In the last couple of days the “not-so-mainstream” types that report on the economics of Australia have been reporting on the fact that CBA seems to have “sweetened up” the figures about Australian house price to income ratios in order to make a presentation to an international investors group.
Many of the overseas investors have recently seen their own countries go through a speculative bubble crash in housing and are therefore wary of any other country that is showing similar signs. They are also sceptical of economists in Australia making statements like “it is different here”, because this was exactly what their own economists were telling them right up until the day it turned out they weren’t different at all.
So yesterday we were very interested to find the UBS report that CBA used to justify its house price to income ratio in our inbox.
The report is a very long 93 pages, and just like the Goldman report seems very well researched on the surface, yet once again we find glaring holes in the analysis that we feel need to be pointed out.
Unsurprisingly the report sets about trying to convince the reader that in fact whatever they have been told about housing prices is incorrect, they are really not so bad , we have graphs to prove it , and even if there is a bubble it isn’t going to effect Australia without some external issue , and even if it did our banks wouldn’t be that badly off.
Firstly they say:
We have undertaken a detailed review of the Australian housing market, which is the greatest exposure for all the banks and many other financials. Given numerous misconceptions about Aussie housing, we attempt to provide accurate facts to
enable investors to come to a more informed conclusion about these exposures.
Lets try an ignore the vested interest of an investment bank telling you about investments and move on.
There has recently been a significant increase in interest from investors in Australian house prices. This follows a number of international articles that point to Australia being amongst the most expensive housing markets globally. The perception has been exacerbated by house price corrections seen across the western world over the past three years, which Australia has largely avoided.
From the outset, we should emphasise our view that Australian housing is expensive. Median house prices have grown at 9.1% CAGR since 1971. While this is broadly in line with nominal GDP at 9.0% CAGR, it far exceeds growth in household income which has grown at a compound rate of 6.8% over this period. This has placed ongoing pressure on housing affordability.
Housing affordability measures, which adjust for movements in interest rates and unemployment, are re-approaching the low points reached in 2008. However, at current levels Australia looks expensive. This is manageable assuming that there is limited further house price inflation and interest rates do not move materially higher in the near term.
The report goes onto say that although housing is “expensive” it isn’t that bad , and Australia is safe because:
- Australia has not posted a negative GDP year in the past five
- There is a undersupply of houses
- The economy is strong and without some sort of exogenous shock housing will be fine.
- Mortgage arrears are low
- Unemployment is low
- Australia has good mortgage underwriting standards
- Australian banks are well placed to absorb direct mortgage losses.
We are not going to analyse these points, but you can read back through previous posts where we have covered many of these topics. Let just point out that housing in Australia is in a “credit driven” government supported speculative bubble.
Like all credit driven bubbles it relies on ever increase debt and leverage to keep going, it doesn’t take some “large” shock to deflate, it simply takes a small mindset change towards debt or holding of that asset and the whole thing starts to unwind. We are sure the Australian banks understand this because they have recently lowered their credit requirements again because of a slowdown in lending. As we have shown before any long term slow down in lending leads to a fall in prices. There is no need for a large external shock, a simple change in demographics, a small change in government policy or an generational change in the view of the value of the asset would be all you would need.
Queensland is currently running below par with the rest of Australia on growth, funnily enough they are also behind in lending, the trouble may already be brewing, yet unemployment is low and the economy seems strong, just as it was in the US and Spain and Japan and Ireland and every other country just before it all fell to pieces.
The US, Japanese and European experiences have shown that a large deflation in housing prices has a massive flow-on effect to the broader economy. According to the Reserve Bank of Australia, household assets in Australia totalled $5.9trn as at June 2009. Housing accounted for $3.5trn or 60% of total assets. So what do you think would happen to consumer confidence, businesses and employment if all of a sudden 30% of the $5.9trn in perceived wealth suddenly disappeared into thing air? Although Australian banks believe that they could absorb the direct mortgage losses it is extremely doubtful that they would survive the broader collapse. Overseas funding is already an issue, how would they get any investment after a housing collapse?
Enough of that however, the reason we are interested in this report is to determine why UBS thinks Oz houses aren’t really that expensive while everyone else is stating that they are the most expensive in the world. The underpinning message of the report is that other sources under estimate the income of the average Australia family. UBS have 50 pages devoted to why housing isn’t that expensive, including population, demographics, income growth, proximity to the coast-line, housing size and density, comparisons to other countries, they even have a logarithmic scaled graph so they can get housing growth to look like a straight line !!!.
But this all hangs on a couple of sentences and the fact that they simply think they are better at analysing data than the ABS:
One of the key data points that economists, particularly those offshore, use to demonstrate the high cost of Australian housing is house prices to median income. Again, we are measuring stock versus flow in this analysis, which can be misleading but it does highlight the household’s capacity to manage debt costs.
We believe, however, that the series that most economists use to measure household income underestimates the real picture of household finances in Australia. Looking across the household income distribution from the ABS survey highlights that mean gross household income was $86,000 in 2008. After taking into account income tax and the Medicare levy (an additional health care tax surcharge), the mean disposable income in Australia was $71,000.
Looking at median income instead of mean income yields a much lower – and we think possibly misleading – outcome. According to the ABS, gross median household income in Australia is $66,000.
So now we have an investment bank basically saying that that the government organisation with absolutely no vested interest in altering data, subject to peer reviews, which is the trusted source for every metric that measures the economy is not a reliable source of “real” income. What we should be doing is throwing all that away and listening to a couple of analysts who work for an investment bank. Are you nervous yet ??
Well lets just see how they went.
We have undertaken a task of deducing household income from the bottom up using the national accounts. We can see that in 2009 Australia had $608bn of wages paid to employees. There was a further $97bn of mixed income.
The report presents two charts showing their version of the total and per household calculations derived from nation accounts.
Dwellings income is a controversial inclusion in the following calculation. It is the imputed value of housing for owner-occupied dwellings. It represents $100m or roughly 12% of household disposable income. Excluding this figure from total household income drops household income to $743m. Below we undertake the same exercise but at a household level. It implies that household disposable income is $98,000 per household, or $87,000 per household if we exclude dwelling income.
But then decide to use it anyway in further analysis.
However that is nowhere near the worst problem with this document. Just before they try to justify using the national accounts for their calculations they say this.
Looking across the distribution histogram of household income also highlights a relatively small gap between median and mean household income.
And show this graph from an ABS document ( from Page 11 of this document )
However what you will notice is the footnote that says that the maximum income used in the graph is $2025. That is why the median and mean are relatively close. The data has been capped and does not include any income over $106,000/year. If you included all of the salary ranges, including the highest earners in the country, then the mean and the median would differ largely because the dataset would be greatly skewed by the smaller number of people earning massive incomes.
So UBS show a graph with a cut-down dataset to justify using mean and not median, because in that case they are close, but then use a full dataset in their calculations for actually calculating the mean.
They even catch themselves with a graph that seems to show that median and mean are the same thing.
As far as we can tell this is a blatant statistical mistake. We cannot see where they have adjusted the national accounts data to remove any bias by including the entire population in the calculation.
Worse still the Demographia report used to produce all of the other data in the CBA investor report uses a “double median”, that is median house price divided by gross annual median household income.
So as far as we can tell the UBS data analysis is poor. You can see that they have leakage of highend earner’s income into the average earner’s income present in the data. The UBS/Demographia data is an apples and oranges comparison. We will leave it to our readers to decide what they think about presenting these two pieces of data in the same chart and implying they are the same thing.
Lets just say we will still be using the ABS data, but that doesn’t stop our RBA representatives quoting these values.
Disclaimer: The content on this blog is the opinion of the author only and should not be taken as investment advice. All site content, including advertisements, shall not be construed as a recommendation, no matter how much it seems to make sense, to buy or sell any security or financial instrument, or to participate in any particular trading or investment strategy. The author has no position in any company or advertiser reference unless explicitly specified. Any action that you take as a result of information, analysis, or advertisement on this site is ultimately your responsibility. Consult someone who claims to have a qualification before making any investment decisions.