The bubble formula

What is it that determines house prices? Supply & demand, availability of credit, government subsidies, taxes, or a level of value in the buyers head?  I think it’s time we try to put a little discipline into the debate. Clearly many things go into determining house prices but with a little thought we can perhaps understand a little more about the drivers.

My approach came from a little mind experiment that established an anchor point. Think of a situation where a typical suburban house is being auctioned. There are two bidders only but one is borrowing 100% of the final purchase price, the other 0%. The borrower has an approved loan based on his “median” income and only access to further funds to pay costs of purchase.  The bidder with no borrowing requirement has access to unlimited funds. Who wins the auction?  If our bidders are acting rational, the bidder borrowing funds sets the price by bidding up to his maximum borrowing capacity but the other bidder with access to unlimited funds wins the auction by bidding $1 or some minimal amount more.

This may sound an unusual situation but if we think about the number of auctions that are occurring around Australia each weekend, my mind experiment could easily be the typical average situation that determines median house prices if sufficient demand exists for each property being bid. Logic also tells me that the auction result is the same in any combination of situations where bidders were borrowing funds, the bidder with the lowest borrowing requirement wins the auction but the bidder borrowing the most sets the price. Following this line of logic, there would seem to be a maximum price that needs to be bid for a house, which is determined by the maximum that the most heavily geared bidder can borrow.

From this simple mind experiment, I propose that there is parameter in a geographical region known as the Maximum Median House Price (‘MMHP”). Actual Median House Prices (“AMHP”) are simply a function of MMHP when the Effect of Demand (“ED”) pushes AMHP towards or away from the maximum. Or, AMHP=MMHP*ED

Having created the simple equation for AMHP, we can focus on separating the determinates of MMHP and ED.

So what determines MMHP?  Being experienced in mortgage lending criteria and factors that affect the net borrowing amount, my list is as follows:

  • Median household income
  • Income tax and medicare levy
  • Henderson poverty index or living expenses
  • Mortgage Repayment (P&I and IO payment, bank cost of funds)
  • Mortgage serviceability  (bank specific but this is the lowest common denominator))
  • Deposit Requirements (amount, whether genuine savings and capitalized costs)
  • Amount of government cash subsidy (eg. FHOG both state and federal)

I’m sure that I’ll get some serious push back on the list above but I’ll strongly defend the list which clearly says that the MMHP has little to do with the house. The house, whether old or new, merely fits to what the MMHP is at any point in time.   Houses may be made of bricks & mortar or wood, but they’re also full of air!

Those of you mathematically inclined would quickly see that the MMHP can be relatively easily put into an equation which could calculate the MMHP for any Australian region on an ongoing basis. The data is available to do this calculation but not easily or readily, but technology is bringing closer the time when databases will exist to allow the calculation to occur and be readily available.

However, as I have asserted on prior occasions the banksters have maximized the amount of available credit and therefore the MMHP beyond any point which is sustainable and thereby putting the whole financial system at risk. This has been done by under weighting certain lending risks outlined above, and consequently being allowed to undercapitalize their balance sheets and use mortgage rehypothecation to ramp up the availability of cheap credit. Nevertheless on its own the MMHP is not the sole issue to be addressed.

  • Assuming that MMHP is calculable, to obtain AMHP we need to look at the demand factors or ED. Here’s my list of factors that effect ED which of course are much more problematic than factors affecting MMHP.
  • Purchase taxes (stamp duty etc)
  • Upfront borrowing costs (fees and mortgage insurance)
  • Deposit Requirements (double direct effect and demand effect)
  • Income tax effect (capital gains, -ve gearing)
  • Availability of new land
  • Infrastructure costs and taxes on new land
  • Regulation on development and redevelopment of land and housing
  • Australia’s beliefs, delusions and intelligence

Demand factors are very complex and interwoven but again useful data is available on most of the factors at any point in time. But what would you do with it? Well I argue that the Australian population acting as a single entity without any conscious decision has done an enormous amount in working out how the factors provide the ED.

Vested interests in all levels of governments and the private sector have fine tuned the ED factors over 15-20 year period to create maximum demand and therefore MMHP in all significant regions by late 2010. How was this done? Each party controlling an ED factor maximises its return by manipulating the ED factor to achieve maximum benefit whilst maintaining maximum belief and delusion in the “value” of housing.

Of course, evidence now suggests that the beliefs and delusions have changed in a number of regions where AMHP have come off their MMHP which also can lead to the creation of the crash spiral as banks change the calculation of MMHP, chasing down the AMHP. Once the contagion spreads, the whole country catches the crash spiral virus.

I have a major problem with Australia’s AMHP and MMHP scenario which we now find ourselves in.

Whilst a large part of the population may have gamed the ED to their advantage it’s the banks and the different levels of government that control nearly all of the factors of MMHP and ED that must take responsibility. To exploit the system to a point where an over inflated MMHP is reached across the country, is a grossly irresponsible act against current let alone future generations.

As George Soros says, “If you see a bubble forming get on board”. So good luck to all those who’ve ridden the expansion. But for those sitting on large amounts of “equity mate”, that’s all the credit you deserve. The whole scheme was not of your making. You’re just one of the factors used by the banks and governments to their certain advantage. The countless spin that housing is a great investment, housing shortages will continue into the foreseeable future and most of all governments at all levels will ensure that house values will be maintained as the nation’s priority. All of it appealing to human greed, delusions and a strong belief in the nanny state. But if you haven’t cashed out on those property investments don’t count those chickens yet.

This is not a conspiracy but a cabal of firstly, banksters, regulators and politicians that work with a common theme to maximize the MMHP, for their own benefit but with the spin that it’s for the common good. Then secondly, federal, state, and local governments, in tune with the banks and the property industry to whip up a frenzy of demand whilst managing to extort taxes, fees and profits from borrowers by filling the gap between what the AMHP should be and the artificially created MMHP. That’s the actual ED.

The relentless march continues and the question of who’ll pay for this plays to the beat of the drudging footsteps.


  1. This is clearly evident in my area (outer west Melb)

    Ive been tracking a couple of suburbs for the last couple of months in my area and found a growth of btw 18 – 31% of immediately habitable houses on the market. This equates to btw 4.8 – 6.5% of total dwellings (in each suburb) including growth adjustments as predicted for 2011 by the Wyndham Shire.

    Clearly a form of MMHP has been reached, and one of the larger forms of ED in this area, public infrastructure promises, has recently had a few doubts thrown on it.

    This combined with the illusion that a city commute is ‘only 25 mins’ (as advertised) when in reality is closer to 70mins has probably left a few people wondering how they were convinced to pay so much in the first place.

    In regards to ‘availability of new land’ it is in abundance, however there seems to be an upper limit on what people expect to pay for 400m2 of outer suburban paradise. Finally.

    As for speculation, its always worth checking out the number of houses available for rent in an area (and also checking out how many appear vacant in the ads) and contrasting this against the total number of dwellings. (the Wyndham Shire website provides this data well)
    This side of town has always been a poor performer in this department but as always caveat emptor to those late to the party.

    Ive seen some decent price reductions in my immediate area (thanks REFinder), however quality stock is still slowing churning, just unsure on the prices 🙂

    For my area, one avenue of mitigating these worrying times would be the reaffirming of said Pub Infrastructure spending, and perhaps doing it.

  2. Fascinatingly short-sighted. The MMHP has been pushed further and further out for decades. Mum’s rarely worked when i was a lad, now they have to whether they want to or not. IO loans were once rare, and certainty unheard of amongst OO intending to refinance/relocate. etc, etc

    one round of hands up and access to super is available. etc, etc

    • I think I’ve said that The MMHP has been pushed further and further out for decades.

      “Vested interests in all levels of governments and the private sector have fine tuned the ED factors over 15-20 year period to create maximum demand and therefore MMHP in all significant regions by late 2010”

      So I’m not sure of your point Doggy S?

      But I do agree with you that access to super is on the table

    • Wasted Opportunities

      I think Doggy is agreeing with you DT. The short-sightedness is on the part of the cabal that has presided over this mess.

      The most depressing side effect of all this is how limited the Australian appetite has become for any kind of progressive reform. Too many “winners” for too long has turned us into a nation of Huxley gammas and deltas, contentedly accepting the status quo. The ease with which the RSPT is a good example.

      Keep up the good work.

  3. The problem with being a bear is that the bulls can survive on their own crap far longer that you can go without.

    Clearly the market is overvalued and the property bears are right. But would you rather be right or rich?

    • Some of us care about the legacy we leave for our children and like to get rich by sweat and productivity. Try it, it feels good

    • Being a bull is great if you get in and out at the right time. The problem is that bulls rarely get out (and bears rarely get in) at the right time. Just ask millions of bulls in the US, Ireland, Spain, etc. You’re only rich if you cash out and collect your gains.

    • Reminds me of an expression. Bulls make money, bears make money, but pigs get slaughtered. If you think you can buy now and get rich….oink oink

  4. yep. i mean “them”. don’t even get me started about global warming, or the amount of money “society” throws at entertainment/sport, whilst meaningful science/research cries poor.

  5. Deep T, you understand what is happening.
    Unfortunately, few people understand the deeper impact that thousands of hopeful home buyers are surrendering a kind of freedom in exchange for a promised security of home ownership.
    Todays’ home buyers are being played by banks, the RE industry and govt as you mention.
    So much wasted potential and talent tied up in chasing over-priced shelter.
    As a country it seems all we are good at producing is debt.

    • Even though my children are fairly young I do hope when they are older that they can have a home at an affordable rate. Deep T I am with you on your comment. Though I have a investment property and bought at the right time. I dont mind losing equity if it will bring houses to where they should be. My belief is investment is long term and if you hold something for a long period of time it will grow. When it grows at record pace then it will go down the same way.

  6. Thanks DT, you are a champ.

    The second last paragraph says it all. A ponzi scheme with an embedded extortion racket.

    Current Legacy for our children: Go forth and be the best slave you can.

    Your history- few will be free

    Convicts- State slaves
    Wage slaves- tax slaves
    Mortgage slaves-debt slaves

    The Iron curtain-Monumental Disaster
    The Bamboo Curtain-Monumental Disaster
    The Debt Curtain-Monumental ?

    Bon Mot of our oppressors: We think, they sweat! (now where did I hear that before?)

    If super, as our reserve is committed, then the pincer movement/envelopment strategy is complete. There is no way out or back. Defeat is imminent.

    Wasted opportunities: Will our squanderlust take us down a similar path to that of Argentina? A country that in 1906 was as prosperous as Australia, to only become a basket case, for the majority of its citizens.

    These 4 walls (girth by sea) do not a prison make, but the debt surely will.