Australia’s households are the third most indebted in the world, relative to GDP, after having passed the Netherlands in 2014. Aussies are now closing in on the leader of the pack, Denmark, and second place, Switzerland.

“Given the current boom in Sydney and Melbourne, it is possible Australia will soon exceed Switzerland to become 2nd, and with enough time, perhaps 1st,” write Lindsay David and Philip Soos in a new report by LF Economics (entire report for free here ).

By the end of 2014, Australia’s unconsolidated household-debt-to-GDP ratio reached 118%. But it’s not because Aussies ran up their credit cards. Personal debt (credit cards, auto loans, and personal loans), after soaring in spurts and starts from 5% of GDP in 1976 to 13% of GDP in 2007, has since plunged back to just over 8% GDP, the lowest since the mid-1990s.

What they did run up was mortgage debt. It funded, as the report puts it, “the largest housing bubble on record.”

In this chart of the household-debt-to-GDP ratio, the black line (total household-debt ratio, including mortgages) has stalled thanks to plunging credit card debt, and remains below its prior peak. But the mortgage-debt ratio (red line), which accounts for most of the total household debt ratio, set a new record in 2014:

This boom in prices goes far beyond consumer price inflation and the quality improvements in housing over time. Adjusted for inflation and for these quality improvements, the Constant Quality Real Housing Price Index has soared nearly 75% for Sydney since the mid-1990s and 150% for Melbourne.

In both Melbourne and Sydney, the ratio of home prices to household incomes, a measure of housing affordability, has more than doubled since the mid-1990s, showing just how rapidly home prices have run away from incomes:

But every city has its own housing market. On an inflation adjusted basis, the capital cities Perth, Brisbane, Adelaide, Hobart, and Canberra have not yet regained their respective bubble peaks before the Financial Crisis, while Darwin has shot a lot higher.

Thus the overall picture of the Australian housing bubble. Since the Financial Crisis, it has largely been driven by Sydney and Melbourne. When adjusted for inflation and quality improvements, the national average started booming in 1996, dipped during the Financial Crisis, and according to the report’s estimate, is likely to hit a new high in 2015:

This confronts potential home buyers with prices that, since 1996, “have outpaced inflation, incomes, rents, and GDP, making it difficult for potential first home buyers (FHBs) to enter the market, while lower income households and marginal groups struggle to afford decent shelter.”

The sharp decline in interest rates since 2008 has lowered the burden of the mortgage payments, but it also provided an incentive to increase leverage for investors and homeowners and gave them the cheap fuel to run up home prices. The net result is what the report calls, “The Great Australian Debt Trap.”

All housing bubbles burst eventually. And when they do, they drag the economy into a deep recession. LF Economics in the report :

Contrary to the analyses of the vested interests, the data clearly establishes Australia is in the midst of the largest housing bubble on record. Policymakers are caught between a rock and a hard place, as implementing needed reforms will likely burst the bubble, causing severe financial and economic fallout as residential land prices revert to mean. The FIRE sector [Finance, Insurance, Real Estate] will surely blame policymakers for the bust and deflect attention away from debt-financed speculation.

The Australian mining sector is screaming towards what may be one of the most colossal economic breakdowns in modern Western history. Read… Australia Runs out of Luck, Now Needs a Miracle

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