I was wrong on Australian house prices

“I was hopelessly wrong on house prices. Ask me how.”

It’s about time I answered that question, isn’t it?

In a nutshell, I got the cause of the Aussie House Price Bubble right, but the direction of the cause wrong. The fundamental determinant of house prices is mortgage debt. I thought that -- as had happened in Japan after its bubble economy burst -- the Australian economy would start to de-lever after the GFC, and that this process would take house prices down with it. This is what happened in the USA and most of the First World.

But in Australia, the rate of change of mortgage debt never went negative and deliberate government policy played a major role in stopping that from happening on two separate occasions: The Rudd stimulus package in October 2008 and the reversal of the RBA’s “fight the inflation bogeyman” policy of rising interest rates in November 2011. Both policies allowed -- and indeed encouraged -- mortgage growth to continue long after it would have stopped without government intervention, and long after it did stop in most of the rest of the First World.

Though they didn’t quite know why it worked, Treasury knew from experience that a boost to the housing market stimulated the economy -- so they advised Rudd to throw in what I nicknamed the “First Home Vendors Boost” into his rescue package. The $7,000 Federal Government grant doubled to $14,000 for buyers of existing properties, and trebled to $21,000 for those buying new properties (State governments threw in their own debt sweeteners as well -- with Victoria purchasers being given up to $36,500 in total). First home buyers flooded into the market, leveraging up the grant by a factor of ten or more in additional mortgage debt. This stopped the decline in mortgage debt in its tracks and growth in mortgage lending -- and house prices -- resumed until the grant ended in mid-2010.

Figure 1: My blog post on the Rudd stimulus package in October 2008

The RBA’s policy intervention was even more shambolic – but, ultimately, even more effective -- than Treasury’s. With its conventional economic mind set, the RBA not only failed to see the GFC coming but continued to put interest rates up after it struck (unlike all other Central Banks, save the equally incompetent European Central Bank). Like a general determined to win the last war, Stevens continued to build his Maginot line against the inflation demon, only to belatedly concede that deflation was the actual foe. Fully one year after the GFC began, the RBA reluctantly joined the global surrender of central banks to this unexpected enemy and dropped its reserve rate from 7.25 per cent to 3 per cent in a mere 8 months.

But then, confident that the war it hadn’t seen coming was over, the RBA resumed its struggle to win the previous one against inflation. It put its rate up from 3 per cent to 4.75 per cent in 14 months -- at the same time as the stimulus from Rudd’s ‘First Home Vendors Boost’ was ending. By this time, Australia’s prosperity stood on the twin pillars of China’s export demand -- thanks to its huge post-GFC stimulus package -- and the investment boom this induced in Australia’s mining sector.

Since even those enormous injections weren’t enough to keep the economy on the mend, the RBA was again forced to reverse direction and began cutting its rate in late 2011 -- this time with the deliberate hope that a restored housing bubble would take the place of an unexpectedly unfulfilling mining boom.

Figure 2: The confident incompetence of the world’s Central Banks—and especially the RBA

On cue, ‘investors’ piled into the housing market, since bond rates were falling, and the share market was just too scary. The fall in the growth of mortgage debt occasioned by the end of the ‘First Home Vendors Boost’ stopped, and mortgage growth took off once more.

Figure 3: Australian mortgage debt never fell after the GFC, unlike the USA

This government meddling in the property market meant that the mortgage bubble, which might have burst in Australia at the time of the GFC, instead continued to grow. In 1992, at the end of the “recession we had to have”, Australia’s mortgage debt level was half that of the USA’s. When Howard first introduced (and then doubled) the First Home Owners Grant in 2000, Australia’s mortgage level equalled the USA’s. Today, thanks in part to Rudd’s and then Steven’s interventions, Australia’s mortgage debt level is more than 75 per cent higher than the USA’s.

When other forms of personal debt are factored in, Australian households are now the most indebted on the planet (the table below, from the Bank of International Settlements, reports debt levels as of June last year, when Australia was already number 2 on the list, behind only Denmark).

Table 1: Household debt to GDP ratios

But is this a problem? After all, isn’t money cheap now -- with borrowing rates the lowest they’ve been in history? Why not lever when debt is cheap? Aren’t Australian households just being clever with leverage? And what’s mortgage debt got to do with house prices anyway -- aren’t they determined by supply and demand?

Yes they are and as I’ll explain in next week’s column, that’s the problem.

Steve Keen is the Head of the School of Economics, History & Politics at Kingston University and author of Debunking Economics. You can follow him on Twitter: @ProfSteveKeen