Local bulls vs foreign bears

On Friday, Bloomberg published an article entitled Australia’s home price plunge pits local bank bulls against foreign bears.

The article nicely summarises the conflicting views about the Australian residential property market, with foreigner’s pessimism largely tempered by the local bank economist’s rose coloured outlook:

Australian home prices in 2011 have fallen the most in three years, pitting local banks which say the drop will be short lived against overseas investors betting it’s the start of an overdue rout.

The nation’s four biggest lenders, which account for about 87 percent of outstanding mortgages, are forecasting prices will be underpinned by a housing shortage, population growth and an economy boasting near full-employment. Overseas investors say high debt, unaffordable homes and rising interest rates could cause home prices to tumble as much as 40 percent…

Make no mistake, this is by no means a ground-breaking article, and it is unlikely to provide any unique perspectives to keen observers of the housing bubble debate. Nevertheless, I want to bring the article to readers’ attention as it would likely have been widely read internationally, and could influence (at the margin) foreign investor’s perceptions of the Australian housing market and Australian bank debt.

Foreign bears:

The article provides the following list of bearish predictions from (mostly) foreign observers:

Marc Faber, publisher of the Gloom, Boom & Doom report, last month urged investors to short-sell Australia & New Zealand Banking Group Ltd. (ANZ) shares, citing excessive household leverage and an overvalued property market…

John Taylor, founder of FX Concepts LLC, the world’s largest currency-hedge fund, says Australia’s banks, which remained profitable throughout the financial crisis without government bailouts, are now overextended and will cut back on credit, helping spark a recession.

“Banks sailed through 2008 like the rest of us were all idiots,” New York-based Taylor said. “They’re not looking as pretty now”…

Taylor said Australia’s dependence on China, its biggest trading partner accounting for about 25 percent of exports, may soon be a drag, rather than boost, as Beijing attempts to cool the economy.

“This is the beginning of a recessionary period for Australia and housing will be one of the markets to get hit,” Taylor said in a telephone interview.

John Kim, an analyst at CLSA Asia Pacific Markets in Melbourne, said there is a speculative problem for residential investment properties driven by the “negative gearing” tax structure. Property investors in Australia can claim tax deductions on losses from property investments and offset those against other income, encouraging property purchases that otherwise don’t make economic sense. Kim said Australian home prices could fall 15 percent in a worst-case scenario…

Jeremy Grantham, chief investment strategist at Boston- based Grantham Mayo Van Otterloo & Co., last year called the Australian housing market a “time bomb” set to blow when rates climb…

Gerard Minack, global developed markets strategist at Morgan Stanley, has said house prices are as much as 40 percent overvalued. Bank of America Merrill Lynch forecast last month that home prices will drop 10 percent from their June 2010 peak…

Mike “Mish” Shedlock, an investment adviser at Sitka Pacific Capital Management, who publishes the Global Economic Analysis blog, says [housing] shortage claims are “pure nonsense.”

“We heard the same thing in the U.S.,” Sonoma, California-based Shedlock, who predicts Australian home prices will decline by as much as 40 percent, said in an e-mail. “There is always a perceived shortage at the market top.”

Admittedly, not all foreigners quoted in the article are bears:

Jack Foster, global head of real estate at Franklin Templeton Investments, said he’s switched from a bearish view on Australia’s housing market as the resilience shown by Australia’s banks following the collapse of Lehman Brothers convinced him a slump is unlikely.

“It was hard to believe, given the weakness in so many housing markets around the world, that Australia wouldn’t suffer,” said New York-based Foster. “But what I missed was the discipline of the banks,” which raised down payment requirements and avoided reliance on loan securitization…

Local Bulls:

Not surprisingly, the Australian bank economists are playing down claims that the Australian housing market is in a precarious position, resorting to the usual arguments about housing shortages, population growth and the strong Australian economy.

Rob Brooker, head of Australian economics and commodities at Melbourne-based National Australia Bank Ltd., said the “soft patch” is temporary. Prices will climb 3 percent to 5 percent over the next two years, driven by an investment boom, he said…

“There is a tendency for people overseas to extrapolate their experience of their own market to the Australian market, without really understanding the strength of our economy, the strength of demand, our connection to China and their growth story and the shortage of housing here,” Brooker said…

James McIntyre, an economist at Commonwealth Bank of Australia (CBA), the nation’s biggest mortgage provider, said income growth, and low unemployment of 4.9 percent, will support the housing market. McIntyre forecasts “subdued” growth for housing over the next year as the central bank raises interest rates to contain inflation…

Matthew Hassan, senior economist at Westpac Banking Corp. (WBC), said higher interest rates will in some ways support, rather than dent, home prices. He argues that higher rates will curb property development and exacerbate a shortage of homes that stands at 228,300 dwellings according to the government’s National Housing Supply Council’s estimate.

“As long as rates stay above average, demand will be suppressed, but supply will also be suppressed,” said Sydney- based Hassan. He said he predicts a “patchy market.”

For mine, there are two ‘forecasts’ that stick-out as nonsensical.

As much as I like Mish Shedlock, and remain a long time reader of his blog, his prediction of a 40% decline in Australian home prices is highly unlikely. To put things into perspective, arguably the world’s biggest housing basket case – Ireland – only experienced a 37% peak-to-trough nominal decline in home prices before recovering slightly (see below chart).

Similarly, US home prices have only fallen by around 30% peak-to-trough in nominal terms according to the narrow 20-city Case-Shiller index (see below chart) and even less according to the broader 50-state FHFA national index.

On the other end of the spectrum, Matthew Hassan’s claim that “higher interest rates will in some ways support, rather than dent, home prices… [since it would] … curb property development and exacerbate a shortage of homes” is ridiculous and reminds me of an argument made recently by ANZ that a China-induced terms-of-trade crash would be favourable for house prices:

…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.”

As noted previously, if commodity prices can remain near record highs and international capital markets remain willing and able to fund our banks, then a New Zealand-style slow melt is probably on the cards for the Australian housing market (see below chart).

But should Australia experience a major external shock, such as a sharp slowdown of the Chinese economy, which causes commodity prices to fall back toward their long-run average, then a UK-style mini crash is more likely for Australia (see below chart).

One thing’s for certain, with downside risks far outweighing any upside potential, I would not be rushing in to buy Australian housing.

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Unconventional Economist
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  1. Torchwood1979

    I feel sorry for Steve Keen. His often misrepresented call of a 40% decline in Australian home values was in real terms over a 10-15 year period and even a NZ style scenario we’ll probably hit a 40% decline in real terms before the decade is out. If we experience a UK style correction (looking more likely all the time, IMO) it could happen in as little as 5 years.

    • I dont feel sorry for him because one day his predictions are going to happen. When commodities crash as everything else has then Australia and its housing market will follow. Never has anything boomed forever and Australia housing and its commodities will go through its great correction.

  2. US inflation figures would be dodgy,
    perhaps the ‘real’ price
    decline is considerably more

  3. You talk as if the Irish and U.S. housing bubbles have bottomed. I respectively disagree.

    • Carbon Bologny

      here here, did you see the Richard Koo speech on ‘balance sheet recessions’? If that’s what we’re experiencing then there could be at least a decade of declines as people get burned by debt and are too scared to leverage.

  4. To this chartist’s eye, those US house price indexes look to be resuming their down trends. So “30% peak to trough” doesn’t look likely to be the end of the decline.

  5. “John Taylor, founder of FX Concepts LLC, the world’s largest currency-hedge fund, says Australia’s banks, which remained profitable throughout the financial crisis without government bailouts.”

    That comment is way out of line.

    – Australian banks tapped the US Fed for billions in emergency funding.

    – Australian banks got deposit and wholesale funding guarantees.

    – Australian banks benefited from the increased lending that stemmed from the FHOB.

    No bailouts? Yeah right!

  6. And over here in NZ our ‘slow melt’ might be about to speed up, what with the Labour Party advocating Capital Gains Tax ( we don’t have,you do). Maybe we’ll get the encumbant National Party proposing Stamp Duty or a Land Tax, as an alternative? Who knows…but none of the proposals look good for residential property here.

  7. Leith, thanks for writing these articles. I was just thinking this morning about what makes supply in Germany so responsive on a national scale.

    We can talk about “Anglo-Saxon culture” and “restrictive planning laws” and so on. I agree with Grantham and you that Australian houses are a bad investment and will eventually mean-revert. This time is never different.

    But for a “scientific” measure of what might make Germany different (from us), we can see how “well” their population is distributed right across the country — ie it tends to obey “Zipf’s law” in terms of distribution. The US also obeys it (Britain and France less so, as London and Paris are much bigger than their competitors).

    Australia’s doesn’t do this at all — it’s even mentioned in a few RBA papers — http://www.google.com.au/search?sourceid=chrome&ie=UTF-8&q=%22zipf's+law%22+site%3Arba.gov.au … so is it a kind of “nationwide” planning failure not to be spaced out better along the coast? Would high-speed rail help?

    • Does it really matter? Countries are just arbitrary geographic regions. What if Victoria were a country – would it better fit zipf’s law?

      A lot of people comment on the fact that Australia’s population if highly concentrated. I wonder if they have ever been to remote parts of the country. Because once you have, you would realise that staying close together in the most fertile areas is a bloody good idea.

    • Also almost all of continental Europe is livable and has consistent rainfall and a cool climate.

      Almost all of Australia doesn’t fit that bill – and as someone who has travelled all across this country, I understand why regional areas concentrate – its because that’s where the water, fertile (or marginal in most cases) and easiest transport corridors (even if a couple 1000 km long!) are.

    • Richard B; If you have never read it, DO look up a paper called “Bigger Better Faster More: Why Some Countries Plan Better Than Others” by Oliver Hartwich and Alan Evans. That tells everything about why Germany does so well.

      • Thanks Phil, I’ve downloaded it and am looking at it now.

        I think countries are more than arbitrary geographic regions — there’s language and political and culture barriers as well — Germany/Australia, North Korea/South Korea etc. I’ll try to read up on why Zipf’s Law might hold and why our cities are so concentrated (for example, why isn’t there a bigger city at Maryborough on the Mary River?) …

  8. The biggest risk to house prices is availability of credit in sufficient size to keep them afloat. As the banks are still heavily reliant on offshore borrowings then the future of house prices is in the hands of those offshore lenders.

    If as the banks are trying to argue,that their reliance on offshore borrowings is decreasing even as they hide those offshore borrowings in “deposits”, then any extra funds directed from the local economy to bank deposits only ends up in housing severely misallocating resources yet again.

  9. Given Debelle’s speech last week, wouldn’t our banks be off the hook and the taxpayer will be the one keeping them afloat.

    • I agree with Deep Y’spost. But in replay to Jack’s question: basically, yes, they have re-written the rules to the surprise (shock) of many. The RBA played their biggest card last week based on the hand they hold – Australian big 4 banks’ balance sheet. There is no putting that one back in the bag now.

      Anything that is worth defending in that the way Debelle did, is, conversely, even more worth the international financial participants shorting it. The brave (little) RBA will now have to try and punch well above their weight to hold that effort at bay.

  10. THANKS again for a really interest analysis Leith.

    I’ve always loved the argument that our really super profitable banks are the key to a strong economy, as if our gouging cartel is actually a benevolent capitalist mutual that we should be really grateful for. I recall a relatively wealthy friend of mine telling me years ago that owning Commonwealth bank shares was like having a never-ending pokie payout every time you get a dividend, not to mention the capital gains. My concern is that if the never ending jackpot grinds to a halt they’ll be the first people to turn around and say “TOO BIG TO FAIL” demanding help from the rest of us who failed to get into that pokie machine like they did. Worst case is something akin to Ireland where the taxpayers are screwed for at least another twenty years paying off the folly of their own housing bubble.

    I understand that super funds etc would all be in the red too but in the old days (1890’s) when Melbourne’s housing market bankrupted many commerical banks the colonial govt. response was to say “Now trade your way out of it”, which they prompty did. Nobody nowdays seems content to let the market take its proper course and that’s why we have stupidly inflated capital city housing (FHBG, generous tax concessions around investment property) and a host of other problems including an unviable car industry on the dole, for example, Holden recently got millions more from the SA and Commonwealth govts. to keep making cars that private Aussie buyers don’t buy any more.

    If you want to see our country in another twenty years look at Japan. The govt. there won’t let any big companies go broke and they are perpetually shovelling taxpayer money into private enterprises. Their system has evolved into some kind of weird proto-socialism where the government has a stake in nearly everything. Case in point is the big nuclear generator Tepco who actually had the cheek to demand compensation from their government for blowing up their own reactor and poisoning the Japanese countryside.

  11. “Matthew Hassan, senior economist at Westpac Banking Corp. (WBC), said higher interest rates will in some ways support, rather than dent, home prices”… haha thats hilarious. I suppose Westpac is hoping for further RBA rate hikes then?

    • Probably their foreign debt obligation is in USD… if higher interest rate = lower repayment in AUD = higher profit?

      Home owners be damned!

    • I guess we can expect Westpac to raise rates on their own, then, to protect the value of homes that secure their loan book?

      Just goes to show, you can still call yourself an economist no matter how uneconomic your view are.

  12. High Unemployement in Australia will cause a major decline.

    Until that time of a major recession, prices will tread water and inflation will eat nominal gains away.

  13. I know the name of the blog is ‘macro’ but regarding property in Australia I think the trends are definitely ‘micro’.

    Even if there is an overall decline, driven by overinflated outer suburbs correcting down, lots of inner city suburbs will remain tightly held and the prices would remain steady.

    In Sydney and Melbourne, this is definitely the case. I can’t say with any certainty if the same is true in other capital cities

    • Dominic,

      If outer area property falls it affects it’s neighbours. We have a choice where to buy. If the premium for inner property is enlarged (by outer property falling) then inner property will fall. Your argument assumes there is a group that will pay the price for inner area property come what may. I don’t agree.

      • Your first statement makes a lot of sense, but I do assume that people are willing to pay higher prices for the right property.

        I’ve seen 3 people bid on Little Collins 1 bd til it reached $715k. I’m not saying that every situation is like this but two reasonable income, no children couples can put down a large deposit after a couple years of savings and not have a huge mortgage burden.

        • Endrortsonhousing

          Sure people can still pay bubble prices, but is it smart to pay a price at the limits of your budget just because you can, or because we have had price distortion for so long that people are deluded into thinking it will never end?

          I call these people the last of the greater fools – and my sense (supported by some of the data on this site) is that the dwindling buyers are certainly not first home buyers. Rather the buyers are made up mostly of those spending some of their ponzi gains accumulated over the last decade.

        • My experience has been that prices in inner-city areas have been more volatile than those further out.

          They increase more quickly during the good times when salaries and bonuses are generous, but they drop more quickly during the hard times when the high mortgage payments are harder to maintain.

          It’s easy to argue that certain areas will always do well (or better than other areas) – couldn’t I just as easily argue that less expensive suburbs will do better because more people can afford to live there when times turn bad?

    • RPData has been saying just the opposite – higher end of the market(i.e. inner city suburbs) is falling over. For eg. Mosman in Sydney’s lower Northshore.

    • Charles Ponzi

      Not true in Adelaide. House prices in Eastern Suburbs are falling. Asking prices are being reduced and still houses sit for months.

  14. Pump more people into an area, restrict supply and make sure credit doesn’t dry up. Three rules to keep prices elevated, but maybe not rising.
    In the meantime caravan parks permanent resident numbers will increase and increased crowding as people try to combat increased accomadation costs.

  15. When this argument is put forward:

    “There is a tendency for people overseas to extrapolate their experience of their own market to the Australian market, without really understanding the strength of our economy, the strength of demand, our connection to China and their growth story and the shortage of housing here,” Brooker said…

    …which implicitly says that the speaker’s direct experience is better than any other observers, and also their data is better than others; and their interpretation of it is better; it means the speaker is talking illogically.

    There are several fallacies in that statement which make it invalid. Unfortunately as bank economists and journalists do not have a good grounding in logic this type of nonsense is permitted to be printed as expert wisdom when it ought to have been challenged and excluded from public commentary.

    • Charles Ponzi

      Everyone thinks they’re different until they’re not. Nice to see so many smug property speculators with worried faces in Adelaide at failed auctions.

  16. Even RPData with their hedonistic index can no longer claim prices are rising.

  17. The Irish data is a crock. I’ve been there and the truth is the prices are at “no bid”, stall out last sticker prices. The government has also been running various stall out programmes. Dublin is not Ireland. I’m also in weekly contact with people on the ground.

    I can assure you that if anyone/everyone at present could get just 30% off peak prices, you would see the biggest sales transactions Ireland has ever seen.

    • That’s my experience too Sean, as a reluctant Dublin homeowner. It is dire.

      To quote from latest Daft.ie property report:

      “The latest data from daft.ie on asking rents and prices clearly shows that there is some room for continued significant losses in residential real estate. Across all geographies covered in today’s report, asking prices continued to fall and these falls are accelerating once again. Nationwide, asking prices are down 5% in three months through June 2011 – the steepest quarterly decline in 18 months.

      Greater Dublin areas asking prices are now down between 44% (North County Dublin) and 55% (Dublin City Centre) relative to the peak. Taking assumed 5% average premium over asking prices at the peak and a similar discount today, the swing in prices in the capital is probably between 50% and 60%.”

  18. High urban land prices relative to incomes, cause the following trends:
    – reduced productivity
    – reduced international economic competitiveness
    – reduced household discretionary income

    Give it time. It is simply impossible to be an international outlier on urban-land-prices to incomes ratios forever.

    If rising house prices WERE “wealth”, ANY Ponzi scheme would be valid and nothing to worry about. They are actually a zero-sum wealth transfer. Even if that transfer is decades of future household discretionary spending, transferred to deceased estates and retirees and speculators “now”. It is “mortgaging the future”, it is “fiscal child abuse”.

    • I disagree.

      higher house prices brings in the ‘wealth effect’ people can borrow against that increase in value for consumption which drives demand.

      Your talking about new entrants into that market – all 17% of them or watever. It doesn’t look good for that group

      If you look at house prices and incomes 30 years ago – 30k was huge back then! Just think what inflation will do to incomes and house prices in the next 30 years.

  19. I would have thought that house prices here HAVE to fall like they did everywhere else…otherwise we will become economically uncompetitive trying to prop-up overvalued real estate?