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Jan 11, 2012

Is Australia’s housing bubble finally close to bursting?

One of the world’s last and greatest house price bubbles is finally ending, argues economist Steve Keen.

Mortgage debt is by far the largest component of debt in Australia today — government debt, which is the focus of political debate, is trivial by comparison (a quick caveat though: finance sector debt may be larger again than mortgage debt, if this claim, sourced from Morgan Stanley, is accurate, since it shows Australia’s aggregate private debt ratio as almost equal to that of America).

The household debt to income ratio may have topped out now, after growing five-fold in the last two decades. Figure 2 shows the ratio of household debt to disposable income, which peaked at 149% of disposable income back in late 2008. Despite the enticement into debt given by the first-home vendor’s boost, aggregate household debt never exceeded this pre-boost peak as a percentage of disposable income, since the fall in personal debt outweighed the rise in mortgage debt.

This huge rise in household debt compared to income has more than offset the falls in interest rates that occurred since the 1990s. The perennial argument from property spruikers that the rise in debt has simply been a rational reaction to the fall in interest rates is pure bunkum — especially when you take a less-than-myopic look at the data, and consider mortgage rates back in the 1960s, which were well below today’s rates (see figure 3).

This comparison stands even when inflation is taken into account. The average real mortgage rate in the relatively low-inflation 1960s was 3% — a full percentage point below the low inflation level of the last decade (see figure 4). Why wasn’t mortgage debt higher back then, if the increase since the 1990s was a “rational response to lower interest rates”?

I date the Australian house price bubble from 1988, when it was spiked by the reintroduction of the first home owner’s scheme by the Hawke government in reaction to the share market crash of 1987 (the scheme works by encouraging would-be buyers to take on mortgage debt, and then hand the leveraged sum over to the vendors — which is why I prefer to call it the first-home vendors scheme). It then really took off in 2001, when Howard doubled the grant in response to a feared recession (see figure 5, which combines Nigel Stapledon’s long-term indexwith the ABS data from 1976 on; “Hawke” and “Howard” respectively mark the re-introduction of the grant in 1988 and Howard’s doubling of it in 2001), though it was already running hot again from 1997 when — without any additional help from the government — the financial sector had enticed Australians to go from a 50% to a 70% mortgage debt to GDP ratio (at a time of rising interest rates).

The combination of higher rates and much higher debt levels means that paying the mortgage is taking far more out of the family purse than it used to do back in the pre-housing bubble years. Readily available data from the RBA shows that interest payments on household debt are five times as high as they were back in the 1970s.

The RBA data for mortgage debt only start in 1976; in the spirit of countering spruiker myopia, I’ve estimated pre-1976 mortgage debt as 30% of total debt, from the RBA’s long-term data (the average from 1977-1980 was 31%). Interest payments on mortgage debt are as much as 10 times as high now as in the 1960s (see figure 6).

Spruikers also prefer to ignore the fact that debt has to be repaid, and focus on the interest payments alone. In the past mortgages been paid off after five to seven years via the resale of the property, but that will be a lot more difficult in future as house prices fall. Figure 7 shows household debt service as a percentage of disposable income with mortgage debt being repaid over 25 years and personal debt over 10. On this basis, there has been a 12-fold increase in the proportion of family income that has to be devoted to servicing mortgages since 1970. Even compared to the high-interest days of 1990, mortgage debt service is now 2.5 times as burdensome.

There is clearly no capacity for debt service to take a larger slice of the family income pie, which in turn is taking the wind out of the housing market. Spruikers happily make a “supply and demand” argument about why house prices have risen, but obsess about regulation-impaired supply and equate demand with population growth. In fact, demand for housing doesn’t come from population growth — it comes from the growth in the number and value of mortgages. That growth rate in fact peaked back in 2004, and it has been trending down ever since; the first-home vendor’s boost merely delayed this process without stopping it.

That in turn is the main factor driving house prices down — just as rising mortgage debt drove prices up, falling mortgage debt is driving them down. As I’ve explained elsewhere, the causal factor behind asset prices is not just rising but accelerating debt. This is an extension of my basic proposition that macroeconomic analysis must include the role of credit — which is ignored by conventional neoclassical economics. In a credit-driven economy, aggregate demand is the sum of incomes plus the change in debt, and this monetary demand is expended buying commodities and claims on existing assets — basically, shares and property.

Part of demand for housing thus comes from income — the focus of the property spruikers — and part comes from the increase in mortgage debt, which they ignore.

For prices to rise, demand must also be rising, and this requires not merely rising mortgage debt but accelerating debt. Of course variations in income (and variations in supply, too) can play a role, but in the overwhelmingly speculative, overly-leveraged market that Australian housing has become, accelerating mortgage debt trumps the lot (see figure 10).

This is especially so since such a large percentage of buyers are so-called investors — “so-called” because a better description is speculators. Actual investors aim to make a profit out of the income flow generated by an investment. Australia’s property “investors” instead lose money on their rental income, and hope to recoup the loss as capital gains via a later sale. With the days of house prices rising faster than incomes well and truly over, this percentage of the market could drop back to pre-1990s levels.

Both sources of demand are now falling strongly from the artificial boost given by Rudd’s spin of the FHVS sauce bottle.

One of the world’s last and greatest house price bubbles is thus finally ending.

*Steve Keen is Associate Professor of Economics and Finance at the University of Western Sydney and author of Debunking Economics and the blog Debtwatch. This article was originally published at Property Observer.

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16 thoughts on “Is Australia’s housing bubble finally close to bursting?

  1. Phen

    These economists love a good ol’ graph dont they? Just a lazy 13 in this article….

  2. Captain Planet

    Presumably this is the same Steve Keen who predicted a 40 % fall in Australian house prices back in 2009, and wound up losing a bet with Rory Robertson.

    Mr. Keen walked 200 km from Canberra to the top of Mt. Kozsiusko wearing a T shirt that said, “I was hopelessly wrong on house prices! Ask me how.”

    Although the economics behind Mr. Keen’s argument, on first glance, appears sound and convincing to the economically illiterate (me), the present history of mr. Keen’s predictions is somewhat less than reliable.

  3. Gavin Moodie


    True, but in this case I find the graphs more informative than a bunch of tables and it is hard to escape economics’ character as a numerical discipline. You’re lucky that Keen didn’t throw in a couple of equations, which all ‘proper’ economics papers include.

    Thus far I’m persuaded by Keen. However, I don’t think even he would describe himself as an orthodox economist and it will be interesting to read whether his view is supported by other economists. A comment from Quiggin would be interesting. There’s nothing on his blog yet.

  4. Toypoodle

    meh. but the trend toward vulnerability has been around for a while. there’s clearly a plateau in prices but is a big fall likely? there is little in this article on ‘triggers’. There’s the mining export boom vis the slowdown in retail/ services. there’s current round of rate cuts. yes there’s vulnerability but big falls? too hard to say…


    Keen picked the GFC.

    House prices will continue to fall.

    Trouble in China and they will crash.

    $2 trillion is one big bubble.

  6. Jones Tristan

    I expect prices to be stable or decline slightly unless China’s economy goes into a major downturn, then they will crash.

  7. Bultaco Metrella

    Let me leave the debunking of this to:-

    The real estate market is far more complex than these simple nostrums.

  8. AR

    A broken clock is right twice a day so, eventually Keen will be correct and eventually we’ll all be dead, as said another economist.

  9. Willie C

    Check out this article for a view from an Irish economist on the Australian housing market (from yesterday)