Bubble deniers plead No Contest

Gavin R. Putland does the time warp.

Housing-bubble deniers keep recycling arguments that have already been refuted or exposed as own-goals. They don't rebut the rebuttals; they simply keep quiet about them. In the following time-warped dialogue, the latest example of the denialist genre — by Jessica Irvine in the Sydney Morning Herald — is rebutted point-by-point by quoting from earlier public statements.

After some gratuitous Shakespearean references, ad-hominems about the motives of the bubblephobes, and counter-ad-hominems about the role of the media, Irvine eventually gets down to the issue at hand...

Irvine:  The Economist magazine recently published yet another of its surveys estimating Australian houses are “overvalued” by 56 per cent — the highest in the world — on a historical ratio of rents to house prices. (The so-called Economist Intelligence Unit manages to routinely overlook the different tax treatment of investment housing in Australia, which encourages landlords to chase capital gains and treat rental returns as secondary.)

Gerard Minack, August 2010:  Australian Tax Office data confirm that residential investment is a poor investment: total rent has not covered total costs since FY2000 (again, the date the bubble started to inflate). In short, this is an investment that depends on capital gain for its payback. With net income not even covering interest charges, this is a classic Hyman Minsky Ponzi scheme... Not only is the aggregate private rental market a loss-making affair, but a rising share of landlords are making rental losses. The percentage of landlords claiming a rental loss (that is, rent not covering interest and other costs) has increased from 50% to 70% over the past decade. It's not just that there are more landlords, there are more loss-making landlords. This matters a lot. Much of the discussion on the residential market concentrates on owner-occupiers. But arguably property investors represent a significantly larger risk if they became widespread sellers of their loss-making investments... Certainly, property investment is more prevalent at higher income scales. But it is simply wrong to assert that rental properties are largely owned by high-income households: losing on residential property investment is largely a middle-class affair. Only 3% of all loss-making properties are owned by taxpayers with a taxable income of over $200,000. Taxpayers who earn $80,000 or less own 80% of all loss-making properties.

Irvine:  Less sophisticated bubblers simply compare the rise in house prices over the past few decades to the rise in wages... But this overlooks the historic boost to household borrowing capacity that occurred in the 1990s with the halving of nominal interest rates. This, in effect, doubled the amount households were able to borrow against a certain income.

Gavin R. Putland (obviously one of the less sophisticated bubblers), October 2010:  The present era of low inflation and low interest rates was precipitated by the “recession we had to have” in 1990–91. During the interest-rate trough of 1992 to 1994, when official interest rates (both real and nominal) were in a range that would now be regarded as normal, the scaled home-price index was almost stable. This “almost stable” value of the index may therefore be taken as an estimate of the “normal” value. The index is now about 47% above the “almost stable” level; that is, it will fall about 32% if it returns to that level.

Irvine:  The relaxation of lending standards by banks in response to financial deregulation also increased the amount banks were willing to lend against that income.

Minack, August 2010:  What caused the bubble? The key is the growing ability and willingness of Australians to increase leverage, compounded by what I would view as ill-advised policy (such as grants to first-home buyers). Owner-occupiers have played a game of financial chicken, competing for property by taking on increasingly imprudent amounts of debt. Investors have become Ponzi borrowers — Hyman Minsky's term for borrowers who rely on capital gains to repay debt and interest — in the belief that housing is a sure-fire long-term investment. History shows that it isn't.

Irvine:  You see, house prices only fall when people are forced to sell their homes. Otherwise, households choose to simply remain in their home and wait things out. Property investors are loath to realise their capital loss.

New York Times, May 27, 2009:  The agents' association estimated that about 45 percent of all sales in April were foreclosures, and brokers in distressed markets are bracing for more.

Irvine:  A true collapse in house prices would indeed require some large external shock — a doubling of unemployment or interest rates — to trigger the wave of forced home sales that it would take to provoke house price falls. With low joblessness in Australia and the big surge in national income created by the mining boom, it is hard to see the trigger for such an event.

Putland, AFR, October 15, 2010:  Ian Graham... says we would need a recession like the early 1990s before house prices would fall sharply... Excuse me, but real “house prices” (or rather residential land prices) peaked in early 1989 and had been falling for more than a year before recession kicked in. That's why we “had to have” that recession. Furthermore, the price decline did not accelerate with the onset of recession, and real prices bottomed before the recession ended. “Unemployment would need to blow through 10 per cent [for the economy] to go back into a recession mode...” says Graham. That last happened in the second half of 1991, when the price slide and the recession were both over. Unemployment is a lagging symptom of recession: when unemployment peaks, the economy is once again growing fast enough to absorb new entrants to the work force and is therefore no longer in recession. A property bubble doesn't burst because GDP falls or because unemployment rises. It bursts because it's a bubble.

Irvine:  Economists such as HSBC's Paul Bloxham have pointed out that there may be good reasons for Australian houses being expensive. Compared to the rest of the world, we have high quality housing stock, with a high proportion of solidly constructed houses on big blocks. Most of the population is concentrated in a few capital cities with often marvellous water views. The dire state of public transport in big cities such as Sydney only increases the premium on properties located close to the CBD.

Kris Sayce, March 18, 2001:  Forgive us if we're wrong, but until Australia took over the honour of having the world's biggest houses, that honour was held by the Americans. Big houses that were quite expensive. And surely they must have been reasonably well built otherwise people wouldn't buy them. Funnily enough, that didn't stop the US housing bubble from popping... We like this one. Bad public transport equals high house prices and no house price bubble... The UK is another good comparison. Many cities have ‘Greenbelt’ areas that prevent development of the city fringes. This means many people move further out to regional towns and cities and then commute into a major city. Back in Australia, perhaps Mr. Bloxham isn't aware that many people commute to Melbourne from places like Geelong each day. And we're sure there's a similar story for Australia's other major cities. So, that's why, according to Mr. Bloxham, high house prices are justified in Australia — but nowhere else apparently.

Irvine:  The Reserve Bank has also sought to dispel fears of a bursting property bubble by pointing out that the rise in debt levels has been concentrated in the hands of those who can most afford it.

Minack, August 2010:  Housing is a risk factor in large part because of the debt used to support it... It's also therefore worth debunking the idea that Australia's debt is not a risk factor because it largely sits with upper-income earners... As it turns out, at the peak of America's housing market, the top 20% of households held an even larger share of US household debt than their Australian counterparts. More debt, as a share of the total, is held by middle-income levels — presumably those loss-making landlords — in Australia than in the US.

Irvine:  Finally, those predicting big house price falls should also recall the recent experience during the global financial crisis when policy makers, confronted by an external shock capable of puncturing house prices, acted quickly to cushion the economy with interest rate rises [sic] and fiscal stimulus.

Putland (ignoring the culture of entitlement to bailouts), October 2010:  Last time prices fell, the fall was arrested by the FHOB. When it becomes painfully obvious that the effect of the FHOB was only temporary, buyers will be unlikely to fall for the same trick again.

Irvine:  The great house price deflation is already happening, just very slowly and in an exceedingly calm manner.

Putland, November 2010:  The average Australian housing investor is negatively geared. That is, the interest cost incurred by the average investor is not justified by rental income alone, but depends on capital gains as well. The “average” is taken over all investors, including those who own their properties outright and/or bought their properties for far less than their current values. Anyone contemplating paying current prices will need faster capital gains than the average investor. Unfortunately for the prospective sellers, and especially for recent buyers, those capital gains have stopped... Now tell me: when buyers, who cannot justify the interest on current prices unless those prices are rising, see that prices have merely flat-lined in the second half of 2010, will they pay the same prices in 2011?

Unless there's a radical change in tax policy, they shouldn't.

P.S. (March 24): Kris Sayce at Money Morning has weighed in to the debate.

P.S. (March 25): Steve Keen endorses the buyers' strike.