Australia’s refugee problem has attracted global attention. This from the New York Times.
Australia’s own Ponzi scheme: the property market
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Across the world, onlookers have looked with a glowing sense of schadenfreude and bemusement at the Ponzi scheme run by former Nasdaq chairman, Bernie Madoff. Upwards of $US50 billion was invested and ultimately lost by some of the world’s allegedly shrewdest investors, from Connecticut hedge funds to European banks. It eventually came to light that Madoff was paying earlier investors with new capital, the same strategy employed by the eponymous Charles Ponzi, way back in 1920. However, before scoffing at Madoff’s investors’ misfortune, millions of Australians are participating in a Ponzi scheme of sorts – known as the property market. While not an exact replica of Ponzi or Madoff’s frauds, many investments which ignore income and hope for a subsequent capital return are, in a sense, the same thing, requiring money from new investors to provide satisfactory returns. In the case of property, many investments are producing yields of three percent (or less in more exclusive suburbs). Why would investors purchase an asset which provides a return significantly below the risk-free rate? Only because they are hoping for a ‘capital gain’ – in other words, the hope that a bigger fool will pay even more for the same property in a few years. Even more concerning is that Australia’s property Ponzi scheme has been largely fueled by debt obtained during a period of full employment. Property prices have already started to adjust, most noticeably, in the highest priced suburbs. The Age reported that the median price in Malvern fell by 32.5% in the past year. In neighbouring Armadale, the drop was 39.5%. Suburbs like Malvern (the home of former Prime Minister, Robert Menzies) were major beneficiaries of the property boom. In the year ending 30 June 2005, Malvern prices rose 57%. At the time, REIV boss, Enzo Raimondo, claimed that the “market was stable”. Of course, in the eyes of the Real Estate Agents union, property prices rising in an unsustainable ‘bubble’ represent stability, while property prices falling by five percent is an irrational panic. Back in 2005, the median house price in Melbourne was $363,000 – most recently the REIV reported that the median property price was $435,000 – an increase of 20% over three years. During the same period, the All Ordinaries Index dropped by 17.5%. In some parts, however, the Ponzi Scheme is still going strong. In the year ending September 2008, prices in North-Western suburbs like Broadmeadows and Oak Park rose by approximately 24%. These suburbs, located near Melbourne’s industrial heartland will be significantly affected by rising unemployment. Despite the ominous signs, Broadmeadows properties still yield around 4%. Like any bubble, there are always those keen to perpetuate the myth. In an article appearing in Business Spectator, Christopher Joye, managing director of property data company Rismark, claimed that he was “amazed at the number of times individuals have expressed disbelief at the remarkable resilience displayed by the median Australian house price during the last 12 months.” Joye later noted that it is “highly misleading to presume that the experience of upper income households can be applied to the average Australian home owner as is the media’s wont. While rising unemployment will inevitably put further pressure on prices, this will be counterbalanced by 30-50% reductions in mortgage rates.” Like many living in a bubble, Joye is using historical data as a reliable indicator of future returns and significantly understates the effect of higher unemployment on property prices (the benefit of slightly lower mortgage repayments is more than offset by one’s income falling by 80% when they lose their job). That is not to say property will never provide capital returns. Inflation alone will lead to higher property values, but ultimately, capital growth is a function of economic expansion. Since 1992, property prices have grown at a far higher rate than economic growth, largely due to increased use of debt. Instead of paying three times income for a property, Australians have been paying upwards of ten times’ income courtesy of banks’ lax lending standards and full employment. However, like shares last year, the property bubble is starting to wobble. Property purchasers are starting to realise the game is up. Melbourne clearance rates have slipped from more than 80% to join Sydney and Brisbane at less than 50% as vendors fail to adequately lower prices to meet the market as the perfect storm approaches. Negative growth, low inflation, high unemployment and tougher lending standards mean that Australia’s residential property Ponzi scheme is about to collapse, just like Bernie’s. |
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16 Comments
Can Joshua Gans and his ilk please state their interests every time they post? Via Rismark’s shared equity concept, he has a vested interest in property prices continuing their ever upward trend.
If anyone is misreading the article Mr Schwab is referring to, it is Mr Gans. From the article
For a change, the winners in the Melbourne market were in the outer suburbs. The median price of suburbs such as Broadmeadows and Narre Warren shot up by more than a fifth while blue-chip areas such as Armadale, Canterbury and Malvern were walloped, dropping by more than a third in some cases.
Dennis, median house prices are not indicators. Here is why. The claim is that median house prices in Malvern fell by 32.5%. That is comparing houses sold in 2007 with those sold in 2008; the medians. But those are most likely different houses. I would like to buy a house in Malvern but I have not found a single one that has declined in price anywhere near 32.5%.
Now if it were a true median house price that was being measured then fair enough. But of traded houses? This is misleading.
But I could be wrong. A median decline means that half of ALL OF THE HOUSES in Malvern have decline by MORE THAN 32.5%. So, could someone please name the address of just one of these? (Oh and while you are at it, find ONE in St Kilda that increased by over 40% in the last year).
Congratulations on some intelligent lateral thinking.
Chris Joye,
You are missing something. Let us rewind the clock back to early to mid-2008 when RBA rates had hit their peak.
1. Interest rates were at benign levels. The OCR was 7.25%, and mortgage rates had not hit double digits;
2. Unemployment was at or around generational lows; and
3. Inflation was a problem, but wages were rising as well.
Compared to the early 90s recession, that seems like a recipe for a boom. Yet default rates reached highs last seen in the 90s recession.
What is missing? The level of debt.
Specifically, the level of debt held by households is significantly higher than it was in 1990-1992. This makes households more sensitive to minor macroeconomic changes than they were during any previous modern downturn.
Therefore, you cannot compare like with like. If unemployment rises to the same degree it did in the 90s, the magnitude of the effect will be greater. The cash rate won’t matter. Government stimulatory attempts won’t matter. Not until the debt burden is reduced.
Further to that, those made unemployed, but eventually rehired, will not be the same economic agents they were when they had job security. So you will not see major economic purchases, financed by credit, made in great number. Financial decisions will have changed.
The prospect for deleveraging is still quite high, even with the RBA and governments actions.
Median house prices in terms of median incomes (or rental yields as compared to house prices) almost certainly can be used to demonstrate a bubble. And there has been a substantial shift, over the past decade especially, where house prices have exploded as compared to both incomes and rents.
While this can be managed by lower interest rates - and the RBA certainly makes this case - this transfers an extraordinarily large risk and debt burden to the household sector. A sector that recent evidence demonstrates is perhaps not as well-equipped to deal with the risk as many thought. A macroeconomic shock - such as an oil spike - leaves the household unable to deal with the risks, and it may default.
This is why we saw a substantial rise in default rates earlier this year to near record levels, despite interest rates being relatively benign (as compared to the IRs in the late 80s) and unemployment being at generational lows. Therefore you cannot compare the unemployment shock of the early 90s with one that occurs today, precisely because the levels of household debt and burden of servicing it is that much higher today.
Furthermore, the effect of defaults is more pronounced in a highly leveraged economy. As reported on Crikey by Michael Pascoe in 2007, the subprime crisis was nothing to worry about, as default rates on mortgages were around the long-term average. Nothing special or scary about them.
It is a month ago so I could be mistaken in my recollection.
But I think there is a stronger point that median house prices are not really something that can be used to established a claim that there is a Ponzi scheme at work. According to the same data, St Kilda achieve a 40% median price increase in the same period. So the scheme was fooling Malvern buyers but not yet St Kilda ones? There is no evidence of a Ponzi scheme at work and no evidence of a house bubble.
On my interests, I have no financial interest in higher house prices and am an advisor to Rismark only. What interest is there to be declared? I own a house. Did anyone else declare whether they did or did not.
Sorry, refer to Graph 6 in that speech to see the default rates…
Dennis,
Your analysis might be fine other than the claim about default rates being wrong.
If you refer to this recent speech by the RBA you will see that as at August 2008 90 day default rates on Australian home loans were still lower than they were in the mid 1990s:
http://www.rba.gov.au/Speeches/2008/sp_dg_301008.html
“Between January 1990 and December 1992 Australia’s unemployment rate rose from circa 5.6 percent to 10.9 percent.” At the same time, variable mortgage rates averaged 13.7% — noticeably far higher than the 6.7% rate that prevails today. “Yet according to the ABS House Price Index, Australian house prices actually appreciated during this three year period by a compound annual growth rate of 2% per annum (ie, over 1990, 1991 and 1992).” And there are few commentators predicting that Australia’s unemployment rate will increase by 5.3% to 9.7%.
One would be hard pressed to identify a more dire historical precedent for rising levels of unemployment. Schwab ignores both this empirical evidence and my discussion of it.
Macquarie Bank’s Rory Robertson has also commented, “Average home prices in Australia remained remarkably stable in the early 1990s - actually rising modestly in nominal terms - in the face of huge job losses, and unemployment rising from 6% to 11%. Then as now, the prices of many multi-million-dollar homes in flash suburbs fell sharply relative to average prices.”
I don’t think there is much argument with the cost of housing as measured against average weekly incomes, my personal and direct experience covers the last thirty years of property and where once an average yearly income would pay for a house in 3 to 5 years, this figure has now become 10 years plus. Buying a house is not something an average wage earner can seriously consider by themselves. Meanwhile the inflated house prices have allowed a burgeoning upper middle class to engage in property speculation which drives down housing availability and drives rental returns up. It might make the capitalist happy but it doesn’t do much for people on average or lower earnings.
Hang on a second, I just looked at the REIV site. For Malvern, the median house price was $1.35m in Dec 2007 and $1.215m in Sept 2008. That is a decline of 8%. Also if you look over 5 years, there is one apparent boom period (seemingly ridiculously large) for two quarters in 2007 (with a seemingly anomalous $1.8m median). Where exactly is the Ponzi scheme?
Also, there is a * on the data cautioning its unreliability on the basis of the low number of sales. Malvern’s problem is not a ton of speculative trading but too few trades.
Joshua, you are flailing. The figures are Sep 07 - Sep 08. Dec 08 stats have not been calculated yet, and therefore would not have appeared in The Age article Adam references. The most recent year-on-year figures from the REIV match those quoted by Adam exactly. He is not making anything up; you are targeting him unfairly.
I am talking about broad medians. The median Australian house costs eight average wage years. It was not like this in generations previously. This is not the case in most other countries.
I think you mis-read that Age article. The link says no such thing about Malvern house prices. I recall that from the paper. The 32.5% was the decline in auction clearance rates. In other words, you haven’t got a bit of evidence here.
According to the REIV the most recent year-on-year price changes (September 2007 - September 2008) available show that Malvern is indeed -32.5% for that period
http://data1.reiv.com.au/trendchart/default.aspx
Mr Schwab is also correct with his figure for Armadale.
I would suppose that the article as it appeared in The Age (also known as the REIV’s mouthpiece) had an accompanying table based on data provided by the REIV, which is not reproduced online.
Care to withdraw your statement and apologise, Mr Gans?
To quote Shane Oliver “ the rise in unemployment associated with the early 1980’s and early 1990’s recessions contributed to significant falls in real house price. While this was masked by much higher inflation at the time, real house prices fell12% in the early 1980s and by 20% in the early 1990s.” Link to full report here http://tinyurl.com/8wtcup
To quote Chris Joye “Australian house prices actually appreciated during this three year period by a compound annual growth rate of 2% per annum (ie, over 1990, 1991 and 1992).”
Who are we supposed to believe? Are you both right? Was inflation really high enough in the early 90’s to make both of you right?
In Adam Schwab’s article he claims that I have significantly understated the “effect of higher unemployment on property prices”. While this statement is false and ignores the analysis that I have presented in Business Spectator on the subject, Mr Schwab has the temerity to present no alternative analysis of his own aside from rhetoric.
In my recent article published by Business Spectator, I explicitly state that “there has been much talk of late about the impact of rising levels of unemployment on house prices. With Australian dwelling prices off only 1-2 percent in the first 10-11 months of 2008 the doomsday scenarios have not materialised.”
“It is sometimes forgotten that just like all other asset prices, house prices are determined by the intersection between demand and supply…The supply-side is pretty easy to deal with. We know with certainty that current Australian housing starts are near historic lows of around 140,000 properties per annum. Indeed, housing starts in NSW, which is Australia’s biggest housing market, are now at their lowest level since 1958…Consensus estimates of housing demand sit around 180,000 to 190,000 properties per annum (with the Commonwealth Treasury on the high-side). There is, therefore, a significant disconnect between the demand for, and supply of, housing that is growing at around 40-50,000 homes per annum.
“Macquarie Bank’s Rory Robertson and I have both previously noted that the most powerful historical precedent that we have for examining the influence on house prices of dramatic increases in unemployment is the 1991 recession.” [Mr Schwab completely ignores this analysis.]
Continued…