before, until China sneezes I cannot see Australia having a cold. The strong currency helps - even if your wages have stayed flat for three years, your spending power on the internet from US or UK has increased by almost 50%.

That is an interesting viewpoint. What is the tax situation around inheritance in Aus?

I have read a couple of articles saying that the ‘bulk’ of the boomer population are now rapidly approaching retirement. Thus over the course of the next few years a lot of these people will be looking to start drawing on assets they have accumulated during their working career. This segment of the population hold the bulk of the ‘investment properties’ (sorry, cannot help myself with the punctuation). As they move in to retirement, the attractions of negative gearing reduce (assuming that they pay less tax). Thus the assumption is that they will become net sellers of property. What do you think?

[Tiger Woods?]

That is an interesting viewpoint. What is the tax situation around inheritance in Aus?

There is no inheritance tax in Oz.

[South Lorne]

Given the current exchange rates, I just don't get it. Aussie houses no longer look cheap relative to the USD/GBP etc.

...probably a lottery winner getting away from it all.....

[Paddles]

http://www.theaustralian.com.au/business/news/housing-finance-down-48pc-in-february/story-e6frg90f-1226037148951

Housing finance 4.8% down in February.

Nothing to see here, move on.

Edited April 11, 2011 by Paddles

[blue skies]

This Time Had Better Be Different: House Prices and the Banks Part 2

by Steve Keen on April 11th, 2011 at 8:57 am

Posted In: Debtwatch

Click here for this post in PDF

Figure 1

In last week’s post I showed that there is a debt-financed, government-sponsored bubble in Australian house prices (click here and here for earlier installments on the same topic). This week I’ll consider what the bursting of this bubble could mean for the banks that have financed it.

Betting the House

For two decades after the 1987 Stock Market Crash, banks have lived by the adage “as safe as houses”. Mortgage lending surpassed business blending in 1993, and ever since then it’s been on the up and up. Business lending actually fell during the 1990s recession, and took off again only in 2006, when the China boom and the leveraged-buyout frenzy began.

Figure 2

Regular readers will know that I place the responsibility for this increase in debt on the financial sector itself, not the borrowers. The banking sector makes money by creating debt and thus has an inherent desire to pump out as much as possible. The easiest way to do this is to entice the public into Ponzi Schemes, because then borrowing can be de-coupled from income.

There’s a minor verification of my perspective in this data, since the one segment of debt that hasn’t risen compared to GDP is personal debt—where the income of the borrower is a serious constraint on how much debt the borrower will take on. As much as banks have flogged credit cards, personal debt hasn’t increased as a percentage of GDP.

On the other hand, mortgage debt has risen sevenfold (compared to GDP) in the last two decades.

Figure 3

The post-GFC period in Australia has seen a further increase in the banking sector’s reliance on home loans—due to both the business sector’s heavy deleveraging in the wake of the crisis, and the government’s re-igniting of the house price bubble via the First Home Vendors Boost in late 2008. Mortgages now account for over 57 percent of the banks’ loan books, an all-time high.

Figure 4

They also account for over 37% of total bank assets—again an all-time high, and up substantially from the GFC-induced low of 28.5% before the First Home Vendors Boost reversed the fall in mortgage debt.

Figure 5

So how exposed are the banks to a fall in house prices, and the increase in non-performing loans that could arise from this? There is no way of knowing for sure beforehand, but cross-country comparisons and history can give a guide.

Bigger than Texas

A persistent refrain from the “no bubble” camp has been that Australia won’t suffer anything like a US downturn from a house price crash, because Australian lending has been much more responsible than American lending was. I took a swipe at that in last week’s post, with a chart showing that Australia’s mortgage debt to GDP ratio exceeds the USA’s, and grew three times more rapidly than did American mortgage debt since 1990 (see Figure 13 of that post).

Similar data, this time seen from the point of view of bank assets, is shown in the next two charts. Real estate loans are a higher proportion of Australian bank loans than for US banks, and their rise in significance in Australia was far faster and sharper than for the USA.

Figure 6

More significantly, real estate loans are a higher proportion of bank assets in Australia than in the USA, and this applied throughout the Subprime Era in the USA. The crucial role of the First Home Vendors Boost in reversing the fall in the banks’ dependence on real estate loans is also strikingly apparent.

Figure 7

Never mind the weight, feel the distribution

The “no bubble” case dismisses this Australia-US comparison on two grounds:

* most of Australia’s housing loans are to wealthier households, who are therefore more likely to be able to service the debts so long as they remain employed; and

* housing loans here are full-recourse, so that home owners put paying the mortgage ahead of all other considerations..

Bloxham made the former claim in his recent piece:

However, there are other reasons why levels of household debt should not be a large concern. The key one is that 75 per cent of all household debt in Australia is held by the top two-fifths of income earners. (Paul Bloxham , The Australian housing bubble furphy, Business Spectator March 18 2011)

Alan Kohler recounted an interesting conversation with “one of Australia’s top retail bankers” a couple of years ago on the latter point:

There is some ‘mortgage stress’ in the northern suburbs of Melbourne, the western suburbs of Sydney and some parts of Brisbane, but while all the banks are bracing themselves for it and increasing general provisions, there is no sign yet of the defaults that are bringing the US banking system to its knees.

We often see graphs showing that Australia’s ratios of household debt to GDP and debt to household income had gone up more than in the United States. So, while the US is deep into a mortgage-based financial crisis, it is surely a cause for celebration that Australia has not seen even the slightest uptick in arrears.

“Please explain,” I said to my dinner companion. Obviously, low unemployment and robust national income, including strong retail sales until recently, have been the most important part of it. But on the other hand, the US economy was doing okay until the mortgage bust happened; it was the sub-prime crisis that busted the US economy, not the other way around.

Apart from that it is down to two things, he says: within the banks, “sales” did not gain ascendancy over “credit” in Australia to the extent that it did in the US; and US mortgages are non-recourse whereas banks in Australia can have full recourse to the borrowers’ other assets, which means borrowers are less inclined to just walk away. (Alan Kohler, “Healthy by default“, Business Spectator August 21, 2008; emphases added)

Kris Sayce gave a good comeback to Bloxham’s “most of the debt is held by those who can afford it” line when he noted that “two-fifths of income earners is quite a large pool of people”:

In fact, it’s nearly half the income earners. Is that number any different to any other economy? You’d naturally think the higher income earners would have most of the debt because they’re the ones more likely to want it, need it or be offered it.

So with about 11.4 million Australians employed, that makes for about 4.6 million Australians holding over $1.125 trillion of household debt – remember total household debt is about $1.5 trillion. That comes to about $244,565 per person.

Perhaps we’re not very bright. But we’re struggling to see how that makes the popping of the housing bubble a “virtual impossibility.” (Kris Sayce, “Are Falling House Prices “Virtually Impossible”?“, Money Morning 18 March 2011)

The best comebacks to Alan Kohler’s dinner companion may well be time itself. Impaired assets (See Note [1]) did hit an all-time low of 4.1% of Bank Tier 1 Assets and 0.2% of total assets in January 2008, but by the time Kohler and his banker sat down to dinner, impairment was on the rise again. Impaired assets have since reached a plateau of 25% of Tier 1 capital and 1.25% of total assets—and this has occurred while house prices were still rising. Despite the pressure that full-recourse lending puts on borrowers, this is comparable to the level of impaired assets in US banks before house prices collapsed when the SubPrime Boom turned into the SubPrime Crisis (see Table 2 on page 10 of this paper).

Figure 8

Since real estate loans are worth roughly 7 times bank Tier 1 capital—up from only 2 times in 1990—it wouldn’t take much of an increase in non-performing housing loans to push Australian banks to the level of impairment experienced by American banks in 2007 and 2008.

Figure 9

The level and importance of non-recourse lending in the US is also exaggerated. While some major States have it, many do not—and one of the worst performing states in and since the Subprime Crisis was Florida, which has full recourse lending.

Finally, the “never mind the weight, feel the distribution” defence of the absolute mortgage debt level has a negative implication for the Australian economy: if debt is more broadly distributed in Australia than in the USA, then the negative effects of debt service on consumption levels are likely to be greater here than in America. This is especially so since mortgage rates today are 50% higher here than in the USA. Interest payments on mortgage debt in Australia now represent 6.7% of GDP, twice as much as in the USA. It’s little wonder that Australia’s retailers are crying poor.

Of course, the RBA could always reduce the debt repayment pressure by reducing the cash rate. But with the margin between the cash rate and mortgages now being about 3%, it would need to reduce the cash rate to 1.5% to reduce the debt repayment burden in Australia to the same level as America’s.

Figure 10

So if America’s consumers are debt-constrained in their spending, Australian consumers are even more so—with negative implications for employment in the retail sector.

Compared to the USA therefore, there is no reason to expect that Australian banks will fare better from a sustained fall in house prices. What about the comparison with past financial crises in Australia?

This time really is different

There are at least three ways in which whatever might happen in the near future will differ from the past:

* On the attenuating side, deposit insurance, which was only implicit or limited in the past, is much more established now; and

* If the banks face insolvency, the Government and Reserve Bank will bail them out as the US Government and Federal Reserve did—though let’s hope without also bailing out the management, shareholders and bondholders, as in the USA (OK, so call me an optimist! And if you haven’t seen Inside Job yet, see it);

On the negative side, however, we have the Big Trifecta:

* The bubbles in debt, housing and bank stocks are far bigger this time than any previous event—including the Melbourne Land Boom and Bust that triggered the 1890s Depression.

I’ll make some statistical comparisons over the very long term, but the main focus here is on several periods when house prices fell substantially in real terms after a preceding boom, and what happened to bank shares when house prices fell:

* The 1880s-1890s, when the Melbourne Land Boom busted and caused the 1890s Depression;

* The 1920s till early 1930s, when the Roaring Twenties gave way to the Great Depression;

* The early to mid-1970s, when a speculative bubble in Sydney real estate caused a rapid acceleration in private debt, and a temporary fall in private debt compared to GDP due to rampant inflation;

* The late 1980s to early 1990s, when the Stock Market Crash was followed by a speculative bubble in real estate—stoked by the second incarnation of the First Home Vendors Boost; and

* From 1997 till now.

I chose the first four periods for two reasons: they were times when house prices fell in real (and on the first two occasions, also nominal) terms, and bank share prices suffered a substantial fall; and they also stand out as periods when an acceleration in debt caused a boom that gave way to a deleverage-driven slump, when private debt reached either a long term or short term peak (compared to GDP) and fell afterwards. They are obvious in the graph of Australia’s long term private debt to GDP ratio.

Figure 11

They also turn up as significant spikes in the Credit Impulse (Biggs, Mayer et al. 2010)—the acceleration of debt (divided by GDP) which determines the contribution that debt makes to changes in aggregate demand (See Note [2]).

The Credit Impulse data also lets us distinguish the pre-WWII more laissez-faire period from the “regulated” one that followed it: credit was much more volatile in the pre-WWII period, but the trend value of the Credit Impulse was only slightly above zero at 0.1%.

Figure 12

The Post-WWII period had much less volatility in the debt-financed component of changes in aggregate demand, but the overall trend was far higher at 0.6%. This could be part of the explanation as to why Post-WWII economic performance has been less volatile than pre-WWII, but it also indicates that rising debt has played more of a role in driving demand in the post-War period than before.

Ominously too, even though the post-WWII period in general has been less volatile, the negative impact of the Credit Impulse in this downturn was far greater than in either the 1890s or the 1930s.

Figure 13

One final factor that also separates the pre-WWII data from post-WWII is the rate of inflation. The 1890s and 1930s debt bubbles burst at a time of low inflation, and rapidly gave way to deflation. This actually drove the debt ratio higher in the first instance, as the fall in prices exceeded the fall in debt. But ultimately those debts were reduced in a time of low inflation.

The 1970s episode, on the other hand, was characterized by rampant inflation—and the debt ratio fell because rising prices reduced the effective debt burden. Whereas the falls in real house prices in the 1890s and the 1930s therefore meant that nominal prices were falling even faster, the 1970s fall in real house prices mainly reflected consumer price inflation outstripping house price growth. The 1990 bubble also burst when inflation was still substantial, though far lower than it was in the mid-1970s.

Today’s inflation story has more in common with the pre-WWII world than the 1970s. Our current bubble is bursting in a low-inflation environment.

Figure 14

Now let’s see what history tells us about the impact of falling house prices on bank shares.

The 1880s-1890s

This was the bank bust to end all bank busts—just like WWI was the War to end all wars. Bank shares increased by over 75% in real terms as speculative lending financed a land bubble in Melbourne that increased real house prices by 33% (Stapledon’s index combines Sydney and Melbourne, so this figure understates the degree of rise and fall in Melbourne prices). The role of debt in driving this bubble and the subsequent Depression is unmistakable: private debt rose from under 30% of GDP in 1872 to over 100% in 1892, and then unwound over the next 3 decades to a low of 40% in 1925.

The turnaround in debt and the collapse in house prices precipitated a 50% fall in bank shares in less than six months as house prices started to fall back to below the pre-boom level.

Figure 15

The excellent RBA Research paper “Two Depressions, One Banking Collapse” by Chay Fisher & Christopher Kent (RDP1999-06) argues fairly convincingly that the 1890s Depression was a more severe Depression for Australia than the Great one—mainly because there were more bank failures in the 1890s than in the 1930s. The severity of the 1890s fall in bank shares may relate to the higher level of debt in 1890 than in the 1930s—a peak of 104 percent of GDP in 1892 versus only 76 percent in 1932 (the peak this time round was 157 percent in March 2008).

The correlation of the two series in absolute terms is obvious (the correlation coefficient is 0.8), and the changes in the two series are also strongly correlated (0.42).

Figure 16

The 1920s-1940s

The 1920s began with the end of the great deleveraging that had commenced in 1892. Real house prices rose by about 25 percent in the first two years—though mainly because of deflation in consumer prices—and then fluctuated down for the next four years before a minor boom. But the main debt-financed bubble in the 1920s was in the Stock Market.

Figure 17

There was however still a crash in bank shares after house prices turned south in early 1929. It was not as severe as in 1893, and of course coincided with a collapse in the general stock market (I can’t give comparable figures because of the different methods used to compile the two indices—see the Appendix). But still there was a fall of 24% in bank shares over 7 months at its steepest, and a 39% fall from peak to trough—preceded by a 25% fall in house prices.

Figure 18

Bank shares also tracked house prices over the 20 years from the Roaring Twenties boom to the beginning of WWII: the correlation was 0.44 for the indices, and 0.47 for the change in the indices.

Figure 19

The 1970s

The 1970s bubble was the last gasp of the long period of robust yet tranquil growth that had characterized the early post-WWII period. The peculiar macroeconomics of the time—the start of “Stagflation”—clouds the house price bubble picture somewhat (I discuss this in the Appendix), but there still was a big house price bubble then, and a big hit to bank shares when it ended.

This was Australia’s first really big debt-financed speculative bubble, which most commentators and economists seem to have forgotten entirely. Its flavor is well captured in the introduction to Sydney Boom, Sydney Bust:

Sydney had never experienced a property boom on the scale of that between 1968 and 1974. It involved a frenzy of buying, selling and building which reshaped the central business district, greatly increased the supply of industrial and retailing space, and accelerated the expansion of the city’s fringe. Its visible legacy of empty offices and stunted subdivisions was matched by a host of financial casualties which incorporated an unknown, but very large, contingent of small investors, together with the spectacular demise of a number of development and construction companies and financial institutions. The boom was the most significant financial happening of the 1970s and the shock waves from the inevitable crash were felt right up to 1980. It was an extraordinary event for Sydney, and for Australia.(Daly 1982, p. 1)

House prices rose 40 percent in real terms from 1967 till 1974, and then fell 16 percent from 1974 till 1980. Bank shares went through a roller-coaster ride, following Poseidon up and down from 1967 till 1970, and then rising sharply as the debt-bubble took off in 1972, with a 31 percent rise between late 1972 and early 1973. But from there it was all downhill, with bank shares falling 35 percent across 1973 while house prices were still rising.

But when house prices started to fall, bank shares really tanked, falling 54 percent in just seven month during 1974.

Figure 20

However, the extreme volatility of both asset and commodity prices, and the impact of two share bubbles and busts—the Poseidon Bubble of the late 1960s and the early 1970s boom and bust—eliminated the correlation of bank share prices to house prices that applied in the 1890s and 1930s: the correlation of the indices was -0.46 and of changes in the indices was -0.01.

Figure 21

The 1980s

“The recession we had to have” remains unforgettable. That plunge began with Australia’s second big post-WWII speculative bubble, as Bond, Skase, Connell and a seemingly limitless cast of white-shoe brigaders established the local Ivan Boesky “Greed is Good” church—with banks eagerly throwing money and debt into its tithing box.

It would have all ended with the Stock Market Crash of 1987, were it not for the government rescues (both here and in the USA) that enabled the speculators and the banks to regroup and throw their paper weight into real estate.

Figure 22

Having plunged 30 percent in one month (October, of course), bank shares rocketed up again, climbing a staggering 54 percent in 11 months to reach a new peak in October 1988, as speculators and the second incarnation of the First Home Vendors Grant drove house prices up 37 percent over just one and a half years. Bank shares bounced around for a while, but once the decline in house prices set in, bank shares again tanked—falling 40 percent over 11 months in 1990.

Figure 23

The positive correlations between the indices and their rates of change which had been swamped by the high inflation of the early 1970s returned: the correlation of the indices was 0.45 and the correlation of their rates of change was 0.42.

Figure 24

Which brings us to today.

From 1997 till today

I have argued elsewhere that the current bubble began in 1997, but the debt-finance that finally set it off began far earlier—in 1990. The fact that unemployment was exploding from under 6 percent in early 1990 to almost 11 percent in early 1994 was not, it seems, a reason to be restrained in lending to the household sector. It was far more important to expand the marketing of debt, and since the business sector could no longer be persuaded to take more on, the virgin field of the household sector had to be explored. Mortgage debt, which had flatlined at about 16 percent of GDP since records were first kept, took off, increasing by 50 percent during the 1990s recession (from 1990 till the start of 1994), and ultimately rising by 360 percent over the two decades—from 19 percent of GDP to 88 percent—with the final fling of the First Home Vendors Boost giving it that final push into the stratosphere.

Figure 25

By 1997 the sheer pressure of rising mortgage finance brought to an end a period of flatlining house prices, and the bubbles in both house prices and bank shares took off in earnest.

The rise in bank shares far outweighed the increase in the overall share index (the two indices are now comparable, whereas for the longer series they were compiled in different ways). Bank shares rose 230 percent from 1997 till their peak in 2007, versus a rise of only 110 percent in the overall market index.

The increase in house prices also dwarfed any previous bubble: an increase of over 120 percent over fifteen years.

Bank shares and house prices both tanked when the GFC hit: house prices fell 9 percent and bank shares fell 61 percent. But thankfully the cavalry rode to the rescue—in the shape of the First Home Vendors Boost—and both house prices and bank shares took off again. House prices rose 17 percent while bank shares rose 60 percent (versus a 45 percent rise in the market) before falling 12 percent after the expiry of the FHVB.

Figure 26

The correlation between bank shares and house prices is again positive: 0.51 for the indices and a low 0.1 for the change in indices over the whole period, but 0.46 since 2005.

Figure 27

So now we are on the edge of the bursting another house price bubble. What could the future bring?

When the bubble pops…

There are several consistent patterns that can be seen in the past data.

Firstly, house prices and bank shares are correlated. There was one aberration—the 1970s—but that was marked by peculiar dynamics arising from the historically high inflation at the time. Generally, bank shares go up when house prices rise, and fall when the fall. Partly, this is the general correlation of asset prices with each other, but partly also it’s the causal relationship between bank lending, house prices, and bank profits: banks make money by creating debt, rising mortgage debt causes house prices to rise, and rising house prices set off the Ponzi Scheme that encourages more mortgage borrowing. The bubble bursts when the entry price to the Ponzi Scheme becomes prohibitive, or when early entrants try to take their profits and run.

Secondly, the fall in the bank share price is normally very steep, and it occurs shortly after house prices have passed their peaks. Holding bank shares when house prices are falling is a good way to lose money—and conversely, if you get the timing right, betting against them can be profitable. That’s why Jeremy Grantham—and many other hedge fund managers from around the world—are paying close attention to Australian house prices.

Thirdly, house prices and bank shares are driven by rising debt, and when debt starts to fall, not only do house prices and bank shares fall, the economy also normally falls into a very deep recession or Depression. This is the crucial role of deleveraging in causing economic downturns, including the serious ones where debt falls not just during a short cycle prior to another upward trend, but in an extended secular decline.

There is also one cautionary note about the current bubble: though history would imply that there is a very large downside to bank shares now, it’s also obvious that bank shares fell a great deal in 2007-09, so that much of the downside may already have been factored in.

However, on every metric: on the ratio of debt to GDP, on how much that ratio rose from the start of the bubble to its end, on how big the house price bubble was, and on how much bank shares rose, this bubble dwarfs them all.

Debt to GDP

The 1997 debt to GDP ratio started higher than all but the 1890s bubble ended, and the bubble went on long after all the others had popped.

Figure 28

Though the actual debt to GDP ratio today dwarfs all its predecessors, in terms of the growth of debt from the beginning of the bubble, it has one rival: the 1920s.

Figure 29

However this is partly because of deflation during the early Great Depression: deflation ruled from 1930 till 1934, and the debt to GDP ratio rose not because of rising debt, but falling prices. Though the increase in debt in the final throes of the Roaring Twenties was faster than we experienced, over the whole boom debt grew as quickly now as then, and it has kept growing for four years longer than in the 1920s. Even though the ratio is falling now, it’s because debt is now rising more slowly than nominal GDP: we still haven’t experienced deleveraging yet (unlike the USA).

House Prices

The rise in prices during this bubble again has no equal in the historical record.

Figure 30

Bank Shares

Bank shares are also in a class of their own in this bubble, even after the sharp fall from 2007 till 2009. In terms of how high bank share prices climbed, this bubble towers over all that have gone before, and even what is left of this bubble is still only matched by the biggest of the preceding bubbles, the 1890s and the 1970s.

Figure 31

It’s a long way from the top if you’ve sold your soul

Bank lending drove house prices sky high, and the profits banks made from this Ponzi Scheme dragged their share prices up with the bubble (and handsomely lined the pockets of their managers).

It’s great fun while it lasts, but all Ponzi Schemes end for the simple reason that they must: they aren’t “making money”, but simply shuffling it—and growing debt. When new entrants can’t be enticed to join the game, the shuffling stops and the Scheme collapses under the weight of accumulated debt. There are very good odds that, when this Ponzi Scheme collapses and house prices fall, bank shares will go down with them.

Appendices

Stagflation

Between 1954 and 1974, unemployment averaged 1.9 percent, and it only once exceeded 3 percent (in 1961, when a government-initiated credit squeeze caused a recession that almost resulted in the defeat of Australia’s then Liberal government, which ruled from 1949 till 1972). Inflation from 1954 till 1973 averaged 3 percent, and then rose dramatically between 1973 and 1974 as unemployment fell.

This fitted the belief of conventional “Keynesian” economists of the time that there was a trade-off between inflation and unemployment: one cost of a lower unemployment rate, they argued, was a higher rate of inflation.

But then the so-called “stagflationary” breakdown occurred: unemployment and inflation both rose in 1974. Neoclassical economists blamed this on “Keynesian” economic policy, which they argued caused people’s expectations of inflation to rise—thus resulting in demands for higher wages—and OPEC’s oil price hike.

Figure 32

The latter argument is easily refuted by checking the data: inflation took off well before OPEC’s price hike.

Figure 33

The former has some credence as an explanation for the take-off in the inflation rate—workers were factoring in both the bargaining power of low unemployment and a lagged response to rising inflation into their wage demands.

Figure 34

The Neoclassical explanation for why this rise in inflation also coincided with rising unemployment was “Keynesian” policy had kept unemployment below its “Natural” rate, and it was merely returning to this level. This was plausible enough to swing the policy pendulum towards Neoclassical thinking back then, but it looks a lot less plausible with the benefit of hindsight.

Figure 35

Though inflation fell fairly rapidly, and unemployment ultimately fell after several cycles of rising unemployment, over the entire “Neoclassical” period both inflation and unemployment were higher than they were under the “Keynesian” period. So rather than inflation going down and unemployment going up, as neoclassical economists expected, both rose—with unemployment rising substantially. On empirical grounds alone, the neoclassical period was a failure, even before the GFC hit.

Table 1

Policy dominance Keynesian Neoclassical

Years 1955-1976 1976-Now

Average Inflation 4.5 5.4

Average Unemployment 2.1 7

There was a far better explanation of the 1970s experience lurking in data ignored by neoclassical economics: the level and rate of growth of private debt. As you can see from Figure 32, private debt, which had been constant (relative to GDP) since the end of WWII, began to take off in 1964, and went through a rapid acceleration from 1972 till 1974, before falling rapidly.

The debt-financed demand for construction during that bubble added to the already tight labor market, and helped drive wages higher in both a classic wage-price spiral and a historic increase in labor’s share of national income—which has been unwound forever since.

Figure 36

Inflation, higher unemployment that weakened labor’s bargaining power, anti-union public policy and an approach to wage-setting policy that emphasized cost of living adjustments but ignored sharing productivity gains, all contributed to that unwinding.

The share market indices

The bank share index used in this post was compiled by combining 3 data sources. Working backwards in time, these were:

* The S&P’s ASX 200 Financials Index (AXFJ) from May 2001 till now;

* A composite formed from the prices for the 4 major bank share prices that matches the value of the Financials Index from 2000 till May 2001; and

*

Data from the Global Financial Database from 1875 till 2000, which in turn consists of three series:

o “Security Prices and Yields, 1875-1955,” Sydney Stock Exchange Official Gazette, July 14, 1958, pp 257-258 (1875-1936), together with D. McL. Lamberton, Share Price Indices in Australia, Sydney: Law Book Co., 1958; and

o The Australian Stock Exchange Indices, Sydney: AASE, 1980; and

o Australian Stock Exchange Limited, ASX Indices & Yields, Sydney: ASX, 1995 (updated till 2000)

From a perusal of the GFD documentation and a comparison of the Banking and Finance index to the broader market index, it appears that the bank index is a straight price index pre-1980, whereas the GFD’s data for the overall market is an accumulation index till 1980 and a price index after that. These inconsistencies make it impossible to compare the two over the very long term, but the movements in each at different time periods can be compared (and the comparison is also fine from 1980 on).

[Tiger Woods?]

This Time Had Better Be Different: House Prices and the Banks Part 2

by Steve Keen on April 11th, 2011 at 8:57 am

Posted In: Debtwatch

Blue Skies - why not just post a link and a few choice quotes? it is much easier to read on Steve Keen's blog and the blog has the all important graphs.

[newjez]

Predicting what is going to happen is childs play.

The trick is predicting when and what will trigger it.

At the moment I'm having trouble seeing what will trigger an Australian crash.

[blue skies]

Blue Skies - why not just post a link and a few choice quotes? it is much easier to read on Steve Keen's blog and the blog has the all important graphs.

Ok I would if I new how too.

[Tiger Woods?]

Ok I would if I new how too.

Copy the URL from your browser and click on the insert link button (looks like a chain link with a green dot under it next to the smiley face and just under the Sizes drop down on the HPC post reply screen) then paste the link into the URL box that appears. Link text can be written in the box below.

If you want to be really clever, proceed as above, but select the text in your reply that you want to be the link text just before pressing the insert link button.

[Paddles]

Copy the URL from your browser and click on the insert link button (looks like a chain link with a green dot under it next to the smiley face and just under the Sizes drop down on the HPC post reply screen) then paste the link into the URL box that appears. Link text can be written in the box below.

If you want to be really clever, proceed as above, but select the text in your reply that you want to be the link text just before pressing the insert link button.

I don't see why he has to though, seeing as how Bardon has spent about 50 pages of this thread copying bullish articles from "news"papers with huge advertising revenue from the Australian house market. It's quite refreshing to fill some space with an alternate view.

But yeah, the graphs work better on Steve's blog.

Mish's email today is hugely bearish on Oz, by the way.

EDIT: Where IS Bardon anyway?

Edited April 11, 2011 by Paddles

[aussieboy]

I don't see why he has to though, seeing as how Bardon has spent about 50 pages of this thread copying bullish articles from "news"papers with huge advertising revenue from the Australian house market. It's quite refreshing to fill some space with an alternate view.

But yeah, the graphs work better on Steve's blog.

Mish's email today is hugely bearish on Oz, by the way.

EDIT: Where IS Bardon anyway?

Maybe he shorted bananas and lost the lot. Two small ones this morning from Woolies: $5.

That's what you get when you're forced to buy Australian. That and potatoes that cost more per kilo than apples.

[blue skies]

EDIT: Where IS Bardon anyway? .......................................It is most out of his charactor not to be jumping on every post . I recon it must be some thing very grave. If I was to gess I would say, Kicked out ? Dead? Debtors Prision? or maybe he finally understands the housing bubble has run its course and is running for the exits. I did get a bulldust personal chat from "moderators" whos listed friend was Bardon . I gess he may have had his wings cliped.

[aussieboy]

Given the current exchange rates, I just don't get it. Aussie houses no longer look cheap relative to the USD/GBP etc.

Me neither. People I know either committed to return when the rate was better, or have structural timing issues (schools) or think / thought that the current cross rates can't / couldn't last forever.

Bloke I know is receiving his payout in four tranches from his old employer in GBP and has been here since 08. First lot was at an ok rate but it's gone south since and he's stuck here with a settled family.

There's lots of small stories that add up to the bigger picture.

[blue skies]

Australian Home Sales Sink, Luxury Units Sell for Half Cost; New Home Loans at 10-Year Low; Australia Retailers in Deep Trouble; Party Officially Over

Things are not looking too hot down under. Not only is the Australia housing collapse picking up steam, but Australian retailers are struggling mightily in spite of rising sales numbers.

Bloomberg reports Australia Retail Sales, Loans Rose in February, Sending Dollar to Record

Australian retail sales rose in February and lending to businesses climbed for the first time in nine months, according to government reports that sent the nation’s currency to a record against the U.S. dollar.

Sales advanced 0.5 percent from a month earlier, when they gained 0.4 percent, the Bureau of Statistics said in Sydney today. That was the biggest increase since July and was higher than the median forecast in a Bloomberg News survey of 24 economists for a 0.4 percent increase.

A separate report from the Reserve Bank of Australia showed total credit extended by Australian lenders last month jumped by the most since May, led by business loans. The signs of stronger consumer spending and a lending revival boosted the local dollar as confidence grew that natural disasters didn’t derail the economy’s expansion.

That is the extent of the good news.

Housing is a veritable disaster. Even retail sales do not look so good from the perspective of retail profits.

Frugal is the New Black, Tourism Sinks, Retailers Struggle

The Australian reports Mining hides flatlining Australian economy

The growth in employment, which yesterday pushed the March jobless rate below 5 per cent, is concentrated in a handful of industries, several of which have little to do with the overall health of the economy.

The Australian Chamber of Commerce and Industry's latest survey of business confidence found that 34.5 per cent of businesses say trading conditions are poor, while the number expecting conditions to deteriorate over the next three months has almost doubled since the beginning of the year to 18.7 per cent.

"The non-mining sectors, which still make up 90 per cent of the economy, are exposed to pressure from interest rates, the dollar, cautious household spending and rising oil prices," ACCI economics director Greg Evans said.

Figures released this week revealed spooked consumers and a sluggish housing market had put even the booming mining state of Western Australia into a technical recession, with two consecutive quarters of economic contraction.

The latest figures from RP Data revealed house prices fell in every capital city except Sydney in February, with the strong growth experienced in the market in 2009 flattened in the past year by the run of interest rate rises.

Retail king Gerry Harvey, co-founder of the Harvey Norman electrical and furnishings chain, yesterday described a "multi-speed economy" in which only the mining, food and hardware sectors were flourishing.

"There's an awful lot of retailers just surviving, who have sacked all their staff and kept on mum, dad and the kids working 14 hours a day just to keep the doors open," Mr Harvey said. "You'll see a lot of retailers going in the next few months - they just can't survive - and the small ones are going under every day."

Australian National Retailers Association chief executive Margie Osmond said retail was "the sick man of the economy. "We've been severely bruised by interest rate activities, and we have a community completely conditioned now to discount-only. Frugal is the new black."

But Australian Tourism Export Council managing director Felicia Mariana notes that foreign visitors are less likely to stray beyond the big cities, starving regional towns of investment. "Further afield, you'll see hotel occupancy rates of 30, 40, 50 per cent," she said yesterday. "People are using the internet to build itineraries and they are less and less inclined to meander and drive four or five hours to find an interesting place."

The trend is most apparent in far north Queensland, where visitor numbers fell 9 per cent last year. Tourism spending fell 12 per cent - and the fall-off came even before Cyclone Yasi and floods ravaged the region.

Luxury Units Sell For 50% of Cost

The Fraser Coast Chronicle reports Luxury units go at basement prices

AFTER more than 18 months on the market, the luxury Riverview On March apartments finally went under the hammer yesterday — and about 140 people came to watch as they sold for a song.

Valued at $650,000 to $700,000-plus each, four of the six units sold. They fetched $510,000, $320,000, $339,000 and $300,000.

Auctioneer Jason Andrew was made to earn his keep in cajoling every last dollar out of the buyers, but bidding was desultory for the two penthouses, which were eventually passed in because they did not meet the reserve price.

Developer Ron Blyth admitted he felt hard done by, with three of the four sold units going for less than half the building cost.

Even on the highest-selling apartment, Mr Blyth lost about $200,000 – or a total of about $1.2 million for the combined sales.

“It's less than encouraging,” he said. “The situation probably is that real estate isn't in vogue at the moment.” “I thought we had enough interest to get them sold, but there w bidders there and they didn't all bid.”

There were not really 30 bidders there were 4 bidders and 26 "Lookie Lous". Expect to see "No Bid" with increasing frequency at auctions.

New Housing Loans at 10-Year Low

The Australian reports Buyer retreat spells slump in home prices

BUYERS are deserting the housing market at a pace that threatens a slump in housing prices and a risk to the economic outlook.

The number of new housing loans approved by the banks dropped 5.6 per cent to a 10-year low in February, after a similarly sharp drop in the previous month.

The buyer retreat comes as the stock of unsold houses mounts. Figures compiled by property analysts SQM Research show there are now 356,600 properties on the market, which is almost 50 per cent more than a year ago.

"It is clear now that the sudden drop in finance approvals in the new year is not to do with the flooding, but is rather due to the Reserve Bank's interest rate rise in November, which was the straw that broke the camel's back," SQM chief executive Louis Christopher said.

The slump threatens to undermine budget calculations for the government, which is counting on a rapid return to growth in the next financial year.

The number of loans for new homes slumped 12 per cent in February and has dropped almost 36 per cent in the past three months. Home building is a key economic sector influencing both the health of manufacturing and consumption.

Mr Christopher said the market was likely to continue weakening until the Reserve Bank cut rates or there was some form of government stimulus.

Stimulus the Problem, Not the Solution

I cannot help but laugh at some of the comments by SQM chief executive Louis Christopher.

For starters, one last interest hike did not break the camel's back, nor will buyers return when the Reserve bank of Australia cuts rates.

Christopher seems to be angling for more stimulus. Has anyone, anywhere learned anything from the popping of the US housing bubble?

Hells bells it took massive stimulus and silly bank loans to reach peak housing insanity in the US, in Australia, in China, in the UK, in Spain, in Ireland, and for that matter everywhere there was a housing bubble.

Perhaps this annotation I made on the Australian graphic will help.

Buyer Exhaustion - Pool of Greater Fools Runs Out

Australia is suffering from buyer exhaustion after the Australian government foolishly stimulated housing to stave off the last recession.

Buyer exhaustion would have set in whether the Reserve Bank made that last rate hike or not. .

Now what?

Housing inventory is both huge and rising, few can afford homes, and those who can afford homes already have one (if not more).

Simply put, the pool of greater fools has run out.

Stimulus will not help. After all, how many rounds of stimulus did the US try to restore housing prices? Let me count the ways.

US Housing Stimulus Tried and Failed

1. Fannie and Freddie nationalized

2. Home buyer tax credits

3. Home buyer tax credit extensions

4. HAMP - Home Affordable Mortgage Program

5. Numerous foreclosure moratoriums

6. QE round I

7. QE round II

8. Fed bought $2 trillion in mortgages to keep rates low

9. Fed holding short-term rates at zero percent

10. Record low mortgage rates

Did any of those work? How many others did I miss?

Regardless of how many I missed, none of them worked. So why would they work in Australia?

Please don't tell me it's different down under, and don't tell me there is a shortage of housing either. Skyrocketing inventory and falling demand says otherwise. Besides, it's a simple economic fact that home prices cannot sustainably rise above people's ability to pay for them. Nor can home prices sustainably rise several standard deviations above rental prices.

Party is Now Officially Over

Please pay attention to those struggling retailers. Australian retail sales will collapse once the housing bubble bust pick up more steam. That collapse in retail sales will crucify banks that made poor commercial real estate loans and it will bankrupt store owners who paid too much for their stores.

Look for the Reserve Bank of Australia to cut rates. It will not matter when they do. It was one hall of a party Australia, but the party is now officially over.

Mike "Mish" Shedlock

[Tiger Woods?]

Maybe he shorted bananas and lost the lot. Two small ones this morning from Woolies:

That's one trade I wouldn't have wanted ot be on the wrong side of...I mean Ladyfingers are expensive and volatile, but Cavendish are $10.99/kilo everywhere around here at the moment

Edited April 11, 2011 by Tiger Woods?