The coming Aussie house price crash.By Bruce Baker, Puzzle Financial Advice 19/3/15 (last updated 30/5/15)http://puzzlefinancialadvice.com.au/Houseprices.pdf The full paper is here.

For many Australians, this (and related issues) is probably the biggest financial risk they face.

The data, which does not fib, tells the story of a coming Australian house price crash larger than in the last two economic depressions (1890s & 1930s). Here is the evidence.

House prices deliver approximately NIL increase in price in real terms over the long term.The most disciplined study that I am aware of about long-term price movements for house prices has been conduct by Professor Robert Shiller. http://www.econ.yale.edu/~shiller/ He cleaned up long-term data (for the USA) by only looking at data pairs where the same house has been bought and sold. Most house price data series are of little long-term statistical value because they do not compare like with like. For example, real estate institute data series of average house prices compare 2 bedroom house prices in the 1960s with 5 bedroom house prices now – which obviously makes house prices look like they have much bigger gains than they really do.

Below is Robert Shiller’s long-term price chart of real US house prices. In 2005ish in his second edition of his book “Irrational Exuberance”, Robert Shiller used this data to declare in his May 2006 book, “Irrational Exuberance” (2nd edition) that the USA had a house price bubble. Shiller was one of the very few who recognised and called the bubble. From mid-2006, US house prices started to crash …… going down about 35% before a bounce. I suspect they have one more leg down before they hit the final bottom but we will see.

Please note that Shiller’s US data below shows that over the very long-term, real house prices trend sideways (approx Nil real return) which is obviously at odds with what most Australians think. When house prices have diverged from this long-term trend, it has later reverted back to the long-term trend.

A 400-year study in Amsterdam shows a somewhat similar finding.

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In Australia, we do not have data of equal quality to Shiller’s data. The best long-term data has been put together by Philip Soos. http://www.philipsoos.com/housing-prices/ Like the USA, Aussie house prices have doubled in real terms since the mid 1990s – and the cause has been the same in both cases – rampant growth in money supply (excessively easy monetary policy), which has encouraged excessive borrowing to buy houses.

Actually Aussie house prices have gone up more than the US since the mid 1990s, as you can see in Philip Soos’s chart below. This is the biggest house price bubble in Australia’s history. There was also a large bubble in the late 1880s (as a result of the gold rush) and Melbourne properties fell about 35% after that.

You will notice that house price rises have been mirrored by a massive rise in mortgage debt, which makes up the bulk of personal debt in Australia.

https://www.prosper.org.au/2014/12/18/soos-and-egan-australian-property-chart-pack/

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And most of the private debt is mortgage debt.

http://www.worldeconomicsassociation.org/downloads/bubble-economics-australian-land-speculation-1830-2013/ http://www.amazon.com/gp/product/1497503868/ref=as_li_tl?ie=UTF8&camp=1789&creative=9325&creativeASIN=1497503868&linkCode=as2&tag=indepenaustra-20 http://www.smh.com.au/business/the-economy/australias-housing-bubble-is-real-and-banks-are-to-blame-says-author-20140828-109ahx.html#ixzz3BfRk5gmI https://www.prosper.org.au/2013/08/09/property-bubble-thats-the-theory-anyway/

“Put simply, for the residential property market to meet Minsky’s definition of a bubble, three conditions must be met: increases in real (inflation-adjusted) housing prices and mortgage debt, along with persistent rental income losses.Three conditions of a bubble

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There is evidence to show all three conditions exist. From the trough in 1996 to the apparent peak in 2010, real housing prices increased nationwide by 123%, the mortgage debt to GDP ratio rose from 35% to 87% over the same period, and from 2001 onwards, aggregate rental income could not cover running expenses and interest repayments on aggregate, let alone principal.”

https://www.prosper.org.au/2013/06/12/a-sore-lesson-from-housing-history/ All these house price bubbles had the same cause – excessively easy developed-world monetary policy. And the outcome for all will be the same. Like Australia, Canada's house prices did not crash during the global financial crisis. And Canada avoided a house price crash during the global financial crisis for the same reasons that Australia did – primarily China. And on average Canadians

now have historical very-large mortgage debts.Because of the parallels between Australia and Canada, it is interesting to hear some of the

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Canadian commentary on house prices:-• https://www.youtube.com/watch?v=IjrL6AsrQvU Hillard MacBeth author of "“When the

Bubble Bursts – Surviving the Canadian Real Estate Crash.”" interviewed 10 October 2014. The data suggests to Hillard that a 50% fall in Canadian house prices is coming.

• https://www.youtube.com/watch?v=k4IihLo3wYM Robert Shilller on the Canadian Housing Market

The Australian mortgage bubble is part of the biggest ever debt bubble Australia has ever seen. And the last 2 debt bubbles in Australia (1890 & 1929) were followed by economic depression ……….. and this is just part of a much bigger very scary set of historical extremes in the western developed world.

But a key point is, when you are at a historic extreme in debt levels, at some point that debt must come down – by one means or another ….. and since a big part of that debt is propping up Aussie house prices, then both of these bubbles will come down together.

Hopefully that helps you understand what is happening with Aussie house prices. This is why I think Australia is looking at the biggest ever house price crash it has ever had – something like 50% sometime ahead of us.

So tough times ahead for Australia. And needless to say, a house price crash would be very bad for Australian banks. Look what happened to Citibank.

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Appendix A. A recession in Australia.

You might also wish to read this article: http://thediplomat.com/2015/01/a-recession-for-australia/ This article starts off as follows:-

A Recession for Australia?The commodities giant has had an impressive run, but the good times might be coming to an end.By Anthony FensomJanuary 27, 2015Australia enters into its 24th straight year of economic expansion in 2015, with its citizens among the world’s richest. But with the mining boom ending, the exchange rate diving, and joblessness increasing, commentators have begun to utter the dreaded “R” word: recession.“Australia has run out of luck,” claims market strategist Gerard Minack, who has assigned a 40 per cent probability of recession for the world’s 12th-biggest economy in 2015.“Under almost any scenario the outlook is for a lower Australian dollar, lower interest rates and underperforming equities,” Minack told ABC News.“If there is a recession expect sharp outright losses in equities, notably banks, and significant falls in house prices.”

Other reading http://qz.com/337973/australias-inflated-housing-market-just-got-a-extra-burst-of-hot-air/ http://www.imf.org/external/research/housing/ http://www.bloomberg.com/news/articles/2015-01-08/canada-home-prices-are-63-too-high-deutsche-bank http://www.afr.com/p/business/financial_services/bank_capital_at_risk_from_house_Fv889o3GZ9upwEbCsjgh7M “Bank capital at risk from house bust”

On asset-price bubbles. The famous economist John Maynard Keynes in the early 1930s “The market can stay irrational longer than you can stay solvent.” It is very difficult to forecast when they burst. You just know that they will. This is particularly pertinent to Australian house prices.

http://www.afr.com/p/business/property/moody_sounds_alarm_bell_on_housing_CwB8yO3idid0YWKDKcePAJ “Moody’s sounds alarm bell on housing prices”

• Australia’s property market appears to be overheating, Moody’s said for the first time, in a report that points to house prices as a key risk to the nation’s economic and financial stability. It also sent a reminder that weaker than expected economic growth and a failure by Canberra to reverse the rise in government debt “would put pressure on the rating”.

http://www.rba.gov.au/chart-pack/household-sector.html

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http://www.afr.com/p/business/property/australian_house_prices_among_world_Z5tvZ8FNVJj3T9uECPY7UK “Australian house prices among world’s highest” “Australian house prices are among the world’s most expensive when measured against incomes and rents, according to the Bank for International Settlements, but it also finds real price growth in the country has been flat once adjusted for long-term trends. According to BIS’s latest quarterly review of global housing, Australia was the second-most expensive market on a seasonally and inflation-adjusted index of advanced economies, behind Norway and ahead of Great Britain and Sweden. Australia scored 200 points, where the base – representing the average of the full sample of countries – is 100.http://www.bis.org/publ/qtrpdf/r_qt1409h.htm

http://www.bis.org/publ/qtrpdf/r_qt1409h.pdf http://www.abc.net.au/news/2014-09-14/bis-figures-confirm-australian-housing-overvalued-emerging-mark/5740808

http://www.theaustralian.com.au/business/house-prices-down-and-may-fall-further-says-peak-central-bank/story-e6frg8zx-1227058236942

• “For a number of countries, current property prices are much higher than those implied by the historical relationship to rents,” the Basel-based organisation noted in its quarterly financial review released yesterday, singling out prices in Australia, Canada, Sweden and France. “A priori, this could be a reason to expect a price correction in the future,” it said.

• Australia’s price-to-rents ratio was 50 per cent above the long-run average, while its price-to-income ratio was 40 per cent above the average.

The IMF also finds Australian house prices expensive.http://www.theaustralian.com.au/business/property/imf-warns-over-australian-house-prices/story-fn9656lz-1226951513707 “IMF warns over Australian house prices” 12/6/2014.

• AUSTRALIAN house prices are among the top five most expensive in the world across two closely watched measures, according to the International Monetary Fund. The findings were released as IMF deputy managing director Min Zhu issued a warning that the global property market was at risk of overheating. “House prices are inching up,” he said. “But is this a cause for much cheer? Or are we watching the same movie again? “Recall how after a decade-long boom, house prices started to fall in 2006, first in the United States and then elsewhere, contributing to the 2008-9 global financial crisis. In fact, our research indicates

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that boom-bust patterns in house prices preceded more than two-thirds of the recent 50 systemic banking crises,” Mr Zhu said. Research from the IMF shows Australian property is the third-most expensive on a ‘house price to income’ basis (compared to historical averages), while local real estate is the fifth-most expensive on a “house price to rent” ratio, with Belgium and Canada the only two OECD nations that topped Australia on both measurements. Such high readings did not bode well for sustainable house prices, Mr Zhu said.

http://www.afr.com/p/world/carney_says_house_prices_pose_biggest_vNubJY62vftoruKxmtboiP “Carney says house prices pose biggest risk to UK economy”. 19/5/14

• 'Bank of England governor Mark Carney has shifted closer to reining in surging home prices in Britain by branding them the No. 1 risk to the economy and listing potential policy responses.'

• 'Bank of England governor Mark Carney has shifted closer to reining in surging home prices in Britain by branding them the No. 1 risk to the economy and listing potential policy responses.'

For the same reason that the Bank of England governor, makes this case for the UK, the same case applies to Australia. David Murray argues precisely that on the next page.

http://www.afr.com/p/national/major_banks_systemic_risk_murray_sfj9HKyd4vK9Xks8Or1RqN “Major banks a systemic risk: Murray report” 21/Jul/14

• 'Beneath the surface of a resilient financial system that stood firm during the global financial crisis and has since grown stronger, more powerful and more profitable, is one riddled with “systemic risk”. It’s a financial system that may no longer be serving the nation and lubricating the economy but growing fatter from feasting on it. That in turn is threatening the stability and prosperity of an island economy (Australia) that still relies on the faith of foreign creditors for funding.'

• 'Housing is a key risk.• A key systemic risk is housing. The banks, partly by choice and partly by

circumstance, have diverted more of their capital towards mortgages at the expense of other sectors, which troubles Murray.....Housing has contributed to making the Australian banks among the most profitable in the world......But as those profits have grown, Australians have come to rely on them for income as a greater portion of our pension system is invested in bank shares, bonds, deposits and notes. As Murray and his inquiry ponders the trade-off between bank profits and the safety of the system, he may come to realise that those very profits are a source of systemic risk........If anything, the report he delivered endorsed even more conservative regulation, and the overriding reason for this is Australia’s reliance on imported capital. Tellingly, the report recognises foreign capital as a good thing – funding a period of strong economic growth. But it makes the system vulnerable: the risks need to be managed.........Also it was important that this foreign capital be used for productive purposes, the Murray report said. One can only conclude that this is a veiled warning that increasing the use of foreign funding to feed a mortgage binge will only create further risks for Australia’s financial system.'

http://www.afr.com/p/national/murray_tells_banks_to_prepare_for_dqitGMktmZ1yDTs87035uO“Murray tells banks to prepare for correction”. 22/Aug/14

• 'David Murray has said his Financial System Inquiry needs to shore up the banking system to be ready for a correction in asset prices that have been inflated by unprecedented global monetary stimulus. In a speech that adds to comments two days ago by Reserve Bank of Australia governor Glenn Stevens that investors have become too complacent about market pitfalls, Mr Murray put the argument for increased regulation of the financial industry. “The

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post-crisis monetary settings have distorted asset prices again,” he said. “That is going to cause a correction at some point, which will put more political pressure on financial systems.” The potential for a fall in share and property prices would expose the Australian banks to big losses.'

http://www.afr.com/p/national/economy/housing_price_to_income_ratio_nears_pKxgtEXMckQAU5x3Sf75yJ “Housing price-to-income ratio nears (record) high”. 2/3/15by Mark Mulligan House prices relative to income are close to historic highs in Australia, and it's not just Sydneysiders stretching their finances to get into the property market, according to a report from Barclays.The Britain-based bank says price-to-income ratios across the country are nearing previous all-time highs set in 2003 and 2010.However, the difference this time is that these peaks were reached as the Reserve Bank of Australia began lifting interest rates, not cutting them as it is now.The risk, according to Barclays, is that further easing by the RBA will drive the metrics even higher, testing borrowers' limits.The central bank is widely expected to follow up last month's 25 basis point cut to the cash rate, to 2.25 per cent, with another reduction either at Tuesday's policy meeting, or in May."In both 2003 and 2010, the ratio of prices to incomes peaked not long after the Reserve Bank had started raising interest rates," said Barclays. "This time the bank is cutting rates.""This suggests to us that valuations are likely to enter unchartered territory on the back of lower interest rates," it said.

http://theconversation.com/debunking-the-myths-peddled-by-australias-property-bubble-deniers-4488 14/12/11 “Debunking the myths peddled by Australia’s property bubble ‘deniers’”

Housing prices always go upAnother popular myth that abounds is that housing prices always go up and never crash. If a bubble denier reluctantly admits that past downturns did occur, it certainly won’t occur this time around.Australia’s recorded housing price history, going back 131 years to 1880, easily debunks this myth. The nine major increases in prices have been met by eight resulting downturns, with the only exception during a small three year period from 1961-1964, where prices leveled off. The table below, from my Prosper Australia report, shows this.

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http://en.wikipedia.org/wiki/Australian_property_bubble

http://keenomics.s3.amazonaws.com/debtdeflation_media/2011/02/KeenMotleyFoolAustralianHousePriceInterview.pdf to 2011. http://www.debtdeflation.com/blogs/page/2/

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http://keenomics.s3.amazonaws.com/debtdeflation_media/2011/04/HousePricesBankSharesPartII.pdf to 2011

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Other data sources:-

http://www.economist.com/blogs/dailychart/2011/11/global-house-prices

Andy Xie - Australia Could Become the Next Spain 28/2/13 (property price bubble).https://www.youtube.com/watch?v=haEwGpa44Mo Andy is an economist that I have a very high regard for.This is a must read article!!!

John Abernethy – 6/4/14 “It's a bubble, let's face it”https://www.youtube.com/watch?v=SWbn2FfTEvY

http://www.globalpropertyguide.com/Pacific/Australia/Price-History http://www.abc.net.au/news/2014-06-12/janda-its-official-property-prices-are-getting-out-of-reach/5517674 http://www.abc.net.au/news/2015-01-15/australian-housing-near-most-expensive-but-forecast-to-rise/6018696 http://www.imf.org/external/research/housing/

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