Tuesday, November 16, 2010

The Australian Housing Fiasco

The Australian housing market has experienced a hiatus at this blog but has been the subject of intense debate elsewhere.  Time for an update on Shocking Tales, Government Intervention, Why we are different, A ridiculous publicity stunt, and Google predictions.

Shocking Tales
Some say the when he catches cold it takes a $40billion bail out to bring him back to health, and that he sneezes deflation, all we know is... that the Stig of Australian banking, insider ‘Deep Throat’, has provided spectacularly shocking insights into the world of banking and housing finance.  Consider the following comment about the use of automated valuation models to ratchet up home values on loan books.

So with roughly a revaluation of the property of 20% (ask any property spruiker, “That’s nothin’ mate!”) a bank can save itself $3.20 of capital per $100 of mortgage which can be recycled as capital to support another mortgage. Think about how that increase in both return on capital and funds allocated to another mortgagor slave is an absolute incentive for bankers to perpetuate the cycle up of house price valuations. Their reward? Huge bonuses based on what is in essence a positive reinforcement spiral where everyone pats each other on the back for what a great job they’re doing. Well at least, that is, until the money runs out

There are more shocking tales over at Delusional Economics, including a prescient story behind the latest intervention being considered by the Australian government to prop up the housing market and the banks.

Government Intervention
The proposed intervention involves extending a government guarantee to residential mortgage backed securities, ala Canada, essentially shifting risks taken by banks in the housing market to Australian tax payers in a bid to secure the ability of Australian banks to raise capital as asset values stagnate.  Welcome to the world of moral hazard that is banking.

What makes the whole fiasco so outrageous is that is has proceeded under the guise of increasing competition in banking and under the housing affordability banner more broadly.

Eager to spur competition in a banking industry dominated by National Australia Bank, Commonwealth Bank, Westpac and ANZ - now with rates higher than central bank policy - Canberra plans sweeping reforms to open up the mortgage market more widely to smaller lenders, by creating a bigger government-backstop to residential mortgage-backed securities. (here)

Regardless of whether we are following Canada into financial a black hole, the degree of continued government intervention is one reason why we are different, for now. Another is variable rate mortgages.

Why we are different
Australia’s love affair with variable interest rate mortgages has enabled monetary policy to be highly effective, unlike other countries that have suffered at the hands of the financial crisis. This gives government, via the RBA, plenty of ammunition to prop up house prices while appearing to act on affordability.  And it also makes our monetary policy far more effective than our counterparts in the US, Asia and Europe.

Of course the big dilemma is what is happening elsewhere in the economy. The dramatic drop in interest rates by the RBA in late 2008 failed to stimulate the housing market without the added assistance of the first home buyers boost.

Given this situation, and coupled with government’s obvious strong desire to see housing prices stabilise, one must be careful when entering into a bet on house prices.

A ridiculous publicity stunt
Australian property spruiker Chris Joye has challenged US fund manager Jeremy Grantham to bet on house prices. This comes as a result of Grantham’s scathing analysis of the extent of Australia’s housing bubble.

As others have remarked, it is a classic ‘heads I win, tails you lose’ bet.

This is the deal. Rismark believes it can facilitate a transaction whereby Mr Grantham will be able to invest $100 million into a short position over the RP Data-Rismark Australian capital cities dwelling price index, which is universally regarded as the most accurate and timely house price benchmark in the market.

Mr Grantham’s investment would be structured as a very simple “delta-one” transaction: for every 1 per cent fall in the index, Mr Grantham would receive $1 million. Conversely, for every 1 per cent rise in the index, Mr Grantham would pay $1 million away. The trade would be settled at the end of three years with monthly margining to manage credit risk.

There are three main reasons why this is all publicity and no substance

1.      The nature of the index
...look at the index Joye wants to use, the RP Data-Rismark Index. You may recall I mentioned above that Joye was the Managing director of Rismark International? Talk about a conflict of interest. Joye wants Grantham to take a bet, the outcome of which is directly reliant on an index which doesn't allow public examination of their methodologies and further to this one that Joye's company is directly involved with? Surely he jests! (here)

Have I mentioned the hazy area of hedonic price indexes before?

2.      Exchange rates
I’m no genius, but if I was an American investor I would want my return in US dollars.  At current exchange rates (which are already dropping from their record highs), the bet in AUD would expose about US$98million to the AUD.  He would be paid AUD$1million for any 1% decline in the index.  Unfortunately a decline in the index will be accompanied by speculation of lower interest rates leading to a decline in the Aussie dollar.

Say the price index falls by 15% and as a result of renewed uncertainty about the strength of Australia’s economy the AUD declines to $0.75USD.  Grantham would win the bet, but lose financially.  He would now have AUD$115million, which is only USD$86.25million – a loss of 12%.

Assuming his position does not entail actually having AUD$100million, but is simply a gamble on the move of the index, he would still earn just USD$11.25million for that 15% move. Remember, the greater the decline in the house price index, the greater is the likely impact on the exchange rate, so Grantham effectively faces a limit to his gains.

3.      Australian government intervention
When the counter-party to your bet has a direct line to many political power brokers (Malcolm Turnbull, the Liberal Party treasurer, had known Joye as a family friend for 15 years), and the Australian government seems hell bent on doing whatever it takes to prop up house prices, I wouldn’t be too keen to put my money on the line.

Even after offering this outlandish challenge, Joye disclaims his position by saying that Australian dwelling prices will be placed under modest downward pressure over the next 12-18months.  This makes no sense, until you look at the following scenarios.

The bet is taken, Joye wins. Now Joye can claim that his index is superior and used by international fund managers and that his analysis is so great he won a bet against Grantham (although his actual prediction was wrong).

The bet is taken Joye loses. Again, a claim of the validity of the index and that his prediction of price movements was correct (ignoring that he lost the bet).

The bet is not taken.  Publicity, and a win whichever way the price index moves.  If it increases he would have won the bet.  If it decreases it is in line with his forecast. 

Google Predictions
I have mentioned before that the frequency of Google search terms was quite a good indicator of the peak of the US housing bubble (see final graph). What is interesting is that the new more refined Google Insights for Search shows a dramatic upward trend for the term ‘housing bubble’ from Australia.

Last week’s auction results from Brisbane confirm the findings from Google – 21 auctions, 2 sales, 8% clearance rate.  


  1. and which city googles "housing bubble" the most?


  2. Regarding the intervention, lower mortgage rates will most likely force the RBA to raise the cash rate to maintain mortgage rates within their preferred range. I don't get the sense in this latest unhealthy attempt to pull against natural market forces, forces that are signaling a requirement for higher rates, not lower rates. If the RBA responds by lifting rates, then this move doesn't help homeowners but will result in greater spread for the banks, boosting their profits. At first glace it appears this will simply increase the existing risk and leverage in our banking system. Did the government consider how this extra risk might impact our carry trade? I doubt it.

    Alex Barton
    Australian Property Forum

  3. Personally I think you are a bit envious of Christopher Joye. A friend of mine went to Uni with him and said he was a bona fide genius.

  4. Richard, I don't doubt Chris is an intelligent fellow, and I have noted in the past that he occasionally has some very good ideas, but his ridiculous spruiking of his 4.6 price/income ratio and that house prices are in line with historical norms is absolute nonsense, and he has obvious vested interests clouding most of his public opinions.

    If you want the nuts and bolts of why his logic is flawed please read this great article.

  5. Thanks Cameron. I read this article. It seems actually quite flawed. I will try and bring it to Chris's attention. As to him being biased, if his company is establishing a house price derivatives market he would benefit from prices falling. Your case in this regard seems a little weak. I have never seen him talk about you, however I think the protocol if you want respect on the internet is to avoid personalising and being rude. As one of Australia's most highly regarded economic minds I don't think he warrants the 'spruiker' label. That is just my opinion.

  6. I think that Chris is using a median household income of around $92,000 pa. That is a little above what I see in the real world, but not by much. I reckon it is about $85,000 but I don't retain stats on that, so it is largely guesswork.

    I don't think CJ's stats are dodgy, but I know Demographia stats are dodgy. I would be careful using or relying on them Cameron.

  7. Agreed Peter - I have my doubts about Demographia as well.

    However, a median household income of even $85,000 still seems high to me. DId you read the link at the end of my previous comment about the difference between the household income measure using the Survey of Income and Housing, and the National Accounts (which include income from not-for-profits, imputed rent and superannuation)?


    I'm hoping CJ will publicly address this concern with his use of the national accounts for household income.

  8. Cameron - I do agree that getting an accurate household income figure is very difficult. I believe Chris uses the national figures and divides by the number of households, but I can't confirm that.

    I will say that I'm staggered by the incomes that I see given by home loan applicants (which I verify if it goes to a full application) - how some quite ordinary jobs can get six figure incomes or close to it, bewilders me - and yet many do. I also see many very well qualified people on ordinary incomes - It must be a new raffle system that the ACTU has introduced recently.

    Frankly in my view the medians that count are the household incomes for the working men and women in the 25 to 35 Y/O age bracket who are likely to be buying their first home, and the median price of homes in the suburbs where they are likely to buy.

    In short what is the income for a young family household, what is the cost of an ordinary home at Forrest Lake or similar, and what is the relationship of their income to price for that transaction.

    What the middle class and the wealthy do is dependant on that transaction, everything is built from the ground up, not the reverse.

    Do you have any stats on that scenario or similar?

    Feel like doing another thesis?

  9. Cameron - I've just read that link now - I had seen it before.

    It raises some serious points, but frankly I just see a lot of static in all the data presented by both sides of the debate. Bears refuse to see a change in size and housing standards has caused a lot of this, and the bulls refuse to see that in many areas house prices are too high, and it has been a cocktail of forces that includes easing of credit standards and low interest rates that has led us to this point.

    I do not take the view however that a sudden large devaluation of house prices is a cure all for our economy, to me that would be like treating cancer with cyanide pills. I would rather have another 6 months of life and some hope than 20 minutes and it's all over if I was the one afflicted.

    And that isn't just self preservation talking, the shock treatment that many prescribe is not the best way out, I think we need to allow the markets to reset levels themselves over time.

    What is your prescription?

  10. No doubt the slower a deflation of real house prices the better. And, if we are very lucky, our variable mortgages might save us from a very sudden shock if the RBA acts to reduce interest rates. Given that mortgages may move into the quite risky lending categories, we might see an accompanying tightening of lending criteria as well. With a bit of luck we will have a rather slow deflation, but I suspect we will still see an initial shock of 10-20% before the downslide is arrested.

    I understand your point about incomes being very high for some ordinary jobs, while quite low for some very well qualified people.