Academic Philip Soos has acknowledged that mainstream opinion is opposed to the idea that a housing bubble exists in Australia, as governments, the FIRE sector (finance, insurance and real estate) and many of his colleagues in academia all claim that prices are linked to fundamentals or intrinsic value.
But noting entrenched views exist on both sides, Soos has repeated his strong belief that evidence suggests the residential property market was currently experiencing a bubble, with prices detached from fundamental valuations.
"This appears to be the largest bubble on record, orders of magnitude larger than all preceding bubbles," he says."When it does burst, heavily indebted property owners (recent home-buyers, negative gearers) will experience financial trouble, including the economy at large," the researcher at Deakin University’s School of International and Political Studies noted in an article published on the Prosper website.
His article came with five charts, and the application of his understanding of the Australian scenario with the works of the late US post-Keynesian economist Hyman Minsky.
Soos notes Minsky's contrarian work revolved around how financial markets interacted with asset prices – a theory called the ‘financial instability hypothesis’, arguing that financial markets continually misallocate substantial amounts of credit into asset markets, creating Ponzi (pyramid) schemes.
It helps to have a sound fix on what an asset bubble is when exploring this matter, Soos says.
"Otherwise, it becomes like pornography: you can’t define it exactly, but you know it when you see it."
Minsky defined three phases of finance: hedge, speculative and Ponzi. With hedge financing, income flows from an asset are sufficient to pay down both principal and interest on the debt used to finance the asset purchase, and prices are based upon intrinsic value. Speculative financing results in income flows covering only interest repayments, not principal, requiring debt to be continually rolled over. Investors may experience financial stress, but it is not widespread and fundamentals valuations are kept largely in check.
Soos explains the terminal phase occurs with Ponzi finance, as income flows cover neither principal nor interest repayments (including running expenses in the case of rental property). "Investors rely solely on escalating capital values in order to realise substantial capital gains at sale to pay down the cost of debt and balance their income losses. Asset prices are completely delinked from fundamental valuations at this stage. Investors rely upon ‘greater fools’ to maintain positive price momentum, resulting in a bubble. Once there are no more investors willing to take upon staggering amounts of debt to finance asset purchases, prices stagnate then collapse, as the market finally realises that prices are based upon a pyramid scheme, not fundamentals," he says.
"With Minsky’s theory, it is possible to determine whether a housing bubble exists.
"Unfortunately, there is evidence to suggest that Australia’s residential property market is experiencing said bubble.
"Figure 1 (above) shows the long-term trend in housing prices, adjusted for inflation and quality. The 1996-2010 period is the largest single boom on record, rising by approximately 130%.