Tuesday, March 13, 2012

457 Germany's affordable housing cf UK/Australia bubble. Negative Gearing makes housing unaffordable-

Germany's affordable housing cf UK/Australia bubble. Negative Gearing makes housing unaffordable

(1) Germany's affordable housing cf UK bubble factory
(2) First Home Buyers grants push up house prices and reduce home ownership - Saul Eslake
(3) Australia's tax system favours Borrowing and Speculators over Working and Saving - Saul Eslake
(4) First-home stimulus and Negative Gearing inflate house prices - banker
(5) Housing should not be a speculative investment, but a place to live & raise a family
(6) Australia's Real Estate Bubble is bursting; Negatively gearers face losses
(7) What the bursting of Australia's housing bubble could mean for the banks - Steve Keen

(1) Germany's affordable housing cf UK bubble factory


How Germany achieved stable & affordable housing

Posted by Unconventional Economist in Global Housing Bubbles on Jun 22nd, 2011

A few months ago, after posting numerous articles advocating the Texan approach to land-use planning, I promised fellow MacroBusiness blogger, The Prince, that I would undertake an analysis of the German housing system, which is regarded as amongst the most affordable and liberal in Europe.

In my findings presented below, I have compared and contrasted the German housing system with that of the United Kingdom (UK), which is considered amongst the most unaffordable and supply-constrained markets in the world.

You will see that German and UK housing policies are polar opposites, with the former providing highly responsive housing supply, significant rental controls, and tighter credit regulations compared with the latter.

Before I kick-off, consider the following broad indicators relating to the German and UK housing markets.

First, real house price growth:  {visit the link to see the graph}

As you can see, German housing values have been stable but falling since the 1970s, whereas UK housing values have experienced four boom/bust cycles and deteriorating housing affordaility (indicative of unresponsive supply) since 1970.

Second, consider the rate of population growth in both countries: {visit the link to see the graph}

After experiencing higher growth in the 1990s, Germany's population has grown more slowly recently.

Finally, consider home ownership rates in the two countries:  {visit the link to see the graph}

Whereas Germany has one of the lowest home ownership rates in Europe (just over 40%), the UK has one of the highest (around 70%).

There are three main factors that seem to account for Germany's stable and lower home prices and lower home ownership rate: (1) responsive housing supply; (2) secure rental tenancy; and (3) more regulated mortgage credit availability.

Housing supply:

Germany has some distinct features that enables it to provide a plentiful supply of housing in response to increasing demand.

First and foremost, the German constitution contains an explicit 'righ-to-build' clause. According to The Policy Exchange:

…this "means that everyone is entitled to a permission to build on his or her property as long as there is no explicit legal rule against it.

…if the proposed building fits into the plan, permission has to be granted and if the local authorities deny it then a court will enforce it…

Although there is very close control of what can be built on any site, provided it meets the requirements of the master plan, a developer just can get on and build new housing without seeking development permission.

Most importantly, the local governments that control the planning process have a direct financial incentive to provide land for housing, since they receive grants based on the number of inhabitants. Therefore, encouraging development is an important way for local politicians to increase their budgets.

Now compare the liberal German system to the centrally planned approach in the UK, which has for decades explicitly constrained the supply of land for development.

First, UK cities are surrounded by strict 'greenbelts' (similar to urban growth boundaries), which prevent development past a certain point. These greenbelts have significantly restricted the availability of land for development, helping to push up prices.

Second, and related to above, the overriding planning objective in the UK has been 'urban containment and 'densification'. There is now a target that 60% of all land for housing should be brownfield land – i.e. land which has already been developed for some other purpose – which necessarily means the restriction of land supply and higher land prices.

Third, any change from the status quo - such as a change in land use from rural to urban, housing to office, or an increase in housing size - requires planning permission.

Finally, the UK operates a centralised fiscal system, whereby local authorities – which are the primary decision makers on development and have statutory obligations to provide services for new houses – receive very little revenue from increased population and housing. As such, these local authorities tend to oppose development.

The divergence in home construction rates couldn't be more stark, as recently summarised by Dr Oliver Marc Hartwich in Business Spectator:

Over the past forty years, both the UK and Germany experienced similar population growth, almost identical decreases in household sizes, and comparable economic growth. Besides, both countries have similar population densities.

Summing it up, the UK and Germany share all the factors that explain housing demand…

However, as comparable as they are with regard to housing demand, they are wildly different in terms of housing supply… The Germans built more houses than the British, both in per capita and absolute terms.

The EU collects data for the housing markets of its 27 member states. According to their statistics, Germany's rate of dwellings completions per 1,000 inhabitants was consistently higher than the UK's. In some years the difference was only 10 per cent, in others more than 110 per cent.

The differences in completions were also reflected in the land made available for development. The Cologne Institute for Economic Research calculated that last year there were 50 newly developed hectares of land per 100,000 population in Germany but only 15 hectares in the UK.

Rental system:

The German rental system is another key factor contributing to the stability and affordability of the housing market. While the majority of rental dwellings in Germany are private, rents are regulated and prices are prevented from increasing sharply. Tenants also have security of tenure as long as they pay the rent and behave well, except on the rare occassion when a member of the landlord's family needs the accomodation or when the building is going to be replaced.

Further, because renting is the dominant housing choice in Germany, the political system is highly sensitive to tenants' rights and perecived threats to the status quo typically receives prominant media attention and political responses.

Since home prices are relatively stable (owing to liberal supply) and renters enjoy secure tenure, Germans have little incentive to rush into owner occupation. As such, Germany doesn't suffer from the 'panic buying' and speculation often present in bubble housing markets.

In comparison, the UK rental system could not be more different. According to the RICS European Housing Review:

The UK now has probably the most liberalised housing sector in Europe since the 1989 abolition for new tenancies of previous controls. There is only limited security of tenure for the first six months of a tenancy in the most common types of rental contract and rents are freely negotiable…

The typical rental property is a terraced house in an outer or inner suburb of a town or city. The property will rarely be new: only 13% are post-1985, and almost two-thirds are pre-1945, although most will have been recently modernised.

And because of the volatile nature of UK home prices (caused largely by supply constraints) and the lack of security of tenure in the rental market, 'panic buying' from first-time buyers and investor speculation is prevelent when house prices are rising, adding to price volatility:

House price expectations influence tenure choice. Periods when rising prices are expected encourage households to enter owner occupation and the opposite occurs when prices are expected to stagnate or fall. Demand cycles for owning and renting consequently tend to vary over time. Currently, more people are renting because of expectations of continuing falling prices as well as because of greater problems in finding mortgages and raising deposits.

Availability of credit:

Mortgage finance in Germany is also conservative relative to most economies that have experienced housing bubbles. According to RICS:

…credit availability is more strictly rationed in Germany compared with the pre-financial crisis experience in many other countries. For example, there is conservative loan appraisal, no sub-prime segment and thorough vetting of loan applicant details.

Moreover, base loan-to-value ratios (LVRs) from mortgage banks (the main provider of home loans) are capped at 60%, although other unsecured loans are often added into loan packages (at higher interest rates), which tends to increase the overal LVRs.

In contrast, the UK mortgage market was fully deregulated in the early 1980s. During the height of the 2000s credit/housing bubble, UK lenders were offering 100% plus LVR(i.e. no deposit) mortgages to first-time buyers. However, since the onset of the global financial crisis, lenders have rationed credit and required higher deposits (reduced LVRs), thus contributing to the boom/bust cycle inherent in the UK housing market.


The contrast between the German and UK housing markets couldn't be more stark.

Unlike Germany, the UK housing market is essentially a bubble factory. Wheras Germany's highly responsive supply ensures that extra demand manifests itself in rising new home construction rather than increased prices, the opposite is the case under the UK's restrictive land-use policies.

The UK's deregulated rental market and lack of tenure has also ensured that renting is a second rate option, thereby encouraging residents to strive (and borrow big) for owner occupancy. And of course the UK's lax financial system has been only too happy to oblige, providing households with no deposit mortgages during the boom followed by rationed credit during the bust.

When all these factors are combined, is there any wonder why Germany's home prices have remained stable and affordable, and free of the speculative behaviour, 'panic buying' , and price volatility inherent in the UK system?

It's a shame that Australia has inadvertently adopted the worst aspects of the UK housing market, namely: the UK-style planning system, complete with similar vertical fiscal imbalances with respect to federal, state and local taxation revenues; a deregulated rental market offering insecure tenure; and a deregulated mortgage market that provides low deposit finance at generous multiples of income.



(2) First Home Buyers grants push up house prices and reduce home ownership - Saul Eslake


Billions in handouts but nothing gained

Saul Eslake

March 16, 2011

IT'S hard to think of any government policy that has been pursued for so long, in the face of such incontrovertible evidence that it doesn't work, than the policy of giving cash to first home buyers in the belief that doing so will promote home ownership.

The federal government began giving cash grants to first home buyers in 1964 when, at the urging of the New South Wales division of the Young Liberal Movement (whose president at the time was a young John Howard), the Menzies government began paying Home Savings Grants of up to $500 to "married or engaged couples under the age of 36" on the basis of $1 for every $3 saved in an "approved form" (generally with a financial institution whose major business was lending for housing) in the three years before buying their first home, provided that the home was valued at no more than $14,000.

This scheme was abolished by the Whitlam government in 1973 (in favour of an income tax deduction for mortgage interest payments by people with a taxable income of less than $14,000 a year); reintroduced under the name of Home Deposit Assistance Grants (without the age or marriage requirements and the value limits and with a larger maximum grant of $2500) by the Fraser government in 1976; replaced by the Hawke government in 1983 with the First Home Owners Assistance Scheme, initially with a maximum grant of $7000 (later reduced to $6000) and subject to an income test; abolished by the Hawke government in 1990; and then reintroduced as the First Home Owners Grant by the Howard government in 2000, without any income test or upper limit on the purchase price of homes acquired, ostensibly as "compensation" for the introduction of the GST (even though the GST only applied to the purchase of new homes, and not to existing dwellings, which the majority of first-time buyers purchase).

On two occasions since 2000, the FHOG has been temporarily increased in response to an actual or feared slump in housing activity (and in 2008, in response to a feared decline in house prices).

Over the past decade, most state and territory governments have "topped up" the basic FHOG payments to first-time buyers with grants from their own resources, with some states providing even larger grants to buyers meeting certain additional criteria (for example, the Victorian government provides an additional $5000 for buyers of new homes in rural and regional areas). State and territory governments also provide indirect financial assistance to first-time buyers by partially or totally exempting them from the stamp duty they would otherwise pay on their purchases.

Governments have thus been providing cash handouts to first-time home buyers for almost half a century. Yet, strikingly, the home ownership rate has never been higher than the 72 per cent recorded at the time of the 1961 census, three years before the first of these schemes began. At every census since then, it has fluctuated between a low of 68 per cent (in 1976) and 72 per cent (in 1971). At the past two censuses (in 2001 and 2006), it stood at 70 per cent.

Indeed, the apparent stability of the overall home ownership rate conceals a substantial decline in home ownership rates among every age group below 50.

Research by Sydney University's Judy Yates and Hal Kendig, and more recently by Flinders University's Joe Flood and Emma Baker, undertaken for the Australian Housing and Urban Research Institute, has shown that between the 1991 and 2006 censuses, home ownership rates dropped by between 5 and 7 percentage points among households headed by each of the five-year age cohorts between 25-29 years and 45-49 years, by 4 percentage points among households headed by 50-54 year-olds, and by 2 percentage points among households headed by 55-59 year-olds. The only reason the overall home ownership rate hasn't fallen more dramatically is the substantial increase in the proportion of households headed by people aged 45 and over, among whom home ownership rates have always been significantly higher than among younger age groups. In other words, the billions of dollars spent on cash grants to first home buyers (and for the first nine years of the FHOG scheme's operations, expenditure on those grants exceeded $10 billion) have spectacularly failed to achieve the objective of increasing home-ownership rates.

And it's pretty obvious why. Cash grants and other forms of help to first-time home buyers have served simply to exacerbate the imbalance between the underlying demand for housing and the supply of it - an imbalance which, according to the National Housing Supply Council, amounted to a shortfall of more than 200,000 dwellings as at June last year.

Cash handouts for first home buyers have simply added to upward pressure on housing prices, enriching vendors (and making those who already have housing feel richer) while doing precisely nothing to help young people into home ownership.

Contrast this with what happened during the 1950s and early 1960s, when the Commonwealth government provided low-interest loans to state governments to build houses for sale to eligible first home buyers. The home ownership rate rose from just under 53 per cent at the time of the 1947 census (a level unchanged from that reported in the first Commonwealth census in 1911) to 72 per cent at the time of the 1961 census. In other words, policies that added directly to the supply of housing worked.

Policies which have, in effect, added only to the demand for housing (or, more strictly, increased the amount which people can afford to pay for housing), have conspicuously failed.

Why, then, have governments persisted with policies that have so miserably failed to meet their ostensible goals? The answer is, surely, that since about 70 per cent of Australians live in homes that they (or members of their immediate family) already own, policies that make them feel richer are much more popular than policies that might allow the small minority of Australians who don't own their own home, but would like to, to join them.

If governments really wanted to do something about housing affordability, they would abolish cash grants to first home buyers, and "quarantine" tax deductions for interest paid by landlords to the value of the rent received in any given financial year (with any excess carried forward against the capital gains tax liability when the property is sold); and use the resulting savings to help local governments to reduce upfront charges imposed on developers, and in various other ways increase the supply of low-cost housing.

But I'd put more money on the chance of Andrew Demetriou becoming an enthusiastic supporter of a Tasmanian team in the AFL. And even more on the chance of Ireland making the next round of the cricket World Cup.

Saul Eslake is a program director with the Grattan Institute.

(3) Australia's tax system favours Borrowing and Speculators over Working and Saving - Saul Eslake


Imagine a tax system that penalised work

Saul Eslake

March 30, 2011

IMAGINE that you have just become treasurer or finance minister in the government of a newly independent nation. Imagine also that, for some reason, you wanted to create a tax system that encouraged the accumulation of wealth through borrowing and speculating, as opposed to working and saving.

So you hire a consultant, who, based on your previous experience, you anticipate will hand you a voluminous report and a large bill after a period of extensive research, consultation with interested stakeholders and all the other things that consultants do. But, to your astonishment, the consultant comes back the very next day and simply hands you a copy of the Australian Income Tax Assessment Act, and tells you to forget the bill.

Why the treasurer of some hypothetical government in a far-away country would actually want a tax system that encouraged borrowing and speculating, and penalised working and saving, is, of course, rather hard to imagine.

Yet that is precisely what Australia's income tax system does: it imposes the highest rates on wage and salary income - that is, income from working - and on income from the most common forms of saving (bank, building society and credit union deposits).

By contrast, Australia's tax system taxes income from investments (other than deposits) at substantially lower rates than identical amounts of income derived from working. And if those investments are funded wholly or partially by debt, it provides a subsidy that reduces even further the amount of tax payable on the income from those investments.

For most people on relatively high salaries, tax rates aren't as high as they used to be, as a result of the substantial increases in the thresholds at which the top rate becomes payable that were implemented during the last term of the Howard government.

However, for people lower down the income scale, the interaction of the income tax system with the income tests on various forms of social security payments can result in them facing effective marginal tax rates considerably above those paid by those on the highest incomes. These high effective marginal tax rates can - and according to at least some research do - adversely affect the willingness of some people, especially women with children, to enter paid employment.

By contrast, the Australian income tax system provides substantial incentives for people to borrow money to acquire property, shares or other assets with a value they expect will appreciate over time. Unlike most other countries, it has always been possible in Australia to deduct any excess of interest payments on loans taken out to fund an investment over the income produced by that investment to reduce the tax payable on wage or salary income.

Since the Howard government's decision in 1999 to tax capital gains at half the rate applicable to the same amount of wage and salary income, a decision that was supported by the then opposition, "negative gearing" has become a means not only of deferring tax, but also permanently reducing it.

In 1998-99, when capital gains were last taxed at the same rate as other types of income (less an allowance for inflation), Australia had 1.3 million tax-paying landlords who in total made a taxable profit of almost $700 million. By 2007-08, the latest year for which statistics are available, the number of tax-paying landlords had risen to 1.7 million, but they collectively lost more than $8.6 billion, largely because the amount they paid out in interest rose more than fourfold (from about $5 billion to more than $20 billion over this period), while the amount they collected in rent "only" slightly more than doubled (from $11 billion to $24 billion), as did other (non-interest) expenses.

If all the 1.2 million landlords who reported net losses in 2007-08 were in the 38 per cent income tax bracket, their ability to offset those losses against their other taxable income would have cost more than $4.8 billion in revenue forgone; if (say) a fifth of them had been in the top tax bracket, then the cost to revenue would have been more than $5 billion.

This is a pretty big subsidy from people who are working and saving to people who are borrowing and speculating (since those landlords who are making "running losses" on their property investments expect to more than make up those losses through capital gains when they eventually sell them).

And it's hard to think of any worthwhile public policy purpose that is served by this subsidy. It does nothing to increase the supply of housing, since the vast majority of landlords buy established properties. Precisely for that reason, it contributes to upward pressure on the prices of established dwellings, thereby diminishing housing affordability for would-be home buyers.

It's also hard to reconcile this subsidy with the government's stated aim of increasing participation in the workforce, especially when abolishing it could help pay for reducing some of the high effective marginal tax rates faced by those contemplating moving from taxpayer-funded benefits into paid employment.

The revenue forgone through negative gearing could alternatively be used to build nearly 20,000 new "affordable" homes each year, making substantial inroads into the massive shortage of affordable housing.

Supporters of negative gearing argue that its abolition would lead to a "landlords' strike", driving up rents and exacerbating the shortage of affordable rental housing. They point to "what happened" when the Hawke government abolished negative gearing (only for property investment) in 1986, claiming that it led to a surge in rents, which prompted the reintroduction of negative gearing in 1988.

This assertion has attained the status of an urban myth, but it isn't true. Rents (as measured in the consumer price index) did rise rapidly (at double-digit annual rates) in Sydney and Perth, but that was because in those two cities, rental vacancy rates were unusually low before negative gearing was abolished. In other state capitals (where vacancy rates were higher), growth in rentals was either unchanged or, in Melbourne, actually slowed.

Suppose, however, that a large number of landlords were to respond to the abolition of "negative gearing" by selling their properties. That would push down the prices of investment properties, making them more affordable to would-be home buyers, thereby reducing the demand for rental properties in almost exactly the same proportion as the reduction in their supply.

And that, of course, is the reason why negative gearing will forever remain untouched - because the negative reaction and loss of votes from people who would experience declines in the value of their properties would outweigh the positive reaction from people who would benefit from lower property prices and would change their votes accordingly.

It's something to remember next time you hear a politician saying he or she is committed to improving housing affordability, or increasing participation in the workforce, or both.

Saul Eslake is a program director with the Grattan Institute.

(4) First-home stimulus and Negative Gearing inflate house prices - banker


First-home stimulus inflated property prices, says banker
Scott Murdoch From: The Australian June 03, 2011 12:00AM

ANZ Bank's Australian chief executive Phil Chronican has said the government's first-home buyer stimulus did nothing but drive up property prices, and warned that mortgage arrears would remain high as consumers struggled with cost of living pressures.

As bank shares fell further on the market yesterday, Mr Chronican said local housing prices were likely to remain flat but governments and regulators needed to address the chronic demand and supply imbalance in domestic property.

ANZ has estimated there is a 230,000 shortfall in the supply of residential houses in Australia, which it blames on governments not releasing enough land for development.

Mr Chronican, who heads the Australian operations of the bank under group chief executive Mike Smith, said state and federal governments needed to invest more in social infrastructure to support housing development.

The government's increased first-home buyers stimulus, delivered during the global financial crisis, did little to ease affordability problems, he said.

"We need to refrain from pursuing short-term policies that add to demand-side pressures," Mr Chronican told an American Chamber of Commerce lunch in Sydney.

"If we really want to help people into homes, we need to address the supply-side issues, not add to the demand that drives prices up.

"We have seen what can happen when (governments) get it wrong in the case of the first-home owner's grant. These grants were capitalised against house prices so quickly they didn't so much benefit first-home buyers ... it was the first-home seller's grant really."

Mr Chronican repeated the warning of major bank bosses that mortgage arrears were beginning to rise as customers struggled with higher interest rates and cost-of-living pressures.

Analysts have forecast that arrears could soar to nearly $13 billion in the next year as mortgages written in 2009 begin to sour.

ANZ was one of the least active banks during the global financial crisis, as it scaled back its residential mortgage-lending in the downturn.

The two Sydney-based banks, Westpac and Commonwealth, were most active and were expected to experience higher rates of arrears.

Arrears were "a problem that's going to stay with us for a while", Mr Chronican said. "I don't know if it will get worse or not."

He said tax policy had created an obsession about investment property ownership. "Governments might want to look at whether ... negative gearing tax breaks are fostering an unhealthy focus on housing as an investment and compounding the affordability issues."

(5) Housing should not be a speculative investment, but a place to live & raise a family

Bank exec questions negative gearing

Eric Johnston

June 3, 2011

One of Australia's most senior bankers has taken aim at the negative gearing millions of property owners use, claiming the tax break is leading to an unhealthy focus on housing as a way to get rich, while pushing property prices to unaffordable levels.

ANZ Australian chief executive Phil Chronican also cast doubt on property as an investment class, saying housing looked "weak" compared with other forms of investment and that the substantial gains in property prices over the past two decades were unlikely to be repeated.

Negative gearing provides billions of dollars of tax breaks, and economists have often blamed it for pushing up property prices. But it is unusual for a banker to enter into the debate, given that investment property often makes up a large portion of banks' lending. Because it is widely used, negative gearing remains a thorny issue politically. Tax Office figures show that about 1.7 million property owners used negative gearing last financial year, claiming rental losses as a tax offset. This generated a $6.5 billion net loss.

Mr Chronican said he was not trying to take on the "sacred cow" of negative gearing, rather he was trying to highlight that property was a poor investment for most people.

"Governments might want to look at whether the current extent of negative-gearing tax breaks are fostering an unhealthy focus on housing as an investment vehicle, thereby compounding affordability issues," he told a business lunch in Sydney.

Real estate should not be regarded as a speculative investment vehicle to get rich, but as "a place to live in, sleep, eat and raise your family".

Mr Chronican said that because of tight supply in the Australian housing market, he did not subscribe to the view that it was a bubble waiting to burst. But with the Reserve Bank still tipped to increase interest rates this year, Australia was facing a sustained period of low growth in house prices, he said.

As an asset class, it offered "poor income returns and high transaction costs, and a lot of volatility in prices - particularly in the slower-growth environment".

He also highlighted housing as an "excessive concentration risk" for the economy, as Australians had up to 60 per cent of their total wealth tied up in real estate. This is one of the world's highest rates - more than double the US rate.

Mr Chronican's comments come after figures released this week showed that Australia's housing market had softened since the Reserve Bank's interest rate rise in November. Auction rates in the main cities are well down on a year ago.

(6) Australia's Real Estate Bubble is bursting; Negatively gearers face losses


Negative Gearing Is Our Ruin

Posted on Tuesday, April 19th, 2011   

by David Collyer

Negatively geared property investors have exposed themselves, our banks and the broader Australian economy to widespread capital destruction, says Prosper Australia campaign manager David Collyer.

“The Great Australian Land Bubble has just burst. ‘Gearers will not be able to sell their holdings into the market fast enough to protect their equity. This group faces financial ruin; their mortgages are full recourse to all their assets,” Collyer said.

“The reliance on heavy borrowings and deliberate thin equity means their financial position can turn around with surprising speed and force. Negative gearing accelerates gains in a rising market. It erases equity in a falling one. Worse, the assets they bought with borrowed money are both illiquid and lumpy.

Prosper called the bursting of the property bubble April 12. Our call is confirmed by:

• The HIA-RP Data Residential Land Report April 18 showing residential land sales slumping to their lowest level in a decade, with land sales on the city’s fringes down 50.1 per cent in the December quarter compared with the same quarter in 2009.

• The REIV revealing April 15 property prices are falling, by an initial six percent in the quarter to March.

• Housing finance statistics from the ABS on April 6 announcing commitments for new dwellings had fallen at the fastest rate in 32 years, ever since the series has been collected.

Warren Buffett famously observed in his 2001 chairman’s letter: ‘You only find out who is swimming naked when the tide goes out’. In the US, a key driver of their property price collapse – now nearly five years old and counting – was sub-prime loans.

“In Australia, the ‘gearers are the most exposed as property prices recede,” Collyer said. “They are the unbridgeable chasm in our economic landscape.”

The ATO says 1.7 million taxpayers have rental income. Of these, around 1.25 million are negatively geared and are claiming a loss against their taxes. Most are middle income earners trying to escape Australia’s punitive PAYE tax system. Middle income earners typically do not have a large enough asset base to promptly top up their equity – as the banks will now require. ...

(7) What the bursting of Australia's housing bubble could mean for the banks - Steve Keen

{visit the above link to see the charts}

This Time Had Better Be Different: House Prices and the Banks Part 2

By Steve Keen on April 11th, 2011 at 8:57 am

Posted In: Debtwatch

In last week's post I showed that there is a debt-financed, government-sponsored bubble in Australian house prices <http://www.debtdeflation.com/blogs/2011/04/11/this-time-had-better-be-different-house-prices-and-the-banks-part-2/>. This week I'll consider what the bursting of this bubble could mean for the banks that have financed it.

Betting the House

For two decades after the 1987 Stock Market Crash, banks have lived by the adage "as safe as houses". Mortgage lending surpassed business blending in 1993, and ever since then it's been on the up and up. Business lending actually fell during the 1990s recession, and took off again only in 2006, when the China boom and the leveraged-buyout frenzy began.

Figure 2

Regular readers will know that I place the responsibility for this increase in debt on the financial sector itself, not the borrowers. The banking sector makes money by creating debt and thus has an inherent desire to pump out as much as possible. The easiest way to do this is to entice the public into Ponzi Schemes, because then borrowing can be de-coupled from income.

There's a minor verification of my perspective in this data, since the one segment of debt that hasn't risen compared to GDP is personal debt—where the income of the borrower is a serious constraint on how much debt the borrower will take on. As much as banks have flogged credit cards, personal debt hasn't increased as a percentage of GDP.

On the other hand, mortgage debt has risen sevenfold (compared to GDP) in the last two decades. {visit the link to see charts}

So how exposed are the banks to a fall in house prices, and the increase in non-performing loans that could arise from this? There is no way of knowing for sure beforehand, but cross-country comparisons and history can give a guide.

Bigger than Texas

A persistent refrain from the "no bubble" camp has been that Australia won't suffer anything like a US downturn from a house price crash, because Australian lending has been much more responsible than American lending was. I took a swipe at that in last week's post, with a chart showing that Australia's mortgage debt to GDP ratio exceeds the USA's, and grew three times more rapidly than did American mortgage debt since 1990 (see Figure 13 of that post).

Similar data, this time seen from the point of view of bank assets, is shown in the next two charts. Real estate loans are a higher proportion of Australian bank loans than for US banks, and their rise in significance in Australia was far faster and sharper than for the USA.

More significantly, real estate loans are a higher proportion of bank assets in Australia than in the USA, and this applied throughout the Subprime Era in the USA. The crucial role of the First Home Vendors Boost in reversing the fall in the banks' dependence on real estate loans is also strikingly apparent.

Never mind the weight, feel the distribution ...

There are at least three ways in which whatever might happen in the near future will differ from the past:

  On the attenuating side, deposit insurance, which was only implicit or limited in the past, is much more established now; and

  If the banks face insolvency, the Government and Reserve Bank will bail them out as the US Government and Federal Reserve did—though let's hope without also bailing out the management, shareholders and bondholders, as in the USA (OK, so call me an optimist! And if you haven't seen Inside Job yet, see it);

On the negative side, however, we have the Big Trifecta:

  The bubbles in debt, housing and bank stocks are far bigger this time than any previous event—including the Melbourne Land Boom and Bust that triggered the 1890s Depression. ...


[1] The notes to Table B05 state that "'Impaired assets' refers to the aggregate of a reporting bank's non-accrual and restructured exposures, both on- and off-balance sheet, plus any assets acquired through the enforcement of security conditions. Off-balance sheet exposures include, inter alia, commitments to provide funds that cannot be cancelled or revoked and the credit equivalent amounts of interest rate, foreign exchange and other market-related instruments."

[2] One of the many issues that distinguishes my approach to economics from neoclassical economists is my focus on the role that changes in debt play in aggregate demand. Neoclassical economists wrongly ignore the role of aggregate level of debt because they see debt as simply a transfer of spending power from one agent to another—so that there is no change in aggregate spending power if debt rises.  This is the reason that Bernanke gave for ignoring Fisher's "debt deflation" theory of the Great Depression (Fisher 1933):

Fisher's idea was less influential in academic circles, though, because of the counterargument that debt-deflation represented no more than a redistribution from one group (debtors) to another (creditors). Absent implausibly large differences in marginal spending propensities among the groups, it was suggested, pure redistributions should have no significant macro-economic effects… (Bernanke 2000, p. 24)

And it's the explicit assumption that Krugman uses in his recent paper on the Great Recession:

Ignoring the foreign component, or looking at the world as a whole, the overall level of debt makes no difference to aggregate net worth — one person's liability is another person's asset. (Krugman and Eggertsson 2010, p. 3)

This shows their ignorance of the capacity for the banking sector to create spending power "out of nothing", and thus create spending power in the process. I cover this topic in detail in these posts (http://www.debtdeflation.com/blogs/2010/09/20/deleveraging-with-a-twist/ and http://www.debtdeflation.com/blogs/2010/10/19/deleveraging-deceleration-and-the-double-dip/)


Bernanke, B. S. (2000). Essays on the Great Depression. Princeton, Princeton University Press.

Biggs, M., T. Mayer, et al. (2010). "Credit and Economic Recovery: Demystifying Phoenix Miracles." SSRN eLibrary.

Daly, M. T. (1982). Sydney Boom, Sydney Bust. Sydney, George Allen and Unwin.

Fisher, I. (1933). "The Debt-Deflation Theory of Great Depressions." Econometrica
1(4): 337-357.

Krugman, P. and G. B. Eggertsson (2010). Debt, Deleveraging, and the Liquidity Trap: A Fisher-Minsky-Koo approach [2nd draft 2/14/2011]. New York, Federal Reserve Bank of New York & Princeton University.

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