15 May 2011

Australian Housing to Bust, Eventually

This post by Terry McFadgen on Australian housing prices is a good summary of the question of if/when prices will tank. One thing overseas readers should keep in mind is that Australian borrowers can't walk away from their debt - the bank can foreclose on you and then go after you or bankrupt you for any remaining debt not paid by the sale of the house.

As you would expect this dampens the negative price spiral that can occur in countries where walk away is an option. However, consequence of this is that in the face of financial difficulties people will tend to restrict other spending and divert money to paying off the mortgage to avoid the stigma of bankruptcy (although this doesn't seem to have bothered "former tennis ace" Mark Philippoussi) This contraction in discretionary spending acts like the “Paradox of Thrift” Terry mentions in his article.

I think Terry makes a good case that "house prices could simply slide down gently over a long period, with inflation doing most of the work of price adjustment" but he does identify four risks/shocks which could bust prices.

He notes that the RBA is between a rock and a very hard place in trying to de-bubble housing but having to increase interest rates too much to control inflation, or having to cut interests rates too much if housing tanks which will weaken the Aussie dollar and stocks as foreign investors pull out.

My view is that push come to shove RBA will cut rates and damn the exchange rate as an imploding housing market is not good for banks and the political pressure will be too intense. This will be an extend and pretend that will work for a few years as there is plenty of room to move with interest rates at the 6% level. A weak exchange rate is good for AUD precious metals prices, by the way, a sort of hedge against house price drop in a way.

I would also not discount politicians doing something stupid to "help" housing. With debt to GDP of 20% a populist call to "do something" could be made when other countries are at 100% ratios ("we have the capacity"). It will all be wasted of course but could drag the game on a bit longer.

However, as the US shows us, once you get to zero interest rates you've got nowhere to go and QE doesn't help housing. Once we reach that point then we will really see a housing price crash as the boomer demographics, China slowdown and "income levels [don't] hold up relative to interest rates" factors all kick in together.

To sum up my view on house prices, "It Won't Happen Overnight … But It Will Happen" (explanatory link for non-Aussies)

4 comments:

  1. so having recourse mortgage loans didn't act as a deterrent to bubble-icious behavior? judging by the chart in the link - Aussie home prices rose even faster than US prices did!

    that's kinda surprising - you'd expect recourse loans to make people act more rationally.. .then again, as I just blogged about, you'd also expect the head of the IMF to not attempt to (Allegedly) rape a hotel cleaning lady...

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  2. Recourse I don't think is any restraint in the face of beliefs that "housing always goes up", preference for stablity that renting doesn't offer, and the perceived reassurance that the bank lending you the money wouldn't do it if they thought the house was overvalued.

    I should also mention that one's primary residence is free from capital gains tax, ie no tax at all. This is a powerful incentive. Note that interest paid on your mortgage is not tax deductible, however.

    For investment properties, if held for more than one year then only 50% of the capital gain is taxed.

    Both of these may account for the greater Australian home price rise.

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  3. One of the best resources on the why of the housing situation is Steven Keen (search: debt deflation), if anyone wants to look further.

    It looks like TPTB are trying to achieve the long slow sideways 'let inflation do the work' correction. All I can say is good luck; we will be better off if it can be achieved, but it is a tightrope.

    If that can't be done, acting to collapse things in a controlled manner might be the best option.

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  4. Well, people are getting pretty upset now their government tells them to pay for the gambling debts of banks. It means you can't trust your government representative or banker anymore. It is now them or us. Unfortunately is too late for a remedy and the game "musical chairs" is in full swing. You and your site are one of a kind and I thank you for that. But at the same time I can't blame upset people to search for answers. "Trust" is gone!

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