No, that’s where the profits are. Who cares where the buyers come from?
All posts by Bryan Kavanagh
CANBERRA TIMES REVIEWS “BUBBLE ECONOMICS”
http://www.canberratimes.com.au/comment/the-housing-bubble-and-the-pin-factor-20140704-zsre1.html
The housing bubble and the pin factor
By Crispin Hull
Some economists and analysts have been saying for a decade or more that we are going to have a major slump in housing prices, and they have, according to real estate commentators and others, been proved wrong. But maybe the doomsayers have not been “proved wrong”. Rather, the predictions were a bit premature and/or we have already had a bit of a correction in 2008-09 with the global financial crisis, postponing the inevitable bursting of the housing bubble for a while longer.
Of course, before a bubble can burst, you must first of all have a bubble. A book just out called, Bubble Economics: Australian Land Speculation 1830 – 2013, by Paul D. Egan and Philip Soos, argues precisely this: there is a bubble and all the evidence points to it being about to burst.
Sobering stuff. Pitted against this is the view that Australian governments will continue to import more and more people into a finite residential land envelope, so continued increased demand will mean ever-rising housing prices. Egan and Soos examine earlier housing bubbles in Australia: the 1830s, 1880, 1920s, mid-1970s and late 1980s. Then they add a hard-headed analysis of the present housing market.
You need more than just rising prices to create a bubble, whether in housing, internet stocks or, indeed, tulips. You also need increasing private debt and a falling yield (as surging housing prices far outstrip comparable rents). To get a bubble these things have to rise quite quickly – at a rate faster than the rest of the economy to a point where the low yield rate and/or high indebtedness forces people to leave the market quickly, causing collapse.
Hitherto, the prospect of ever-rising house prices has meant the prospect of capital gains has held the market up, but, as Egan and Soos point out, it cannot go on forever, if the debt and low yields outstrip the prospect of capital gains. That defies economic fundamentals.
The statistics they present are quite forceful. Between the low in 1996 and apparent peak in 2010, real housing prices soared by 123 per cent (more than doubling) and they are getting back to 2010 levels now. Total land values relative to GDP doubled between 1996 and 2010, driven by rising residential land values. In the meantime, yields in the form of rent have fallen to just 1.9 per cent. The price-to-earnings ratio has blown out to 53. That means a $1 million house is returning just $19,000 a year, compared to $40,000 from the poorest fixed-interest deposit.
It means you need an awful lot of capital gain to make the housing investment worthwhile. There clearly comes a point at which the returns are too low and the expectation of capital gains too unrealistically high, so that people desert housing, or banks refuse to lend or demand their existing borrowers reduce their debt.
The only questions are how soon will that happen, and when it happens will it be sudden and large or gradual and incremental?
Egan and Soos argue that it will be soon, sudden and large, and point to the historical experiences, noting Mark Twain’s point that while history does not repeat itself, it does at least rhyme. Indeed, they point out the Australian housing bubble is bigger now than those in the 1920s, mid-1970s and late 1980s.
The present housing price-to-earnings ratio of 53 is interesting. The dot-com bubble in the US burst before the ratio got to 53 – it reached 47.2 at its peak. In that market, people expected dot-com stocks to always increase in price, just like Australian housing investors expect lots of capital gains, so they paid more for the assets than their returns suggested they were worth, until reality set in.
An interesting aspect to Egan and Soos’ work is that they take account of the owner-occupier part of the market. The yield for those dwellings is saved rent. There comes a point at which a person says it is better to rent than buy. You can borrow $1 million worth of capital in the form of a house for rent of just 1.9 per cent of its value. Pretty good deal.
We are seeing that with historic lows in first-home buyers and in lower rates of owner occupation. This can contribute to price collapse. The hidden pin in the bubble-bursting exercise is debt.
“Deregulation, privatisation and liberalisation since the end of social democracy in the 1970s has allowed the financial sector to lend freely,” Egan and Soos write. “The dire consequence has been the rise in the unconsolidated household debt to GDP ratio from 46 to a record 111 per cent between 1993 and 2010, lifting residential land prices far beyond economic fundamentals.”
They predict that high population growth and fixing the huge level of private indebtedness will probably cause a large decline in per-person income and production. They attack the standard explanations for ever increasing house prices, such as a housing shortage, high population growth, demographic change, falling nominal interest rates, a low rate of inflation, regulated land supply and foreign-investment controls. Rather, they argue, the real causes are debt-financed speculation and a taxation system that rewards speculators – a classic unsustainable bubble.
Their warning is grim: “Real housing prices may fall 30 to 50 per cent across the capital cities, devastating the economy and rendering Australia’s financial sector insolvent.”
One might well argue that negative gearing and political aversion to allowing housing prices to collapse will mean that there will be no bursting bubble. Also, the prospect of capital gains tax tends to make sellers delay sale until they get a favourable year for themselves with either capital losses to offset or a general low-income year.
Further, stamp duty; the time-consuming conveyancing process; and the requirement to sell the whole asset means that housing markets are not as susceptible to sudden collapses in the way sharemarkets are. But all that said, there comes a time when prices rise so high that these factors lose their force and the rational desire to make a reasonable return leads to the inevitable re-entry of economic forces.
It would be better for Australia if there were no bursting bubble but rather a gradual levelling out of housing markets.
To that end the government and the big lenders might well look at policies that favour productive rather than speculative borrowing.
Australia’s public debt is low, yet the government gets in a frenzy about it. Whereas our private debt is among the highest in the world, yet our government financiers just add fuel to the fire.
WHY IT’S NOT ALL GLOOM AND DOOM
THE NATION
The federal budget and its architects are as popular as a turd in a lunchbox precisely because they have failed to end some of the most egregious entitlements for the relatively wealthy, while cutting support for some of our poorest citizens.
AIMING PITCHFORKS AT THE PLUTOCRATS?
Straight talking from a billionaire.
Many thanks to IDEA economics for sending this article. They’re currently looking for Mr Hanauer.
WHY IS IT LEFT TO “RUSSIA TODAY” TO PRESENT ECONOMIC FACTS ABOUT AUSTRALIA?
Usually I ensconce myself daily in front of my computer to tap out some of the more obviously bad financial news confronting Australia, to get it out of my system before getting on with my day, because the reasons have become so blatantly obvious to me. I can see it all ending as badly, or worse, for Australia than it did for the US, Ireland, Greece, et al.
Manufacturing continues to be replaced by speculative FIRE sector activity, which in turn has become cosseted and promoted by Australian governments. (“Aren’t we post-industrial anyway?”)
However, whilst the bad economic effects are indeed reported in the news, they tend to be reported as transitory events that will disappear over the horizon because “there is nothing structurally wrong with the economy.”
There is, you know: but efforts to get these structural weaknesses out to the general public are suppressed in the name of “maintaining confidence” in what any open mind would consider to be a doomed economy if they had all the facts. But the facts are difficult to get out in these circumstances.
Philip Soos and Paul Egan’s Bubble Economics: Australian Land Speculation 1830 – 2013 , worth thousands of dollars for its unique research data alone, should be a best-seller in economics. But what book companies would promote such a book in the current economic climate? It was therefore left to the World Economics Association to get it out on the web – for free.
Much the same with Lindsay David’s book Australia: Boom to Bust. It happened to get a mention in a report on Australia by Bryan McDonald in Russia Today.
The inaction is frustrating – because if you don’t have all the facts about where the economy is failing, badly, the country will have no chance of repair before it disappears down the gurgler.
NEO-CLASSICAL ECONOMICS BREACHES HUMAN RIGHTS
I am constantly overwhelmed by the depth of knowledge displayed by scholars and individuals in the sciences and humanities. From where came their essential inspiration, incessant determination and constant application to succeed so obviously in their field?
Whilst myriad discoveries from these people tend to progress modern society, the countervailing forces have become all too obvious.
I’ve read many erudite papers in economics and constantly felt let down. I do admit to becoming bewildered and lost in some of the mathematics, but then I’m able to get a pretty good sense of what a paper is trying to get across to me, and come away feeling underwhelmed, even cheated, from virtually everything I read in economics.
It is not an exaggeration to say much economics is bunkum, and even the maths is unable to serve and save it. (It often seems to compound the problem!)
Economics is the most overarching study of all. People and the world constitute economics, but the study of economics has led us into a dead end.
Neoclassical economics currently acts as a deadweight that holds society and human aspirations back as it hijacks the rewards from work, knowledge and innovation, donating these to speculative rent-seeking parasites.
My 2007 report Unlocking the Riches of Oz: A case study of the social and economic costs of real estate bubbles 1972 to 2006 for the Land Values Research Group (on behalf of Prosper Australia), demonstrated in easily understood maths how we could double GDP and see to its better distribution in short order by tweaking our revenue system. Why is the study of economics not up for this?
The relatively few heterodox economists and other disciplines must call modern economics to order and to an intellectual rigour which accounts for economic rent.
We first need to understand the difference between public and private property–because economics currently breaches human rights–and the great lawyer William Blackstone (1723-1780) is a good starting point here:
The earth, therefore, and all things therein, are the general property of all mankind, from the immediate gift of the creator.
…there is no foundation in nature or in natural law why a set of words upon parchment should convey the dominion of land.
– “Commentaries on the Laws of England” (1766)
UK UNAFFORDABLE HOUSING ANALYSIS
GOOD INTERVIEW, JOE!
Couldn’t find much wrong in this interview with Joseph Stiglitz on the ABC’s Lateline last night.
I especially enjoyed his commenting to the effect that we can indeed have higher taxes, provided we draw them from miners and property speculators.
CANADA DAY – BACK AFTER THIS COMMERCIAL
Desiderata
Go placidly amid the noise and haste,
And remember what peace there may be in silence.
As far as possible, without surrender, be on good terms with all persons.
Speak your truth quietly and clearly; and listen to others,
Even dull and ignorant; they too have their story.
Avoid loud and aggressive persons; they are vexations to the spirit.
If you compare yourself with others, you may become vain and bitter;
For always there will be greater and lesser persons than yourself.
Enjoy your achievements as well as your plans.
Keep interested in your own career, however humble;
It is a real possession in the changing fortunes of time.
Exercise caution in your business affairs; for the world is full of trickery.
But let this not blind you to what virtue there is; many persons strive for high ideals;
And everywhere life is full of heroism.
Be yourself. Especially do not feign affection.
Neither be cynical about love, for in face of all aridity and disenchantment
It is perennial as the grass.
Take kindly the counsel of the years,
Gracefully surrendering the things of youth.
Nurture strength of spirit to shield you in sudden misfortune.
But do not distress yourself with imaginings;
Many fears are born of fatigue and loneliness.
Beyond a wholesome discipline, be gentle with yourself.
You are a child of the universe, no less than the trees and the stars;
You have a right to be here; and whether or not it is clear to you,
No doubt the universe is unfolding as it should.
Therefore be at peace with God, whatever you conceive Him to be,
And whatever your labors and aspirations,
In the noisy confusion of life, keep peace with your soul.
With all its shams, drudgery, and broken dreams,
It is still a beautiful world. Strive to be happy.
Author – Max Ehrmann (1872-1945)
OZ FIRE WINS OUT!
Ever since returns on capital declined from the 1970s through to the early 1990s, the FIRE sector (finance, insurance and real estate) has won out hands down in Australia. “Why produce?”, it asked. “Here’s some dough for speculating!” Now, Australia’s banks lead the world.
Why wouldn’t our banks be making super profits out of our bubble-inflated land prices and the vast mortgages around Australians’ necks? http://www.smh.com.au/business/big-four-on-top-of-the-world-for-profitability-says-bis-20140629-3b2c6.html
Don’t worry, boys, we’ll bail you out when things go pear-shaped!