Economics would be one of the few fields where the views of those who have gotten it wrong continue to be taken seriously, while the opinions of those few oracles who were correct are too often blissfully ignored. Even after the global financial crisis, the media and politicians follow the advice of stimulating, quantitative easing Keynesians, and ignore the percipient few who correctly predicted the recent financial woes. If form is any guide, the media and investors should be listening to every word uttered by Steve Keen or Bill Bonner or Jeremy Grantham.

Of course, ignoring the views of those bearing bad news is hardly novel, it has as much to do with self-interest than reality — or the grown-up equivalent of shutting the bedroom door when your mother beckons you to take out the rubbish.

As share markets rebound after their most recent tumble, investors continue to turn a blind eye to the economic calamity befalling Europe (including Greece, which recently saw its debt downgraded to junk status and Spain, which has been forced to deny rumours that the EU is planning a rescue for its moribund economy). Meanwhile, the Australian federal government presses on with plans to introduce a mining profits tax (which was more accurately described as a giant margin loan by Professor Stephen Grey) that not only threatens stifling Australia’s primary exports, but more worryingly places billions of taxpayer dollars at risk should China’s commodities demand drop.

But while the federal government does its best to quell the booming mining sector, the other boom area, residential housing, appears to be finally losing its froth. Clearance rates for housing in Melbourne have dropped from more than 80% in 2009 to a far more sedate 60% (while other capital cities have fallen even more). This hasn’t yet translated into falling prices though, with agencies reporting that residential house prices still managed a small rise in May and vendors not fully adjusting their expectations.

All that doesn’t mean housing isn’t grossly over-priced. That was the view of Demographia’s 6th International Housing Affordability Study, which came out earlier this year. Demographia’s research compares house price-to-income ratios in Australia, the US, Canada, Britain, Ireland and New Zealand. The study indicates that nine of the 15 most expensive cities are located in Australia, with Sydney coming in second, Sunshine Coast third and Melbourne seventh. London comes in 14th while New York slumped to 16th behind cosmopolitan Bundaberg.

While Demographia’s figures have in the past been challenged by the likes of Chris Joye (and plenty of other surveys that use different metrics don’t rate Australian cities as the world’s most expensive), Demographia aren’t the only ones claiming the Australian housing bubble will inevitably burst. Fund manager Jeremy Grantham, who correctly predicted the GFC and dotcom crash, told The Australian media section on Wednesday that:

If [Australian and UK house prices] don’t come back to the normal multiple of family income, it will be the first time in history … you may not know when, but when you know with something approaching certainty that one day the combination of [borrowing] seven-and-a-half times [the average family income] and an unpleasantly high interest rate will equal a non-compute.

… Any bubble can be an exception to the rule, but bubbles have quire a few things in common, and housing bubbles have a spectacular thing in common; every one of them is considered unique and different.

Steve Keen writing in Business Spectator last week proffered a similar finding, stating that:

[Bubbles] are all driven by borrowed money, and they can only be sustained so long as rate of growth of debt outpaces incomes. Once that stops, the engine of unearned income that enticed speculators to enter the market breaks down — since the only way that we can all appear rich without working is if we spend borrowed money.

Keen had last week warned of housing nearing a precipice, analysing financial data and concluding:

The telling figure is the rate at which owner-occupier buyers are leaving the market. In both number and value terms the people who actually want to live in houses are increasingly sceptical of taking on massive debt to buy a home. In trend terms, the number of loans for all borrowers excluding refinancing of existing home-loans has fallen in nine of the last 10 months. In value terms, it’s eight of the last 10 months.

But the view is not unanimous. Earlier this week, deputy governor of the Reserve Bank Ric Battelino appeared to dismiss the notion of a debt-fuelled property bubble, telling financial executives:

If we look at the way the increase in household debt has been distributed, what households have done with the money, and the arrears rates on loans, it is reasonable to conclude that the household sector has the capacity to support the current level of debt.

Like many other optimists, Battelino appeared to base his confidence on Australia’s low level of non-performing loans (see graph below) and the structural decline in Australia’s level of interest rates. Battelino (who presumably speaks for the RBA) must not have a great respect for history, appearing to hold the view the interest rates will never return to their previous peaks, or that unemployment in Australia is dead. The RBA deputy governor also noted that “households in the top two income quintiles account for 75% of all outstanding household debt”, which is a somewhat brave assumption that those who earn a lot of income are not capable of going broke. Battelino himself even noted that “most of the rise [in household debt levels] was due to housing debt, including debt used to fund investment properties”. This could be somewhat of a problem if those purchases turn out being vastly over-priced.

The likes of Keen and Grantham have been proven right in the past while the RBA have tended to overreact (though not as badly as the US Federal Reserve) with easy monetary policies, together with federal government fiscal stimulus, which sowed the seeds of our continuing housing bubble.

Who you gonna believe?

Peter Fray

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