Australia's housing bubble will burst eventually, with debt the main cause

During the past four days days the latest monthly data on credit growth in Australia from the RBA and the latest quarterly house prices data and monthly building approvals data from the ABS have ll been released. Together, these confirm trends that I’ve identified on numerous occasions between the acceleration of mortgage debt and the change in house prices.

Building approvals plunged 13.9% in September, while housing credit increased by 0.5% over September (see the RBA release for details), but this involved a further deceleration of mortgage debt, as figure 1 shows.

Figure 1: Change and Acceleration of Mortgage Debt in Australia

 As I explained in A Much More Nebulous Conception, there is a complex causal link between the acceleration of mortgage debt and the change in house prices. In a nutshell, the two sources of monetary demand are income and the change in debt; these then finance the purchases of both newly produced goods and services, and the turnover of existing assets. There is thus a causal link flowing from change in debt to the level of asset prices, and consequently a link between the acceleration of debt and the change in asset prices.

That relationship is evident in the pattern of change in Australian house prices over the last two decades. The most recent figures – that prices fell 1.2% over the June to September 2011 quarter, and 2.2% from September 2010 to September 2011 (see the ABS Release for details) – confirm that mortgage debt acceleration, and not “population pressure” etc., is the key determinant of house prices.

Figure 2: The Mortgage Acceleration and House Prices Change Relationship (R^2 = 0.54)

Of course, one can’t forget the role of government intervention in sustaining an asset bubble either, and here the Australian government has a peerless record – whether the conservatives (Liberal Party) or progressives (Labor Party) have been in power. Whenever the economy was facing a recession, its favourite tool of macroeconomic policy has not been fiscal stimulus, but stimulating the housing sector via the 'First Home Owners Scheme'.

It was first introduced by the Hawke Labor government in 1983, in response to the recession that had swept the previous Liberal government from power; it was reintroduced by the Hawke government after the share market crash of 1987, given fears then of a serious recession; the Howard Liberal government brought it back as a "temporary" measure to counter the impact of the GST in 2000 (and it has never been removed!), and then doubled it in 2001 to counter an imminent recession; and finally Rudd doubled (and for new homes, tripled) the grant as a counter-measure to the Global Financial Crisis in late 2008.

Though restarting the housing bubble wasn’t the express intent of government policy, its 'collateral damage' included spikes in house prices as well (see figure 3). The turnaround from an 8% per annum rate of fall in real house prices to a 15% rate of increase was merely the latest (but not the greatest) such instance of government manipulation of house prices that has given Australia the most expensive housing in the Western world.

Figure 3: The First Home Vendors Scheme and House Prices