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Don’t get starry-eyed about housing

Published in The Sydney Morning Herald, 5 September 2011 (PDF)
http://www.smh.com.au/business/property/dont-get-starryeyed-about-housing-20110904-1js8g.html

During the Cold War reliable information about the inner workings of the Soviet leadership was hard to get, and so a new pseudo-scientific discipline emerged.

”Kremlinology”, shorthand for ”Kremlin Astrology”, was the study of the tiniest signals about Moscow’s next political step. Reading between the lines of Communist Party press releases or analysing group pictures of Politburo members, the Kremlin astrologists were second-guessing the Soviet Union’s policies.

With the end of communism in Russia, many Kremlin astrologists became unemployed. So it was fortunate that they quickly discovered another area in which to practise their dark art. Now they are forecasting the ups and downs of the housing market.

The methods are pretty much the same as in the bad old days of the secretive Soviet Union. Every minor indicator of economic confidence in the US, the movements of European stockmarkets or even the colour of Reserve Bank boss Glenn Stevens’s tie are all analysed as if they were clues as to the prospects of the local property market. If only it was that simple.

In textbook markets there is no need for price forecasts. Prices are determined by the interaction of supply and demand. If you fed a supercomputer with all the relevant information about buyer preferences, budgets, demographic change and building activity, the market price would be a logically derived conclusion.

But does this textbook description even sound remotely like the housing market? Not quite. Unlike the market models they teach in undergraduate economics courses, the housing market is not a sanitised place behaving in an always rational, easily predictable fashion.

As recent shifts in global property markets demonstrate all too clearly, housing markets can wildly swing from one extreme to another. Arguing with the standard forces of supply and demand, then, only gets you so far. A market that was booming just a few months ago may suddenly enter a slump without any correspondingly big swing in the underlying fundamentals.

Britain’s housing market provides a good example of such a swing. For years pundits were convinced that for Britain’s property prices there was only one way: up. Demand was strong, supply heavily restricted, and those lonely voices warning of the cyclical nature of property markets were dismissed as naysayers.

British house prices suddenly collapsed in the course of the financial crisis. There were, of course, good reasons for a fall in house prices. Credit got tighter, and unemployment rose. On the other hand, the dramatic cut in interest rates reduced housing costs for those home owners with variable mortgages. In any case, it is possible that the sudden correction was as much an exaggeration as the previous boom had been in the other direction.

What does this tell us about the Australian housing market? Frankly, not much. Though the Australian market shared the strong performance of the British market until the financial crisis, it has since decoupled from the British market. In fact, the Australian housing market now seems to be the ”last man standing” of those housing markets in developed countries that had experienced strong gains over the past 15 years.

Predicting the near to middle-term development of the Australian housing market is almost impossible. Worsening economic conditions may well trigger a house price decline. Bizarrely, however, the opposite may occur just as well. Should an economic slowdown lead the Reserve Bank to cut interest rates, it may sustain or even boost the housing market.

This means that attempts to second-guess the movement of the housing market in the short run may not be any more reliable than Kremlin Astrology of times past. Sure, we can all read the signs – and yet we can differ about their interpretation.

The housing market may well be one of those cases in which it is actually easier to make long-term than short-term predictions. Though we may not know where Australia’s property market will stand at the end of next year, we can identify some fundamental issues much more clearly.

Last week, the Bank for International Settlements published a fascinating report about public and private debt trends in the developed world. One of the findings concerned household debt, which has gone up as a share of GDP in all countries except Japan and Germany over the past three decades. In Australia it jumped from 42 per cent in 1980 to 113 per cent in 2010. A vast chunk of this debt consists of mortgages.

It is obvious that this development cannot go on indefinitely. Australia is already among the countries with the highest household debt ratios. It is therefore plausible that this process will either come to a halt or even go into reverse. This will also be the moment when house prices will peak.

How far we are from this moment? You’d better ask a Kremlin astrologist.

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