The property bubble makes us slaves to each other’s debt

Are ordinary homeowners perpetuating Australia’s property bubble? AAP

While my recent commentary (here and here) demonstrates Australian housing is in a bubble, I have not explained where this situation has come from.

Asset markets, in this case, property, are the subject of speculation based upon the delusional premise that past price rises will continue indefinitely into the future, with no chance that a downturn will occur. The dream of creating and realising capital gains has prompted ever more Australians to participate in the property market as either first home buyers or investors (speculators).

Incomes rise too slowly and savings are too low to inflate a bubble into the stratosphere. Another ingredient is needed: mortgage debt.

Property is not bought for the rental income stream it provides because this is insufficient to finance the debt used to purchase property at inflated prices during a bubble. As prices are bid up, owner-occupiers and investors take on ever-increasing amounts of mortgage debt, supplied by banks and other financiers. This creates an upwards spiral of increasing prices and debt, leading to a housing bubble (aslo known as a pyramid or Ponzi scheme).

Australians have shouldered a mountain of debt, readily supplied by the banking system. Mortgage debt currently stands at $843 billion and $359 billion for owner-occupier and investment properties, respectively, for a combined total of $1.2 trillion or approximately 90% of GDP in 2011. A report by the Bank of International Settlements shows that a ratio of 85% or more becomes damaging to the economy.