Australian Boom and Bust Cycles
International Capital Flows and Bubbles
"The RBA engineered the land price and construction boom by sharply cutting interest rates from 2012-14. The plan was to offset the looming mining investment slump. It worked out ... but perhaps a little too well" (Greg Canavan, Coal Under Fire and Heat Leaves Aussie Housing Market, dailyreckoning.com.au, April 18, 2016).
"The economic environment of 2012 was poised to create a house price boom, Domain Group chief economist Andrew Wilson said.
"Interest rates were being steadily cut, years of soft house prices had created a relatively affordable property market, housing construction was relatively low and mining exports more than tripled in the 10 years to 2012. In April 2012, the cash rate was 4.25 per cent" (Jennifer Duke, Sydney's prices have peaked: When will they boom again? smh.com.au, April 24, 2016).
"Macro-prudential controls introduced in early 2015 (APRA to keep banking crackdown secret) had worked its magic until the Reserve Bank blew it, slashing the official cash rate in May and August of 2016. One month later in September, investor mortgage growth had rebounded" (Investor mortgage rates rise on confirmation of housing bubble, whocrashedtheeconomy.comMarch 24, 2017).
Twelve interest rate cuts from April 2012 to March 2020 has the cash rate at 0.25%.
"Purchases by foreigners, many with a connection to China, helped drive an almost 55 per cent jump in home prices across the nation's capital cities in the past seven years as mortgage rates dropped to five-decade lows" (Narayanan Somasundaram, China's little emperors prop up Aussie housing with parents' aid, smh.com.au, March 31, 2016).
"Foreign buyers, almost all from China, are purchasing 25 per cent of new homes NSW, 17 per cent in Victoria and 8 per cent in Queensland, a report released by the investment bank on Wednesday shows" (Chris Kohler, Chinese buyers of Australian property set to increase with higher taxes no deterrent - Credit Suisse domain.com.au, October 11, 2017).
"Bubbles are NOT created solely by interest rates nor by changes in money supply. The driving force is always international capital flows ... any country can be overwhelmed by external forces" (Martin Armstrong, Stockman v Greenspan - Just Absurd, armstrongeconomics.com, July 26, 2014).
"The year 1973 had opened with a flurry of activity in almost every portion of the Sydney property market...
"April and May 1973 marked the peak of the boom. Land prices in Sydney rose 5.5 per cent through April and 3.3 per cent in May... A fever spreading from Sydney through the resort lands of New South Wales coast to south-east Queensland, gripped the east coast of Australia... The Queensland market was even more speculative than that of Sydney and it was estimated that 40 per cent of the sales were to overseas buyers from Papua-new Guinea, Hong Kong and Britain...
"The boom was the most significant financial happening of the 1970s and the shock waves from the inevitable crash were felt up to 1980" (M. T. Daly, Sydney Boom Sydney Bust, (Sydney: George Allen & Unwin, 1982), pp. 12- 13, 1).
"Overseas investors have taken a strong lead as the most consistent and competitive acquirers of Australian office and retail assets...
"According to Savills, Australian office sales totalled $12.8 billion in the 12 months to June 2014 of which foreign investors accounted for 39 per cent of the stock sold, worth about $5 billion.
"Some of these properties, including 570 George Street, which was snapped up by Singaporean investors, and is expected to be converted into apartments.
"Savills national head of research, Tony Crabb, said that during the same period 246 properties were sold, up from the previous year of 199, and up on the five year average of 191.
" "The capital that has been coming in strongly from Europe and South East Asia since the GFC, is now competing significantly with institutional and private capital from mainland China along with strong competition from the domestic market," Mr Crabb said.
"Overseas investors accounted for 39 per cent of the deals, with local super funds at 32 per cent and the rest spread between real estate investment trusts and private syndicates and developers" (Carolyn Cummins, Foreign buyers leap into commercial sector, smh.com.au, August 1, 2014).
There is also an interesting 'rhyme' with the post-WW1 boom.
Flats 1920s - Appartments 2010s
"The growth of the suburbs was accompanied by a rapid rise in property prices... There was a further factor in causing high land prices in the eastern suburbs and one which was new to Sydney: a boom in flats... In 1921 only nine per cent of dwellings units in Sydney were flats, but the 1933 census revelaed that the figure had reached 32 per cent" (M. T. Daly, Sydney Boom Sydney Bust, pp.166).
"The great Aussie dream used to be about the family home, the picket fence, the quarter-acre block.
"But not any more. with population growth, higher property prices and an increased desire for inner-city lifestyle driving a surge in families trading traditional suburban life for high density living...
Australians were also getting more comfortable with the idea of living in a unit, he [social demographer Mark McCrindle] said, describing this shift in mindset as a "massive attitudinal change"...
"BIS Shrapnel senior manager of residential property, Angie Zigomanis ... warned some households, especially those with kids, could get locked out of the market for units because developers were focused on courting investors who preferred one-bedroom units" (Sam McKeith, Buyers Swap 'Traditional Aussie Dream' For High Density Apartments, huffingtonpost.com.au, February 4, 2016).
"Such has been the splurge in building of apartments that houses, which back in the 1980s accounted for 75% of all residential building work, and which even at the start of 2012 accounted for 62% of the total, in September accounted for just 51% of private sector building numbers" (Greg Jericho, Apartment building is booming, so betting on a rate cut isn't as safe as houses, theguardian.com, January 21, 2016).
"According to the Reserve Bank of Australia, Australia's household debt as a proportion of disposable income now stands at a record high...
"The two closest episodes were the 1880s and the 1920s, which both preceded the only two economic depressions ever experienced in Australian history in 1890 and 1929" (Joe Hildebrand, Australia headed for 'economic armageddon,'news.com.au. February 18, 2017).
The ends of the post-World War booms provides 'types' for the end of the post-Cold War boom.
Sydney and Melbourne house prices to crash at least 50%. Here's why.
"The land mania of the 1880s took two main forms. The first was based on a plethora of building societies, whose optimistic officials believed that every family in the colony could simultaneously build their own house, keep up the payments through good times and bad, and support an army of investors who were being paid high rates of interest for the use of their money. The second form of mania was the deeply-held belief that it was impossible to lose money by 'investing' in land - a belief which persists to the present day" (Michael Cannon, The Land Boomers, (Melbourne: Lloyd O'Neil, 1986), p.18).
"... investment expert Jonathan Tepper, who has predicted mortgage bubble bursts in both Ireland and the United States, told [60 Minutes reporter] Mr Coulthart Australia would be next.
"Mr Tepper believes property values will plummet by 30 to 50 per cent, leaving investors with incredibly high loans to pay back and a lack of return from their investments...
"He questioned why people are being encouraged to borrow 10 to 20 times their gross income.
" "It's an unsustainable level of borrowing," he said" (Olivia Lambert, Banks are loaning too much to people who can't pay it back, news.com.au, February 21, 2016).
"... a debt bomb is growing Down Under. Australia's total non-financial debt is over 250 per cent of GDP, up around 50 per cent since 2010. Household debt is currently over 120 percent of GDP, among the highest proportions in the world. The ratio of household debt to income has nearly quintupled since the 1980s, reaching an all-time high of 194 per cent" (Satyajit Das, Bloomberg, Far too dependent on 'houses and holes': Australia's economic luck is running out, smh.com.au, October 4, 2017).
"... household debt is at a record-high 194 percent of income, compared with 104 percent in the U.S., wages are stagnant and policy makers are fretting that consumers could be spooked into pulling back. That would be a major hit given household spending accounts for more than half of gross domestic product" (Michael Heath, 26 Recession-Free Years Hide a Darker Picture for Australia, bloomberg.com, October 3, 2017).
"Stagnant real incomes have contributed to the problem, as have high home prices and the associated mortgage debt. Despite record-low interest rates, around 12 per cent of income is now devoted to servicing all this debt.
"That's a third more than in 1989-90, when interest rates neared 20 percent" (Satyajit Das, Bloomberg, Far too dependent on 'houses and holes': Australia's economic luck is running out, smh.com.au, October 4, 2017).
"Expensive property markets, soaring levels of household debt and predatory lending practices have come under fire with experts warning thousands of households are on the verge of mortgage stress.
"Australia now has the second highest housing debt in the world, after Switzerland, and almost twice that of the US - leaving the housing market ripe for a crash that "could be as bad as Ireland or the US", Digital Finance Analytics' Martin North said on Monday evening on the ABC's Four Corners" (Jennifer Duke, 'Perfect storm of issues' leaving Aussies on verge of mortgage crisis, smh.com.au, August 21, 2017).
"This figure was about 70 per cent in the early 1990s, and has been more or less constantly rising ever since, despite a brief dip after the global financial crisis. This ratio is higher here than in most countries, and foreign analysts often say it looks like a weak point in our economy" (Clancy Yeates, Low rates fuel household debt surge, smh.com.au, April 26, 2016).
Bank-Government Nexus - Too much debt exposure
"... Australian debt levels remain high. [Shane] Oliver says this makes housing our Achilles' heel, with house prices being vulnerable to an economic slowdown (with rising unemployment) or further interest-rate rises" (Annette Sampson, House prices can't go up indefinitely, smh.com.au, June 4, 2011).
"As [Ross] Garnaut and his co-author David Llewellyn-Smith relate [in their book the Great Crash of 2008], in early October bank chiefs met Rudd to warn him that foreign lenders were refusing to roll over their foreign debts: ''The banks told (Kevin Rudd) that, if the Government did not guarantee their foreign debts, they would not be able to roll over the debt as it became due. Some was due immediately, so they would have to begin withdrawing credit from Australian borrowers. They would be insolvent sooner rather than later... The process of adjustment would be enormously disruptive and costly''" (Tim Colebach, We failed the GFC test, theage.com.au, October 27, 2009).
"Over 60 percent of the Australian banking system's loan book is in residential property, nearly 20 percentage points more than second-placed Norway and more than double the U.S. ratio, according to data from the International Monetary Fund. In Hong Kong's frothy housing market, the ratio stands at only 14 percent...
"Australian banks are prepared to lend a greater proportion of a borrower's income than many overseas peers. Half of Australia's mortgage credit is held by households who have borrowed more than six times their annual income, according to research by JCP Investment Partners, an equities fund. In the U.K., banks are only allowed to issue 15 percent of new mortgages at more than 4.5 times borrowers' income...
"The Reserve Bank of Australia recently estimated that one-third of borrowers have little or no buffer in the form of money set aside to meet an unexpected rise in mortgage loan repayments or other costs" (Emily Cadman, Moody's Downgrade Brings Australia's Home Loan Risks Into Focus, bloomberg.com, June 20, 2017).
"Government net debt borrowing, ostensibly low at around 20 percent of GDP, is higher than it looks. That figure ignores borrowing by state governments, which adds around 10 per cent to government debt levels. It also ignores contingent liabilities, such as implicit government guarantees. These relate primarily to Australia's large banking system, which accounts for over 200 percent of GDP.
"In 2008, the government was forced to guarantee bank deposits and borrowing to ensure liquidity. In addition, governments implicitly bear a portion of the risk of private-public partnerships used to finance essential infrastructure and services, which can't be allowed to fail.
"Public finances are deteriorating, since strong growth in the commodity sector no longer offsets weak domestic conditions. Budget deficits reflect an eroding tax base and an aging population, which is driving up health, aged care and retirement expenditures.
"The high debt levels increase the risk of a banking crisis, which could be sparked by rising losses on real estate loans. Australia's especially vulnerable because of its dependence on foreign capital; foreign net debt tops 50 per cent of GDP, much of it borrowed by banks to cover the shortfall between loans and domestic deposits.
"The high debt levels increase the risk of a banking crisis, which could be sparked by rising losses on real estate loans. Australia's especially vulnerable because of its dependence on foreign capital; foreign net debt tops 50 per cent of GDP, much of it borrowed by banks to cover the shortfall between loans and domestic deposits..." (Satyajit Das, Bloomberg, Far too dependent on 'houses and holes': Australia's economic luck is running out, smh.com.au, October 4, 2017).
"... you can be insolvent for two types of reasons, one: you get yourself into trouble with the way you've managed your debt and you can't roll over your debt as it becomes due, or you run into trouble with the value of your assets.
"The rest of the world's problems, Europe and American's problems were problems with their bad assets, our problems were the problems of excessive reliance on a source of debt that turned out not to be reliable...
"We've had a couple of times in history when banks have been ... or when the economy has been heavily reliant on foreign debt and foreign debt dried up.
"In the 1890s, we had the Great Depression of that time, when most of our banks went bankrupt in those circumstances. The time of the Great Depression, more of the debt was government debt, so it didn't give rise to that situation.
"This time, the banks were in trouble with their debt, and the Government stood behind them" (Ross Garnaut, Ross Garnaut joins The 7.30 Report, abc.net.au, October 12, 2009).
"... a "bail-in" of creditors. This is where senior bondholders are exposed to losses in a bank collapse, rather than taxpayers.
"S&P said adopting "bail-in" rules could affect the major banks' ratings, as these were currently premised on the assumption that government support for banks in a crisis was likely.
"It also warned the economy would made more be vulnerable in a financial crisis if Australia chose to "bail in" the foreign investors that banks rely on for part of their funding.
" "We believe Australia could find it challenging to effect an economic recovery in circumstances whereby a key source of funding upon which the recovery would likely depend - senior unsecured creditors - had been 'bailed in' during the downturn," it said" " (Clancy Yeates, Beware the 'disorderly correction': Standard & Poor's warns on overheating mortgage market, smh.com.au, September 5, 2014).
"Dr Anthony said the government had far less "wriggle room" to avoid a recession than it had before the onset of the global financial crisis in 2008.
"In January 2008 the Reserve Bank's cash rate was 6.75 per cent, giving it plenty of room to cut interest rates...
"In January 2008 gross government debt totalled just $55 billion. It's now $415 billion, or 25 per cent of GDP, giving the government less room to borrow more without alarming rating agencies.
"Australia is going into 2016 with an expected budget deficit of $35.1 billion. In 2008 it had an expected surplus of $19.7 billion (Peter Martin, Australia has few tools left to fight recession, warns leading forecaster Stephen Anthony, smh.com.au, January 15, 2016).
Will Australia, in the next crisis, have both types of trouble - trouble with foreign debt and trouble with asset prices?
Australia, in the next crisis, to follow Ireland, in the last crisis?
"The $1.9 trillion mountain of household debt in Australia has been fuelled by the "Irish-style wealth creation model" of home buyers and investors borrowing heavily from the banks to flip houses for the next buyer, who takes out even greater debt to speculate" (Frank Chung, Will housing bubble pop in 2017? news.com.au, May 22, 2015).
From The Economist's House price indicator, economist.com, March 19, 2009:
% change 1997-2008
* Case-Shiller ten city index
** Office of Federal Housing Enterprise Oversight
"Ireland's decade-long housing boom ended after borrowing costs rose and demand for property cooled. House prices have fallen in every month since May 2007 and are now 45 percent below their peak earlier that year, according to Friends First" (Colm Heatley, Irish Building Activity Slows to 6-Month Low, Ulster Bank Says, bloomberg.com, December 14, 2009).
Bursting housing bubble to take the big banks with it?
"Australia is in the midst of the greatest credit-fuelled real estate bubble the country has ever seen. When it pops it's going to devastate the economy, and quite possibly take the big banks with it...
" "Lehman Brothers had assets on its balance sheet equivalent to 5 per cent of US GDP. Australian banks hold the equivalent to 50 per cent of GDP each. How do you save a bank that big? They're too big to save unless they're nationalised, unless there's a $380 billion facility ready at the RBA. I [Lindsay David, founder of LF Economics] can't see a $1.6 trillion economy printing $380 billion. It would collapse the Australian dollar" " (Frank Chung, Will housing bubble pop in 2017? news.com.au, May 22, 2015).
"Sitting in the big four banks is $522 billion worth of Australian household deposits. This is equivalent to one-third of Australia's gross domestic product; the loss of just a fraction of these funds would represent a major burden for taxpayers...
"Treasurer Joe Hockey has tasked the financial system inquiry to examine the issue. In a speech in November last year he highlighted how the big four banks had grown larger since the GFC by acquiring smaller lenders such as St George and Bankwest.
" "In short, the four major banks have largely become the Australian financial system," he said
"... Australia's economy is so heavily weighted towards housing.
"All our eggs are in one basket here," Credit Suisse strategist Damian Boey says. "Most of the loan book is wrapped up in housing collateral. In a really bad situation, what you would find is that house prices would go down because people would lose their jobs.
"This would lead to a crash in the market, with demand unable to keep up with supply"...
"Rodney Maddock, an economics professor at Monash University and former CBA executive, says based on the current size of the big four banks, it would be impossible for any tax to cover a bailout.
"The banks have about $500 billion each in liabilities. If one of them collapsed and was worth nothing, it would have to find $500 billion or about 20 per cent to 25 per cent of GDP," he says...
"The downside is that having dodged a bullet this time, given Australia's very high household debt to income ratio, it would leave Australia very vulnerable to the next global economic downturn" (Shane Oliver, Australian house prices on the up again - Is it sustainable? Oliver's Insights, ampcapital.com.au, August 6, 2009).
At the time, the co-ordinated Central Bankers' intervention of December 2007, in response to the crisis, suggested from history that there would be one more global boom/recovery before the real crisis would begin. The recovery began in 2009.
This implies that the Australian bust will come in the second contraction.
What had the potential to become a crisis in 2007-2009, but prevented from occurring due to favourable circumstances - monetary and fiscal stimulus and China, etc. - will become a crisis in the future.
The world economy, will experience a severe depression rivaling the Hoover recession - the first contraction of the Great Depression.
The intervention will not only aggravate the seriousness of the coming crisis but will limit the effectiveness of the government's response to provide some support for the most vulnerable.
Post WW2 - This time it is different
Two economic environments are key to understanding the future - low inflation during the boom and deflation during the bust - that is, house price deflation in a world economy experiencing general deflation.
"A common myth is that house prices only go up, never down. This is nonsense... house prices do fall. However, in the past the adjustment has been masked by high inflation which allowed real house prices to fall without nominal prices necessarily coming down. It is unlikely we will have this luxury this time around with inflation now very low. One of the arguments often cited against large falls in house prices is that home owners tend to be in for the long haul and hence, unlike many share investors, are unlikely to sell in response to short term weakness. This is true to a degree but ignores the large role played by investors in driving up prices recently" (Shane Oliver, The beginning of the end for the house price bubble? Oliver's insights, amp.com.au, December 8, 2003).
"The current business cycle is inching towards a deflationary ending. Excessive increases in leverage and capacity in this cycle could turn disinflation into deflation during the coming downturn...
"The Anglo-Saxon consumer debt and Chinese overcapacity will likely become the main factors in causing cyclical deflation as the current cycle turns down...
"In addition to the risk of experiencing some cyclical deflation ahead, the risk of secular deflation remains..." (Andy Xie, To deflation, morganstanley.com, June 10, 2005).
Previous booms and busts
"... two housing economists [Lindsay David and Philip Soos] ... believe the current bubble is worse than those in the 1880s, 1920s, mid-1970s and late 1980s" (Heath Aston, Australian housing market facing 'bloodbath' collapse: economists, smh.com.au, June 22, 2015).
The "boom and bust" cycles of the 1880s-1890s, 1920s-1930s-1940s, 1960s-1970s, and 1980s-early 1990s, provide clues to understanding the direction of the fallout of the latest property boom of the late 1990s-2000s-2010s.
"The crash began in 1891. Land values fell to levels around one half their boom levels. In addition ... data on individual suburbs are available. In Prahran, prices peaked at an average of over £1,000 per property in 1888 and fell to £520 by 1898. Similarly, in Brighton, average property values peaked at around £950 in 1888 and then fell to around £400 in 1893 and £300 in 1898. A comparison of these data to the accounts in Cannon (1966) suggests that the picture is fairly accurate but may understate the speed of the bust. For example, Cannon writes that, 'by the end of 1891 the bottom had completely dropped out of the land market ... In Collins Street, sites for which £2,000 a foot had been rejected a short time before, were now being offered for £600 a foot - and could not find buyers even at that price' (Cannon 1966, p. 18)" (John Simon, Three Australian Asset-price Bubbles, rba.gov.au, 2003, pp.22-23).
Note: "The level of household debt [todau] is higher now than at any other time in Australia;s history, with records going back to the 1850s. The level of bank lending as a share of GDP is now more than double the share of the previous peak, which was during the 1890s land boom" (Mortgaging our children's future: Aussie ticking time bomb sparks fears should new GFC hit, news.com.au, March 16, 2015).
"Recession in 1886 produced a large number of unemployed and even more strident opposition to assisted immigration. The government was forced to concede and immigration slowed to a trickle after 1887, not to recover in the 19th century.
"The general antipathy towards immigration stimulated by the fear of wages being driven down and by the recurrent increases in the level of immigration, was matched by religious bigotry and racial intolerance. The longest standing enmity was against the Irish ... The other group to attract the abuse of the general population were the Chinese, and they did eventually cluster in particular location in Sydney..." ( M. T. Daly, Sydney Boom Sydney Bust, pp.174-75).
"The world depression found Australia unable to meet her repayments, and the boom was rapidly translated into a disastrous slump. The average price of a house in Sydney fell from the 1925 level of £959 to £668 in 1935, but this was a bonus only to those who had money... for the years 1931 to 1934, building in Sydney came to a virtual standstill" (M.T. Daly, Sydney Boom Sydney Bust, (Sydney, George Allen & Unwin, 1982), p.169).
Over ten years, from 1925 to 1935, average Sydney housing prices fell 30.3 per cent.
See for more at the bottom of this page.
Boom and Bust 1960s-1970s
"Sydney had never experienced a property boom on the scale of that between 1969 and 1974. It involved a frenzy of buying, selling and building which reshaped the central business district, greatly increased the supply of industrial and retailing space, and accelerated the expansion of the city's fringe. Its visible legacy of empty offices and stunted subdivisions was matched by a host of financial casualties which incorporated an unknown, but very large, contingent of small investors, together with the spectacular demise of a number of development and construction companies and financial institutions. The boom was the most significant happening of the 1970s and the shock waves from the inevitable crash were felt right up to 1980. It was an extraordinary event for Sydney and Australia...
"The fluctuating fortunes of the property market in Sydney during the 1970s left many bewildered. The enormous losses sustained by so many individuals and firms gave the lie to the deeply rooted conviction that property was the safest form of investment" (Daly, pp.1 & 132).
"The 1972-1974 bear market proved to be the worst for Australia in this century. The declines of the Great Depression were mitigated by the strength in Gold and other resource stocks" (Dr. Bryan Taylor, The Global Financial Data Guide to Bull and Bear Markets, globalfinancial data.com).
Boom and Bust 1980s-1990s
"The housing and inner city office boom of the late 1980s was the precursor to Australia's most prolonged recession in over 50 years..." (ACOSS, More Affordable Housing, acoss.org.au, October 2003, Paper 352, p.2).
"For the purposes of this book the most important period was from October 1987 (when [interest] rates were comparatively low) to the end of 1991... [There was] the relaxation of rates after the crash as the monetary authorities tried to avoid a money panic. This was a legitimate fear, but rates were eased to far..." (Trevor Skyes, The Bold Riders, (Sydney: Allen & Unwin, 1994), p.27).
"With the share market dead on its feet in late 1987, the surviving cowboys swung into the property market... The relatively low interest rates of early 1988 encouraged them to believe that they might escape their troubles in the equity market by gearing up in Central Business District (CBF) property...
"The cowboys and their lenders who stampeded into the office block construction in 1988 and 1989 showed woeful lack of experience. History tells us that a share market crash is frequently followed within a couple of years by a property crash..." (Skyes, pp.28-29).
"In the late 1980s, it was the business sector that ramped up its debt levels - to a large extent to finance speculation in assets (mainly corporate takeovers and inner city offices)..." (ACOSS, p.10).
"... the commercial property bubble inevitably burst, and when it did property values halved. In Melbourne and Perth, property values in 1993 were below their 1985 levels while in Sydney values were only slightly above their 1985 level. The commercial property boom ended for pretty much the same reason that most land booms end - supply increased and rental returns couldn't support the prices being paid. This was particularly true of highly-leveraged investors who faced higher and higher interest rates over this period as monetary policy was progressively tightened" (Simon, ibid., p.36).
"... figures from the Real Estate Institute of Australia show in the two years following the boom of the late 1980s the median house price in Sydney fell by 25 per cent" (Ross Gittins, Beware the bang if the property bubble bursts, smh.com.au, June 15, 2005).
Property and borrowing boom of the 1980s
Business credit as a %of GDP, 1982-2003
(Source: Simon, 2003 - (ACOSS, p.11)
"A major reason for the sluggish recovery from the 1991 recession was the need for the corporate sector to unwind its high debt levels. These may have been sustainable during the boom, but they were no longer so once demand for goods and services fell. This was a major factor behind the severe round of corporate 'down sizing' in the early 1990s..." (ACOSS, p.14).
What else to expect
" ... the wealthiest areas could be hit hardest.
""Some of the top-end properties are more vulnerable than the middle-market because their buyers are typically employed in sectors most likely to be hammered by an economic slowdown and rise in unemployment, namely banking and finance," he [Morgan Stanley chief equity strategist Gerard Minack] said.
""We could also see big falls in the places these people have holiday homes - the (NSW) Central Coast for example - which could even see prices fall by 50 per cent."
"Blaxland MP Jason Clare said the Bankstown sheriff's office had a list of 30 homes to be repossessed in the next few weeks.
""They had to evict a 70-year-old couple after they had gone guarantor for their children's home and couldn't keep up the repayments," he said.
""They said that was one of the most terrible things they'd seen"" (Angela Saurine, Property slump worsening, news.com.au, April 12, 2008).
Fragile Financial Sector
"The Economic Sphere never appreciates how its behavior and fortunes are dictated by the Financial Sphere" (Doug Noland, Digging a Little Deeper into "Financial Sphere" Analysis prudentbear.com, April 29, 2005).
Financial sector imbalances are the crucial factor in determining the severity of a bursting asset bubble. This has been the case in Australian crises, as the next section introduces.
Two Australian Depressions, One Banking Collapse
Chay Fisher and Christopher Kent in a June 1999 Research Discussion Paper entitled "Two Depressions, One Banking Collapse" outlines the Australian experience:
"Over the past 150 years, Australia has experienced two macroeconomic depressions, both of which coincided with worldwide depressions. The first of these was in the 1890s and the second in the 1930s. These were also times of financial distress both domestically and in the rest of the world. For Australia there were many similarities across both depressions... in this paper we highlight one of the major differences between the two depressions. Namely, the 1890s involved the collapse of a significant proportion of the Australian financial system, whereas the disruption to the financial system in the 1930s was comparatively mild...
"The central argument of this paper is that variation in the performance of the financial system across the two depressions was primarily due to variation in the condition of the financial system prior to each depression. We show this by examining the behaviour of a range of indicators of financial stability over the decade prior to each depression. These indicators are:
(i) the level and nature of investment;
(ii) property market speculation;
(iii) credit growth;
(iv) capital inflows;
(v) degree of risk management within the financial system; and
(vi) competitive pressures in the financial sector.
"Each indicator suggests that the financial system during the 1880s was becoming increasingly vulnerable to adverse shocks. During that period there was a sustained increase in private investment associated with extraordinary levels of building activity and intense speculation in the property market. This was accompanied by rapid credit growth, fuelled in part by substantial capital inflows (much of which appears to have been channelled through financial intermediaries). At the same time, banks allowed their level of risk to increase in an attempt to maintain market share in the face of greater competition from a proliferation of new non-bank financial institutions.
"In contrast, if anything there was only a moderate decline in measures of financial system stability during the 1920s compared with the 1880s experience. It is therefore not surprising that whereas the financial system essentially collapsed following the substantial shock to real output in the first year of the 1890s depression, a shock of at least the same magnitude during the first year of the 1930s depression had relatively little impact on what was clearly a more robust financial system.
"Historically one of the major causes of financial instability has been rapid increases in bank lending in conjunction with unsustainable rises in asset prices. In recent times the catalyst for this process has been financial deregulation. In a way, this force was also present in the 1880s. The Australian banking system in the 1800s had operated under direction of the British Treasury in accordance to the 'real bills doctrine', which among other things prohibited lending backed by land. However, Pope (1991) suggests that after the arrival of 'responsible government' in the 1850s, these regulations were largely ignored and banks increasingly engaged in lending for speculative purposes. Increasing willingness to ignore the real bills doctrine was at least in part a response to increasing competition from non-bank financial institutions" (rba.gov.au).
""The old theory says investors are "rational." The fact, however, is that fear is stronger than greed, which is why financial markets fall more rapidly than they climb" (Robert Folsom, If It Works in Practice... Will It Work in Theory? elliottwave.com, May 25, 2005).
Responsible government is required to protect people from themselves. Greed and fear are powerful forces that can play havoc in an economy.
House prices losses - asset-inflation gains wiped out
""Typically, real house prices give up 70 per cent of what they gained in a boom during the bust that follows" Professor [Morgan] Kelly, a professor at University College, Dublin, who has studied earlier real estate bubbles] said. "This is a remarkably robust relationship, holding across very different OECD housing markets over more than 30 years"" (Bloomberg, Irish owners not smiling, AFR, July 5, 2007, p.57).
The busts of the last thirty years occurred against a background of inflation/disinflation.
"The value of Sydney's median house has risen by a cool $503,351 since prices took off four-and-a-half years ago, Domain Group's property data shows" (Matt Wade, After the boom: What Sydney can expect when the property party is over, smh.com.au, May 13, 2017).
"House prices in Sydney and Melbourne have more than doubled since 2009 following unprecedented interest rate cuts by the Reserve Bank of Australia as the country navigates its way through the aftermath of a mining boom" (Emily Cadman, S&P cites risk of sharp correction in property prices as it cuts 23 lenders' ratings, smh.com.au, May 22, 2017).
"A funny thing often occurs after a mania-fueled asset bubble pops: an echo-bubble inflates a few years later, as monetary authorities and all the institutions that depend on rising asset valuations go all-in to reflate the crushed asset class...
"It seems housing bubbles take about 5 to 6 years to reach their bubble peaks, and about half that time to retrace much or all of the gains.
"Bubbles have a habit of overshooting on the downside when they finally burst. The Federal Reserve acted quickly in 2009-10 to re-inflate the housing bubble by lowering interest rates to near-zero and buying over $1 trillion of mortgage-backed securities.
"When bubbles are followed by echo-bubbles, the bursting of the second bubble tends to signal the end of the speculative cycle in that asset class. There is no fundamental reason why housing could not round-trip to levels below the 2011 post-bubble #1 trough" (Charles Hugh Smith, Housing's Echo Bubble Now Exceeds the 2006-07 Bubble Peak, oftwominds.com, April 25, 2017).
The Australian house busts of the 1890s and 1930s occurred against a backdrop of deflation and depression; so will the coming bust.
How far, then, will house prices collapse? A historical precedent:
"The depression-era drop in U.S. housing prices wiped out the total gain during the inflationary boom dating back to World War I...
"British data show a similar pattern in prices of private homes and farm land for the previous "Great Depression" that began in 1873. It too, wiped out the whole inflationary gain during the preceding boom. Private houses in Britain rose in value by 13 percent from the period 1851-52 to their peak in the years 1876-77. They then declined by 19 percent over the next thirty-five years...
"Evidence from the past two depressions show that deflation reduced the value of the average home each time by wiping out the inflationary gains of the previous boom" (James Dale Davidson & William Ress-Mogg, The Great Reckoning, (London: Sidgwick & Jackson, 1993), pp.403-404).
If we say that the inflationary gains equals the doubling of house of house prices then values would have to fall 50 per cent.
The first global housing bust will be severe as it also coincides with the restructuring of the global economy for the Information Age proper.
Therefore, there is a possibility that the inflationary gains from, say 1986, may be wiped out. If this was the case the national average prices would have to fall 80 per cent. (The Dow Jones Industrial Average fell 89% from September 1929 to July 1932).
Note: It is argued that the Industrial Age proper began after the Great Depression of 1873-95, over 80 years from the beginning of the Industrial Revolution (say, the Watt-Boulton steam engine of 1786). So that the Information Age proper begins after the coming depression, over 70 years from the beginning of the Computer Revolution (say, the UNIVAC 1 computer of 1951).
Boom and Bust 1920s-1930s
"... Forget Crocodile Dundee and rugged individualism, the country was built by state governments"
- The Economist, Oz and the monarchy, November 6, 1999, p.14
"In the decade before 1930, borrowing, mostly from Britain, amounted to £250,000,000, and after 1925 no year had a favourable balance of trade. Very few saw this imbalance as an ominous sign for the future" (John Molony, p.244).
'If the United States sneezes the rest of the world catches a cold'
- an old saying
"It was ironic, to say the least, that while the American boom of the 1920s had not been transmitted to the rest of the world, the rest of the international community very quickly felt the impact of the American crash..." (David Meredith & Barrie Dyster, Australia in the Global Economy, (Cambridge: CAP, 1999), p.85).
"Germany was easily the largest debtor nation, and in the period 1925-1929 she borrowed four times as much as Australia, the next largest debtor" (C.B. Schedvin, Australia and the Great Depression, (Sydney, Sydney University Press, 1970), p.39).
"The closure of the London money market to Australian long-term borrowing... [and] the rapid accumulation of short-term debt in London which followed in the second half of 1929 and in 1930 was the most important single factor in shaping depression policy to mid-1931. The interaction between the pressure this debt exerted and the instrumentalities of domestic policy formation is an important theme... Australia found herself in a much more embarrassing position on the eve of the world depression than other large debtor nations" (Schedvin, p.106).
"It did not take long for the [Scullin Labor] administration to appreciate that the heavy adverse trade balance was the most urgent problem that it had to deal with, for the growing trade deficit was primarily responsible for the deterioration in Australia's international credit rating and was also giving rise to speculation that the country would be forced to default on interest payments due abroad" (Schedvin, p.140).
"Consider this scenario. The economy has shrunk by 10 per cent; unemployment is 31 per cent; the government can't pay its public servants and so defaults on its foreign debt. Sound familiar?
"Greece 2015. Right?
"Wrong. We are talking New South Wales. 1932.
"On 29 January, Jack Lang, the incendiary and one-of-a-kind state premier, announced New South Wales would not pay interest owing to British bond-holders.
"And it wasn't the first time. In April the previous year, Lang had similarly declined to pay the interest then due on British bonds, arguing the money should instead be spent on the dole...
"Britain showed no such mercy to its colonies.
"... in 1930, it sent Sir Otto Niemeyer from the Bank of England to argue that Australia deal with the Depression with deflationary policies, including savage cuts to social services and insisted that the debt be serviced. Lang, alone among state and federal leaders, rejected this so-called "Melbourne agreement" (because it arose from a meeting in the Victorian capital).
"Instead, he expanded the welfare and related measures he'd embarked upon when first elected in 1930 - restoring the 44 hour week, preventing landlords from auctioning evicted tenants' possessions, establishing a lottery to help finance hospitals, extending the repayment period of mortgages and other loans, and directing state funds into public works.
"He could not dissuade the (also Labor) federal government from cutting wages nor to agreeing that NSW could expand its debt. But he was adamant that British bond-holders would not get funds that could do at least some good to the economically distressed in NSW.
Because of our federal structure, the Commonwealth was obliged to assume responsibility for NSW's debt obligations. It paid the Poms - and tried to recover the funds from Lang's Treasury. To say Lang resisted, and set legal and administrative traps to thwart the feds, would be a severe understatement.
The legal and political tussles between Canberra and Sydney over control of NSW finances in the wake of the second default were way too byzantine to summarise here but they make todays politics look very tame indeed" (Anne Summers, Debt needs to be cut for economies to rebound, smh.com.au, July 10, 2015).
"In the year 1932, just over 30 per cent of Australian breadwinners were out of work. Unlike the 1890s, this was a world-wide depression: but Australia's ability to cope with it was gravely impaired by its heavy overseas debt...
"How did Australians manage to work their way out of the difficulties? They traded their way out of trouble. That's the modern, glamorous way of expressing it, but in fact they sweated their way out of it. They reduced their imports and increased their exports. Unfortunately, I doubt whether we could expect to "trade our way out" very easily [today].
"... the extent of unemployment experienced in the early 1930s rapidly cut down the import bill... Thus in the year 1928-29, Australia's total import costs £130 million. They cost only £51 million three years later. In case you think that changes in money, including the first big currency depreciation in our history, mainly caused this sharp fall, let me specify how the actual tonnage of imports fell away.
"In the two years after 1929-30, imports of motor cars chassis fell from 62,000 to 4000. In the same two years the imports of electric cables and wires fell from 15,000 to 2000 tons. The impact of petroleum - our consumption of petroleum - was almost cut in half. The imports of whisky fell to a mere one-sixth, and in this era of the sardine sandwich even the imports of tinned fish were halved.
"... we will not be able, in a future debt crisis, to fight our way to solvency with such ruthless cuts in imports.
"Nor are we certain to ease a future debt crisis by the kind of speedy recovery in export prices seen in the past..." (Geoffrey Blainey, Our extended Australian family: over-extended or third time lucky, The Australian, March 2, 1990).
Australia quickly recovered its 1929 sharemarket high primarily because its economy was based more on raw materials, than on industrials, and because its economy was not as closely tied to the United States and Europe as many other countries (Brian Taylor, Could this decade be the next 1930s? gold-eagle.com, December 13, 2002).
The Australian sharemarket rose 196.1% from December 1916 to February 1929. It then fell 46.3% from February 1929 to August 1931.
The sharemarket recovered its 1929 high in October 1934. (Brian Taylor, ibid.,).