Co-written by Kate Tucker. This article is the second part of my “State of the Housing Bubble” series, which began with Housing bubble is now official, commence arse-covering (panic)!. It is a long form article, so I put some pictures in it for you. Take your time, it’s a good story.
Australia’s story of the housing bubble that never burst is beginning to feel a bit like the reassuring fairy tale such a fanciful but still widely held truism conjures up. A story that we tell our children to reassure them that everything is alright, that mum and dad have their best interests at heart, and that naughty naysayers are just trying to get something for nothing, and certainly won’t be getting any presents from Santa. Go on, say it out loud. If you repeat it enough times, you might even convince yourself. Which is compensation for the fact that your children stopped believing in fairy tales some time ago.
Because anyone who has been marginalised by the ravages of the bubble that ate our economy knows that the opposite of these assurances is in fact true. Fairy tales always come with a moral, and a story about a thing that had never happened, is fairly likely to end with an ‘unexpected’ twist, in which the thing… happens, leaving us with the newfound moral comprehension of the folly of believing that just because something has never happened, doesn’t mean it never will. In fact, when the ‘thing’ is some kind of entity that grows and grows in size, consuming ever more resources, space, and attention, generating its own mythology in the process, it is a near certainty that it will inevitably blow up in our faces.
Or put another way, while all sane investors and economists know the incontrovertible truth that past performance is no guarantee of future returns, according to a majority of participants, supporters, insiders, and onlookers, the Australian housing market is apparently immune to this fundamental economic law.
This seemingly unshakable faith in the twisted nursery rhyme of Australian bubble exceptionalism is a growing anathema to the nearly universal acceptance among officials and experts that Australia’s residential housing market is experiencing a bubble. This should come as no surprise for a country that routinely ignores the testimony, research, and empirical evidence of experts in favour of popular mythology and the safety of mainstream cultural acceptance.
One only needs to look at the personal, constant and coordinated attacks against those that have dedicated themselves to the cause of warning about Australia’s housing bubble to understand that Australia’s tall poppy syndrome has never applied more than it does now to the largest housing bubble in our history, and our intimately related record economic run. No one enjoys being a Pariah, and in Australia, to be a housing market Cassandra has for many years now been a short path to ostracism, selective reputation bashing, and a dishonest and immoral rewriting of history upon vindication.
And so it is that those who for years have feverishly denied the presence of a bubble, have mostly been forced to accept that one does indeed exist, and now seek to deny that we will ever need to face a day of reckoning for our failure to heed the afore-mentioned warnings, warnings that were routinely and casually laughed off.
I ask you, how much longer can these masters of Spruik keep the game up? How many more pages of this fairy tale are actually left, and more importantly, when we reach the final pages, should we expect a happy ending? Knowing what we know about moral tales, it doesn’t seem likely does it? Are we really going to escape learning any moral from this story? Are these imbalances and building pressures somehow just gonna sort themselves out? Something will come up, right…?!
The political, psychological, regulatory, economic, and market pressures are piling up around our ears. To coin another investment truism, the Australian housing bubble that never burst is a prime candidate for ‘buy the rumour, sell the fact’. We’ve been buying our own bullshit for so long, that the apparent achievement of market immortality feels like a huge disappointment, and is itself the best possible reason to take profits off the table.
The burden of proof for the existence and sustainability of Australia’s housing bubble has become fully inverted, as the dangerous combination of record household debt and record house prices in comparison to history and current economic fundamentals becomes obvious to all those with a preference for reality.
We have finally achieved widespread (although still bitterly contested) recognition that these imbalances constitute a debt-fuelled housing bubble, exhibiting all the hallmarks of irrational exuberance, massively debased lending standards, complete detachment from economic fundamentals, and my favourite: an indentured cultural blindness from both the sceptics (the bears) and true believers (the bulls) to the possibility that anything will ever change.
But I’ve spent enough time cataloguing those imbalances over the last few years. If you still don’t believe that we have a debt-fuelled housing bubble in Australia, then you’re reading the wrong blog. What’s more valuable at this juncture is to scrutinise this transitional phase of the bubble, in which the debate has shifted from “Is there a housing bubble?” to “How big is the bubble, and when and how does it end?”.
For most people, but particularly our market obsessed media, this question frequently takes the form “How far will prices fall?”. In my last article, I promised to spend some effort addressing this question, and will keep that promise in the third part of this series. But for now, I’d like to dive into the real fairy tales unfolding before our eyes, as everyone moves to cover their arses, keep their jobs, position their financial affairs, and worst of all, protect their reputations by virtue signalling and rewriting history, the ultimate insult to those who urged action before reaching this critical and dangerous juncture.
There are moral lessons being learned left, right and centre for those who care to notice (and for those who’ve ‘learned’ without explicitly seeking a lesson, such as the 13% of apartment sellers now incurring a capital loss). Most have not yet played out to their conclusion, but the familiar patterns of human folly are recognisable in the deluge of daily bubble events going on locally, and even globally. It only remains for us to use this information to understand what lies ahead, hopefully protect ourselves as best we can, and most importantly to hold to account those who have long tried to convince us that all fairy tales have happy endings.
Budget or Bust (The Goose That Laid the Golden Egg)
A cottager and his wife had a Goose that laid a golden egg every day. They supposed that the Goose must contain a great lump of gold in its inside, and in order to get the gold they killed [her]. Having done so, they found to their surprise that the Goose differed in no respect from their other geese. The foolish pair, thus hoping to become rich all at once, deprived themselves of the gain of which they were assured day by day.
The Goose That Laid the Golden Egg
In this first fairy tale, the cottager and his wife are the Australian public, the goose is the Australian government, and the golden eggs are the government guaranteed housing riches that we’ve been enjoying daily for the best part of 20 years. But we’ve now pushed so far down the policy support path, that we’ve broken the money-making machine that lays golden eggs of tax and fiscal support for the bubble day after day.
In the same way that the goose must be cared for properly in order to produce golden eggs, in order for these government guaranteed housing riches to continue flowing, we require stable government, a strong fiscal (budget) position, a high quality credit rating, regulatory support, and most crucially, political support for the countless advantages afforded to land owners – typically and erroneously considered part of the actual market fundamentals that justify sky-high prices.
It is pretty safe to say that most of these conditions are now in short supply, and deteriorating fast. The greed and hubris inherent in our embrace of the hyperinflation of land has crippled the goose that laid the golden egg, and will soon dismember it as we attempt to claim the gold that we believe must exist in the creature’s belly.
This deplorable and short-sighted greed has crippled the goose by destroying productivity, competitiveness and diversity in the economy, destroying the federal budget, jeopardising the sovereign credit rating, steadily destabilising the whole political context and derailing the economic reform agenda over the last 10 years. It has forced regulators to clamp down on terminal systemic financial risk, in turn putting pressure on the government to withdraw policy and fiscal supports. And it has so thoroughly destroyed housing affordability, wealth equality, and economic sustainability as to finally reverse the public’s political support for the golden goose.
The recent “government-saving” budget has turned out to be…well, not much of a government saver. While plenty of energy has been expended on the general failure of the budget to save this non-governing government, more interesting is the previously common expectations of a bubble-saving budget, replete with cash handouts for house-horny hipsters and a general reaffirmation of infinite government guaranteed house price inflation.
But rather than a ‘Budget-O-Bubble’, we actually got a set of measures that taken on balance are mildly negative for the house price outlook. It’s pretty hard to argue that the golden goose is still producing gold eggs when it is reacting – however mildly – to political, regulatory, and market pressure to reign in debt and prices. As I argued in the lead up to the budget, the government no longer has room to move, as any further market manipulations or stimulus would work at cross purposes to the modest efforts to avoid a financial disaster – thereby guaranteeing a financial disaster by forcing rate hikes or more severe macroprudential controls, defeating the intended purpose of the stimulus. It would also destroy the government’s AAA sovereign credit rating, an essential backstop to the low offshore funding costs that the major banks rely on to continue growing their enormous mortgage books.
Let it sink in. The government knows that it is caught between a rock and a hard place. Even the watered down first home super saver scheme is intentionally avoiding “bringing demand forward” by instantly unleashing more cash into the market. Rather, it looks like an admission that in 2 years from now, when the first boosted savings would be available for withdrawal, prices will already be lower, and so the stimulus would not further jeopardise financial stability. They may be indeed hoping that it works as a buffer to the downside that they know is just around the corner.
In addition to the budgetary and regulatory pressures, the political pressures are also mounting, as the former sacred cows of negative gearing and capital gains tax concessions are inevitably headed to the slaughterhouse, support for unfettered and un-policed foreign investment in residential real estate all but disappears, and even Australia’s endless and record population growth faces a reversal of public support as living standards amongst the existing population continue their inexorable slide.
Just as the cottagers eventually killed the goose as their greed overcame their common sense, so too has the unrelenting pressure over the last 20 years for governments to use any and all fiscal and policy levers to prop up housing wealth, finally destroyed any capacity to continue producing golden eggs, as the survival of political incumbents now relies on preventing rather than sponsoring further escalation of house prices and household debt.
Speculators are Public Enemy #1 (The Gingerbread Boy)
“I’ve run away from a little old woman,
A little old man,
A barn full of threshers,
A field full of mowers,
A cow and a pig,
And I can run away from you, I can!”
Then the fox set out to run. Now foxes can run very fast, and so the fox soon caught the gingerbread boy and began to eat him up. Presently the gingerbread boy said, “Oh dear! I’m quarter gone!” And then, “Oh, I’m half gone!” And soon, “I’m three-quarters gone!” And at last, “I’m all gone!” and never spoke again.
In our next fairy tale, the Gingerbread Boy is the blessed property speculator, able to outrun all of the humble town folk, the other participants in the economy. Their highly taxed wages and productive investments have no chance of keeping up with the taunting property speculator and his unearned and untaxed windfall land increment, robbed from the common prosperity. But there is of course one creature that the Gingerbread Boy has no chance of outrunning, the fast and cunning fox. In our little tale, the fox is the tightening grip of regulatory, political and credit rating pressures.
The protected species known as the property speculator has long revelled in its presumed ability to outrun its fellows and enjoy endless land riches. Our real estate investing Gingerbread Boy has gloated over and over that “The government would never let the market fall, or let interest rates rise, or let population growth slow, or take away our negative gearing and capital gains toys etc…”. But in the speculator’s narrow perspective born of limited experience living outside housing bubble conditions, it had never occurred to him that a creature existed with the speed to finally catch up to him: the dreaded financial regulator.
The RBA, APRA and ASIC, although 5 to 10 years late to the party, are pushing up the cost of mortgage credit, reducing the availability of investor mortgages, and forcing stricter appraisal of mortgage applications. They’ve imposed higher interest rate buffers for loan serviceability assessments, set benchmarks for year-on-year growth in investor lending and most recently have put a hard limit on Australia’s own sub-prime loan scandal – the 40% of new and existing mortgages that are interest-only. They are on record as saying that alarm bells are ringing over household debt levels and are ready to implement harder controls should that debt level not begin falling.
Credit ratings agencies are also starting to take chunks out of the not-so-humble speculator, by downgrading our banks’ credit ratings because of their extremely high and dangerous exposure to the property market and because, as Moody’s put it, “the resilience of household balance sheets and, consequently, bank portfolios to a serious economic downturn has not been tested at these levels of private sector indebtedness”. The federal government’s credit rating downgrade will follow in due course.
And thirdly, government regulations, taxes and charges centred around foreign property speculators have tightened considerably, with stricter rules on bank funding, additional upfront taxes and charges, capital gains withholding through the ATO, and removal of the capital gains tax discount for foreign investors. These changes are adding up to a serious impost on foreign speculators, but will also punish local speculators, who have been benefiting from the additional offshore demand for residential property.
The rules of the speculation game are changing. If I was a property speculator I would be increasingly panicked about my recent upgrade to public enemy number one. Regulators want a piece of you, ratings agencies want a piece of you, politicians want a piece of you. And the general public want a piece of you. They have all slowly but surely been chipping away at the profitability and ultimately the viability of property speculation. Real estate prices have an inverse relationship to the cost and availability of mortgage debt, and even though our official cash rate is unlikely to rise anytime soon, the cost of mortgages has changed direction for the foreseeable future.
Australia’s financial regulators, having witnessed years of the Gingerbread Boy’s taunting of economic fates and utter disregard for risk, has finally caught up to our self-aggrandising edible creature. And they’ve begun to devour him piece by piece, until pretty soon there’s going to be nothing left, and the property speculator will “never speak again”.
Inverting Bubble Vectors (King Canute)
Canute set his throne by the sea shore and commanded the incoming tide to halt and not wet his feet and robes. Yet “continuing to rise as usual [the tide] dashed over his feet and legs without respect to his royal person. Then the king leapt backwards, saying: ‘Let all men know how empty and worthless is the power of kings, for there is none worthy of the name, but He whom heaven, earth, and sea obey by eternal laws.'”
King Canute represents the sponsors of our housing bubble, while their seemingly unshakable exceptionalism and denial in the face of reality, are his efforts to hold back the very tide itself. Like most kings, even though his subjects may not revere him, the majority do believe in his power over their own destinies. And just as King Canute inevitably failed to halt the rising tide, so too will our housing bubble sponsors fail in their efforts to hold back the tide of inverting bubble vectors.
Australians have developed a peculiar habit of imagining that the government would never “let” the market fall. We make a national pastime of condemning our government as untrustworthy and incompetent, and even more so in recent years of political instability. Yet we have somehow led ourselves to believe that our government is more competent than any other in the long history of bubbles (including our own) in preventing anything bad from happening. As if all others had not already tried and failed to hold back the tide. This is a special kind of cognitive dissonance borne of the ‘grey-sky thinking’ that comes with twenty years of pro-bubble policy, reinforced by a deeply cynical but unrealistic judgement that the corruption of the public good can somehow indefinitely override inviolable natural forces.
Canute fails because of universal laws that even he, the most powerful man in the land, cannot break. He may be able to pretend for a time that those rules do not exist, or claim to be excepted from them, but when tested, he must ultimately abide by the laws just as his subjects must. The rise and fall of the tide perfectly reflects the rise and fall of economic forces, the ebbs and flows of economic, market, political and other external fortunes and factors which for better or worse, invariably change course in the fullness of time.
We made the crucial mistake of assuming that cyclical (temporary) economic, financial and political circumstances were structural (permanent) in nature. Like every bubble that came before ours, we took a set of favourable market conditions, based on some fundamental but limited economic truth, and hypothecated them into a future of limitless speculative gains.
The tidal forces now rising around the ankles of our bubble sponsors are fatal and many, and were always inevitable:
- Mortgage interest rates have likely bottomed, and continue to march higher
- Banks tighten lending criteria across the board, and begin to abandon riskier loan products
- Rental growth has fallen to the lowest on record
- Population growth, while still strong, is quickly losing political support
- The oversupply of apartments in major cities is finally showing
- Apartment prices are now falling in Melbourne and Brisbane as a result
- Foreign investors are deserting the housing market
- Our largest external bubble ‘sponsor’, China, heads towards its own debt calamity and bubble-destroying reforms
- Wage growth is the lowest on record, and set to worsen
- Underemployment becomes the new “unemployment” crisis
- Recessionary forces stalk the country, with mining, commodities, manufacturing and construction facing massive headwinds
Every one of these factors once acted in favour of house price inflation before finally changing direction, and were of course never permanent conditions. Even one or two of those temporary forces reversing has the potential to finally upend the market. But they are now undergoing a simultaneous inversion. Good luck with that. The rising tide lifted all boats, but we forgot that the falling tide must follow eventually, and will likewise lower all boats.
Internal Contradictions (The Midas Touch)
So Midas, king of Lydia, swelled at first with pride when he found he could transform everything he touched to gold; but when he beheld his food grow rigid and his drink harden into golden ice then he understood that this gift was a bane and in his loathing for gold, cursed his prayer.
King Midas and the Golden Touch
In this well-known tale, King Midas represents the presumed beneficiaries of the housing bubble – the landed gentry, incumbent political parties, central bankers, the financial and real estate sectors etc. His golden touch is the magical ability to create wealth through hyperinflation in the price of land, the infamous “wealth effect” that turns house price rises into greater economic growth.
But the golden touch of the wealth effect has driven the landed gentry and their sponsors (the actual beneficiaries) to a terminal greed, and in so doing, have almost completely turned our once diverse and vibrant industrial economy into a debt-fuelled real estate money machine. Just as Midas came to curse his prayer for a golden touch, so too will we inevitably come to curse our prayer for infinite land price inflation, and the illusion that such inflation ever represented wealth, much less prosperity or economic justice.
Supporters of endless house price inflation like to imagine that house prices rise in a vacuum. As if the broader economy is impervious to the distortions created by record low housing affordability, record high mortgage debt, record high land prices as our largest economic input cost, and the record proportion of capital and resources allocated to unproductive fixed asset investment.
We are now witnessing mountains of evidence that these imbalances are crushing the productive economy, and in time have sown the seeds of the housing market’s own destruction, by irreparably undermining the supposedly strong economic fundamentals that support high house prices, as well as by fundamentally – and ironically – altering the normal functioning of the housing market itself:
- Household financial confidence and consumer confidence is destroyed by obscene housing and mortgage costs.
- The retail and consumer sectors are smashed as a result of the disposable income recession.
- Terminal household debt levels create a hard ceiling on endless house price inflation.
- Terminal affordability completely undermines market entrants at the bottom layer of the Ponzi scheme.
- Mortgage stress accelerates owing to the these two factors, and preceding the actual price bust (despite the common myth to the contrary).
- The housing market eats itself from the inside out, as owners, sellers and buyers increasingly refuse to face the costs and risks of relocating, downsizing or upgrading in a runaway market – a phenomenon that MacroBusiness labelled “Shrinkflation“.
- Real estate listings and transactions fall as a consequence, damaging the profits of the real estate and financial sectors riding the bubble – until nervous sellers finally begin to capitulate to a negative capital growth outlook, foreshadowing falling prices.
- Economic tipping points caused by a historic build up of systemic imbalances and a broken economic model loom on the horizon.
- Financial risks reach the point of no return, where either the bubble is intentionally burst, or allowed to continue for a little while longer before bursting even more spectacularly.
It is both tragic and reprehensible that these internal contradictions have been the constant blind spot of commentary and analysis on housing affordability and the housing bubble. And it is our all-consuming greed in concert with an ignorance of history and economics that have created this enormous collective oversight. We have magically turned our whole economy into fictional on-paper housing ‘wealth’. But we cannot magically turn our paper wealth back into the an economy. And just as we cannot eat gold, nor can we sustain a modern economy on debt and inflated land prices.
Liquidity is King (The Emperor’s New Clothes)
So now the Emperor walked under his high canopy in the midst of the procession, through the streets of his capital; and all the people standing by, and those at the windows, cried out, “Oh! How beautiful are our Emperor’s new clothes! What a magnificent train there is to the mantle; and how gracefully the scarf hangs!” in short, no one would allow that he could not see these much-admired clothes; because, in doing so, he would have declared himself either a simpleton or unfit for his office. Certainly, none of the Emperor’s various suits, had ever made so great an impression, as these invisible ones.
“But the Emperor has nothing at all on!” said a little child. “Listen to the voice of innocence!” exclaimed his father; and what the child had said was whispered from one to another.
“But he has nothing at all on!” at last cried out all the people. The Emperor was vexed, for he knew that the people were right; but he thought the procession must go on now! And the lords of the bedchamber took greater pains than ever, to appear holding up a train, although, in reality, there was no train to hold.
This is one of my favourite tales in our collection, because while it is a well-known analogy for the phenomenon of herd mentality, group-think, or being uncovered as a fraud, it also describes beautifully the process of a whole world view evaporating on the simple act of a bluff being called. That moment when the worst suspicions (fears) of a whole population crystallise, and greed and pride transform into fear and revulsion.
The Emperor is of course our beloved housing bubble, demanding celebration of its own vanity, and adorned in all of its mythical finery, parading down the homogenous cultural exceptionalism of our real estate obsession. The parade attendees are of course the nervously cheering citizens, too afraid to call out the plain truth, for fear of being labelled a “simpleton or unfit for his office”, a common experience for ‘naysayers’ like yours truly.
But of course, all it takes to break the spell of the naked Emperor is a small dose of truth. And once that truth has become apparent to all, what happens next is all a matter of that oft-forgotten market principle: Liquidity.
It has been well established by recent data that Australia does not have a physical shortage of housing. What we do have is a mismatch between properties available for sale, and the number of people wanting to purchase property – multiplied by the average credit available for each buyer. In bubble conditions, this mismatch becomes self-fulfilling, as speculative greed, panic buying, and loose credit conditions conspire to drive the prices higher for the naturally available stock of properties for sale at any particular time.
Only a very small proportion of the housing market “turns over” each year (current RBA figures show around 5% of housing stock), and the prices set for the properties sold each year are hypothecated to represent the actual value of every property in the country – whether or not it has been sold in recent times – or never! To demonstrate this principle, one only needs to imagine what market conditions and apparent “housing shortages” would look like if even 10% of current property owners (instead of the current 5%) decided they wanted (or needed) to sell their properties at the same time. Simple arithmetic says that other things being equal, twice as many properties for sale for the same number of buyers would equal half the average sale price.
In short, the crux of a speculative housing bubble is around the ability to sell to a large pool of willing buyers armed with cheap mortgage credit. And if buyers sense that the housing Emperor is actually wearing no clothes, that pool of willing buyers can simply evaporate, as speculative predictions turn on a dime to fear of catching a falling knife. As the pool of buyers quickly dries up, the stock of housing for sale begins to stagnate, and then swell, as sellers hold on to unrealistic price expectations.
Soon enough, agents start advising sellers to slash 100K increments off their prized assets to secure a sale in a stagnant market, but by the time they do, every other seller has received the same advice. As the smaller number of sold properties begin to clear for significantly lower prices, yet more buyers catch on to the souring market and get cold feet, just as once relaxed sellers who may have presumed that they “could sell if the market turned down”, suddenly realise that an extremely illiquid asset that in poor market conditions might take three or more months to sell, is losing 10K a week in value.
And then the deluge comes. The same self-fulfilling speculative mania that drove tight buying conditions on the long march upwards for prices, becomes a self-fulfilling wait-and-see deflation, as buyers see no benefit in risking everything in a falling market, and motivated sellers swell in numbers and become increasingly desperate to secure a sale. At this point in a bubble burst, it doesn’t matter that the real rental value of a property (ie. the actual investment fundamental) may still be relatively high, the maxim “property is worth what someone is willing/able to pay” becomes all important, as a property with no willing buyers is effectively “worth” nothing to someone who needs the cash. It is thus the self-fulfilling absence of willing buyers that finally bursts a bubble, in the same way that the bubble citizens could no longer ignore the naked state of the Emperor’s body.
Don’t believe me? Heard it all before? Sellers will just refuse to sell? Sidelined buyers will step in and catch the market? Those truisms are only relevant until they are not, and right now, Canada is showing us exactly what this unwinding looks like. As a panicked Canadian agent described back in May before the bust really got going, Canada is just the latest market to prove that it is Liquidity, not physical Supply/Demand that bursts a bubble:
“They disappeared – no one is talking about buying money-losing rental properties any more. The whole excitement and euphoria is kind of gone right now. The whole mood of the market has changed, and that is the bigger factor. People are spooked – investors are spooked, buyers are spooked – and I think that’s the huge issue. Our agents are getting calls from listing agents begging them for offers, just begging them, because the seller is freaking out because they already bought something and they need to sell their house.”
Crisis Does Not Obey Schedules (The Boy Who Cried Wolf)
A mischievous Lad, who was set to mind some Sheep, used, in jest, to cry “The Wolf! the Wolf!” When the people at work in the neighbouring fields came running to the spot, he would laugh at them for their pains. One day the Wolf came in reality, and the Boy, this time, called “The Wolf! the Wolf!” in earnest; but the men, having been so often deceived, disregarded his cries, and the Sheep were left at the mercy of the Wolf.
Now this story is one told through the eyes of the housing market true believers, or more crucially, the housing bubble deniers. These bubble denying villagers would have it that the “doomsayer” shepherd boy is seeking to deceive them by claiming that a wolf in the form of a bubble is stalking his herd of Australian home-buying sheep, and that we would do well to ignore his cries. Indeed this has become an all too common cultural refrain, repeated often enough to now be a presumed truth. Many such villagers love to proclaim the opportunity costs inflicted on the home-buying sheep by the shepherd’s bubble warnings that have seemingly yet to come to fruition.
But in order to see how this story actually applies to the Great Australian Housing Bubble, we need only remember that eventually the wolf did come, and devoured the shepherd’s flock while the villagers were busy assuring themselves (and in our analogy, assuring the sheep as well) that the boy was telling lies. And recall that the sheep are the hapless victims of this tale.
You see, in the real world version of this story, the shepherd was not playing a trick on the villagers – which is clearly a thoroughly fruitless act in the fullness of time – but rather was trying to warn of the actual wolf that he regularly spots stalking around the woods, ready to prey on the sheep at an opportune moment. The shepherd, warning of a genuine threat, pleading for help to protect his flock, is ridiculed for repeatedly explaining a threat that the villagers are unable to perceive. More specifically it is a threat that they are unwilling to perceive, as they wilfully ignore the increasingly obvious signs of its existence; the wolf droppings, the nervous sheep, the record high population of wolves recorded in the forest, and the increasing frequency of similar attacks in other villages.
And of course, when the wolf finally comes and devours the innocent home-buying sheep, rather than apologising to the shepherd, the villagers scorn him, claiming that a wolf always comes eventually, and that the shepherd was simply trying to claim credit for being able to predict the future. Worse still, some will even blame the shepherd for tempting fate, “talking down the market” and the like, as though the wolf could simply be invoked by mention of its name – a truly medieval assertion.
But the greatest crime will be that the villagers, in their determination to ignore the risks of the wolf and label the shepherd as a liar or a charlatan, will have expended their efforts and influence lulling many sheep into a false sense of security, instead of actually helping to avoid or mitigate the risks of a wolf attacking – to provide the support that the boy was convinced was required and repeatedly pleaded for, preferring to scoff at and marginalise those that might take a more preventative approach to risk management.
And of course the sheep do not care for who thinks who was right or wrong about a wolf eventually coming. They care that they are being eaten by a wolf. And they will blame those that tried to claim there was no wolf, those that had the power to do something about the wolf, but chose not to.
It is indeed twisted that these housing market true believers, our wolf-denying villagers, are the ones historically and presently most capable of mitigating the risk of crisis, but instead they prefer to spend their time spreading ignorance of it, and even worse, blaming those that might warn of the dangers lying immediately ahead.
And so it is that the real stakes in the housing bubble debate are not whether or not it exists, when it will burst, and how far prices will fall, and indeed neither is it ultimately the affordability of housing. What is at stake is the very economy itself, as it faces the crisis caused by the bubble when it inevitably bursts. The exact timing and scale of the market correction is irrelevant when we consider the consequences of the crash is a crisis. A banking crisis. A financial crisis. An economic crisis. And these are the most likely outcomes of a housing bubble that is now far larger against nearly all measures than the bubbles that famously brought the United States, Irish, Spanish and Japanese economies to their knees.
It is called an asymmetric risk. Crisis does not obey schedules. Rather, it typically arrives when there is maximum complacency and most people least expect a crisis. The sheep are complacent. The villagers are complacent. And yet a lone boy stands atop the hill, peering into the dark woods, and he can see the stalking wolf, he really can. The measure of whether or not the boy was ‘right’ or ‘wrong’ throughout the history of his countless warnings, will not be the timing and scale of the bubble bursting, it will be that we suffered a crisis at the mercy of the wolf’s jaws. A crisis that was entirely preventable had the shepherd been taken seriously.
I am on record here as providing some kind of measure with which to resolve the endless and fruitless debate over the timing and scale of a housing market correction. If we face the next housing correction (officially but arbitrarily defined as a > 20% fall in prices) without some kind of financial or economic crisis, then the housing bubble custodians and deniers may claim some vindication that Australia was the first economy in history to have a bubble of this scale deflate (by even a small amount) without facing a crisis. But my challenge to them now, is that if we do face such a crisis, they will owe the nation an un-payable debt for their failure to act or counsel action when still able.
When that time comes, do not allow the custodians and deniers to rewrite history, as some have already began to do. Remind them that they ignored the warnings, and they must therefore bear the largest portion of blame for misleading the flock.
Happily Ever After for the Bubble Fairy Tale? (The Magic Porridge Pot)
So what about the housing bubble that never burst? The fairy tale I mentioned way back at the beginning in which the housing bubble keeps growing, and growing, and growing…until?
There was a poor but good little girl who lived alone with her mother, and they no longer had anything to eat. So the child went into the forest, and there an aged woman met her who was aware of her sorrow, and presented her with a little pot, which when she said, “Cook, little pot, cook,” would cook good, sweet porridge, and when she said, “Stop, little pot,” it ceased to cook. The girl took the pot home to her mother, and now they were freed from their poverty and hunger, and ate sweet porridge as often as they chose.
Once on a time when the girl had gone out, her mother said, “Cook, little pot, cook.” And it did cook and she ate until she was satisfied, and then she wanted the pot to stop cooking, but did not know the word. So it went on cooking and the porridge rose over the edge, and still it cooked on until the kitchen and whole house were full, and then the next house, and then the whole street, just as if it wanted to satisfy the hunger of the whole world, and there was the greatest distress, but no one knew how to stop it. At last when only one single house remained, the child came home and just said, “Stop, little pot,” and it stopped and gave up cooking, and whosoever wished to return to the town had to eat their way back.
Now, bear with me on this final moral lesson. The poor little girl is the landless citizen, and her mother is the land-owning citizen. The street is the housing market, and the town is the economy. The pot is our deregulated banking sector, and the porridge is of course, mortgage debt. In the same way that mother and daughter used porridge to satisfy their hunger, so too have they used mortgage debt to satiate their need for shelter. But the mother got greedy, and decided to use mortgage debt to acquire multiple investment properties while her daughter was out looking for food. And in so doing, the banks were encouraged to produce endless amounts of mortgage debt, until the whole housing market and economy became overcome by it, to the point where “whosoever wished to return to the town had to eat their way back”.
Now that the ever-expanding quantity of mortgage debt has terminally overwhelmed both mother and child, the landless citizen must put a stop to it by saying no to ever greater sums of debt. There are now mountains of evidence that this will happen as a natural consequence of the above fairy tales playing out to their inevitable moral conclusion, and the inability of anyone to participate in the economy when it is utterly saturated with household debt.
But the debt legacy will of course remain, and the only way for the economy to have any sustainable future is for an unprecedented deleveraging of the economy. There is simply no way forward except to eat shitloads of porridge. Years. And. Years. Of. Porridge.
So what is going to happen as a consequence of having to eat our way through this mountain of debt? You guessed it. House prices are going to fall significantly, possibly catastrophically. We will most likely face some kind of banking crisis, and a protracted and deeply painful economic downturn as debt deflation wracks our ability and desire to spend and invest in the real economy. At both an individual and economy-wide level, our fundamental hierarchy of needs has been completely inhibited by the financial parasite of endless exponential porridge growth. The legendary (and in Australia, infamous) economist Steve Keen describes exactly why there is a physical limit to porridge expansion:
These countries avoided a crisis during the GFC because they kept demand expanding via credit. They can continue booming only if they keep credit—the annual change in private debt—positive. This is the Faustian bargain of private debt: because total demand is the sum of the turnover of existing money plus credit, then once private debt is very large compared to GDP, aggregate demand can fall even if GDP and private debt are still rising. When you have become dependent on credit to sustain demand, you need to continually increase debt faster than GDP rises, or you suffer a fall in aggregate demand, and therefore a recession.
So Australia can’t avoid a crisis by merely stabilising its level of private debt to GDP: to avoid a crisis—or rather to delay it even further—Australia’s private debt has to keep growing faster than GDP forever.
This can’t happen: the higher debt gets compared to GDP, the more of available income is taken up by debt servicing, the more bad debts are taken on, the more wary both banks and borrowers (and even so-called regulators like Australia’s asleep-at-the-wheel champions APRA and the RBA) get about yet more debt. This process is already clearly visible in Australia.
It’s also never happened: no large country has ever exceeded 250% of GDP as its private debt level.
It never ceases to amaze me that it is the nature of the human creature to believe itself the first of its kind to avoid such moral lessons. As if moral lessons were written for the less exceptional. Do not be fooled. These morals have been told and retold across dozens of generations for a reason. They contain warnings from our wiser selves, those who have experienced the pain, and might hope their lesson is not a futile one. But perhaps we really do never learn. And there’s not many pages left in this book.
Will the last page leave us happily ever after?
I hope you like porridge.
12 thoughts on “The housing bubble that never burst, and other fairy tales”
As they in the RSA: “someone buy that man a Bells!”.
South Africa? Wouldn’t mind a Bells (whiskey?) after that effort believe me 😉 Thanks for reading.
You nailed it. I particularly like your descriptions of how anybody pointing out there is a real-estate bubble in Australia is ostracised by the Australian public.
The economic situation in Australia is even worse than you describe. A fair fraction of the Australian population does not have any mortgages and is not knowingly invested in real-estate, however, the odds are high their superannuation (pension) funds are. A (random) investigation into the portfolios of Australia’s largest superannuation funds shows a large percentage of ASX-300 listed REITs (Real Estate Investment Trusts), retailers with large premises (another form of real-estate play), and “financial sector” stocks that are nearly all real-estate lending.
I also note the P/E’s of ASX-300 listed REITs is at an all time low and large foreign bank and hedge fund short positions in Australian real-estate plays is at an all time high.
The Australian real-estate crash is going to be bigger than the Texas real-estate crash of the mid 1980’s when many properties lost 96% of their pre-crash values. This one is going to be a real whopper, but only after it happens can a real economy begin to redevelop.
I’m not telling my kids this fairy tale….I want them to sleep.
I know right?! Scares the crap out of me too!
top rationale Matt, it’s a good reasoned and well supported point of view
I look forward to part 3 where you say you may address the magnitude of adjustment/correction
Absolutely brilliant! Especially liked “eat shitloads of porridge. Years. And. Years. Of. Porridge.”
Yes I thought I was an evocative image 🙂 I happen to like porridge, but I don’t want to eat it every meal for the rest of my life!
Brilliant!! The Economists, Intelligence Unit have just rated a slowdown in China as a Risk of 20, towards end year once power is consolidated. List of countries most likely to feel a flow on effect. Australia is placed at number 1.
You should be being paid for writing this stuff Mr Ellis. Terrific article!
It’s 2019 and wow this is as relevant as ever.. Really enjoyed reading this and will be printing it out to keep.. Loved the insight and included illustrations.. Beautiful work!!