LONDON, March 28 (Reuters) – Like the towers now dominating its skyline, London property prices have moved in almost only one direction in recent decades, ever higher. But uncertainty surrounding Britain’s impending European Union exit and fears of an exodus of thousands of financial sector jobs, have cast a shadow

When (if at all) do you think the Australian housing bubble will burst? Why/why not?

When (if at all) do you think the Australian housing bubble will burst? Why/why not?

This gets complicated. A crystal ball and some economics will help.

Sadly, I don’t have a crystal ball.

And you really do need a crystal ball to understand economics, too.

But that won’t stop me.

Economics is really the study of how and why we value things and how we go about matching our needs and wants against their availability. It’s about people and lots of individual decisions.

In Australia we use markets to solve what is essentially a distribution problem and elect governments to oversee those markets and ensure that things like fairness, equity and stability are more or less achieved.

We do like to see some movement in a market, it’s expected, and some people derive their income from it; so we let it run as free as we dare, within sensible limits.

Sadly, governments are people too and like all of us are prey to all sorts of shortcomings. Apart from human fallibility, poor advice and corruption, the chief shortcoming may be that they serve the people, and thus seek to be re-elected every 3 or 4 years (or whatever).

Which is to say that keeping people ‘happy’ in the short term may conflict with any longer-term vision.

That aside, understanding how a market works helps us to plan on both sides, matching the supply and the demand in a sustainable way.

Housing is just one such need, but it’s complicated by all of the wants we build into that simple shelter.

If we have access to enough money, and if we have it in our heads that we (a) need to own a house and (b) that it must fall within a certain range of sizes and shapes and be located within a specific area, then our internal analytical software will do the maths and tell us its “value”.

Now we happen to be a wealthy, developed nation with relatively low unemployment. And finance is available currently at historically low rates. So as enablers go, we are well enabled. This sets us up for a boom, of course, because so many of us want the same sort of dwelling in the same preferred locations, and can afford it, too.

Well we think we can afford it, anyway.

Fortunately we are also well educated. We can mostly read and write, do some maths and look around at all of the options, like renting, renovating or moving to a cheaper suburb or city. And we have at least a bare-bones understanding of mortgages, rates, upkeep, accessibility and the housing market in general.

We are informed.

But we are human, too, and prone to all sorts of social programming and biases. We have short memories and big dreams. Many of us are hopelessly optimistic about ourselves and our prospects, too.

We thus don’t necessarily factor in climate change when we buy on the coast. We often rate views over possible erosion or flooding risks. And so on.

And we don’t generally expect to lose our jobs or get injured or sick. Nor do we fully grasp how expensive children are to feed and clothe. Or that some costs, like fuel, rise as well as fall. Indeed we often forget that we will even age.

Which means that at least some part of our decision making will be based on hope rather than a reasonable and fundamental analysis.

We get a little carried away at times, especially in Sydney, but also in Melbourne. Anywhere, really.

So, is it a bubble?

An asset bubble of any kind will be a significant and sustained period of trading where the market valuation of the asset appears to be based on something other than reasonable or ‘fundamental’ analysis. Which is to say that it’s become inflated by something else, like emotion, or hope, or intervention by a deity.

If it looks overvalued, then it probably is.

But we can’t really be certain that it’s a bubble, at least not until later, when with the benefit of hindsight it suddenly becomes obvious.

If history is any guide, the longer it lasts – and it is already quite a long time – the sooner will come the correction. Of course we are in the business of making history, and we collectively pull at least some of the strings.

Aussies like to own their own homes, even when it doesn’t make much sense to do so. But then again we’ve only been Aussies since 1901. And whilst a lot has happened between then and now, it’s not a long time, really.

We simply aren’t the people we were at Federation, or even the people we thought we were. We’ve changed.

We’ve also grown, and upgraded our social and economic make up and attitudes in the process. We’ve gone through an agricultural phase or 2, and a mining boom or 2 as well. And wars. And immigration. And the rest.

It may be that the post-WWII economic boom (and bust) that saw us build on lots of quarter-acre blocks in the ‘burbs makes less sense to many of us now. We may have some growing doubts, especially when we get stuck on grid-locked roads or are packed into train carriages like sardines.

Maybe we are simply more diverse, even more flexible, and won’t necessarily chase that home-owning dream forever. Perhaps this is all a dream.

Perhaps it’s only the economic incentives, like the capital gains and new home owners grants, the negative gearing and the political and media spin that keeps it all alive and kicking.

Oh yeah, and the building trade and the home furnishing juggernaut, too. And the banks, the insurers and the real estate agents, of course.

They all have an interest here.

Take away any part of that post-war economic construction ethos, that “Australia unlimited” and “populate or perish” mindset, and it might all fall apart.

We may even have been lulled into a false sense of security by 25 consecutive years of economic growth, too. How long can we actually get it so right?

But still, we all have to live somewhere. And currently lots of us like to own homes. As long as that desire persists, we’ll be OK.

Or will we?

Things like wars and economic booms and busts tend to have outside influences, too. How we respond to these external events matters. Handled well, we push through and get by. Handled badly and we get social and economic stagnation, or recession. Or worse.

Confidence is up there as a factor as well. Undermine confidence and you negatively influence the buying and selling of everything.

So yeah, it’s multi-factorial and interdependent.

We could just be waiting for the next trigger. How soon that arrives is anyone’s guess, although coupling a pending Trump Presidency with a slowly arriving Brexit suggests something of an impending trigger or 2.

But a property bubble, if one exists, doesn’t have to burst.

It could just level off and let us (and all of our other economic indicators) catch up.

Or it could deflate, perhaps in a series of smaller ‘corrections’.

Or it could just keep on growing.

To continue growing would be wildly optimistic, however, and would open up some clear gaps between property haves and have-nots. (Oh, too late, we’ve already done that.)

Leveling-off or a controlled deflation sound like good options. And they are do-able, too.

The Federal government and the Reserve Bank have the necessary levers, they just need, respectively, the political will and the necessary courage to use them.

But given all of the vested interests (like the financiers, the insurers and the real estate agents, let alone the property owners themselves), it’s unlikely that any sort of significant control will occur. At least, not until it becomes really, really obvious to everyone that something has to happen.

If a Government did make a move to reform negative gearing or to do whatever it takes, they’d be risking their very existence. So it just won’t happen; not in any meaningful way, anyway. Too little, too late is more likely.

Rather it will only take a trigger of some sort, like world-wide stagflation exported from a collapsing world economic power, perhaps one turning inwards and ramping up protectionism, to burst our bubble for us.

How far we fall would then depend on the scale and timeliness of any reaction.

On the other hand, we have been expecting the Aussie property bubble to burst for at least the last 4 years, and it just hasn’t. Actually I think we first started thinking about a downturn around 2003.

And yet here we are, still wondering and waiting.

Could it be a Magic Pudding?

We even made it through the Global Financial crisis of 2007–2008, although much of that is down to the then Rudd Labor government’s good sense in acting fast and going big with targeted spending. Of course they got other things wrong, like cutting taxes even when they knew they shouldn’t. But governments make bad choices sometimes. We all do.

Government stimulus is one side of it, propping up the market and keeping people employed. But we had also learned some lessons from our earlier experiences, opening up and ‘modernising’ the economy with some key reforms, like strengthening our banks against such economic shocks.

It all helped, but will it continue to help us?

History tells us that any bubble will burst, unless we do something to stop it. Generally it’s better to stop it earlier rather than later.

Unless we have become so wise to everything that it no longer matters how long it grows or how big it gets.

Does it even exist?

Philip Soos and Lindsay David from LF Economics have a wonderful chart pack on the supposed bubble, and they made a handy submission to the sadly lapsed Inquiry into Home Ownership as well (from which I have cribbed the following graph).

To quote Lindsay and Philip (from their submission), “Since 1996, prices have outpaced inflation, incomes, rents and GDP… the Australian housing market shares similarities with countries that experienced real estate bubbles, such as the United States, Spain, Denmark, the Netherlands and Ireland”.

Certainly the data supports the bubble proposition. Even if all you did was draw a mean trend line from the end of the post war boom, around 1952 or so, to 1996, you can see that something has happened since then. Even allowing for a recent dip just outside scope of the graphic, we remain waaay above trend.

It looks like a bubble. A big one, too.

Their submission goes on to say that “Australia’s economic history demonstrates (that property bubbles) occurred during the 1830s, 1880s, 1920s, mid-1970s and late 1980s. The bursting of these bubbles invariably caused economic recessions and depressions. Contrary to the analyses of the vested interests, the data clearly establishes Australia is in the midst of the largest housing bubble on record”.

So the history looks compelling, and the current bubble is the worst we’ve ever seen. If it really is a bubble, of course. It may just be that we live in the best of times, in terms of housing assets. Or again, we are dreaming.

History is of course open to interpretation. Although we had falls, it must be said that we have bounced back every time. So far.

There were significant house price booms from around 1971 to 1974, from 1980 to 1981 and again (the one I remember personally) from around 1988 to 1989; after which the real price of housing fell. However, in the longer term real price rises were greater than the falls, resulting in an overall rise. And it was quite a worthwhile rise, if you had hung onto your property throughout the dips.

Not everyone could hang on, though. Each dip hurt.

And in terms of scale, the boom from 1996 to 2015, at least, is the longest and the biggest of them all.

Given Australia’s 25-year-and-counting streak of economic growth, it makes some sense that we have converted some of that stability into bricks-and-mortar “value”. The market even appears to have taken off again after a short pause.

But is our confidence misplaced?

So what does it all mean?

Let’s assume that some sort of correction will occur and we’ll drop down towards the mean sometime soon. That seems more likely than assuming that a ‘magic pudding’ effect is in play.

It all comes down to timing, then, and the individuals and the pain they will feel.

I lived through the “recession we had to have” and survived. But I was young, single and fairly employable. It still hurt. Immediately before the Aussie economy went pear-shaped, it went weird. I was paying an unsustainable 18% – yes, 18%! – on my mortgage at the time (the cash rate peaked at about 15%) and decided to take advantage of the then housing “boom” in prices to cash in before the impending crash hit.

But I only just made it out of the market in time. Whilst the overall drop may have averaged just 10% or so, many individuals faced 20% or greater falls in real prices. And it took a further 6 years or so to see any real recovery.

And yes, we all learned from that period. We renovated and hardened our economy as well as the banks. But just look at that graph again and ask, ‘have we done enough to survive an even bigger hit?’.

The trigger could be months or even years away.

And the impact will reflect upon individual circumstances as well as questions of scale, timing and exposure.

Or it could just be a magic pudding after all.

Further reading:

The history of Australian property values

Early 1990s recession in Australia – Wikipedia

Housing market ‘bloodbath’ a near certainty

Timeline of the United States housing bubble – Wikipedia

Robert Russell’s answer to Why can’t Australia, which is a democracy, tackle the property price problem?

Robert Russell’s answer to What will be the effect of a Trump presidency on the Australian economy?