Never Trust a Real Estate Economist

With the the 7th Annual Demograhia International Housing Affordability Survey due to be released on 24 January 2011, you can expect the banks and property spruikers to come out in force proclaiming that: Australia’s housing market is not overvalued; that there is no housing bubble; that house prices will continue to rise inexorably; and that somehow Australia is different to other Western nations.

The first salvo in this campaign was launched today by ANZ Bank, in an article published in Smart Company. Here’s some of what ANZ had to say, together with some commentary of my own:

A new report from ANZ claims residential properties aren’t overvalued and has taken aim at traditional methods of evaluating affordability, including price-to-income ratios, saying they don’t take into account more complicated and less-quantifiable factors including historic declines in interest rates.

Senior economist Ange Montalti also says the current short-term trends affecting housing prices, including a decline in demand and the lack of first-home buyer stimulus, won’t last for more than a year, predicting stronger growth in 2011-12.

“We’ve had a few rate rises, but these are temporary reactions, we believe, and are not significant in the long-term. Our view is that with the housing market being quite tight, we should see some support for prices over the next 12-18 months.”

Montalti says the new report was written in order to bring into consideration pricing factors that are not recognised, including those that are less quantifiable such as deregulation which has caused credit to become more widely available.

“So what happens is that people tend to look at main pricing measures including house to income ratios to determine the affordability of the market. But those are only okay as a starting point and don’t take into account bigger movements over long periods of time.”

“In the late 1980s you had very high mortgage payments, which meant for any given dollar of debt you had to pay 15 cents in the dollar. Any dollar in debt today only costs you seven cents – you can sustain double the debt levels for the same burden.”

In a previous report, ANZ produced the following chart in support of their claim that a halving of interest rates justifies a doubling of house prices relative to incomes (see below).

The question then is: why has ANZ chosen the period 1980 to 2010 to compare mortgage interest rates? Why not choose a longer timeframe, say from 1960? What difference would a longer time period make?

Well, as it turns out, choosing a longer time period completely discredits the ANZ’s argument that mortgage interest rates have halved, thereby justifying the near doubling of house prices-to-income levels. To prove this point, the below chart plots Australia’s standard variable mortgage interest rates from 1960 using RBA data.

Average mortgage interest rates in the 1960’s (around 5.5%) were below the average rates in the 2000’s (around 7%). Even rates in the 1970’s (around 9%) were only a little higher than those of the past decade.

So, based on the ANZ’s logic that low rates justify higher house price-to-income levels, why weren’t house prices far more expensive in the 1960’s and similar in the 1970’s?

Further, with interest rates lower in nearly all advanced economies (see earlier ANZ chart), why aren’t other countries house prices even more over-valued than Australia’s?

The ANZ’s comments also infer that actual mortgage repayments as a proportion of incomes in the 1980s were similar to today, thanks to the near halving of interest rates over this period. Nothing could be further from the truth.

The below chart again uses RBA data to plot the ratio of average mortgage interest payments to household disposable income.

Mortgage interest repayments have increased significantly from 4.9% of income over the second half of the 1980s to 9.2% over the second half of the 2000’s! So despite lower interest rates, thanks to our much higher house prices, today’s households are sacrificing nearly twice as much of their take home earnings to cover their mortgage interest repayments compared to households in the mid-to-late 1980s.

Let’s not forget that the RBA’s data, used in the above chart, does not include the repayment of loan principal. When added to the above analysis, housing affordability now compared to the 1980s is even worse! To highlight this point, let’s compare 30-year principal and interest (P&I) loan repayments on a $300,000 mortgage at 7% interest versus a $150,000 loan at 14% interest (i.e. twice the loan size but half the interest rate).

The P&I repayment on the $300,000 mortgage is $1,996/month versus $1,777/month for the $150,000 mortgage. This difference of $219/month relates to extra principal repayments arising from the higher starting loan balance.

The point is that when it comes to assessing housing affordability, the crucial issue is how much P&I households actually have to pay, not the prevailing level of mortgage interest rates. In this regard, Australian housing affordability has clearly worsened substantially over the past decade.

Clearly, ANZ has deliberately cherry picked the highest period of mortgage interest rates ever experienced in Australia to justify its argument rather than undertaking a more objective analysis.

Anyway, back to the article.

He [Mr Montalti] points out the country has quite a low delinquency rate, which is evidence of a largely affordable market that is valued correctly.

“Critically, the persistence of very low housing loan delinquency rates over several decades (including through the most recent GFC) is the greatest testament to the sustainability of debt levels and house prices in Australia,” the report points out.

Yeah right. Try telling that to the Americans, English or Spaniards. Their delinquency rates were also very low prior to the onset of the Global Financial Crisis (GFC), as shown by the below RBA chart. We all know how it ended there.

ANZ then predictably resorts to the spruiker’s number one argument: that Australia’s so-called housing shortage will continue to drive house prices higher:

Looking forward, Montalti believes a shortage of properties in certain areas, based on the population growth models, will keep prices moving in the second half of 2011, moving on into 2012.

“Worst case scenario is that we get some more flatness for a bit longer. But we have pent up demand, and there aren’t enough homes, so we suspect there will be upward movements in prices going into 2012 and 2013.”

As I have explained previously, unresponsive housing supply results in greater house price volatility – both on the way up and the way down. Such a situation can be explained using basic supply and demand analysis, as shown in Figure 1.

Q0 and P0 represent the initial equilibrium situation in the housing market. Initial demand is provided by D0, whereas supply is shown as either SR (restricted) or SU (unrestricted), depending on whether land supply constraints exist.

Following an increase in demand, such as a surge of investors following changes to tax rules (e.g. Australia’s CGT reduction in 1999), the demand curve shifts outwards from D0 to D1. When land supply is restricted, house prices rise sharply from P0 to PR. By contrast, when supply is unrestricted, prices rise more gradually from P0 to PU.

The situation works the same way in reverse. For example, if there was a sharp fall in demand following a contraction in credit availability or a sharp decrease in Australia’s Terms of Trade, causing demand to fall from D1 to D0, then prices fall much further when land supply is constrained.

The key point is that declines in demand can bring sharply falling house prices even when supply is constrained. So contrary to the ANZ’s claim that Australia’s so-called housing shortage would prevent house prices from falling, the opposite is in fact the case.

The economic theory explained above is supported empirically. In the years leading up to the US housing crash, parts of the US – particularly, California, Florida, Nevada and Arizona – operated highly restrictive land use policies and regulations that hindered the ability of housing supply to adjust quickly and efficiently to changes in demand. In contrast, Texas operated liberal, market-oriented land use policies that enabled builders to provide sufficient new housing at affordable prices.

As shown in the below chart, when credit standards and interest rates were loosened in the early 2000s and demand boomed (particularly speculative demand), prices rose sharply in the supply-restricted states, but remained relatively flat in Texas.

Then, in early 2007 when the sub-prime crisis manifested itself in contracting credit, reduced confidence and then rising unemployment, resulting in large reductions in housing demand, prices fell sharply in the supply-restricted states, but again remained relatively flat in Texas.

In fact, the housing supply situation in California just prior to the crash sounds eerily similar to the situation currently in Australia:

The California Building Industry Association (CBIA) continues to express alarm over what it calls an ongoing housing crisis in Southern California. Alan Nevin, the association’s chief economist, projected in a 2006 CBIA Housing Forecast that only 185,000 to 205,000 building permits will be granted this year, far short of the 240,000 new homes needed each year.

Southern California has been experiencing a massive population boom in recent years and it’s believed that 6 million new residents will be living in the region by 2020. The population increase, coupled with the housing shortage, has the CBIA worried that it will be increasingly difficult for first-time homebuyers to find a moderately priced unit (9 February, 2006).

Let’s also not forget that similar housing shortage arguments were used as a reason why prices would not fall in Britain and Japan in the late 1980s / early 1990s. Both regions then experienced large house price slumps, with Japan’s house prices still less than 50% of the peak value reached two decades ago, whilst Britain’s house prices fell to their lowest multiple of income ever record in 1997.

What ANZ and other commentators need to understand is that Australia’s restrictive urban planning structure should not necessarily be viewed as a bullish indicator for house prices. Rather, whilst supply constraints help to explain the strong house price growth experienced in Australia’s capital cities, these same constraints would likely drive house prices down when the inevitable housing correction arrives.

Finally, ANZ provides only a superficial examination of downside risks to the Australian economy and house prices:

The report also points out that in a risk scenario based around a major collapse in the terms of trade, could likely prompt policy settings “that can only be favourable for house prices, particularly if house price momentum has been restrained”.

“Policy-makers intent on preparing for a ‘post-terms of trade collapse’ environment are likely to shift settings to a more accommodating stance. While the economy is likely to slow, the interest rate-sensitive sectors such as housing will benefit considerably and swiftly.”

So, according to the ANZ, we don’t have to worry about a potential terms of trade (ToT) collapse, since the resulting lower interest rates would benefit house prices!

As I have explained previously, a ToT crash would be devastating for the Australian economy. Not only would unemployment rise, incomes and growth fall, and the Government’s fiscal position worsen significantly, but the Australian banks, which have borrowed heavily offshore to inflate the housing bubble, would once again find it extremely difficult to roll-over their maturing foreign borrowings. Only, unlike in 2008, the Australian Government might not be in the position to guarantee their debt given the significant other drains on the budget from diminishing tax receipts and rising welfare payments. Obviously, any resulting contraction of credit would have a devastating effect on house prices.

The ANZ also conveniently ignores Australia’s ageing demographics, which are likely to significantly weigh on asset prices going forward (see here for details). They make no mention either of the fact that the availability of credit is likely to tighten significantly as the banks increasingly have to compete with foreign governments in offshore debt markets and the new stricter Basel 3 capital adequacy and liquidity requirements come into effect.

Beware the property spruiker:

The ANZ’s motives in talking-up the Australian housing market are understandable. Since 57% of the Australian banks’ total lending is directed toward housing, the banks are heavily reliant on increasing mortgage debt to sustain their profit growth. At the same time, the security over their assets (loans) depends heavily on the value of the underlying houses on which they have lent. These two factors combined means that the banks are highly exposed to any change in sentiment that causes: (1) a reduction in mortgage lending; and (2) a correction in house prices.

Even so, these motivations do not excuse ANZ from releasing such a biased and misleading report.

To me, the most disappointing aspect of the ANZ’s commentary is that it builds upon the common misconception that house prices in Australia are a one way bet – that the only way is up. In turn, this type of commentary invites greater investor speculation and encourages first-time buyers to leverage-up and purchase a home before they ‘miss out’. But with house prices already severely overvalued by every measure, and Australian households amongst the most indebted in the world, you have got to ask yourself whether such encouragement is warranted and in the national interest?

Cheers Leith

Leith van Onselen

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.


  1. Excellent article Leith, great details that everyone should consider. First it was CBA with their shonky 'analysis' of the housing bubble (or non-bubble as they claimed) and now ANZ are doing the same. It's about time these bank spruikers were exposed for what they are, sellers of debt enslavement. I mean look at the ridiculous price of housing and the spruikers tell us its going to double again from here, and how are we supposed to pay for that? More debt from the banks of course. The banks will never admit housing is in a bubble for as soon as they admit it they know the whole ponzi comes crashing down. Oh well, I guess we just wait. The insanity can't go on for much longer and soon we'll see the market collapse under its own weight. The first cracks are starting to appear and I suspect that's why the banks are so desperate to convince us otherwise with these shonky reports!

    Andrew B
    Aussie House Price Crash Forum/Blog

  2. This is all outrageous lies, the truth of the matter is:
    Property doubles every 7 to 10 years
    Australia has a massive shortage of housing
    Population growth is enormous
    Property prices always go up
    Rent money is dead money
    If you don't buy now you will miss the boat, end up homeless and have to raise your family in a dumpster
    Property doubles every 3 to 4 seconds
    Australia has a shortage of 229 million dwellings
    Population growth is 700% a week
    Prices have ALWAYS gone up and ALWAYS will.

    Yours Sincerely,

    Charles Ponzi

    P.S: Why is everyone complaining about that Madoff guy?

  3. Financial Follies

    >The report also points out that in a risk scenario based around a major collapse in the terms of trade, could likely prompt policy settings "that can only be favourable for house prices, particularly if house price momentum has been restrained".

    This statement above has got to be the most idiotic thing I have read in any bank report in a long time! It's like telling the Queenslanders they should wish for more floods because the resulting government cleanup spending "can only be good for them."

    Nice post.

  4. Leith,

    One day this is all going to blow up in all these stupid idiot economists faces. I am looking forward to it. I am so sick of hearing that Australia is great and everyone just hammers the US. China is going great guns although its starting to become apparent that their govt could be fudging there numbers and all of it is bulls$%t. Why is it the Australia media wont get off their A$$e$ and report that things are not looking good. Why is it the govt wont wake up and start doing things that will help the economy but instead just ignore what is inevitably about to happen. I just dont get it sometimes. The day I can look at all my friends and family who said I was crazy/stupid to think Australia was going to crash is going to be great. I have only a little of debt and have prepared myself for whats coming. I cant wait to say I TOLD YOU SO to all of them. It just blows my mind.



  5. This ANZ garbage is just another illustration of the fact that bank employed economists are whores.

    There is a strong case for a code of ethics for economists.If such a code was seriously applied then the whores would have to stop calling themselves economists.

    How about Bankster Frontmen?

  6. That interest rate chart reminds me of a Gold Chart doing the rounds and being used to justify why gold is still undervalued relative to inflation. The chart also starts in 1980 which was the peak price of gold at the time.

    They conveniently failed to mention that gold went up 2000% in the 70's which was astronomically above inflation.

  7. One factor that has held up our aussie housing market is our clustering in big cities. This creates scarcity and even the most cynical economist must bow to the old supply and demand theory. It is the interest rate data I find most supporting of your contrary view.

  8. pitty there are no "like" or "dislike" ticks on the comments field or I'd be clicking like on the comment from Mr Ponzi 😉

    great writeup and thanks for bringing to mind critical analysis of data sets …

  9. Is there no commission that aims to prevent misleading advertisements and bad behaviour by the financial institutions in Australia?

    like this one in The Netherlands?

    On a different note… I encourage everyone to post this on Facebook, LinkedIn, MySpace, Twitter… whatever social media available. Traditional media are never going to report this side of the story because of their reliance on property ads. Let's get some viral campaign going.

    People should have the opportunity to decide for themselves which side of the story to believe. 🙂

  10. Hey Leith, great article.

    The only thing my contrarian mind does not fully agree with is this comment about a collapse in Terms of Trade:

    " Only, unlike in 2008, the Australian Government might not be in the position to guarantee their debt…."

    At this stage, I'm so pessimistic about the credibility of (both sides) of our government, that I don't think we can predict what they would do. I know you said "might not", but I think we are underestimating how much our politicians will do to keep winning the 24hr news cycle, irrespective of the consequences.

    I have absolutely no faith left any more that they will not completely stuff our country by doing something totally stupid.

  11. Financial Follies comment about ToT says it all. Prior to the floods, we were being schooled on how historically high ToT was contributing to our national wealth, and consequently housing prices. Now, we are are being told that a collapse in ToT is also good for housing prices as it will send a signal for intervention. We can probably conclude that ToT is largely irrelevant for a macro-assessment of house prices and we are better to focus on the element that the banks seem reluctant to address: heaps of debt.

  12. over analysis from every corner, pro and con. Economics defy analysis as it is just too complex and unpredicatable. I'm not saying why bother but to be so adament that any one view is correct is scary. People need a place to live. House prices just keep going up, how many more decades do you want to get it wrong? People have made fortunes by not accepting your arguements. I guess if it eventually crashes you can rush out and say i told you so… but i reckon it will be too late. A 50% crash wouldn't even wipe out my profits. Get in the game. Actually, don't as there will be more for me. 🙂

    PS if it crashes i will just buy more!

  13. Another really good post Leith.

    On the big picture have you seen this PwC report on the world's economy to 2050?
    I posted the link but its not acceptable so have to google it.

    It has Australia dropping out the Top 20. I haven't read it in detail but if it was good news its the sort of thing that would get play in the and by politicians.

    And if I can offer a little note that the ANZ imply and as readers we infer. e.g "The ANZ's comments also infer…"

  14. great post Leith – you won't be getting a Xmas card from ANZ!
    Here in NZ (probably Aus too), the bank economists proclaim their independance and objectivity.
    Yeah right!!!!!!

  15. "Never trust a real estate economist"

    Allow me to expand on that idea and add, "ANY" economist. Believe me, if you can balance your own checkbook, you're already WAAAAAAaaaaay ahead of these guys.

    Keep up the good fight Lieth, great article!

  16. Jeremy: Texas has a higher proportion of its population in its five largest conurbations than Australia does. Yet its house prices are much lower. The only "shortage" is created by official discretionary control over land use. You take the Great Northern Road in Sydney, or head out to the west and north of Melbourne, and tell me there is a land "shortage".

  17. Great dissection.

    I got the sense (and maybe I’m also getting old) that someone wet behind the ears wrote that ANZ report. Someone who had never worked in anything before 1999 and certainly never had to balance a checkbook in the late 70s.