They say that admitting there's a problem is the first step towards a solution. In an interesting turn of events, it appears that the media and 'experts' are now admitting that there's a housing bubble. This is certainly a commendable step, but it is far from admitting the true scale of the problem. Despite the media and even the RBA are subtly hinting that there is a housing bubble, all are convinced that this isn't something that is going to effect us for several years... at least.
For the uninitiated, or even offended if you're reading this sort of thing for the first time, here is a brief overview of the Great Australian Housing Bubble and how it will affect you:
Short term interest rates are manipulated by the central banks, RBA in Australia (Federal Reserve in the US). The rate at which banks can borrow from the central bank, to lend at a higher rate of interest to other banks and the general population, are artificially lowered by the central banks in order to 'stimulate the economy' into growth and/or in response to a recession. This causes an expansion of money and credit (via the money multiplier effect), a process known as monetary inflation. Unfortunately, as the short term interest rate also effects medium and long term interest rates, this sends incorrect signals to entrepreneurs, businesses and corporations on the availability of savings and resources in the real economy. They embark on projects (of all time frames) using freshly available credit from their local bank. Some of these projects are successful, even lucrative, which can lead to an irrational mania that is technically known as an 'asset bubble'. These asset bubbles attract more and more people with increasing success, however it is all supported on the ability of individuals to borrow money to speculate within the asset bubble, which is all tied into the availability of money and credit. These bubbles are Ponzi schemes in nature as they depend on the next buyer borrowing more money than you did to purchase the asset. In the real economy, the expansion of money and credit leads to rising asset and commodity prices that is reflected in indexes such as the Consumer Price Index. The rise in prices is more commonly known as inflation, but it is more accurate to label it 'price inflation' to not confuse it with 'monetary inflation'.
Eventually the lack of real savings and resources to justify rising asset prices are realised in the market. Sellers suddenly find themselves without buyers as the level of credit required to perpetuate the bubble is too high to service. These sellers are then left with a huge debt burden and no buyers willing to pay the 'bubble price'. The only way for sellers to cut their losses is to sell the asset at a loss, which precipitates a sharp decline in 'bubble prices'. As projected income, based on 'bubble prices' aren't realised, bankruptcies ensue, profits diminish and expenditure reduces. The effects on the real economy begin to manifest as reduced expenditure, from diminishing profits, also cuts the projected income of businesses that previously profited from individuals enriched by the asset bubble. The net effect of this avalanche is a recession, unemployment and a reduction in the expansion of credit, as the debt can't be serviced and thus banks aren't willing to lend.
To examine where a potential asset bubble may be forming, start looking for asset prices that have been rising faster than the rate of inflation (price inflation, which reflects monetary inflation)... it's a rough guide but a good start. Let's look at the Australian housing market (following graphs were taken from Dr Steve Keen and Henry Thornton's website, but they got it from the RBA... so there):
CPI-deflated house price indices for the US and Australia (a comparison of 2 house bubbles)
(http://www.debtdeflation.com/blogs)
Compare that to the expansion of credit in the Australian economy (can you spot the association):
(http://www.henrythornton.com)
AND this one from Dr Steven Keen:
(Source: debtdeflation.com/blogs)
And finally, the CPI (made this one myself, thank you rateinflation.com):
These charts typify the effect of a low interest rate monetary policy by the central bank. What we have here is a speculative and irrational bubble in house prices that took off shortly after 1990 and the 'recession we have to have'. House prices historically double every 7-10 years because of inflation, not because of any gain in value. If you examine the first graph (red line), this displays an index of house prices that are adjusted for inflation, so they display market forces in house prices. As you can see after 2000, house prices hae skyrocket above the 100 year average! The interesting part of that graph is that in the blue line you can see American house prices, which also demonstrated a massive bubble in prices after 2000 but, as we all have seen in the past 2 years, have now collapsed. About the same time that US house prices were declining, ours started to as well, but the government successfully reflated the bubble with an extension to the FHOG, which brought in ~1% of the whole Australian population into new mortgages.
Here's some more evidence for the skeptical:
House price index adjusted for inflation (assembled by Dr Nick Stapledon, published by the stubbornmule.net)
(Note: I don't like it when graphs scale the axis like the above y-axis, it mis-represents the data)
Another graph demonstrating disconnect between house prices and inflation
(source: http://www.aph.gov.au/library/pubs/rn/2006-07/07rn07.htm)
Interesting the above graph and link is from a government report conducted into the housing bubble in 2006-07!
The speculative nature of the bubble
(Source: Dr Wik E Pedia, http://en.wikipedia.org/wiki/Australian_property_bubble)
Oliver's Insights, AMP Capital Investors, 12/11/2008 (http://www.investblue.com.au/imgresource/amisc/item_26.pdf)
(Comparing housing bubbles)
(Truly frightening to see the scale of debt taken on by folks, this indicates the sensitivity of mortgage repayments to increases in interest rates)
The historicity of housing price corrections
(Again I don't think this is the best put-together graph, but it does demonstrate that house prices inevitably snap back to normal levels, I believe that this graph isn't adjusted for inflation so the growth you're seeing is mostly due to inflation)
Mortgage Debt in relation to GDP (from debtdeflation.com/blogs again)
There are some popular erroneous arguments made to justify ever increasing house prices, the popular ones are:
1) Increasing population/immigration
2) Increasing demand
We've addressed some of these myths previously, specifically related to the data used to support a mythical housing shortage that isn't. But simply put, the population of Australia has undergone substantial growth between 1890-1990... obviously. Yet inflation-adjusted house prices have only risen modestly, almost not much at all. While more people can contribute to a greater demand for homes, that doesn't explain the quantum leap in house prices from 2000+. The answer is found in the nature of demand, which addresses point number 2. Demand for housing, or more specifically mortgages, comes from the availability of credit, the willingness of banks to lend and people to enter into debt. The government can speed the process along through catalysts like the First Home-owners Grant, which I think has been successful at keeping the housing market afloat for as long as it has.
What threatens the housing bubble now is increasing unemployment (remember the avalanche), economic slowdown in China and rising interest rates which makes debt servicing impossible with house prices this high. As for interest rates, the RBA will be forced to raise them higher and higher because of price inflation, which is running pretty high but understated in government numbers and even the CPI. The RBA will be forced into a rate trap, where to keep the economy running, credit growth must continue to expand so rates must be low... but this will cause more inflation, which will ruin our economy. This is what happened in the 70s. The link below also confirms my point that interest rates will at least hit 10%, but I'm forecasting them to go even higher.
Also, something really interesting is to use the rate of mortgage delinquencies to track the popping of the housing bubble. Stubbonmule.net was sent a very useful graph from the RBA which I've posted below:
% Delinquent Mortgages in the UK, US, Canada and Australia
This graph demonstrates that we have yet to experience the bursting of our housing bubble, but you can almost bet that delinquencies will dramatically rise with rising unemployment (which can be triggered by a 2nd round GFC shock, slowdown in China etc) and/or increasing interest rates which will make mortgage repayments impossible to service.
And to answer the question why haven't house prices collapsed like in the UK and US (and many other OECD countries):
(Source: Dr Steve Keen, debtdeflation.com/blogs)
Bottom line:
1) There's a housing bubble, prices are way too high
2) It will pop, history has shown this time and time again (happened in the US)
3) If I'm thinking about buying a home, I need to calculate whether I can afford repayments if the interest rates are ~20% and whether I can stomach having a mortgage 2-3 times greater than the value of the home.
4) Instead of risking $30K for 10% down on a mortgage and be left holding the bag with a crushing debt, I would rather save my money (buy gold/silver/precious metals to protect your wealth from inflation at least). If I'm right about the collapse of house prices... then I have saved money and didn't get into debt, and I'm in an excellent position to potentially buy homes at a more reasonable price while taking on less debt if any. Best case scenario is that I'm wrong and I didn't make money off speculating on house prices, I still have savings with zero debt.
God bless,
Washo
Disclaimer: This is not financial advice, talk with a sensible financial planner. Any financial scenarios listed above are related to my own reasoning based on my interpretation of the data.
