housepricesbanksharespartii

7/31/2019 HousePricesBankSharesPartII

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SteveKeensDebtwatch HousePricesandtheBanksPartII April11th2011

www.debtdeflation.com/blogs Page1

This Time Had Better Be Different:

House Prices and the Banks Part 2

Figure1

InlastweekspostIshowedthatthereisadebtfinanced,governmentsponsoredbubbleinAustralian

houseprices(clickhereandhereforearlierinstallmentsonthesametopic).ThisweekIllconsiderwhat

theburstingofthisbubblecouldmeanforthebanksthathavefinancedit.

Fortwodecadesafterthe1987StockMarketCrash,bankshavelivedbytheadageassafeashouses.

Mortgagelendingsurpassedbusinesslendingin1993,andeversincethenitsbeenontheupandup.

Businesslendingactuallyfellduringthe1990srecession,andtookoffagainonlyin2006,whenthe

Chinaboomandtheleveragedbuyoutfrenzybegan.

1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 20200

100

200

300

400

500

CPI-deflated Bank Share Index

Real House Prices

CPI-deflated All Ordinaries

Bank Shares and House Prices 1880-2011

Global Financial Database AUABIIM + ASX Financials; Nigel Stapledon House Price Index + ABS; Yahoo Financ

Index1880=100(1997=100f

orAllOrds)


2/39



Figure2

RegularreaderswillknowthatIplacetheresponsibilityforthisincreaseindebtonthefinancialsector

itself,nottheborrowers.Thebankingsectormakesmoneybycreatingdebtandthushasaninherent

desiretopumpoutasmuchaspossible.TheeasiestwaytodothisistoenticethepublicintoPonzi

Schemes,because

then

borrowing

can

be

de

coupled

from

income.

Theresaminorverificationofmyperspectiveinthisdata,sincetheonesegmentofdebtthathasnt

risencomparedtoGDPispersonaldebtwheretheincomeoftheborrowerisaseriousconstrainton

howmuchdebttheborrowerwilltakeon.Asmuchasbankshavefloggedcreditcards,personaldebt

hasntincreasedasapercentageofGDP.

Ontheotherhand,mortgagedebthasrisensevenfold(comparedtoGDP)inthelasttwodecades.

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 20120

1 105

2 105

3 105

4 105

5 105

6 105

7 105

8 105

9 10

5

1 106

Real Estate

PersonalCommercial

Bank Loans Australia

RBA Sheet B02

$million


3/39



Figure3

ThepostGFCperiodinAustraliahasseenafurtherincreaseinthebankingsectorsrelianceonhome

loansduetoboththebusinesssectorsheavydeleveraginginthewakeofthecrisis,andthe

governmentsreignitingofthehousepricebubbleviatheFirstHomeVendorsBoostinlate2008.

Mortgagesnow

account

for

over

57

percent

of

the

banks

loan

books,

an

all

time

high.

1988 1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 20120

10

20

30

40

50

60

70

80

90

100

Real Estate

PersonalCommercial

Bank Loans Australia

RBA Sheet B02

$million


4/39



Figure4

Theyalsoaccountforover37%oftotalbankassetsagainanalltimehigh,andupsubstantiallyfrom

theGFCinducedlowof28.5%beforetheFirstHomeVendorsBoostreversedthefallinmortgagedebt.

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 20120

5

10

15

20

25

30

35

40

45

50

55

60

Real EstatePersonal

Commercial

Loans by Sector

Percentoftotalbankloans

FHVB


5/39



Figure5

Sohowexposedarethebankstoafallinhouseprices,andtheincreaseinnonperformingloansthat

couldarisefromthis?Thereisnowayofknowingforsurebeforehand,butcrosscountrycomparisons

andhistorycangiveaguide.

ApersistentrefrainfromthenobubblecamphasbeenthatAustraliawontsufferanythinglikeaUS

downturnfromahousepricecrash,becauseAustralianlendinghasbeenmuchmoreresponsiblethan

Americanlendingwas.Itookaswipeatthatinlastweekspost,withachartshowingthatAustralias

mortgagedebttoGDPratioexceedstheUSAs,andgrewthreetimesmorerapidlythandidAmerican

mortgagedebtsince1990(seeFigure13ofthatpost).

Similardata,thistimeseenfromthepointofviewofbankassets,isshowninthenexttwocharts.Real

estateloansareahigherproportionofAustralianbankloansthanforUSbanks,andtheirrisein

significanceinAustraliawasfarfasterandsharperthanfortheUSA.

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 20120

5

10

15

20

25

30

35

40

Real EstatePersonal

Commercial

Loans by Sector

Percentoftotalbankassets

FHVB


6/39



Figure6

Moresignificantly,realestateloansareahigherproportionofbankassetsinAustraliathanintheUSA,

andthisappliedthroughouttheSubprimeEraintheUSA.ThecrucialroleoftheFirstHomeVendors

Boostinreversingthefallinthebanksdependenceonrealestateloansisalsostrikinglyapparent.

1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 201520

25

30

35

40

45

50

55

60

Australia

USA

Real Estate Loans Percent of All Loans

Perc

entofCommercialBankLoans


7/39



Figure7

ThenobubblecasedismissesthisAustraliaUScomparisonontwogrounds:

most of Australias housing loans are to wealthier households, who are therefore morelikely to be able to service the debts so long as they remain employed; and

housing loans here are full-recourse, so that home owners put paying the mortgage aheadof all other considerations..

Bloxhammadetheformerclaiminhisrecentpiece:

However, there are other reasons why levels of household debt should not be a large

concern. The key one is that 75 per cent of all household debt in Australia is held by the top

two-fifths of income earners. (Paul Bloxham , The Australian housing bubble furphy, Business

Spectator March 18 2011)

Alan

Kohler

recounted

an

interesting

conversation

with

one

of

Australias

top

retail

bankers

a

couple

ofyearsagoonthelatterpoint:

There is some 'mortgage stress' in the northern suburbs of Melbourne, the western suburbs

of Sydney and some parts of Brisbane, but while all the banks are bracing themselves for it and

increasing general provisions, there is no sign yet of the defaults that are bringing the US

banking system to its knees.

1970 1975 1980 1985 1990 1995 2000 2005 2010 201510

15

20

25

30

35

40

Australia

USA

Real Estate Loans Percent of Assets

Perc

entofCommercialBankLoans

FHVB


8/39



We often see graphs showing that Australias ratios of household debt to GDP and debt to

household income had gone up more than in the United States. So, while the US is deep into a

mortgage-based financial crisis, it is surely a cause for celebration that Australia has not seen

even the slightest uptick in arrears.

Please explain, I said to my dinner companion. Obviously, low unemployment and robust

national income, including strong retail sales until recently, have been the most important part of

it. But on the other hand, the US economy was doing okay until the mortgage bust happened; it

was the sub-prime crisis that busted the US economy, not the other way around.

Apart from that it is down to two things, he says: within the banks, sales did not gain

ascendancy over credit in Australia to the extent that it did in the US; and US mortgages are

non-recourse whereas banks in Australia can have full recourse to the borrowers' other assets,

which means borrowers are less inclined to just walk away. (Alan Kohler, Healthy by default,Business Spectator August 21, 2008; emphases added)

KrisSaycegaveagoodcomebacktoBloxhamsmostofthedebtisheldbythosewhocanafforditline

whenhenotedthattwofifthsofincomeearnersisquitealargepoolofpeople:

In fact, its nearly half the income earners. Is that number any different to any other

economy? Youd naturally think the higher income earners would have most of the debt

because theyre the ones more likely to want it, need it or be offered it.

So with about 11.4 million Australians employed, that makes for about 4.6 million Australians

holding over $1.125 trillion of household debt remember total household debt is about $1.5

trillion. That comes to about $244,565 per person.

Perhaps were not very bright. But were struggling to see how that makes the popping of

the housing bubble a virtual impossibility. (Kris Sayce, Are Falling House Prices Virtually

Impossible?, Money Morning 18 March 2011)

ThebestcomebackstoAlanKohlersdinnercompanionmaywellbetimeitself.Impairedassets1didhit

analltimelowof4.1%ofBankTier1Assetsand0.2%oftotalassetsinJanuary2008,butbythetime

Kohlerandhisbankersatdowntodinner,impairment wasontheriseagain.Impairedassetshavesince

reachedaplateau

of

25%

of

Tier

1capital

and

1.25%

of

total

assetsand

this

has

occurred

while

house

priceswerestillrising.Despitethepressurethatfullrecourselendingputsonborrowers,thisis

comparabletothelevelofimpairedassetsinUSbanksbeforehousepricescollapsedwhenthe

SubPrimeBoomturnedintotheSubPrimeCrisis(seeTable2onpage10ofthispaper).


9/39



Figure8

Sincerealestateloansareworthroughly7timesbankTier1capitalupfromonly2timesin1990it

wouldnttakemuchofanincreaseinnonperforminghousingloanstopushAustralianbankstothelevel

ofimpairmentexperiencedbyAmericanbanksin2007and2008.

1994 1996 1998 2000 2002 2004 2006 2008 2010 20120

10

20

30

40

50

0

1

2

3

4

5

Percent of Tier 1 Assets

Percent of Total Assets

Impaired Assets

RBA Table B05

PercentofTier1Capital

Percentoftotalassets


10/39



Figure9

ThelevelandimportanceofnonrecourselendingintheUSisalsoexaggerated.Whilesomemajor

Stateshaveit,manydonotandoneoftheworstperformingstatesinandsincetheSubprimeCrisis

wasFlorida,whichhasfullrecourselending.

Finally,

the

never

mind

the

weight,

feel

the

distribution

defence

of

the

absolute

mortgage

debt

level

hasanegativeimplicationfortheAustralianeconomy:ifdebtismorebroadlydistributedinAustralia

thanintheUSA,thenthenegativeeffectsofdebtserviceonconsumptionlevelsarelikelytobegreater

herethaninAmerica.Thisisespeciallysosincemortgageratestodayare50%higherherethaninthe

USA.InterestpaymentsonmortgagedebtinAustralianowrepresent6.7%ofGDP,twiceasmuchasin

theUSA.ItslittlewonderthatAustraliasretailersarecryingpoor.

Ofcourse,theRBAcouldalwaysreducethedebtrepaymentpressurebyreducingthecashrate.But

withthemarginbetweenthecashrateandmortgagesnowbeingabout3%,itwouldneedtoreducethe

cashrateto1.5%toreducethedebtrepaymentburdeninAustraliatothesamelevelasAmericas.

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 20120

100

200

300

400

500

600

700

800

Real Estate

PersonalCommercial

Loans as percent of Tier 1 Capital


11/39



Figure10

SoifAmericasconsumersaredebtconstrainedintheirspending,Australianconsumersareevenmore

sowithnegativeimplicationsforemploymentintheretailsector.

ComparedtotheUSAtherefore,thereisnoreasontoexpectthatAustralianbankswillfarebetterfrom

a

sustained

fall

in

house

prices.

What

about

the

comparison

with

past

financial

crises

in

Australia?

Thereareatleastthreewaysinwhichwhatevermighthappeninthenearfuturewilldifferfromthe

past:

On the attenuating side, deposit insurance, which was only implicit or limited in the past,is much more established now; and

If the banks face insolvency, the Government and Reserve Bank will bail them out as theUS Government and Federal Reserve didthough lets hope without also bailing out the

management, shareholders and bondholders, as in the USA (if you havent seen Inside

Job yet, see it);2

Onthenegativeside,however,wehavetheBigTrifecta:

The bubbles in debt, housing and bank stocks are far bigger this time than any previouseventincluding the Melbourne Land Boom and Bust that triggered the 1890s

Depression.

1975 1980 1985 1990 1995 2000 2005 2010 20150

1

2

3

4

5

6

7

8

Australia

USA

Interest payments on mortgages

PercentofGDP


12/39



Illmakesomestatisticalcomparisonsovertheverylongterm,butthemainfocushereisonseveral

periodswhenhousepricesfellsubstantiallyinrealtermsafteraprecedingboom,andwhathappenedto

bankshareswhenhousepricesfell:

The 1880s-1890s, when the Melbourne Land Boom busted and caused the 1890sDepression;

The 1920s till early 1930s, when the Roaring Twenties gave way to the GreatDepression;

The early to mid-1970s, when a speculative bubble in Sydney real estate caused a rapidacceleration in private debt, and a temporary fall in private debt compared to GDP due to

rampant inflation;

The late 1980s to early 1990s, when the Stock Market Crash was followed by aspeculative bubble in real estatestoked by the second incarnation of the First HomeVendors Boost; and

From 1997 till now.Ichosethefirstfourperiodsfortworeasons:theyweretimeswhenhousepricesfellinreal(andonthe

firsttwo

occasions,

also

nominal)

terms,

and

bank

share

prices

suffered

asubstantial

fall;

and

they

also

standoutasperiodswhenanaccelerationindebtcausedaboomthatgavewaytoadeleveragedriven

slump,whenprivatedebtreachedeitheralongtermorshorttermpeak(comparedtoGDP)andfell

afterwards.TheyareobviousinthegraphofAustraliaslongtermprivatedebttoGDPratio.

Figure11

1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 20200

10

2030

40

50

60

70

80

90

100

110

120

130

140

150

160

Australia's long term private debt to GDP ratio

Fisher & Kent 1999; RBA Historical Data; Tables D02, G12

PercentofGDP


13/39



TheyalsoturnupassignificantspikesintheCreditImpulse(Biggs,Mayeretal.2010)theacceleration

ofdebt(dividedbyGDP)whichdeterminesthecontributionthatdebtmakestochangesinaggregate

demand.3

TheCreditImpulsedataalsoletsusdistinguishthepreWWIImorelaissezfaireperiodfromthe

regulatedone

that

followed

it:

credit

was

much

more

volatile

in

the

pre

WWII

period,

but

the

trend

valueoftheCreditImpulsewasonlyslightlyabovezeroat0.1%.

Figure12

ThePostWWIIperiodhadmuchlessvolatilityinthedebtfinancedcomponentofchangesinaggregate

demand,buttheoveralltrendwasfarhigherat0.6%.Thiscouldbepartoftheexplanationastowhy

PostWWIIeconomicperformancehasbeenlessvolatilethanpreWWII,butitalsoindicatesthatrising

debthasplayedmoreofaroleindrivingdemandinthepostWarperiodthanbefore.

Ominouslytoo,eventhoughthepostWWIIperiodingeneralhasbeenlessvolatile,thenegativeimpact

oftheCreditImpulseinthisdownturnwasfargreaterthanineitherthe1890sorthe1930s.

1860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910 1915 1920 1925 1930 1935 194015

10

5

0

5

10

15

Impulse

Mean (0.1 %)

Credit Impulse in Australia 1860-1940

PercentofGDP

0

1893 1931


14/39



Figure13

OnefinalfactorthatalsoseparatesthepreWWIIdatafrompostWWIIistherateofinflation.The1890s

and1930sdebtbubblesburstatatimeoflowinflation,andrapidlygavewaytodeflation.Thisactually

drovethedebtratiohigherinthefirstinstance,asthefallinpricesexceededthefallindebt.But

ultimatelythosedebtswerereducedinatimeoflowinflation.

The1970sepisode,ontheotherhand,wascharacterizedbyrampantinflationandthedebtratiofell

becauserisingpricesreducedtheeffectivedebtburden.Whereasthefallsinrealhousepricesinthe

1890sandthe1930sthereforemeantthatnominalpriceswerefallingevenfaster,the1970sfallinreal

housepricesmainlyreflectedconsumerpriceinflationoutstrippinghousepricegrowth.The1990

bubblealsoburstwheninflationwasstillsubstantial,thoughfarlowerthanitwasinthemid1970s.

TodaysinflationstoryhasmoreincommonwiththepreWWIIworldthanthe1970s.Ourcurrent

bubbleisburstinginalowinflationenvironment.

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 201515

10

5

0

5

10

15

Impulse

Mean (0.6 %)

Credit Impulse in Australia 1955-Now

PercentofGDP

0

1975 1992


15/39



Figure14

Nowletsseewhathistorytellsusabouttheimpactoffallinghousepricesonbankshares.

The1880s1890s

ThiswasthebankbusttoendallbankbustsjustlikeWWIwastheWartoendallwars.Bankshares

increased

by

over

75%

in

real

terms

as

speculative

lending

financed

a

land

bubble

in

Melbourne

that

increasedrealhousepricesby33%.4Theroleofdebtindrivingthisbubbleandthesubsequent

Depressionisunmistakable:privatedebtrosefromunder30%ofGDPin1872toover100%in1892,and

thenunwoundoverthenext3decadestoalowof40%in1925.

Theturnaroundindebtandthecollapseinhousepricesprecipitateda50%fallinbanksharesinless

thansixmonthsashousepricesstartedtofallbacktobelowthepreboomlevel.

1860 1870 1880 1890 1900 1910 1920 1930 1940 1950 1960 1970 1980 1990 2000 2010 202015

10

5

0

5

10

15

20

25

30

Annual

SmoothedMean (2.78%)

Australian inflation rate

Percent

0


16/39



Figure15

TheexcellentRBAResearchpaperTwoDepressions,OneBankingCollapsebyChayFisher&

ChristopherKent(RDP199906)arguesfairlyconvincinglythatthe1890sDepressionwasamoresevere

DepressionforAustraliathantheGreatonemainlybecausethereweremorebankfailuresinthe

1890sthaninthe1930s.Theseverityofthe1890sfallinbanksharesmayrelatetothehigherlevelof

debtin

1890

than

in

the

1930sa

peak

of

104

percent

of

GDP

in

1892

versus

only

76

percent

in

1932

(thepeakthistimeroundwas157percentinMarch2008).

Thecorrelationofthetwoseriesinabsolutetermsisobvious(thecorrelationcoefficientis0.8),andthe

changesinthetwoseriesarealsostronglycorrelated(0.42).

1886 1887 1888 1889 1890 1891 1892 1893 1894 1895 189660

70

80

90

100

110

120

130

140

150

160

170

180

190

200

CPI-deflated Bank Shares

Real House Prices

Bank Shares and House Prices

IndexFirstYear=100

100


17/39



Figure16

The1920s1940s

The1920sbeganwiththeendofthegreatdeleveragingthathadcommencedin1892.Realhouseprices

rosebyabout25percentinthefirsttwoyearsthoughmainlybecauseofdeflationinconsumer

pricesandthenfluctuateddownforthenextfouryearsbeforeaminorboom.Butthemaindebt

financedbubble

in

the

1920s

was

in

the

Stock

Market.

1886 1887 1888 1889 1890 1891 1892 1893 1894 1895 189675

60

45

30

15

0

15

30

45

60

75

25

20

15

10

5

0

5

10

15

20

25


Real House Prices

Change in Bank Shares and House Prices

Chan

geinCPI-deflatedBankShares

Chan

geinCPI-deflatedHousePrices

0


18/39



Figure17

Therewashoweverstillacrashinbanksharesafterhousepricesturnedsouthinearly1929.Itwasnot

assevereasin1893,andofcoursecoincidedwithacollapseinthegeneralstockmarket(Icantgive

comparablefiguresbecauseofthedifferentmethodsusedtocompilethetwoindicesseethe

Appendix).Butstilltherewasafallof24%inbanksharesover7monthsatitssteepest,anda39%fall

frompeak

to

troughpreceded

by

a25%

fall

in

house

prices.

1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 194050

100

150

200

250

300

350

400

CPI-deflated Share Accumulation Index

Real House Prices

All shares Shares and House Prices

IndexFirstYear=100

100


19/39



Figure18

Banksharesalsotrackedhousepricesoverthe20yearsfromtheRoaringTwentiesboomtothe

beginningofWWII:thecorrelationwas0.44fortheindices,and0.47forthechangeintheindices.

1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 194070

80

90

100

110

120

130

140

150


Real House Prices


Index1888=100

100


20/39



Figure19

The1970sbubblewasthelastgaspofthelongperiodofrobustyettranquilgrowththathad

characterizedtheearlypostWWIIperiod.Thepeculiarmacroeconomicsofthetimethestartof

Stagflationcloudsthehousepricebubblepicturesomewhat(IdiscussthisintheAppendix),but

therestill

was

abig

house

price

bubble

then,

and

abig

hit

to

bank

shares

when

it

ended.

ThiswasAustraliasfirstreallybigdebtfinancedspeculativebubble,whichmostcommentatorsand

economistsseemtohaveforgottenentirely.ItsflavoriswellcapturedintheintroductiontoSydney

Boom,SydneyBust:

Sydney had never experienced a property boom on the scale of that between 1968 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

financial 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 for Australia.(Daly 1982, p. 1)

1920 1922 1924 1926 1928 1930 1932 1934 1936 1938 194075

60

45

30

15

0

15

30

45

60

75

25

20

15

10

5

0

5

10

15

20

25


Real House Prices


Chan


Chan


0


21/39



Housepricesrose40percentinrealtermsfrom1967till1974,andthenfell16percentfrom1974till

1980.Bankshareswentthrougharollercoasterride,followingPoseidonupanddownfrom1967till

1970,andthenrisingsharplyasthedebtbubbletookoffin1972,witha31percentrisebetweenlate

1972andearly1973.Butfromthereitwasalldownhill,withbanksharesfalling35percentacross1973

whilehousepriceswerestillrising.

Butwhenhousepricesstartedtofall,banksharesreallytanked,falling54percentinjustsevenmonth

during1974.

Figure20

However,theextremevolatilityofbothassetandcommodityprices,andtheimpactoftwoshare

bubblesandbuststhePoseidonBubbleofthelate1960sandtheearly1970sboomandbust

eliminatedthecorrelationofbanksharepricestohousepricesthatappliedinthe1890sand1930s:the

correlationoftheindiceswas 0.46andofchangesintheindiceswas 0.01.

1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 198040

50

60

70

80

90

100

110

120

130

140

150

160

170


Real House Prices


IndexStart=100

100


22/39



Figure21

Therecessionwehadtohaveremainsunforgettable.ThatplungebeganwithAustraliassecondbig

postWWIIspeculativebubble,asBond,Skase,Connellandaseeminglylimitlesscastofwhiteshoe

brigadersestablishedthelocalIvanBoeskyGreedisGoodchurchwithbankseagerlythrowing

moneyand

debt

into

its

tithing

box.

ItwouldhaveallendedwiththeStockMarketCrashof1987,wereitnotforthegovernmentrescues

(bothhereandintheUSA)thatenabledthespeculatorsandthebankstoregroupandthrowtheirpaper

weightintorealestate.

1967 1968 1969 1970 1971 1972 1973 1974 1975 1976 1977 1978 1979 198075

60

45

30

15

0

15

30

45

60

75

25

20

15

10

5

0

5

10

15

20

25


Real House Prices


Chan


Chan


0


23/39



Figure22

Havingplunged30percentinonemonth(October,ofcourse),banksharesrocketedupagain,climbingastaggering54percentin11monthstoreachanewpeakinOctober1988,asspeculatorsandthesecond

incarnationoftheFirstHomeVendorsGrantdrovehousepricesup37percentoverjustoneandahalf

years.Banksharesbouncedaroundforawhile,but oncethedeclineinhousepricessetin,bankshares

againtankedfalling

40

percent

over

11

months

in

1990.

1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 199225

30

35

40

45

50

55

Business Debt to GDP

Percent


24/39



Figure23

Thepositivecorrelationsbetweentheindicesandtheirratesofchangewhichhadbeenswampedbythe

highinflationoftheearly1970sreturned:thecorrelationoftheindiceswas0.45andthecorrelationof

theirratesofchangewas0.42.

1985 1986 1987 1988 1989 1990 1991 199290

95

100

105

110

115

120

125

130

135

140

145

150

155

160

165

170


Real House Prices


IndexStart=100

100


25/39



Figure24

Whichbringsustotoday.

Ihavearguedelsewherethatthecurrentbubblebeganin1997,butthedebtfinancethatfinallysetit

offbegan

far

earlierin

1990.

The

fact

that

unemployment

was

exploding

from

under

6percent

in

early

1990toalmost11percentinearly1994wasnot,itseems,areasontoberestrainedinlendingtothe

householdsector.Itwasfarmoreimportanttoexpandthemarketingofdebt,andsincethebusiness

sectorcouldnolongerbepersuadedtotakemoreon,thevirginfieldofthehouseholdsectorhadtobe

explored.Mortgagedebt,whichhadflatlinedatabout16percentofGDPsincerecordswerefirstkept,

tookoff,increasingby50percentduringthe1990srecession(from1990tillthestartof1994),and

ultimatelyrisingby360percentoverthetwodecadesfrom19percentofGDPto88percentwiththe

finalflingoftheFirstHomeVendorsBoostgivingitthatfinalpushintothestratosphere.

1985 1986 1987 1988 1989 1990 1991 199275

60

45

30

15

0

15

30

45

60

75

30

24

18

12

6

0

6

12

18

24

30


Real House Prices


Chan


Chan


0


26/39



Figure25

By1997thesheerpressureofrisingmortgagefinancebroughttoanendaperiodofflatlininghouse

prices,andthebubblesinbothhousepricesandbanksharestookoffinearnest.

Theriseinbanksharesfaroutweighedtheincreaseintheoverallshareindex.5Banksharesrose230

percent

from

1997

till

their

peak

in

2007,

versus

a

rise

of

only

110

percent

in

the

overall

market

index.

Theincreaseinhousepricesalsodwarfedanypreviousbubble:anincreaseofover120percentover

fifteenyears.

BanksharesandhousepricesbothtankedwhentheGFChit:housepricesfell9percentandbankshares

fell61percent.ButthankfullythecavalryrodetotherescueintheshapeoftheFirstHomeVendors

Boostandbothhousepricesandbanksharestookoffagain.Housepricesrose17percentwhilebank

sharesrose60percent(versusa45percentriseinthemarket)beforefalling12percentaftertheexpiry

oftheFHVB.

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 201215

20

25

30

35

40

45

50

55

60

65

70

75

80

85

90

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

BusinessMortgage

Unemployment

Debt to GDP

PercentofGDP

PercentofWorkforce

FHVB


27/39



Figure26

Thecorrelationbetweenbanksharesandhousepricesisagainpositive: 0.51fortheindicesandalow

0.1forthechangeinindicesoverthewholeperiod,but0.46since2005.

1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 201290

100110120130140150

160170180190200210220230240250260270280290300310320

330340350


Real House PricesCPI-deflated All Ordinaries


IndexStart=100

100

FHVB


28/39



Figure27

Sonowweareontheedgeoftheburstinganotherhousepricebubble.Whatcouldthefuturebring?

Thereareseveralconsistentpatternsthatcanbeseeninthepastdata.

Firstly,housepricesandbanksharesarecorrelated.Therewasoneaberrationthe1970sbutthat

wasmarkedbypeculiardynamicsarisingfromthehistoricallyhighinflationatthetime.Generally,bank

sharesgoupwhenhousepricesrise,andfallwhenthefall.Partly,thisisthegeneralcorrelationofasset

priceswitheachother,butpartlyalsoitsthecausalrelationshipbetweenbanklending,houseprices,

andbankprofits:banksmakemoneybycreatingdebt,risingmortgagedebtcauseshousepricestorise,

andrisinghousepricessetoffthePonziSchemethatencouragesmoremortgageborrowing.Thebubble

burstswhentheentrypricetothePonziSchemebecomesprohibitive,orwhenearlyentrantstrytotake

theirprofitsandrun.

Secondly,thefallinthebanksharepriceisnormallyverysteep,anditoccursshortlyafterhouseprices

havepassedtheirpeaks.Holdingbankshareswhenhousepricesarefallingisagoodwaytolose

moneyandconversely,ifyougetthetimingright,bettingagainstthemcanbeprofitable.Thatswhy

JeremyGranthamandmanyotherhedgefundmanagersfromaroundtheworldarepayingclose

attentiontoAustralianhouseprices.

Thirdly,housepricesandbanksharesaredrivenbyrisingdebt,andwhendebtstartstofall,notonlydo

housepricesandbanksharesfall,theeconomyalsonormallyfallsintoaverydeeprecessionor

19971998199920002001 20022003200420052006 20072008200920102011 201275

60

45

30

15

0

15

30

45

60

75

30

24

18

12

6

0

6

12

18

24

30


Real House Prices


Chan


Chan


0


29/39



Depression.Thisisthecrucialroleofdeleveragingincausingeconomicdownturns,includingtheserious

oneswheredebtfallsnotjustduringashortcyclepriortoanotherupwardtrend,butinanextended

seculardecline.

Thereisalsoonecautionarynoteaboutthecurrentbubble:thoughhistorywouldimplythatthereisa

verylarge

downside

to

bank

shares

now,

its

also

obvious

that

bank

shares

fell

agreat

deal

in

2007

09,

sothatmuchofthedownsidemayalreadyhavebeenfactoredin.

However,oneverymetric:ontheratioofdebttoGDP,onhowmuchthatratiorosefromthestartof

thebubbletoitsend,onhowbigthehousepricebubblewas,andonhowmuchbanksharesrose,this

bubbledwarfsthemall.

DebttoGDP

The1997debttoGDPratiostartedhigherthanallbutthe1890sbubbleended,andthebubblewenton

longafteralltheothershadpopped.

Figure28

ThoughtheactualdebttoGDPratiotodaydwarfsallitspredecessors,intermsofthegrowthofdebt

fromthebeginningofthebubble,ithasonerival:the1920s.

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1520

30

40

50

60

70

80

90

100

110

120

130

140

150

160

1886

1920

1967

1985

1997

Debt to GDP from Start of Bubble to End

Years since start

PercentofGDP


30/39



Figure29

HoweverthisispartlybecauseofdeflationduringtheearlyGreatDepression:deflationruledfrom1930

till1934,andthedebttoGDPratiorosenotbecauseofrisingdebt,butfallingprices.Thoughthe

increaseindebtinthefinalthroesoftheRoaringTwentieswasfasterthanweexperienced,overthe

wholeboom

debt

grew

as

quickly

now

as

then,

and

it

has

kept

growing

for

four

years

longer

than

in

the

1920s.Eventhoughtheratioisfallingnow,itsbecausedebtisnowrisingmoreslowlythannominal

GDP:westillhaventexperienceddeleveragingyet(unliketheUSA).

HousePrices

Theriseinpricesduringthisbubbleagainhasnoequalinthehistoricalrecord.

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 2090

100

110

120

130

140

150

160

170

180

190

200

1886

19201967

1985

1997

Debt to GDP from Start of Bubble to End

Years since start

Indexstart=100


31/39



Figure30

BankShares

Banksharesarealsoinaclassoftheirowninthisbubble,evenafterthesharpfallfrom2007till2009.In

termsofhowhighbanksharepricesclimbed,thisbubbletowersoverallthathavegonebefore,and

evenwhat

is

left

of

this

bubble

is

still

only

matched

by

the

biggest

of

the

preceding

bubbles,

the

1890s

andthe1970s.

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 1580

90

100

110

120

130

140

150

160

170

180

190

200

210

220

230

240

1886

19201967

1985

1997

House Prices from Start of Bubble

Years since start

Indexstart=100


32/39



Figure31

Banklendingdrovehousepricesskyhigh,andtheprofitsbanksmadefromthisPonziSchemedragged

theirsharepricesupwiththebubble(andhandsomelylinedthepocketsoftheirmanagers).

Itsgreatfunwhileitlasts,butallPonziSchemesendforthesimplereasonthattheymust:theyarent

makingmoney,butsimplyshufflingitandgrowingdebt.Whennewentrantscantbeenticedtojoin

thegame,theshufflingstopsandtheSchemecollapsesundertheweightofaccumulateddebt.There

areverygoododdsthat,whenthisPonziSchemecollapsesandhousepricesfall,bankshareswillgo

downwiththem.

Stagflation

Between1954and1974,unemploymentaveraged1.9percent,anditonlyonceexceeded3percent(in

1961,whenagovernmentinitiatedcreditsqueezecausedarecessionthatalmostresultedinthedefeat

ofAustraliasthenLiberalgovernment,whichruledfrom1949till1972).Inflationfrom1954till1973

averaged3percent,andthenrosedramaticallybetween1973and1974asunemploymentfell.

ThisfittedthebeliefofconventionalKeynesianeconomistsofthetimethattherewasatradeoff

betweeninflationandunemployment:onecostofalowerunemploymentrate,theyargued,wasa

higherrateofinflation.

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 150

20

40

60

80

100

120

140

160

180

200

220

240

260

280300

320

340

1886

19201967

1985

1997

Bank Shares from Start of Bubble

Years since start

Indexstart=100


33/39



Butthenthesocalledstagflationarybreakdownoccurred:unemploymentandinflationbothrosein

1974.NeoclassicaleconomistsblamedthisonKeynesianeconomicpolicy,whichtheyarguedcaused

peoplesexpectationsofinflationtorisethusresultingindemandsforhigherwagesandOPECsoil

pricehike.

Figure32

Thelatterargumentiseasilyrefutedbycheckingthedata:inflationtookoffwellbeforeOPECsprice

hike.

1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 19800

1

2

3

4

5

6

7

89

10

11

12

13

14

15

16

17

18

19

20

0

10

20

30

40

50

Inflation

Unemployment

Debt

Percentp.a.

PercentofGDP


34/39



Figure33

Theformerhassomecredenceasanexplanationforthetakeoffintheinflationrateworkerswere

factoringinboththebargainingpoweroflowunemploymentandalaggedresponsetorisinginflation

intotheirwagedemands.

1954 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 19800

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

1718

19

20

0

1

2

3

4

5

6

7

8

9

10

11

12

13

14

15

16

1718

19

20

Inflation Rate

Oil Price

Oil Price

Global Financial Database

Percentp.a.

Dollarsp.b.

WestTexasIntermediateC

rude


35/39



Figure34

TheNeoclassicalexplanationforwhythisriseininflationalsocoincidedwithrisingunemploymentwas

KeynesianpolicyhadkeptunemploymentbelowitsNaturalrate,anditwasmerelyreturningtothis

level. ThiswasplausibleenoughtoswingthepolicypendulumtowardsNeoclassicalthinkingbackthen,

butit

looks

alot

less

plausible

with

the

benefit

of

hindsight.

1970 1972 1974 1976 1978 19804

2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

3032

34

36

4

2

0

2

4

6

8

10

12

14

16

18

20

22

24

26

28

3032

34

36

Inflation

Nominal WagesReal Wages

Inflation and Change in Wages

RBA Table G06, Column I

Inflationpercentp.a.

Wagechangepercentp.a.

0


36/39



Figure35

Thoughinflationfellfairlyrapidly,andunemploymentultimatelyfellafterseveralcyclesofrising

unemployment,overtheentireNeoclassicalperiodbothinflationandunemploymentwerehigher

thantheywereundertheKeynesianperiod.Soratherthaninflationgoingdownandunemployment

goingup,asneoclassicaleconomistsexpected,bothrosewithunemploymentrisingsubstantially.On

empiricalgrounds

alone,

the

neoclassical

period

was

afailure,

even

before

the

GFC

hit.

Table1Policydominance Keynesian Neoclassical

Years 19551976 1976Now

AverageInflation 4.5 5.4

AverageUnemployment 2.1 7

Therewasafarbetterexplanationofthe1970sexperiencelurkingindataignoredbyneoclassical

economics:thelevelandrateofgrowthofprivatedebt.AsyoucanseefromFigure32,privatedebt,

whichhadbeenconstant(relativetoGDP)sincetheendofWWII,begantotakeoffin1964,andwent

througharapid

acceleration

from

1972

till

1974,

before

falling

rapidly.

Thedebtfinanceddemandforconstructionduringthatbubbleaddedtothealreadytightlabormarket,

andhelpeddrivewageshigherinbothaclassicwagepricespiralandahistoricincreaseinlaborsshare

ofnationalincomewhichhasbeenunwoundforeversince.

1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 20152

0

2

4

6

8

10

12

14

16

18

Inflation

Unemployment

Inflation and Unemployment 1955-Now

0

19761980


37/39



Figure36

Inflation,higherunemploymentthatweakenedlaborsbargainingpower,antiunionpublicpolicyand

anapproachtowagesettingpolicythatemphasizedcostoflivingadjustmentsbutignoredsharing

productivitygains,allcontributedtothatunwinding.

The

share

market

indices

Thebankshareindexusedinthispostwascompiledbycombining3datasources.Workingbackwardsin

time,thesewere:

The S&Ps ASX 200 Financials Index (AXFJ) from May 2001 till now; A composite formed from the prices for the 4 major bank share prices that matches the

value of the Financials Index from 2000 till May 2001; and

Data from the Global Financial Database from 1875 till 2000, which in turn consists ofthree series:

o "Security Prices and Yields, 1875-1955," Sydney Stock Exchange OfficialGazette, July 14, 1958, pp 257-258 (1875-1936), together with D. McL.

Lamberton, Share Price Indices in Australia, Sydney: Law Book Co., 1958; ando The Australian Stock Exchange Indices, Sydney: AASE, 1980; ando Australian Stock Exchange Limited, ASX Indices & Yields, Sydney: ASX, 1995

(updated till 2000)FromaperusaloftheGFDdocumentationandacomparisonoftheBankingandFinanceindextothe

broadermarketindex,itappearsthatthebankindexisastraightpriceindexpre1980,whereasthe

GFDsdatafortheoverallmarketisanaccumulationindextill1980andapriceindexafterthat.These

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005 2010 201552

54

56

58

60

62

64

66

68

Wages share of GDP

Percent


38/39



inconsistenciesmakeitimpossibletocomparethetwoovertheverylongterm,butthemovementsin

eachatdifferenttimeperiodscanbecompared(andthecomparisonisalsofinefrom1980on).

Figure37

Bernanke,B.S.(2000).EssaysontheGreatDepression.Princeton,PrincetonUniversityPress.

Biggs,M.,T.Mayer,etal.(2010)."CreditandEconomicRecovery:DemystifyingPhoenixMiracles."SSRN

eLibrary.

Daly,M.T.(1982).SydneyBoom,SydneyBust.Sydney,GeorgeAllenandUnwin.

Fisher,I.(1933)."TheDebtDeflationTheoryofGreatDepressions."Econometrica1(4):337357.

Krugman,P.andG.B.Eggertsson(2010).Debt,Deleveraging,andtheLiquidityTrap:AFisherMinsky

Kooapproach[2nddraft2/14/2011].NewYork,FederalReserveBankofNewYork&Princeton

University.

1 ThenotestoTableB05statethatImpairedassetsreferstotheaggregateofareportingbanksnonaccrualand

restructuredexposures,bothon andoffbalancesheet,plusanyassetsacquiredthroughtheenforcementof

securityconditions.Offbalancesheetexposuresinclude,interalia,commitmentstoprovidefundsthatcannotbe

cancelledorrevokedandthecreditequivalentamountsofinterestrate,foreignexchangeandothermarket

relatedinstruments.

1900 1950 200010

100

1000

10000

1 105

1 106

Bank Share Index

Market Index

1980


39/39


2OK,socallmeanoptimist!

3Oneofthemanyissuesthatdistinguishesmyapproachtoeconomicsfromneoclassicaleconomistsismyfocuson

therolethatchangesindebtplayinaggregatedemand.Neoclassicaleconomistswronglyignoretheroleof

aggregatelevelofdebtbecausetheyseedebtassimplyatransferofspendingpowerfromoneagenttoanother

sothatthereisnochangeinaggregatespendingpowerifdebtrises. ThisisthereasonthatBernankegavefor

ignoringFishers

debt

deflation

theory

of

the

Great

Depression

(Fisher

1933):

Fisher'sideawaslessinfluentialinacademiccircles,though,becauseofthecounterargumentthatdebtdeflation

representednomorethanaredistributionfromonegroup(debtors)toanother(creditors).Absentimplausiblylarge

differencesinmarginalspendingpropensitiesamongthegroups,itwassuggested,pureredistributionsshouldhave

nosignificantmacroeconomiceffects(Bernanke2000,p.24)

AnditstheexplicitassumptionthatKrugmanusesinhisrecentpaperontheGreatRecession:

Ignoringtheforeigncomponent,orlookingattheworldasawhole,theoveralllevelofdebtmakesnodifferenceto

aggregatenetworth oneperson'sliabilityisanotherperson'sasset.(KrugmanandEggertsson2010,p.3)

Thisshowstheirignoranceofthecapacityforthebankingsectortocreatespendingpoweroutofnothing,and

thuscreatespendingpowerintheprocess.Icoverthistopicindetailintheseposts

(http://www.debtdeflation.com/blogs/2010/09/20/deleveragingwithatwist/and

http://www.debtdeflation.com/blogs/2010/10/19/deleveragingdecelerationandthedoubledip/)4StapledonsindexcombinesSydneyandMelbourne,sothisfigureunderstatesthedegreeofriseandfallin

Melbourneprices.5Thetwoindicesarenowcomparable,whereasforthelongerseriestheywerecompiledindifferentways.

housepricesbanksharespartii

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