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It's the leverage, stupid

It's the leverage, stupid

Steve Keen
5 November 2009

So I'm walking to Kosciusko--now that the ABS Established House Price Index has cracked its September 2008 peak of 131 to reach an all-time high of 134.4 (as of September one year later). This renewed bubble reversed the trend of falling nominal house prices that had dropped the index to a low of 123.8 in March 2009.

This level of price volatility--down 5.5 per cent in six months, only to rise 8.5 per cent in the subsequent six months-- almost matches the stock market's manic-depressive performance.

Though you'd see no mention of it if it you only read Chris Joye ("Keen concedes defeat"), the main factor behind the revival of the bubble is what is formally known as the First Home Owners Boost (FHOB), but what is more accurately described as the First Home Vendors Boost. As at the end of September--the date of the latest ABS house price data--171,000 applicants had received this $7,000 bribe. Since many are couples, more than one per cent of Australia's population has leapt into the property market pool at the behest of a government stimulus.

So how has a mere $1.2 billion injection of government money driven the average house price up by eight per cent in six months? By the "magic" of leverage: the typical First Home Buyer (FHB) took that $7,000 to the bank and leveraged it up to another $40-50,000, which then was handed over to the First Home Vendor (FHV) as cold, hard cash.

The FHV then took that extra $40-50,000 and leveraged it to an additional $200,000-$250,000, which meant that that new place which had been just out of reach prior to the FHOB was now well within range. Competing with other lucky recipients of government and bank largesse, he drove up the price of that middle to upper tier house by an additional $100,000 or more.

The aggregate impact of this government enticement into private debt was that Australian households reversed the deleveraging process that had begun in late 2008, and as a result the mortgage debt to GDP ratio, which had been falling, began to rise once more. The FHOB has led to Australians taking on an additional $50 billion of mortgage debt. That "demand" factor, far more than any other, is why I've lost the second half of Rory's bet with me.

Normally I regard the "ceteris paribus" assumption of conventional economic theory as a copout--in a market economy everything is connected to everything else, and you can't assume that, for example, a firm's output can change without affecting the market price. But I think I'm entitled to ask the "ceteris paribus" question here: what would have happened to house prices had the government not spiked the market with the FHVB? I somehow doubt that Rory would be crowing today had that irresponsible policy move not been made.

In fact, there's a good argument that we wouldn't be having a property bubble here at all, were it not for the First Home Buyers policy. I'm not one for making arguments solely on statistical correlations--I'm only too aware of the "correlation isn't causation" argument--but I think I can also spot a smoking gun when I see one.

Prior to the FHB, though real house prices were rising, so was real household disposable income. Then add two dollops of the FHB--one its introduction as a "temporary" measure to get us over the shock of the GST in 2000, the other its doubling to boost the economy during the brief 2001 recession--and off go real house prices relative to real household disposable income.

Last year, as the market starts to head back towards parity between house prices and incomes again, Rudd throws in another temporary doubling (of this temporary measure that is now almost a decade old), and off goes the house price bubble once more.

In the main, I've been a critic of banking practices as the underlying cause of the Global Financial Crisis. But I also believe that the crisis would have occurred long ago (in 1987) and been far less severe if governments and Central Banks hadn't attempted to rescue the system from its own follies. The First Home Owners is a classic government folly, and its doubling last year is the main reason I'll be walking to Kosciusko some time in April 2010.

Important information: This content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. For this reason, any individual should, before acting, consider the appropriateness of the information, having regard to the individual’s objectives, financial situation and needs and, if necessary, seek appropriate professional advice. 

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