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Are economists ignoring Australia’s property bubble?

One aspect of housing and stock market bubbles continually repeats: the vast majority of economists either miss or deny their existence. In recent years, enormous asset bubbles have burst in many countries…

House prices grew by 127% between 1996 and 2010, but few people believe there is a property bubble. AAP

One aspect of housing and stock market bubbles continually repeats: the vast majority of economists either miss or deny their existence.

In recent years, enormous asset bubbles have burst in many countries.

The most notable have been in the United States. The first was a US$10 trillion stock market bubble, popularly known as the Dot-com bubble.

Worrying indicators ascended to astronomical heights in the late 1990s, but the mass popular delusion of ever-rising prices kept the economics profession, investors and the public from seeing that a bubble was forming. We know what happened later – the Dot-com bust.

This was followed by an US$8 trillion housing bubble, which saw an 86% run-up in housing prices between 1996 and 2006, climaxing with a spectacular crash that nearly bought down the entire banking and financial system in the US.

Again, economists either missed or denied the existence of a housing bubble, though many fundamental indictors clearly pointed to this reality.

In Australia, our $2 trillion housing bubble has seen prices rise by 127% from 1996-2010, and every fundamental indicator is off the chart.

But while it seems logical to conclude that Australia’s property bubble will inevitably burst, very few observers seem willing to do so.

A decade of hearing the drumbeat that prices always rise and never fall has been replaced with the more subdued claims of a return to affordability as housing prices decline slightly.

By definition, an asset bubble requires the vast majority of the public and economists to participate in the mass delusion that prices will endlessly rise.

If people believed otherwise, they would take rational individual action, which then would either prevent a bubble from forming or would quickly burst it in the early stages.

Unsurprisingly, a study by economist Dirk Bezemer found that only 12 economists correctly predicted the US housing bubble and global financial crisis. Similar to that study, 18 economists have picked the largest housing bubble in Australia’s history.

Why do economists continually get it wrong?

There are two causes. The first is a widely discredited form of economics that is taught in universities and practiced in government, industry and research institutes.

This is called “equilibrium economics” and is associated with the neoclassical school of economic thought. It teaches, using many unrealistic assumptions, that markets operate in equilibrium – a state in which economic resources are put to their most efficient use.

This worldview assumes, because markets operate efficiently, assets are almost always priced correctly – so bubbles cannot occur.

Neoclassical theories of equilibrium price statics, rational expectations, efficient markets hypothesis, capital assets pricing model, utility, and so on are doctrines with almost no empirical justification. This economic theory does not reflect reality. If it did, then why are so many countries generating the largest bubbles in history?

The second reason is one of wealth. During a bubble, the rich become much wealthier. This wealth is actually rent, which is unearned income.

We are told that in a capitalist economy, people make a living by either working or deploying capital in a productive enterprise.

The rich, however, are rich precisely because they manage to privatise the rents that land produces, including what is made from speculation (intellectual property is another). Rent stemming from residential land equates to about 30% of GDP in Australia.

Meanwhile, many leading economists whose analysis and commentary the public relies upon have so many conflicts of interest it would fill a small book. Consultancies, university chairs, endowments, six-figure salaries, and industry directorships comprise part of the package that ensures economic “thought leaders” within government, industry and universities speak the words pleasing to the rich.

Accordingly, economists do not go out of their way to question the astronomical wealth of the opulent minority, as that would be tantamount to heresy. Thus, it comes as no surprise that mainstream economists are bubble deniers.

Literally three months before the peak of the housing bubble in the US, the two leading economists in that country, Alan Greenspan and Ben Bernanke, testified before Congress that a bubble didn’t exist. If they couldn’t see it, what hope do Australia’s economists have?

So how do we get it right?

The answer is easy – give weight to the economists who picked the housing bubbles and global financial crisis and consider their comments carefully.

Follow their analysis and don’t be afraid to have an opinion different to that of the majority. Breaking free of the doctrinal system that says the rich earn their wealth and that there is no bubble takes time and effort, but is well worth the struggle.

Join the conversation

11 Comments sorted by

  1. Paula Chavez


    Thank you for bringing this up. I just experienced a bubble burst in France where I bought a property (with a hefty mortgage) in 2005. In 2011 I went to sell it. It has lost half of its value. I am "underwater." I admit I got caught up in the bank's willingness to loan me money to buy and remodel the home. That is where this bubble has started - with the banks' willingness to loan huge amounts of money to finance these overpriced purchases. The values of homes are based upon the willingness of the banks to loan and has nothing to do with the intrinsic value of the property. Now the banks won't loan in the US and Europe and so the home values have plummetted. The lesson learned - do not buy a home with a mortgage.

  2. Kevin Cox

    logged in via LinkedIn

    Bubbles occur when there is compounding. Because most houses exchange hands through the creation of loans and because most loans have interest paid on interest then we will get a bubble. It is inevitable. The simplest way to fix the problem is to use non compounding simple interest for loans and for repayments to loans to be a return of capital and then a payment of interest. In other words loan repayments are off the capital and rent accumulates to be paid after the capital is repaid. This removes the so called "time value of money" from the equation which is an computational construct useful as a way to compare similar investments - not as a real cost.

    1. Bryan Kavanagh

      Research Associate, Land Values Research Group

      In reply to Kevin Cox

      There's another reason for real estate bubbles. The price of a block of land is actually the private capitalisation of that part of its annual rental value which has not been captured by way of council rates or State land tax.

      If we adopted Ken Henry's recommendations for an all-inclusive land tax to replace stamp duty and payroll taxes, we'd go a long way towards keeping a lid on property bubbles.

      In a report I did "Unlocking the Riches of Oz: A case study of the social and economic costs of real estate bubbles 1972 to 2006" I noted that at each property bust the real estate lobby achieves the winding back of taxes on property. This leaves greater land rents in private hands to be capitalised into an even greater bubble next time around.

      The banks don't mind this phenomenon, because it equates to larger and larger mortgages.

      Population growth is a small factor, but IMO the lessening public capture of land rents explains the greater part of these bubbles.

  3. Joseph Baron

    logged in via Facebook

    Australian property is in a massive bubble that's now in full-on crash mode!

    There's going to be a new Australian recession and property is doomed. All the stimulus did was kick the can down the road, and now the housing collapse will be even worse.

    It's driven along by excessive debt. To understand why unsustainable credit and debt leverage will have a hugely damaging impact to the real estate in the years ahead, read up on the excellent work by Professor Steve Keen here on the Australian Property…

    Read more
    1. Andrew Hack

      IT Project Manager

      In reply to Bryan Kavanagh

      I was referring to the property bubble crash in the US.

      Australia's bubble has not yet been burst.

      The problem with blaming capitalism for the crash is that capitalism does not exist. The fluctuations of boom and bust can more accurately be attributed to various levels of government intervention by central banks and central planners. Your article does not appear to do much in the way of explaining the causes but merely observing that fluctuations do exist.

    2. Bryan Kavanagh

      Research Associate, Land Values Research Group

      In reply to Andrew Hack

      Yes, it would be stupid to blame capitalism itself for developing and bursting property bubbles - either in the US or Australia. These bubbles, of course, are generated by perverse tax regimes that penalise labour and capital whilst they reward property speculation.

      If our politicians had the guts to put into practice the recommendations of Ken Henry's panel, we'd see 100-odd inefficient taxes abolished and only four bases used for revenue, including an all-in land tax.

      That would keep the lid on property bubbles developing and free up the cogs of business and industry.

  4. Walter Babience

    logged in via Facebook

    OH MY GOD !
    You should see what's happening here in Canada, you ain't seen NOTHING yet !
    Here in Toronto, Ontario, Canada, we have BIDDING WARS on $1.2 Million dollar 3-bedroom homes, and in just 20 minutes the price sold shoots up to $2 Million !

    And its worse in Vancouver, where $20 Million dollar 3-bedroom homes is common.

    All of this and yet our average personal income is only around $40,000 per year !

    So if Australia thinks they have a housing bubble, FORGET IT, ours is WAY BIGGER than your has ever been !!!

  5. David Tomlins

    logged in via LinkedIn

    Hi Philip

    Actually came back to this post after seeing some interesting comments of recent by Bill Moss. Interesting linkage with your article around property and equity bubbles e.g. "Once you turn off debt, the property market begins to act like equities".