Australia Faces Its Demons

[blue skies]

Nope afraid not I think you bears are all salivating about nothing as usual. Not a skerrick of a bubble in that statement. Quite the opposite in fact.

You bears can convince yourself of anything, we know that, but putting words in the Governors mouth, continually restating it, and conjuring up a bubble and giving ecah other high fives, well that is getting a bit desperate. But desperation is all you have.

[/quote

Hmmmmmmmm you put a lot of faith in Glen Stevens and oddly enuf dismiss his warnings.

Are you the only person in Australia who has a different veiw of what he is trying to comunicate?

Any how its yours and mostly other peoples money do as you will.

RBA's housing comments 'stun' real estate chief

March 30, 2010 - 5:22PM

The president of Australia’s peak real estate industry body is ‘‘astonished’’ that Australia’s top central banker queried the wisdom of going into hock to invest in property.

The comment sparking the reaction came from Reserve Bank of Australia governor Glenn Stevens in an interview aired yesterday.

‘‘I think it is a mistake to assume that a riskless, easy, guaranteed way to prosperity is to be leveraged up into property.

‘‘It isn’t going to be that easy,’’ Mr Stevens told interviewer David Koch on Seven’s Sunrise program.

On the other hand, the real estate industry would prefer it to be just that easy.

In a statement released today, the Real Estate Institute of Australia said its president, David Airey, was ‘‘stunned’’ to hear Stevens had said ‘‘property was no longer the easy path to prosperity’’.

‘‘I’m astonished the RBA governor would get so involved in the property market and effectively warn Australians not to buy or invest in property,’’ the statement quoted Airey as saying.

The divergence of views is understandable, given that the RBA and the REIA have divergent mission statements.

Even so, it would be easy to overstate the extent to which the RBA’s plans threaten to dash the hopes of the real estate industry - assuming the real estate industry’s hopes extend beyond the coming weekend’s auctions.

Once the dust settles, the recovery in demand for housing will come to be seen as ‘‘a normal upturn followed by a stabilisation period’’.

But, in all likelihood, that would be considered by the RBA to be an ideal outcome rather than something to be avoided.

What the RBA would like to avoid is a boom financed by ever-increasing levels of debt, which explains Stevens’ pointed comment about being ‘‘leveraged up’’, or in greater debt to finance bigger asset purchases.

The problem with leveraging, as many homebuyers in the US and the UK are finding, is that it also magnifies the potential losses, exposing the homebuyer or investor to the real risk of owing more than the value of their asset if prices fall.

It is not the first caution the RBA has issued on this score.

‘‘Increased indebtedness raises households’ exposure to shocks to their incomes and financial circumstances’’, it warned in its quarterly monetary policy statement earlier this month.

Only a small proportion of households were ‘‘very highly geared’’ - that is, with a very high level of borrowing relative to their assets.

The most recent data, for late 2008, showed only about 2 per cent of households with mortgages on their homes paid more than half their disposable income on debt repayments and owed more than 90 per cent of the value of their homes.

And households with mortgages made up only a little over a third of the total.

Two per cent of one third amounts to a relatively small proportion.

But the global financial crisis showed what can happen when excessive borrowing gets out of control and defaults by a small number of borrowers can start an avalanche.

It does not want that 2 per cent to grow to 4 or 6 per cent.

And the REIA should be glad the RBA takes that view.

For the alternative, it has only to look to the US.

There, despite more than a year of near-zero official interest rates, housing prices are still down by around 30 per cent from their peak four years ago and lenders have foreclosed on five million home loans in the past two years alone.

Partygoers will always complain when, as the old saying goes, the central bank takes away the punchbowl just as the party gets going.

But it can avoid a nasty hangover.

[Mmmm]

Every time someone pulls out this clever rejoinder with no effort to explain why Australia should be exactly the same as every other country, they're going to get me posting this piece of unaddressed selective statistical guff from the King of the Bears which actually shows an incredible amount of inter-country price variability over the last 25 years.

http://www.keenwalk.com.au/wp-content/uploads/images/T-Shirt/KeenT-Shirt01RealHousePrices02.jpg

"Notice he doesn't have the UK prices on his T Shirt.

Would anyone in the "all countries are the same" camp care to explain the vast inter-country differences on this chart?"

Aussieboy, do you live in Coober Pedy? The whole point of that chart you posted seems to have flown so far over your head I think you must be living underground.

Steve Keen has put that chart on his T-shirt design because it illustrates the fairly simple point that house prices, and house bubbles, go up when you increase debt (massively), and they go down, or pop, when you can no longer afford to service that debt. Hence Japan has had twenty years of deflation after their bubble poppped in 1980, US prices are goingdown as they are deleveraging, and Australian prices are still going up because since the GFC started we have actually increased our debt levels. Go back a few posts and look at Mill's model for the lifecycIe of a bubble and you see the three lines show what happens at three different stages of a bubble - Revulsion (Japan), Financial distress (US) and euphoria (Australia). In other words, that chart is showing you what Australia has to look forward to.

The other thing you seem to have missed is that the slogan on the chart is ironic. A bit subtle for you perhaps. But just to make it clear, Steve Keen didn't put the chart on the T-shirt because he thinks it shows he was wrong about house prices. He put the chart on the T-shirt because he think it shows he's right. Irony you see.

[Mmmm]

From The Age:

Caught in the cogs of the tax regime March 30, 2010

Housing exists to provide shelter for families, not shelter from tax, and the law should be changed to reflect this.

SINCE 1987, under Labor and Liberals alike, the federal government's housing policy has worked to make housing more unaffordable. The task of policy now is to reverse that, and make housing affordable. That cannot be done by small schemes, such as those Kevin Rudd took to the 2007 election. It will require bold actions, and politically dangerous ones.

But if you want to solve the problem, and make housing affordable, these are actions you have to take. While housing is a tax shelter, more and more money will flow into it. That money will keep bidding up prices, pushing them further out of reach of aspiring home buyers.

The same is true for the foreign money that has flowed in over the past year, after the Rudd government changed the foreign investment rules. At the time, it feared a damaging property bust. Instead, it has fuelled another price boom - how much, we don't know, because for all the anecdotes, the government collects no data on how many properties temporary residents are buying.

Ordinary Australians expect to be able to buy their own home. Young and lower-income Australians are fed up with policies that work against them being able to do so. The proportion of homes they can afford to buy is shrinking year by year - right now, month by month.

For a bold government, there is an opportunity to cut through and make big reforms by appealing to people's sense of fairness and the need to get policy back on track.

In one swoop, it should remove the two big tax distortions of the market. End the exemption of the family home from capital gains tax. End the tax break for negative gearing - or limit it to new homes built by the investor. And, at the very least, require temporary residents to report their property purchases, so we can know whether we have a problem or not.

Over time, those changes will bring down housing prices relative to income. Tax breaks for housing have inflated house prices. Phase them out, and prices will fall back into a range that ordinary people can afford.

Last week, the Tax Office reported that at least 1.2 million Australians - one in every 10 taxpayers - are now negatively geared landlords. On average, in 2007-08, they claimed losses of more than $200 a week on their properties. This gave them a tax break of about $5 billion that year - 4 per cent of all income tax revenue. In effect, other taxpayers had to pay that $5 billion to subsidise their losses.

As public policy, this is ridiculous. But since negative gearing was restored in 1987, this tax break and the decision to halve the tax rate on capital gains have seen investors' share of finance to buy existing homes jump from 8 per cent to 40 per cent. Those squeezed out were first home buyers.

My article last week led to an interesting debate on The Age website, and later on the Business Spectator website. Not surprisingly, many landlords argue passionately that negative gearing is good for us - but mainly because they misunderstand how the housing market works. Let's take those arguments, and see how they stack up to reality.

Claim 1: If tax breaks for negative gearing were limited to offsetting rental income, landlords would pull out of the market. This would create a shortage of rental housing, and drive up rents. The victims would be the renters.

Response: This is a basic misunderstanding of something that is quite simple. If a house is not sold to a landlord, it will be sold to someone buying their own home. There will be one less home for rent, and one less household looking for rental accommodation. Supply will fall by one, demand will fall by one. There will be no change in the balance of supply and demand, hence no shortage, and hence no rent rises on this score. It would be different if investors stopped building new housing. But 91 per cent of lending to investors is for purchase of existing homes. One option for reform is to restrict the tax break to construction of new homes.

Claim 2: We saw what happened when the negative gearing tax break was abolished in 1985. Investors stopped building new homes and and rents soared. That will happen again.

Response: Sorry, but that is an urban myth. Yes, construction fell, but by investors and owner-occupiers alike, and why? Because interest rates soared to 17.5 per cent for investors and 15.5 per cent for owner-occupiers. Even so, construction by investors was a higher share of GDP in those years than in 2009.

As for rents, Bureau of Statistics figures show capital city rents rose 22 per cent in the two years when the tax break was abolished, and 23 per cent in the following two years after it was restored. End of urban myth!

Claim 3: Investors in all kind of assets are allowed to write off losses against income from other sources. To restrict rental investors to writing off losses against rental income only would introduce a new distortion that would simply push investment elsewhere.

Response: This argument normally has force. But when 70 per cent of housing investors are claiming losses, we have a distortion here and now. It is sending investment into activities that clearly do no good to the economy, and harm those who want to be able to buy their own homes.

The problem is not landlords: they will always have an important social role. The problem is the tax laws, and the politicians on both sides who lack the courage to right the wrong done to younger and lower-income Australians.

We also need to build more homes, especially in inner and middle suburbs where people want to live. But that is another story, for another day.

Tim Colebatch is economics editor.

[aussieboy]

Aussieboy, do you live in Coober Pedy? The whole point of that chart you posted seems to have flown so far over your head I think you must be living underground.

Steve Keen has put that chart on his T-shirt design because it illustrates the fairly simple point that house prices, and house bubbles, go up when you increase debt (massively), and they go down, or pop, when you can no longer afford to service that debt. Hence Japan has had twenty years of deflation after their bubble poppped in 1980, US prices are goingdown as they are deleveraging, and Australian prices are still going up because since the GFC started we have actually increased our debt levels. Go back a few posts and look at Mill's model for the lifecycIe of a bubble and you see the three lines show what happens at three different stages of a bubble - Revulsion (Japan), Financial distress (US) and euphoria (Australia). In other words, that chart is showing you what Australia has to look forward to.

The other thing you seem to have missed is that the slogan on the chart is ironic. A bit subtle for you perhaps. But just to make it clear, Steve Keen didn't put the chart on the T-shirt because he thinks it shows he was wrong about house prices. He put the chart on the T-shirt because he think it shows he's right. Irony you see.

Ooh, get her. Back in the knife drawer. Just to check, you do know that the slogan on the chart was the one he was required to put there by the terms of his wager, that being the whole point of his walk of penance..? You can't have missed that.

I'm clearly blind as well as thick, because you are going to have to show me where on the T shirt debt levels are compared. Without putting any debt info on the chart it's hard to draw any conclusions. The link behind this chart and the model you espouse rather stands or falls on that I would have thought. I'm not a Japanese debt expert, but I would suggest they've had insufficent household deleveraging to explain their degree of house price deflation. Looking through his website, there's little information relating to this relationship.

I also take issue with Prof Keen's selective use of data. Is the UK omitted because it doesn't conform to the model or some more technical reason? I'd suggest that the UK economy is rather more similar to Australia's than the Japanese economy is so it seems odd that Japan is given ad nauseam as the exemplar house price model. The uncharitable would jump to the conclusion that the UK doesn't work so well on the T shirt... which is probably why you've also chosen to ignore that part of what I posted.

Also, look at the time frames on his graph. It took Japan 20 years to go from peak to (probable) trough. It took the US, what, three if we take these graphs as our gospel (see - it's ticking up)? Look at the graph on the front page of this website. It took the UK twelve months to do the same. Wish for a double dip all you like, but it ain't happening according to the latest Rightmove figures. And have you looked at how UK mortgage debt has changed during the last twelve months of this recovery? Has it gone up? What do you reckon?

You also we're at different points in the cycle... but I thought all countries were the same? Are you saying that Australia is different? If so, great, can I quote you?

[Mmmm]

Ooh, get her. Back in the knife drawer. Just to check, you do know that the slogan on the chart was the one he was required to put there by the terms of his wager, that being the whole point of his walk of penance..? You can't have missed that.

Yes I knew that.

I'm clearly blind as well as thick, because you are going to have to show me where on the T shirt debt levels are compared. Without putting any debt info on the chart it's hard to draw any conclusions. The link behind this chart and the model you espouse rather stands or falls on that I would have thought. I'm not a Japanese debt expert, but I would suggest they've had insufficent household deleveraging to explain their degree of house price deflation. Looking through his website, there's little information relating to this relationship.

You're probably right, about deleveraging in Japan. Japanes house pirces still aren't going up are they? By the way, the buble burst in 1990 not 1980 (my mistake) and I note from the chart in your link that household debt as a percentage of GDP increased by about 50% in the decade before the bust.

I also take issue with Prof Keen's selective use of data. Is the UK omitted because it doesn't conform to the model or some more technical reason? I'd suggest that the UK economy is rather more similar to Australia's than the Japanese economy is so it seems odd that Japan is given ad nauseam as the exemplar house price model. The uncharitable would jump to the conclusion that the UK doesn't work so well on the T shirt... which is probably why you've also chosen to ignore that part of what I posted.

UK fits fine. They have turned around prices by slashing interest rates and cutting stamp duty. In other words, expansionary monetary policy... which inflates asset prices. Increasing debt is usually a by-product of expansionary policy, but in this case the debt is already inflated to a critical level, so the loose policy just stops it from collapsing... for the time being...if/when the expansionary policy leads to inflation they may be forced to tighten and asset prices will fall again. Certainly you're right that the UK graph wouldn't look good on the shirt. I can see why they took the UK off the T-shirt because you need to explain the bounce.

Also, look at the time frames on his graph. It took Japan 20 years to go from peak to (probable) trough. It took the US, what, three if we take these graphs as our gospel (see - it's ticking up)? Look at the graph on the front page of this website. It took the UK twelve months to do the same. Wish for a double dip all you like, but it ain't happening according to the latest Rightmove figures. And have you looked at how UK mortgage debt has changed during the last twelve months of this recovery? Has it gone up? What do you reckon?

Japan has taken ages to correct, resulting in the famous "lost decade" which was really two decades, of virtually no growth. Within those two decades they had rallies, of 12 months length even, when they thought it was all over. What makes you think the US has bottomed? Quite possibly it will take the US and UK a decade to shake this through. I think you'd be rather stretching it to say the US or UK are out of the woods. UK is on the verge of losing their AAA credit rating (like Japan did). US may get there too.

You also we're at different points in the cycle... but I thought all countries were the same? Are you saying that Australia is different? If so, great, can I quote you?

Edward Chancellor's article posted a couple of pages back gives a pretty good account of why Australia has avoided a crash so far

http://www.ft.com/cms/s/0/be5b9b52-2308-11df-a25f-00144feab49a.html

[JonoP]

One of the other things that makes me chuckle is the Australian LAFHA scheme. Or the ‘Living Away From Home Allowance’ to give it it’s full title.

Pretty much anyone on temporary working visa can get it.

Basically, it is another housing related tax dodge. So, say for example rent for an apartment is just over $3K per month. The renter would be delighted to find that they can claim 40 odd percent tax back against the cost of the monthly rent.

This tax rebate is deducted at source by their employer, basically meaning that they pay circa $1200 less income tax each month (and get to keep the $1200 themselves).

So, on one hand, you have the negative gearing tax break pushing up the price of housing. This in turn means that rents get more expensive, which means that I pay less income tax. Classic!

The really bad thing about all of this is that there are a whole bunch of ‘average joe’ Australians out there who are funding these tax breaks for property speculators like Bardon and renters such as myself. I do question why they do not kick up more of a stink.

But, I suppose, these are the same people who are used to getting fleeced day in, day out, by Australian businesses, so it does not really register when the government does it as well. Oh well.

As a final point, I was advised the other day that Vegemite purchased in a UK supermarket is a third of the price of Vegemite purchased in an Australian supermarket. Not sure if this is an urban legend as I cannot be bothered to check it out, but it makes a good story.

[Mmmm]

I can feel a T Shirt coming on

Non-performing loans are primarily related to unemployment, which spikes in the recessionary aftermath of a housing crash. You can see that on the graph. Non-performing loans in Australia will increase after a crash, not before it.

[aussieboy]

Edward Chancellor's article posted a couple of pages back gives a pretty good account of why Australia has avoided a crash so far

http://www.ft.com/cms/s/0/be5b9b52-2308-11df-a25f-00144feab49a.html

You're relying on that? Really?

On other matters:

Yes I knew that.

Your writing suggested quite the opposite

You're probably right, about deleveraging in Japan. Japanes house pirces still aren't going up are they? By the way, the buble burst in 1990 not 1980 (my mistake) and I note from the chart in your link that household debt as a percentage of GDP increased by about 50% in the decade before the bust.

Yes - and it stayed there. Bugger all deleveraging, yes? Went up from 66% to 69% or something during the lost Decade? Prices aren't going up... but they sure aren't crashing either.

UK fits fine. They have turned around prices by slashing interest rates and cutting stamp duty. In other words, expansionary monetary policy... which inflates asset prices. Increasing debt is usually a by-product of expansionary policy, but in this case the debt is already inflated to a critical level, so the loose policy just stops it from collapsing... for the time being...if/when the expansionary policy leads to inflation they may be forced to tighten and asset prices will fall again. Certainly you're right that the UK graph wouldn't look good on the shirt. I can see why they took the UK off the T-shirt because you need to explain the bounce.

Does it bunnies fit fine. It isn't on the T shirt because house prices in the UK, like Australia, haven't dropped 40% like they "should do" and the prices have recovered during the "Despair" part of the cycle like they "shouldn't do".

And you can't exclude UK data just because "they have turned around prices by slashing interest rates and cutting stamp duty". That's what governments do (er... Japan and its negative interest rates... should they have had a big bounce too?). What kind of model excludes government's (obvious) responses? If you start salamiing your criteria you have lost the argument.

Japan has taken ages to correct, resulting in the famous "lost decade" which was really two decades, of virtually no growth. Within those two decades they had rallies, of 12 months length even, when they thought it was all over. What makes you think the US has bottomed? Quite possibly it will take the US and UK a decade to shake this through. I think you'd be rather stretching it to say the US or UK are out of the woods. UK is on the verge of losing their AAA credit rating (like Japan did). US may get there too.

I have to say "So what" on your Jpn info... except I can't recall any 10% bounces in the house price curve. In fact, I've just scrolled down to look at the T shirt again, and there are no bounces whatsoever. Please show me one. Again, pig sh1t thick I may be, but I always thought my eyesight was fine.

The reason I say the US has bottomed is because according to Prof Keen's T shirt, the US price line goes up at the end. As I pointed out in my post.

The UK has had an entire year of HPI through the worst economy for 80 years. How is it going to get worse? Are they going to sack some people twice?

[aussieboy]

The net effect of all of this is a massive increase in tax, new tax on private home sales and a, reduction in investment deduction.

Guys like this start of on the basis that taxation is a tool to penalise success sand is the right of the govt to collect, some of us have different views on taxation and see reduction as the solution. He also has the audacity to talk about rasing taxes and what is goof for the economy in the same article.

Socialist brainwashing tripe pay more taxes that will fix it.

If negative gearing is removed, rents will rise.

That's why the yields are lower here than in Australia and that, plus LAFHA, is why you can have fun if you relocate to here from the UK.

The guy in the Age's commentary s ridiculous. Does he only think in closed systems?

[aussieboy]

The other thing we don’t talk about in the family anymore was his prediction that unemployment would increase to 20%......

shhh we don’t talk about that anymore.....

What about a graph of Keens predictions for Hpc and unemployment against reality with an adjusted y axis so that it will fit on a normal size human being.

I was disappointed by the lack of charts on his charts page:

http://www.debtdeflation.com/blogs/debtwatch-charts-page/

His data seems to be largely T-shirt based.

[aussieboy]

You know what, he didn't know.

I'll give him the benefit of the doubt on that one...

[blue skies]

1,705,683 land lords

But let's leave our fictional town and return to reality. Last Thursday's Australian Financial Review and The Weekend Australian Financial Review laid bare the desperate story behind property investing, and the confirmation of what we've said all along, that property investors invest solely in the belief that house prices always rise.

We were scorned by some investors who claimed that wasn't true, that income generation was a big part of it. Well, let's take a look at some of the numbers...

According to last Thursday's paper, there are 1,705,683 landlords in Australia. That's roughly 7% of the entire population. But here's the amazing thing, of those 1.7 million landlords 69.4% of them are making a loss based on the income received versus outgoing expenses.

That doesn't surprise us. We've pointed out before that rental properties are a money pit. More money goes in than comes out. And with average rental yields in Melbourne under 4%, it doesn't take a Doctorate from the Université Paris Sorbonne to work out that your costs will exceed your income.

The Weekend AFR, lays out the details. Based on the numbers, $22.9 billion of rent is received each year by landlords, yet total outgoings come in at $31.2 billion, creating a loss of $8.3 billion.

Call us mad if you will, but we're yet to find anywhere in our investing textbooks where it says making a loss from your investments is a good idea.

Now, we're assuming that property investors aren't dumb. They must be taking the hit on the income for a reason. And the simple reason is that they believe the price of housing will continue to rise, and that the rise in the price of the property will more than offset the loss from the income.

Therefore reader, it's unarguable that the primary reason that property investors invest in property is for capital gains rather than income. There's no denying it. In which case, prices have to keep increasing in order for the investors to make any money.

And there's the problem. As we know from every other asset class in Australia and around the world, it's just not possible for the price of an asset to continually rise without a major correction.

Take it from me, whatever excuses the property spruikers come up with, the Australian property market isn't immune from this outcome.

As you can see from our make-believe economy, resources have been skewed towards one area, the buying and selling of houses. All other industries are potentially suffering as no one wants to invest in those industries.

As we say, it's exactly what the Australian banks are doing, investing in houses and mortgages at the expense of other productive sectors of the economy.

But I wanted to mention one other thing. Referring back to the risk/reward attitude, housing is a perfect example of the cart being put before the horse. If you're like me, and you see housing as a consumer item then it makes sense you only buy the consumer item as a reward for your productivity.

It's should be the same with housing.

However, thanks to leverage and the ingrained impression that house prices always go up, housing has changed from being a 'reward' for productivity to being treated as the source of productivity - it is of course, nothing of the sort.

It's not helped by all the ridiculous stories about buying a home being the "Australian dream", and "rent money is dead money", etc...

But this attitude explains why housing is now seen as a leading indicator. How many times over the past year or so have you heard economists looking for positive signs from housing? Almost every month from what we can recall.

There's a simple reason for that. And it's exactly what happens with every asset bubble. Buyers overestimate future price rises and scramble to get in early. You saw it with the dot-com boom, and you're seeing it with the housing boom - "buy now before it's too late."

The overestimation leads to anticipatory buying. Only, not everyone can afford to pay up in advance to get onboard so they have to borrow in order to get a piece of the action. This pushes prices up further and necessitates further borrowing.

Again, does that sound familiar?

In reality and absent price and market manipulation, housing should lag the economy not lead it. Housing is the reward paid for by the productivity of the economy, it's not the driver of the economy itself.

The idea that the housing market can lead an economy out of recession, or to grow the economy is false. Housing is a consumable item. When it is bought or built it is consumed at that point. It provides no further benefit to the economy.

To claim it does is false.

If anything, a positive housing market indicates one of two things. Either people are rewarding themselves for their past productivity, or they are anticipating future productivity and price rises by buying houses now.

The trouble is, if the economy is skewed towards the buying and selling of houses, guess what? There won't be the necessary future productivity to pay off today's anticipatory buying of houses.

With all the credit and investment going into the housing market today, you have to wonder about the future state of the lopsided Australian economy. The simple fact is, buying houses today in the hope that others will pay a higher price for them in the future, isn't the recipe for a sustainable and healthy economy.

Rather, it's the recipe for a boom that is set to bust.

Cheers,

Kris.

[blue skies]

If interst rates go to 10%. just wonder what that will do to house prices?

[aussieboy]

If interst rates go to 10%. just wonder what that will do to house prices?

If interest rates go to 0%, what would that do?

[aussieboy]

SNIP

That doesn't surprise us. We've pointed out before that rental properties are a money pit. More money goes in than comes out. And with average rental yields in Melbourne under 4%, it doesn't take a Doctorate from the Université Paris Sorbonne to work out that your costs will exceed your income.

Not if your post-tax cost of funds is less than 4% post-tax. To someone who has done their dough on Allco etc, a steady ~4% return on a cash investment with some possible upside looks just dandy.

Too late to learn a bit of conversational French?

[Mmmm]

You know what, he didn't know.

Perhaps you suspect in others, what you see in yourself

[Tiger Woods?]

If negative gearing is removed, rents will rise.

Or house prices will fall. It is clear that rents are being determined by what renters can pay when IO mortgages are far higher than rent.

Interestingly, realestate.com.au now allows you to look at property prices in a suburb by suburb basis since 2001.

Every single suburb I looked at was down since 2008. All the significant capital gains were between 2002 and 2006.

Edited March 30, 2010 by D'oh

[blue skies]

If interest rates go to 0%, what would that do?

I asked first!

World wide low interest rates are a new experment that has yet to show the results.

Money allways goes were it does best.

There are only 3 places to put money

1 property: realestate, gold etc

2 cash: bank, government bonds etc

3 shares: equities

Interest rates are close to that in some countries.

So money is feeding the mother of all bubbles as money that was cash is going in to 1 and 3. in the carry trade.

It can only end in tears,

I see 2 possible end games.

1 poverty with no money in our pockets.

2 poverty with our pockets stuffed full of money.

[aussieboy]

More good news

Iron ore price negotiations - Nippon and Sumitomo agree on 90 pct

Nikkei English News, without providing a source for the information, reported that Japanese steelmaker Nippon Steel Corp and Sumitomo Metal Industries has reached a tentative agreement with Brazilian mining giant Vale SA on 90% YoY jump in the price of iron ore for the April June quarter.

The paper said the two sides are not in full agreement and the price negotiations will continue.

The Nikkei said that they hope to resolve their differences by the end of next month, with the agreed on price to be applied retroactively to April 1st 2010.

According to the report, POSCO also provisionally agreed to the price increase.

(Sourced from Bloomberg & Reuters)

Outcompeted by Chinese buyers.

[blue skies]

The bubble that is comodity prices: Iron ore, aulminimum etc must be close to poping.

I remember only 8 years ago new start mines closed down because of poor prices.

In fact the Ravenswood mine was closed down after opening only last year because of the GFC.

It is nothing new for miners to become price takers and not price makers.

[blue skies]

RBA Governor Glenn Stevens Reveals Intention to Raise Interest Rates to Normal Levels

By Dan Denning • March 30th, 2010 •

Well you have to give RBA governor Glenn Stevens credit (no pun intended). He is no Alan Greenspan. He got on the idiot box yesterday and told anyone who would listen that speculating on house prices is crazy. Specifically he said that, "I think it is a mistake to assume that a riskless, easy guaranteed way to prosperity is just to be leveraged up into property. It isn't going to be that easy."

There are two reasons why it's not going to be easy, although we don't speak for the governor. The first is that he pretty clearly telegraphed his intention to raise interest rates to what the RBA considers more "normal" levels. "We can't assume rates will remain low," he told Seven. "The relationship between the cash rate and what they pay for mortgages or small business loans is what we think is useful."

Useful for what? For predicting where mortgage rates are headed. And that would be higher if the relationship between the cash rate and mortgage rates persists. "If you look back when the economy was stable and we had low inflation, the cash rate, that is the rate we decide on, the rate has been in the average of 5 per cent."

So if Stevens thinks the economy is pretty normal now with low inflation, then you'd expect the cash rate to rise from 4% now to at least 5% by the end of the year, beginning as soon as April 6th when the RBA meets again to rig the price of money (we mistakenly said they meet today in yesterday's edition.) In February, Stevens said there was a good chance rates were headed up in the first half of this year.

When the man who sets interest rates tells you that you're rising, it would be wise to at least hear him out. Whether you take him at his word is up to you. But if you're making financial plans - say, like you're going to buy a house and are trying to figure out if you can stand a few extra points rise in the interest rate - the man has told you what is going to happen.

Of course there is the chance, mentioned last week, that bank interest rates have decoupled from the cash rate. This was the possibility raised by NAB execs when they said Australia's dependence on wholesale borrowing from overseas meant that the foreign cost of capital would determine the local cost of capital, not the RBA's price for money. We'll see about that.

In the meantime, Stevens has also said the RBA is watching whether or not "the role of foreign purchases [in the Australian housing market] is an important one." We'd submit that it is. This is the second reason it won't be "easy" for Australians to get risklessly rich in leveraged property investments. They'll be outbid!

It's obvious now that the Rudd government has opened the Australian property market wide open to overseas investors in order to keep the housing market bubbling along. The stamp-rich gorging state governments have not objected. The end result is a huge spike in prices that locks out Australians hoping to enter the market at the bottom end of the property ladder.

Some people might call this the government selling-out the interests of its citizens in order to prevent the bubble from popping on their watch. In fact, we just muttered that aloud to ourselves. And we're not even Australian. But as an American, we've seen these desperate attempts to keep the good times rolling before. It always costs the little guy the most.

To be fair, there isn't much data yet on how much of last year's national price surge was fuelled by foreign buying. And let's face it. By "foreign," most of the media accounts mean Chinese. And you know, from a Chinese perspective, buying real Australian houses with money not subject to Australian interest rates is probably a great investment.

But whether it's such a good thing for Australians depends on who you ask. If you're a Baby Boomer with 3.6 investment properties that you're counting on to fund your comfortable retirement, the influx of cashed-up foreign buyers is just what the doctor ordered. If you're a first home buyer...well...you're going to need a bigger grant...or be willing to live in an outer suburb...or rent for the rest of your life.

Can you see now that we have the confluence of two bubbles? The first is Australia's fevered national pastime of speculating on property. It's all good as long as it's making someone - property spruikers or investors - rich. But what if it makes the Chinese rich? And what if the Chinese investment in Australian property is itself a product of China's massive lending bubble?

As always, all bubbles come back to excessive credit growth. You have to prune away at the flowers these bubbles are decorated with. They make it look pretty, desirable, and natural. But beware!

In a great article we read over the weekend by GMO's Edward Chancellor we found this quotation from 19th century economist John Mills: "Panics do not destroy capital; they merely reveal the extent to which it has previously been destroyed by its betrayal in hopelessly unproductive works."

Has Australia over-invested in higher house prices at the expense of other national investment and productive possibilities? Let us know what you think at dr@dailyreckoning.com.au

And if you think we're making up the idea that China has exported its property bubble to Australia, well, that's alright. Free thinking is encouraged here at the Daily Reckoning. But according to today's Wall Street Journal, "China's banking regulator banned new property loans to 78 companies owned by the central government in an effort to control risks in property credit and curb asset bubbles, which pose a threat to the country's strong economic recovery."

Urban property prices rose 11% in February compared to the same time last year. In fact, there's a way of seeing the performance of the entire commodity sector - and by extension Australian resource stocks - as a function of China's retreat from the U.S. T-bill market and into tangible asset markets like copper, iron ore, coal, and high-rise flats in Melbourne.

We're taking these concerns and questions to a meeting in an hour with Diggers and Drillers editor Alex Cowie. Alex sent us a note yesterday that one of his gold stock recommendations has nearly doubled. But he hinted that there are some decisions he's made regarding the rest of his recommendations. He'll share those with D&D readers when he's made them. But tomorrow, I'll let you know what he thinks about the big picture and the China risks highlighted above.

Until then...

Dan Denning

for The Daily Reckoning Australia

[blue skies]

10 Signs of Speculative Mania in China

Inquiring minds are reading a GMO white paper on China’s Red Flags

In the aftermath of the credit crunch, the outlook for most developed economies appears pretty bleak. Households need to deleverage. Western governments will have to tighten their purse strings. Faced with such grim prospects at home, many investors are turning their attention toward China. It’s easy to see why they are excited. China combines size – 1.3 billion inhabitants – with tremendous growth prospects. Current income per capita is roughly one-tenth of U.S. levels. The People’s Republic also has a great track record. Over the past thirty years, China’s Gross Domestic Product has increased sixteen-fold.

So what’s the catch? The trouble is that China today exhibits many of the characteristics of great speculative manias. The aim of this paper is to describe the common features of some of the great historical bubbles and outline China’s current vulnerability.

Past manias and financial crises have shared many common characteristics. Below is an attempt to list ten aspects of great bubbles over the past three centuries.

1. Great investment debacles generally start out with a compelling growth story. This may be attached to some revolutionary new technology, such as railways in the nineteenth century, radio in the 1920s, or more recently the Internet. Even when the new technology is for real, prospective rates of growth may beexaggerated. Early growth spurts are commonly extrapolated into the distant future. ....

2. A blind faith in the competence of the authorities is another typical feature of a classic mania. In the 1920s, investors believed that the recently established Federal Reserve had brought an end to “boom and bust.” A similar argument was trotted out in the mid-1990s when it was widely believed that the Greenspan Fed had succeeded in taming the business cycle. The “New Paradigm” disappeared in the bear market of the new millennium. It was soon replaced with the “Great Moderation” thesis of Ben Bernanke, which suggested that high levels of mortgage debt made sense because monetary policymaking was so vastly improved. ...

3. A general increase in investment is another leading indicator of financial distress. Capital is generally misspent during periods of euphoria. Only during the bust does the extent of the misallocation become clear. As the nineteenth century economist John Mills observed: “Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal in hopelessly unproductive works.” ...

4. Great booms are invariably accompanied by a surge in corruption. ...

5. Strong growth in the money supply is another robust leading indicator of financial fragility. Easy money lies behind all great episodes of speculation from the Tulip Mania of the 1630s – which was funded with IOUs – onward. ...

6. Fixed currency regimes often produce inappropriately low interest rates, which are liable to feed booms and end in busts. This lesson was ignored by the creators

of the European Monetary Union, which brought low rates and real estate booms to its smaller members, Spain and Ireland. ....

7. Crises generally follow a period of rampant credit growth. In the boom, liabilities are contracted that cannot subsequently be repaid. ...

8. Moral hazard is another common feature of great speculative manias. Credit booms are often taken to extremes due to a prevailing belief that the authorities won’t let bad things happen to the financial system. ...

9. A rising stock of debt is not the only cause for concern. The economist Hyman Minsky observed that during periods of prosperity, financial structures become

precarious. Investments financed with borrowed money don’t generate enough income to either service or repay the loan (what Minsky called “Ponzi finance”). ...

10. Dodgy loans are generally secured against collateral, most commonly real estate. Thus, a combination of strong credit growth and rapidly rising property prices are a reliable leading indicator of very painful busts. ...

The GMO article looks at each of the above points through the eyes of China.

1. The China Dream. For centuries, foreigners have pondered how to make money from China’s vast population. Today, the China Dream is more vivid than ever. The People’s Republic has more than 1.3 billion citizens, making it the world’s most populous nation. China’s rural population is gradually moving into its cities. A further 300 million country-dwellers – that’s roughly the same size as the U.S. population – are expected to head toward towns and cities over the next decade. It is generally assumed that the Chinese economy will continue to grow by around 8% annually in the coming years. ...

2.In the Communist Party of China We Trust.

Twenty years ago, it was argued that “Japan is different” and that Tokyo’s economic policies were better than the West’s. A number of best-selling books lauded the land of the rising sun. One bore the infamous title, Japan as Number One.

Today, similar claims are made about the singularity of the Chinese economy and the superiority of Beijing’s policies. And similar expectations are entertained about China’s inexorable march to economic primacy.

3. Investment Boom. In a market-oriented economy, investment might be expected to fall during a period of uncertainty and economic turbulence. Yet in 2009, Chinese fixed asset investment climbed by 30% and contributed 90% of last year’s economic growth. Investment rose to a record 58% of GDP. These are remarkable figures. The key question is: how well was this money spent? ....

4. Corruption. All great speculative manias have been accompanied by rising levels of fraud. Only in the bust do we get to see the full extent of the “bezzle,” as the Enrons, WorldComs, and Madoffs come to light. The upturn in China’s property and infrastructure spending, however, provides a cyclical spur to malfeasance. The People’s Republic recently slipped to 79th place in Transparency International’s 2009 Corruption Perceptions Index, just below Burkina Faso. ....

5. Easy Money. Nobel laureate Friedrich Hayek differed from his great rival J.M. Keynes. While the latter argued that bubbles were the result of turbulent “animal spirits,” Hayek claimed that asset price inflation followed from excessively low interest rates. Easy money, said Hayek, fed through to monetary and credit expansion, leading to inflation, either in the general price level or in asset prices. ...

6. The Fixed Exchange Rate and Capital Inflows. The Chinese currency, the renminbi, is pegged to the U.S. dollar. An undervalued exchange rate has boosted exports and kept interest rates low. It has also encouraged massive capital inflows, mostly in the form of foreign direct investment. Capital controls have limited inflows of hot money, although speculative inflows have picked up recently. ...

7. The Credit Boom. In response to the global financial crisis and the collapse of export orders, Beijing ordered its banks to go out and lend. Last year, new bank lending increased by nearly RMB 10 trillion, a sum equivalent to 29% of GDP. These loans largely went to fund infrastructure projects, property developments, and state-owned enterprises in a number of industries. It was as if the economy had received an enormous adrenaline shot. What most analysts fail to consider is the hangover that generally follows a credit binge.

8. Moral Hazard. The major Chinese banks are controlled by the state. They have a history of poor lending decisions. ...

9. Risky Lending Practices. .... No one can gauge the robustness of the credit system since Chinese banks appear particularly reluctant to report problematic loans. Ernst & Young published a 2006 report that estimated non-performing loans (NPLs) at $900 billion. This report was subsequently withdrawn. NPLs continued to decline in 2008 even as the stock market imploded and exports crashed. Fitch has suggested Chinese banks have been rolling over, or “ever-greening,” problematic loans. Bank employees have their own reasons for burying bad loans. A loan officer who reports problem debts is liable to have his salary reduced to below that of a migrant worker. Few seem to care about the practice of concealing nonperforming loans since it’s generally assumed that so long as the economy continues growing quickly, bad credits will turn good over time.

10. The Bubble. Surging credit has revived the animal spirits of Chinese investors. The Shanghai stock market recovered sharply in the first half of last year. On a single day in late July, turnover of “A-shares” in Shanghai exceeded the combined trading of the New York, London, and Tokyo stock exchanges. Chinese IPOs accounted for nearly two-thirds of global issuance by market value in the third quarter of last year. Chinese companies accounted for seven of the ten largest IPOs in the world. New issues were often massively oversubscribed and saw huge first day “pops.”

The Field of Dreams

Three years ago, Premier Wen described China’s economy as “unstable, unbalanced, uncoordinated and unsustainable.” The Great Recession hasn’t cured these imbalances. Rather, China’s ensuing investment and credit booms exacerbated them. The real estate market displays the classic symptoms of a bubble – stretched valuations, rampant speculation, and frenzied new construction. Sooner or later, this

bubble will burst.

In the past, whenever an economy has exhibited the 10 red flags listed in this paper there has been an unpleasant outcome. Forecasting the end game is no easy task since speculative bubbles can run to extremes. It’s made more difficult in this case by the fact that China is not a pure market economy. Stateowned enterprises can be called upon to prop up markets. Losses may be concealed or shuffled around like a shell game, as has happened in the past. Such measures, however, won’t cure China’s problems. They only delay the dénouement. .

[Mmmm]

no it just stuck out like dog balls thats all

I'm sure it did stick out, in your mind. Like your certainty about increasing house prices, you seem to be very sure about things for which you have no evidence.

Anyway what are you doing posting at 4.54 am?

[Guest tbatst2000]

Not having time to read the 100 odd pages of this thread, can anyone tell me if Australia has in fact faced its demons yet? Assuming it has, what happened? Did the demons do anything interesting beyond standing there to be faced? I'm thinking demon hoards running through the outback worrying the sheep, that kind of thing. Just curious.

[blue skies]

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Default Governments Remove Interest Rate Support

March 31st is a very important day for interest rates. In Australia it is the last day that the Federal Government allows Deposit Taking Institutions to use its AAA rating to borrow at 70 basis points above the Cash Rate. The floaties come off and the banks have to learn to swim for themselves.

http://www.rba.gov.au/publications/b.../bu-0310-6.pdf

On the same date the US will stop purchasing Residential Mortgage Backed Securities (RMBS). The Fed bought a tidy $1.25 trillion dollars of mortgage with this scheme;

Quote:

Fed Vice Chairman Donald Kohn told a conference last month that any increase in rates is likely to be “modest” but added “that judgment is subject to considerable uncertainty.” Yun believes 30-year fixed rates will probably end up jumping to about 5.7 percent by year’s end. Freddie Mac, which issues many of the MBS being bought by the Fed, said in late December that rates would hit 6 percent by the end of 2010, sending a shock through the market… Bill Gross, head of Pimco, one of the largest and earliest private investors in mortgage-backed securities, believes that due to a rising interest rate environment in general, mortgage rates could settle anywhere between 6 to 6.5 percent, but admits at this point he’s simply making an educated guess.

Note that the official rate in the US is near zero. Mortgage rates are expected to rise even if the Fed keeps rates low.

In Australia the Federal Government has been reducing its purchase of RMBS, as it expects the market to improve. When the US securities once more hit the general market, Australian RMBS will be exposed to competition and may seem less desirable.

In the US the Home Buyer Tax Credit of $8000 (First Home Buyer) and $6,500 (Existing) is stopping in April. There really is nothing new under the sun.

Federal Housing Tax Credit: Home

So the US is expecting a rate rise of around 1%. Australians should consider why we are different and will not suffer a similar fate.

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SuitablyIronicMoniker SuitablyIronicMoniker is online now

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Default Greenspan says rates will rise

Alan Greenspan himself has stated that he thinks that interest rates will rise soon;

Quote:

March 29 (Bloomberg) -- Former Federal Reserve Chairman Alan Greenspan’s warning that rising yields on government debt will drive up American borrowing costs is resonating with the world’s biggest bond traders, who say this month’s losses in the market for U.S. Treasuries are just the beginning.

Yields on 10-year notes, the benchmark for everything from mortgages to corporate bonds, climbed as high as 3.92 percent last week from a low of 3.53 percent in February. The 18 primary dealers of U.S. debt forecast the rate will reach 4.2 percent this year, the highest since October 2008, according to the median estimate in a survey by Bloomberg News.

Higher yields are the “canary in the mine,” Greenspan said in a March 26 interview on Bloomberg Television’s “Political Capital With Al Hunt.” The increases reflect concern over “this huge overhang of federal debt which we have never seen before,” he said. The budget deficit, which hit $1.4 trillion in fiscal 2009, will drive Treasury sales to a record $2.43 trillion this year, a February survey of 10 dealers showed.

Treasuries Find Greenspan's Canary Fainting in Mine - Bloomberg.com