Australia’s Bubble that Wasn’t
Australia’s experience with house price inflation is attracting a lot of attention in the US, featuring on the front page of the WSJ, which notes that Australia provides a ready example of a major house price inflation that has ended benignly:
As the U.S. confronts its own housing-price boom, Australia’s experience suggests that the end of a boom needn’t necessarily lead to widespread economic distress. So long as most people decide to hold on to their homes and ride out the storm, the economy can hold up. Australia has yet to experience a trigger, such as widespread job losses or a spread of panic about the real-estate market, that would drive owners to unload their homes en masse and create a crisis.
The above extract implicitly concedes the point that house prices are driven by broader economic conditions, not the other way around. But the notion that people would ‘unload their homes en masse’ in response to some sort of exogenous shock is nothing short of bizarre. There are many reasons why house prices might fall, but people abandoning their homes to rent or live in the streets is not one of them. Most participants in the housing market are buying and holding, not speculating, and choose the most favourable time to rollover their asset. Falling prices lead to a reduction, not an increase, in market turnover. Much of the post-boom weakness in Australia has been seen on volumes rather than prices.
The article also argues:
Mr. Greenspan has said that it’s hard to know when asset bubbles truly exist, raising the odds that a pre-emptive strike will unnecessarily damage an otherwise healthy economy. The other school of thought, exemplified by Australia, holds that it’s wiser to pop likely bubbles before they get out of hand. Even if Mr. Greenspan wanted to follow Australia’s lead, he might find it hard to. The U.S. Fed is already raising interest rates at a steady pace. If it moved any faster in an attempt to pop a bubble, it would risk putting the brakes on U.S. economic growth, with potential global consequences.
The RBA has in fact denied that it is targeting house prices and Governor Macfarlane has argued against the wisdom of doing so. The article also overlooks the prevalence variable rate mortgages in Australia, which are closely tied to the RBA’s official cash rate. This gives the RBA much more traction over household disposable income than is available to the Fed. Targeting house prices with monetary policy is a much riskier proposition in the US than it is in Australia. Greenspan is right not to follow Australia’s supposed example.
posted on 19 July 2005 by skirchner
in Economics
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Really Stephen, do you take us for complete fools? Every one knows that AUS’s post-Olympics real estate price bubble was driven by Residential Investment Property investors capitalizing on favourable changes to the Capital Gains Tax. Gittins summarises the case
The asset price bubble in real estate may end in a bang or a whimper. But steady growth in real estate asset prices is over for the rest of this decade.
This may well cause a massive dent in overall activity as investors have to repair holes in their balance sheets. The greatest waste has already occurred in the staggering amount of resource dedicated to title-transaction churning and in the over-capitalization of assets with property-porn rennovations.
Posted by Jack Strocchi on 07/19 at 04:35 PM
Since 1999 people who hold any asset for more than 12 months have been able to pay half the otherwise punative capital gains tax rate. The argument that this alone caused the sharp rise in property prices (that in any data I see looks at least 12 months past its peak) is just not credible.
Other asset classes (say shares) have much lower transaction costs, similar CGT tax status, a higher yield (especially post costs of maintenance, property taxes, rates, delinquent tenants, insurance, etc.) and more liquidity. Indeed in the last 2 years they have probably performed much better than property.
So it seem more plausible that people bought property when they thought property was a good investment, shares when they thought equities were a good investment and at some point will by fixed income securities to lock in yield. Any non exempt asset held for more than 12 months (a silly boundary that does distort behaviour, especially in more liquid asset classes) has the same tax status.
Property investment has probably been helped by financial technology. The ability to easily access the equity in a home or investment property is a substantial market change that aleviates the liquidity problem in the property sector and allows property investments to play a bigger role in a portfolio. It always astonishes me that critics of property investment (say Gittins) are not happy that people are investing less of their equity capital in their home and are able to redeploy those funds in other choices.
Gearing is more important in Australia partly because marginal tax rates are high, making tax deductions such as on interest (which are also available for property in say HK) worth having. If you are concerned about excess consumer sector gearing - try reducing marginal tax rates!
A serious economic analysis of the property market needs to look more broadly at investment and consumption decisions.
Posted by .(JavaScript must be enabled to view this email address) on 07/20 at 12:56 PM
Posted by stacman on 07/20 at 02:56 AM
“less of their equity capital”? Is stacman saying that in AUS over the past decade property investment as a ratio of total portfolio (ie pecuniary) investment (ie equities, securities, liquidities etc) has gone down? He must be off his rocker if he is.
Moreover in AUS over the past decade investment in housing (construction & rennovation) as a ratio of total direct (ie real) investment appears also have to have risen, going by the number of building sites one sees. Although institutional-economics claims that there has been a much more significant rise in real investment in the minerals and energy sector.
For some reason, the issue of asset prices causes people of broadly similar intellectual and moral outlook to suddenly take leave of their senses.
Posted by Jack Strocchi on 07/20 at 10:29 PM
The general rise in all major asset class (property and equity) prices over the past few years is somewhat consistent with rational portfolio investment allocation, given the halving of the CGT. But property has risen much more than is warranted by its productivity, as evinced by falling rental yields. By contrast equities are still somewhat undervalued, given the strong growth in earnings.
Posted by Jack Strocchi on 07/20 at 11:11 PM
“less of their equity capital”? Is stacman saying that in AUS over the past decade property investment as a ratio of total portfolio (ie pecuniary) investment (ie equities, securities, liquidities etc) has gone down? He must be off his rocker if he is.
Property as a % of Household Net Assets was roughly 53% in December 1994 and is 54% today. It has ranged from 48% (1997-1999) to 57% (2003). Nothing particularly dramatic here - the numbers rise and fall they are not so different to 10 years ago and are actually lower than 18 months ago. The RBA data actually shows that property is not the fasted growing part of household portfolios over 10 years - both equities and superannuation have grown more quickly. Do we have a superannuation “bubble”?
My point was more micro. Property investment is now order of magnitude more flexible because of home equity products - one of many factors that can provide reasonable non “bubble” explanations for some good years for property prices. Recall also that GST impacted directly on the values of property by increasing costs of building by 6-8% and the “first home owners” grant was rapidly capitalised in asset values.
Posted by .(JavaScript must be enabled to view this email address) on 07/21 at 11:04 AM
I dont know where stacman gets his AUS asset portfolio figures from, possibly from the same place that i-e gets his NASDAQ bubble data - ie pulled out of thin air.
The Australian Treasury reports that Australia’s total real private household wealth (at nominal $AUD market prices) more than doubled in value from 1996 ($2,206 b.) through to 2004 ($5,145 b.). During this time the share of total wealth found in the property dwellings class jumped, going from 54% ($1,186 b.) in 1996 to 64% ($3,297 b.) in 2004. Correspondingly, business assets declined in their share of total wealth, going from 39% ($862 b.) in 1996 to 36% ($1,881 b.) in 2004. For some reason the associated pie chart depicting 2004 portfolio asset compostion gives the business asset class only 27% of total asset value.
Trasure notes that these asset ratios are now re-composing to more normal levels:
Still, the evidence is overwhelming that AUS’s portfolio of assets has experienced a massive and unprecedented shift in favour of the property class. And this has not been associated with any startling population or per capita income growth, at least in the post-GST phase. Hence property earnings (rental yields) are at very low - about half their historic average.
I call this a bubble.
Posted by Jack Strocchi on 07/21 at 02:56 PM
The data is from RBA Bulletin table B20, with an estimate of housing related liabilities based on subtracting non mortgage consumer credit from total household liabilities. The 54% number is the estimated net equity in dwellings divided by household net equity. This probably overstates exposure to property by not estimating values of any non financial assets outside consumer durables and dwellings. The RBA is quite clear that property price data is not very good - one further reason not to base policy on it.
The underlying issue remains that “bubble talk” is not very useful for understanding markets and because it implicitly assumes mistaken choices by individuals tends to promote policy follies to correct those “mistakes”.
The price of oil is “high”, percentage gains are high in a short time frame - but it is not widely described as a “bubble”, because demand and supply drivers are more apparent. If the price of oil drops say 25% it is not a “bursting bubble”, but changes to information about demand and supply. If oil prices reflect known information and preferences why wouldn’t housing be the same?
Posted by .(JavaScript must be enabled to view this email address) on 07/21 at 03:54 PM
Posted by stacman on 07/21 at 05:54 AM
That is how I Treasury derived the asset class ratios which gives property a 64% share of net equity. Can stacman please explain this disparity?
This begs the $64 question of whether or not markets or Central Banks are best at forecasting economic fundamentals. The examples of boom and bust - Great Depressions and NASDAQ bubbles - are a prima facie proof that markets do sometimes get it badly wrong. Keynsian economics was not a policy folly - the West never grew so fast except under Keynsian fiscal policies.
Asset price bubbles and busts do not dependent on autonomous household financial choices. They frequently relate to monetary policy and regulation.
The FRB in 1933, under the influence of the Classical liquidationism, contracted the US monetary supply which caused a Depression. Conversely the FRB in 1998, under the influence of Greenspan’s committee to save the world in the face of various financial crises, expanded the monetary supply. Asset prices consequently slumped and ballooned corresponding to changes in the availability of speculative credit.
So it is acknowledged that bad Central Banks are a real problem. But there are good and bad Central Bankers. And they should not beholden to the fear and greed of the markets.
Posted by Jack Strocchi on 07/22 at 12:55 AM
From your link:
“The scope of the estimates presented in this article is the Australian private sector. This consolidation of the private household and business sectors greatly simplifies the calculation of private sector wealth. However, this consolidation does result in a loss of detail on the liabilities of these two sectors. Consequently, the data on asset types contained in the attached tables and charts should not be used to infer relative ownership by either the household or business sectors, or the level of personal wealth”
The RBA data does separate Household and Business liabilities.
I will leave the $64 question for another time - sufice to say that asset prices may respond to policies that change and then correct in response to that change - this does not seem like a case against markets to me.
Posted by .(JavaScript must be enabled to view this email address) on 07/22 at 01:24 AM
Asset holders (and prices) respond irrationally to central bankers policies - it is the gambling herd mentality of the market. Householders and firms have limited time horizons and their investment decisions have external effects, awhich is what can turns individual rationality into market irrationality when validated by weak central banks.
Posted by Jack Strocchi on 07/22 at 02:13 PM