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Should we be bracing for an inevitable housing bubble bust?

By now it should be obvious to anybody who is not a banker or a real estate agent that Australia is in the grip of a substantial housing bubble. The greatest housing-price rise in the history of Australian…

Could a housing bubble burst occur in Australia on the same scale as in the US during the financial crisis? AAP

By now it should be obvious to anybody who is not a banker or a real estate agent that Australia is in the grip of a substantial housing bubble.

The greatest housing-price rise in the history of Australian residential property represents an inflated bubble – one that is ready to burst.

Perhaps unsurprisingly, only a handful of economists accept this view. This small number shows that the formation of a bubble requires a mass popular delusion to occur, with the vast majority of economists playing along by either missing it or denying its existence.

As the economist James Galbraith has pointed out, only about 12 out of 15,000 economists in the US noticed the US$8 trillion dollar housing bubble that occurred there. It appears that mainstream economists have the insight and independence of a herd of sheep.

From 1996 to 2010, house prices climbed by 127%, adjusted for inflation, though rents increased only 15% over this period.

The graph below shows the disconnect between housing prices and rents.

This is one obvious indicator of a bubble because renting is a substitute for purchasing a home.

If prices have risen substantially, then people would adjust their preferences to renting, resulting in a fall in housing prices and a rise in rents until a balance is reached. Clearly, this is not the case.

Australians have embarked upon a speculative property binge, chasing capital gains rather than long-term net rental income.

As the US economist Dean Baker noted two years before the bubble burst in the US, “No one can produce an explanation as to how fundamental factors can lead to a run-up in home sale prices, but not rents.”

Binge, followed by bust. AAP

Perhaps the idea of a bubble could be questioned if the price-to-rent ratio was the only confirmatory indictor.

Unfortunately for the housing bubble deniers, there is little recourse. Many ratios and valuations point to a bubble, with the following showing that Australian property is severely overvalued: price to rent, median multiples, mortgage debt-to-GDP, household interest payments-to-disposable income, housing debt-to-disposable income, household debt-to-assets, and total residential housing stock value.

These statistics are publicly available, but for the most part have been swept under the carpet because the government and industry do not want to hear otherwise.

Below is a graph of Australia’s long term housing price history from 1880 to 2006. It certainly contradicts the notion that prices always rise and never fall – the usual propaganda trumpeted by industry.

According to housing price data, eight of the nine substantial price increases over the last 131 years have resulted in a decline, with the only exception being a short three year period from 1961-1964. The question to ask now is whether the tenth and greatest price increase in Australian history will go the way of the other eight declines.

In response to the rapid escalation of housing prices, the housing bubble deniers have created an explanation of a housing shortage.

These deniers believe that the combination of population growth, net immigration and demographic change has resulted in increasing demand, thus causing an undersupply of housing.

One common factor between the housing bubbles of recent times in the US, UK, Spain, Ireland – and now Australia – is that the housing shortage argument has been put forth to explain the price rises.

Yet, we know that once the bubbles burst, a huge oversupply of housing always emerges.

Housing shortages have been used to explain price rises. AAP

The National Housing Supply Council, which was set up by the government to monitor housing demand, has tried its best to create a shortage by twisting the social needs of the homeless, couchsurfers, those sleeping rough and caravan park residents into market demand.

Obviously, these people do not have the money to purchase a property, which explains their predicaments. Additionally, from 1951-2008, the year-on-year growth in dwellings was greater than population growth, and there have been more new dwellings constructed per new person in Australian than in the US over the last couple of decades.

The real reason for these astronomical prices are three factors: financial liberalisation with its liberal lending policies, government tax exemptions and programs, and restrictive planning policies.

What weighting should be given to each of the three is unclear, but all have contributed to the formation of the bubble. The last two are insufficient to push prices as high as they are now – rather they act as fuel, while the easy availability of credit acts like a fire starter.

Unsurprisingly, mortgage debt has increased rapidly, reaching over $1 trillion, or almost 90% of GDP, in recent years.

Current tax policies and programs have distorted the residential property market substantially. A Senate report on housing affordability aggregates the assistance provided to Australian property owners: $53 billion per year. This is five times the amount that is spent on public housing and rent assistance to the low-income earners.

From 1996 to 2010, the value of the residential property stock has increased by $2.5 trillion. Simply put, the government is forking out tens of billions a year to property owners as they privatise trillions in capital gains.

This is one of the reasons why the so-called experts have desperately attempted to deny the existence of a bubble using lies, damned lies and statistics: they want the gravy train to keep rolling, which overwhelmingly benefits the rich.

They have also promoted policies to benefit established owners and speculators to the detriment of first-home buyers and renters – under the pretext of helping first home buyers and renters.

Government policies haven’t benefited first home buyers. AAP

The ratios and valuations mentioned above suggest that a substantial correction will have to occur if prices are to reflect fundamentals, with an approximate 40% fall on the cards. If the government does not intervene again, as it did during the GFC by boosting the first-home-owners grant, then the market should plunge. The results will not be pleasant, as evidenced in other countries affected by bursting bubbles.

Thus, the gravy train will run out of steam and eventually grind to a halt, with a less-than-tasteful result. The Great Australian Land Bubble will be replaced with The Great Australian Land Bust.

There are several solutions available to remedy the economic and social fallout. Some of the solutions are over a century old, for instance, land value taxes and debt write-downs or jubilees.

The Right to Rent plan and limiting the amount of mortgage debt that potential owners can access are policies proposed in recent years.

Regardless, this will not stop the finance, insurance and real estate sectors from huddling behind the conservative nanny state, begging for bailouts.

Given the track record of government, industry and economists over recent years, the public should be more skeptical of their pronouncements.

For instance, in the US, they missed – or denied – the existence of a US$10 trillion stock market bubble, an $8 trillion housing bubble and the GFC. In Australia, the same has occurred.

A sane course of action requires that we listen to the economists who have a track record of getting it right.

Join the conversation

32 Comments sorted by

  1. Colin Trudgen

    Farmer, Teacher.

    Great article Philip. I have been worried about this for some time. During your research did you come across any data relating a fall in house prices to agricultural land? I've noticed that agricultural land is also rising at what seems to be unsustainable levels. It seems to me that it is getting to the point where normal agricultural activities can no longer provide enough to service a mortgage on the land.
    Colin

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    1. Philip Soos

      Deakin University

      In reply to Colin Trudgen

      Obtaining accurate data on residential property is difficult enough; there is next to nothing about commercial and agricultural land in the public domain. It doesn't surprise me that the residential bubble has spilled over into agricultural land.

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  2. Tim FitzGerald

    Marketing consultant

    This is a really interesting article. There's one niggling - ahem - housekeeping issue, though. Your article refers to "the graph" in several places, which isn't embedded or linked to in the text.

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  3. Jon Wardle

    Chancellor's Research Fellow, Faculty of Health at University of Technology, Sydney

    Interesting article. I wouldn't limit it to housing though.

    One of the areas I research is the affordability of food. One constant I've noticed is that commercial property sales and rents in Australia are also overpriced, and this is probably one of the major factors in reducing healthy food affordability in Australia. I would assume this is also a large factor as to why goods in Australia are usually more expensive than overseas (these overheads being passed on to consumers).

    It would be interesting…

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  4. Steven Shaw

    logged in via Twitter

    Which economists would you recommend? I can't think of any with a good track record. In fact most have conflicts of interest of one type or another.

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    1. David Collett

      Sales at https://aussiebuilder.com

      In reply to David Collett

      Steve Keen and Leith Van Onselen have been on the case for years too..

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    2. Steven Shaw

      logged in via Twitter

      In reply to David Collett

      not a big fan of Saul Eslake, he seems quite happy with the status quo. He certainly hasn't been pointing out the huge housing/credit bubble here in Aus.

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    3. Steven Shaw

      logged in via Twitter

      In reply to David Collett

      Yes, I thought of Steve Keen too but unfortunately he was more-or-less wrong on timing. I like his work though if not his world-view.

      I quite a fan of Leith Van Onselen's writing. Quite right.

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    4. Steven Shaw

      logged in via Twitter

      In reply to Philip Soos

      Thanks Philip! I'd completely forgotten about Garnaut. Apparently talks about it in his book about the GFC, "The Great Crash of 2008". I believe David Lewellyn-Smith helped him with the production of the book. There's also Minack too but he's really backed away from his predictions AFAIK. The others are - unfortunately - little known or offshore economists. It shows how long I've been following the bubble myself in that I know all the names you mention bar two - Edward Chancellor and Prakash Loungani. I wish the thing would bust already but I fear we'll eventually be in for ZIRP here in Australia. This has certainly helped to prop the bubble in the UK and to a lesser degree - but the looks of it - in the US.

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  5. Clive A Marks

    logged in via email @attglobal.net

    Great article Philip. I had a look at your main article and was very impressed by your arguments - especially the clear way they are presented.

    There are a few fundamental principles that Philip's work offers up; should those who are not independent and have a clear vested interest be trusted? If economists and financial advisors have such a bad record in predicting trends, why do we listen to them? I can't see the point of listening to form tips that I know are going to be wrong from a person…

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    1. Philip Soos

      Deakin University

      In reply to Clive A Marks

      Government and policymakers are not interested in fixing these obvious conflicts of interest given the power of the banking and real estate industries. The average Australian will suffer for it.

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  6. Richard Hogg

    IT Consultant

    Just a couple of observations not so much criticisms.
    I can see some parallels with the climate change debate here. The climate change debate has a small number of "deniers" and and large number of "believers" and the housing property bubble theory has a large number of "deniers" and a small number "believers". Not sure what this says but curious. I guess climate change theory is heavily science based but I hesitate to call economics a science :)

    I have been following the predictions of a housing price "crash" for probably 6 years now when I first heard Stephen Keen discuss it but have seen little evidence of it (apart from some softening at various times). I can understand all the arguments put to support the bubble theory just not much evidence....yet :)

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    1. Philip Soos

      Deakin University

      In reply to Richard Hogg

      Climate change science is a science despite the inherent uncertainty of very long range forecasts. Conventional economics is not a science. Steve Keen is right, and the bubble should've burst in 2008 but the government rescued it through the FHOG.

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  7. Joseph Baron

    logged in via Facebook

    The Aussie real estate bubble depends on China, and China is in the midst a housing bubble bigger than any in the globe, except from Australia!! By any measure The Aussie bubble's on a far larger scale and less sustainable that Chinese bubble. Just like Oz, China's investing in pointless excess infrastructure nobody needs including huge over-supply of homes. Sure, Australia might have had strong <a href="http://australianpropertyforum.com/blog/main/3580451">population growth</a> in the past to fill…

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    1. Philip Soos

      Deakin University

      In reply to Joseph Baron

      Both China and New Zealand have housing bubbles. When they burst, it will not bode well for Australia's export industries (e.g. mining). Australia already has a high private debt and external debt to GDP ratio, and once the bubble bursts, we will have a high public debt to GDP ratio as well. Economists have done a lousy job in the last few decades.

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  8. Joseph Baron

    logged in via Facebook

    Furthermore, the real estate industry is corrupt. The spruikers running this ponzi scheme lie through their teeth, tell you anything, in order to keep the bubble inflated for just a little bit longer. I take any media report about property with a pinch of salt, lending figures, capital growth, rents through the roof etc etc. All nonsense.

    Take auction clearance rates for example. They're published every week in the MSM and every week they "appear" to be rising even though they're not really. How…

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  9. David Floyd

    Dr. at Monash University

    The following (2004) article is well worth a read:
    http://www.federalreserve.gov/pubs/feds/2004/200450/200450pap.pdf

    This was a US Federal Reserve researcher writing in 2004 (independent research, not necessarily approved by Fed as a whole).

    The article starts with the basic economics governing house prices vs. rent (subject to fiscal realities in the United States). He then examines house price bubbles and corrections over the whole post-war period, and attempts to model them.

    Without fail it is house prices that revert to rental prices (which in turn are anchored to reality through paycheques!). He finds a typical timescale for the corrections of ~3 years, and, interestingly (it was 2004 remember) states that the US economy already appears to be in a housing bubble, before quickly backtracking and providing all the arguments why this can't be quite right. Obviously. Enjoy...

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  10. Clive A Marks

    logged in via email @attglobal.net

    @Richard Hogg

    An interesting observation, but I have never really understood this way of looking at trends or 'bubbles' Perhaps Richard might care to comment further as it seem to be a key issue?

    If someone predicts that you will eventually reach the summit of a hill, that you have not got there yet is no logical reason why the summit does not exist. Clearly, irrational boom growth is not sustainable and this is the issue; is the housing market sustainable? The best that most economists come…

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    1. Philip Soos

      Deakin University

      In reply to Clive A Marks

      Our taxation system rewards speculation and unearned income rather than labour and productive business.

      The business commentator Alan Kohler said it well:

      Five years ago Treasurer Peter Costello told Australians: “Work for a living and we'll tax
      you at close to 50 cents in the dollar; speculate and we'll only take 25 cents. Not only that
      but, as a special deal - while stocks last - we'll pay half your speculating costs.”

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  11. Peter Dellys

    logged in via Facebook

    Let one thing be absolutely clear. There has been no wholesale capitulation of the Australian property market, so those who have and are still predicting this have yet to be proven correct. There is no reason why property prices cannot remain flat or show minor growth while incomes increase. People want to live here, and not coincidentally, the places on earth that have experienced little or no property crash are the same places voted most desireable to live. I say this as someone who finds the whole real estate industry repugnant, but facts is facts!

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    1. Philip Soos

      Deakin University

      In reply to Peter Dellys

      There are 1.25 million investors with one or more investment properties in Australia, and approximately 70% are negatively geared. They have been chasing capital gains, not long-term net rental income. A stagnant market, let along falling prices, with no prospect of future capital gains, will cause many of them to sell, placing enormous downward pressure on housing prices. Factor in that even a moderate 10% fall will see nearly 300,000 owner-occupiers, many first home owners, face negative equity, will place more downward pressure.

      With the ABS house price data recently released, housing prices have fallen 5.3% adjusted for inflation since the peak in June 2010. A year after the peak in the US, prices had only fallen 4%. Comparatively, Australia’s market is falling faster than that of the US in the first year after the peak.

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    2. Winnifred Louis
      Winnifred Louis is a Friend of The Conversation.

      Associate Professor, Social psychology at University of Queensland

      In reply to Philip Soos

      Philip, thanks for your article! I'm interested in the role of foreign and institutional investors in Australia's market & wonder if you can comment. First, are there data on how much residential & commercial real estate Aussie super funds own? If the #s are significant it would support higher house prices than elsewhere where there is no or lower mandatory retirement savings so less of a tsunami of annual $ seeking investment opportunities. Second, it seems to me one reason for the slowdown is the high Australian $ and foreigners pulling out of the market. Are there data on shifting #s and holdings of foreign owners?

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  12. infinet

    logged in via Twitter

    Great article!
    It always amazes me how Australians can watch property bubbles inflate and then burst overseas and still maintain that we are different.

    For those interested there is great analysis of the Aussie Property bubble and the economy at http://macrobusiness.com.au

    Cheers

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  13. Andrew Ayers

    logged in via Facebook

    Excellent article, the usual responses of a flat rather than a falling market is offered as one outcome. It seems a larger overview needs to be examined to predict price movements in this (and any) market. One factor that seems to have been generally overlooked is the importance of availability of mortgage credit to the domestic economy, At this stage, due to tight lending conditions there is a shortage of buyers eligible to compete for property. Sellers, on the other hand, have the upper hand in…

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    1. Steven Shaw

      logged in via Twitter

      In reply to Andrew Ayers

      Andrew, there won't be a return to pre-GFC credit growth here in Australia. Also, I find it odd that commentators talk about a flat market when the market is _already_ falling.

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  14. Greg Gillespie

    logged in via Facebook

    Phillip brilliant commentary on the obvious housing bubble that was indeed propped up during the GFC by the extended first home buyers grant. If the federal government had truly wanted to assist first home buyers, surely allowing a natural correction to take 40% off house prices would have done a lot better job.

    The big Q still remains what is it going to take to bring some realistic value back to the Australian property market?

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