Housing affordability figures fudged by finance institutions by James Sinnamon 4 April 2005
Alun Breward, an industry economist for the Victorian government, has shown how the Commonwealth Bank and the AMP have misrepresented the available data in order to present a picture of good housing affordability up until late 2003. This was at a time when the direct experience of ordinary Australian homebuyers was of their dream of a secure roof over their heads, which had been attainable by their own parents, was impossibly beyond their reach.
Alun Breward's talk was first broadcast on 3rd April 2005 on ABC Radio National's Ockham's Razor radio program. The full transcript can be found here.
The article shows how claims of good housing affordability, made until late 2003, were based on half-truths and fudges, and a textbook example of the abuse of statistics. Some devices used included:
Ignoring of the trend to have periods of loans extended. Calculation of affordability of the price of a median house with reference to a mean measure of income. Shifting of the focus of their assessment towards towards more prosperous Australians, that is, more towards those who are buying their second or third homes. Ignoring the fact that many of today's mortgages are being paid for with two incomes, rather than one as was the case a generation ago. This myth of housing affordability has served the political purpose of allaying the potential alarm that many Australians would have otherwise have felt at skyrocketing property prices. In this way it has been easier to sell, to the public, the nonsense that the 'housing boom', largely fueled by population growth, where there was a limited supply of housing, was somehow good for our economy. An example of this kind of thinking is this editorial, which appeared in Brisbane's Sunday Mail newspaper on 26 February :
Real Estate Rock Solid
Nervous Nellies try to talk it down, but the Queensland real estate market remains strong and vibrant.
Figures published today show the Brisbane market has shrugged off a slight slump and there has been double digit annual growth throughout out the state.
There is double comfort for Queensland in that growth and security are reflected in that growth and security are reflected in all regions - an important consideration for such a decentralised state.
Queenslanders like to bank on bricks and mortar and their faith has paid a handsome dividend.
Only a few days after this editorial was written, the Reserve Bank issued a report which was savagely critical of the way that the property investment 'industry' had diverted so much investment funds away from more productive areas in recent years, and had thereby done enormous harm to our economy.
In the light of this incontrovertible evidence of the mismanagement of our economy by the 'rational' economists who have dominated almost every aspect of Australian public policy in the last 20 years, Alun Breward's conclusion is particularly apt:
Because of what economic rationalists have done and said, Australia?s economic prosperity now depends on a lie.
The only way to conclude this review of economic rationalists' performance is to say that they have shown themselves to be everything they criticised in others. They are deluded. They are a threat to our economic wellbeing.
The full transcript of Alun Breward's talk is included below:
Housing Affordability Measures Under The Microscope
Economic rationalists are great believers in reviewing things. They have always reserved the right to pass judgment on anything or anyone. Around a decade ago, that brought a respectable amount of scrutiny their way, but I think they have been left to their own devices for many years now, and we need to turn the spotlight on them again. It's time to re-acquaint ourselves with how they operate, and I'd like to do this with a review of how they've handled the issue of housing affordability. While we go through their half-truths and fudges, I'd ask you to note that there is $80-billion of turnover in the housing industry per years. The cash flows are huge.
A few academic economists have been voicing concern over the past decade that Australians' capacity to buy a home is eroding. Some have predicted that in future only half of Australians will own their homes, down from just over 70% today. Despite this, you could find economic rationalists arguing, until late 2003, that the affordability of housing was good. With interest rates at 6%, the story was, it was a great time to buy a house.
Every quarter, two major financial institutions, the Commonwealth Bank, otherwise known as the CBA, and also AMP published numbers showing how manageable a mortgage was. But when you look at how they come up with these numbers, what emerges is a textbook example of the abuse of statistics.
Let's begin our review with the statistical fiddle that first drew my attention to the deceit in calculations of housing affordability, AMP's view of others' debt.
As anyone who has ever had a mortgage or even a car loan would know, the size of your repayment reflects how fast you repay the debt. Whatever sum you borrow, the amount the bank wants per month will shrink the more you postpone the date of final repayment.
But being able to manage the size of your monthly repayment has absolutely no effect on the burden of your mortgage. Someone who borrows $200,000 and agrees to repay it over 30 years does not have a smaller debt than someone repaying $200,000 over 20 years. They have not received any sort of special deal.
Despite this, the AMP indicator centres on the percentage of a typical household's monthly income that goes on the mortgage repayment. The indicator makes no adjustment for how many repayments will be necessary to eliminate the debt. Whatever repayment a person may arrange for their mortgage, the AMP treats it as equivalent to the repayments of any other borrower.
This flaw has, over recent years, been a major plus for economic rationalists and other spruikers of real estate. Borrowers have ditched shorter repayment periods. The AMP's data on what borrowers spend on repayments, as against their mortgage debt, shows that the 30 year mortgage is common nowadays. But before the 1990s, such loans were unknown: 20 years to repay your mortgage was the norm.
The extension of credit has enabled the finance industry to claim that borrowers have more money in their pockets. But if AMP was being straight with us, their affordability measure would be 10% worse than it is today.
By contrast, the Commonwealth Bank does not pretend that a person is better off by staying in debt longer. Their numbers focus on changes in the cost of a mortgage repayable over 25 years.
But switch your attention from the expenditure side of home buying to the income facet, and the CBA's fiddle with their affordability measure emerges. They calculate the affordability of the price of a median house with reference to a mean measure of income. They could have chosen to compare median income with median house price, or a mean income with a mean house price, but they've muddied the comparison. Let's look at what happens as a result of that.
Australian Bureau of Statistics data consistently show that the mean income is greater than the median income. In 1999 the mean was 16% higher than the median.
When a country experiences, as Australia has, a widening gap between rich and poor, the mean and median diverge even more. The purchasing power of the mean income grows at a faster rate than that of the median income.
This shows up in house prices. Victorian Valuer-General data reveal that mean house price growth is faster than median house price growth. This Valuer-General data indicates that if the CBA measure used mean house prices, the purchasing power of the mean income would have dropped. Affordability would have fallen to levels at least 10% below what the CBA measure showed. That is not the sort of message that a financial institution wants borrowers and the public to hear.
The finance institutions utilise another classic method to come up with affordability measures that suit their marketing department. Step by step over time, they have shifted the focus of their affordability assessments towards more prosperous Australians.
The AMP measure provides the clearest evidence of this. At present, its figures show that on average, a person with a mortgage takes out a loan for just 57% of the value of the median house. Three years ago it was 60%. Now how could that be? House prices over that time have risen around 70%, and finance institutions have shown a growing willingness to lend 100% of the value of a house. In these circumstances you might expect that the typical home buyer would be borrowing a growing proportion of the value of their property. The reason that AMP is able to report increasing equity, not increasing debt among home buyers, is that their measure is increasingly focused on second or third time buyers. These are people who bought 10 or 20 years ago, and have accumulated significant assets. If first home buyers, who tend to have few assets, were not the endangered species they have become, the typical mortgage and repayments would be at least 20% higher. What AMP creatively calls 'affordability' would plummet.
The Commonwealth Bank treatment of the same issue, the profile of house buyers, requires some caution. This is because just as it's a myth that economic rationalists love rigour, it is also untrue that they value what they call 'transparency'. The Commonwealth Bank is so committed to transparency that they make only a bare minimum of information on their calculations available to the general public. Fortunately the Australian Bureau of Statistics is less secretive, and acknowledges that it provides household income data to the CBA for analysis of housing affordability. After comparing the CBA's data on income with published ABS household income data, I am satisfied that the CBA are pulling a swifty. I'm confident that they calculate the ability of first homebuyers to afford homes by focusing solely on those who, against the odds, have escaped the rent trap. This is rather like attempting to monitor Australians' life expectancy by studying those over 80 years of age. This CBA fiddle distorts their measure by 10%.
So let's tally things so far. The AMP's measure has a 10% flaw from the shift to long term debt, and a 20% inaccuracy from the fact that first homebuyers are becoming extinct. The combined effect is, that in its own terms, the AMP measure is out by one third. Two separate 10% errors in the CBA calculations have a net effect of misrepresenting affordability by at least one fifth. But these are relatively minor, compared to the common shortcoming of both the CBA and AMP measures.
The major problem that these indicators have is that they make no allowance for the effort put into earning income and making repayments. A dollar is a dollar is a dollar, no matter how long it took to earn. This is a problem because both indicators have been running since the 1980s and over that time, women's involvement in the work force has increased greatly.
A generation ago the income of a family (the AMP term) or household (the CBA term) was predominantly, if not solely, the result of paid work by one adult. Particularly during the 1980s, in parallel with the Hawke government's industrial relations Accord, many women entered paid work and especially in our capital cities, two-income households became the norm. Even if households today were spending the same proportion of their income on the mortgage as they were 20 years ago, there is a strong case that housing is more expensive, because that income takes more effort to earn.
Assessing how much of an increase in workplace effort has occurred is difficult, especially without delving at some cost into the archives of the Australian Bureau of Statistics. Work effort is a factor of being employed and the number of hours that people work.
There is only some information on hours worked, which suggests that this has not changed a great deal over the long term. But on the issue of involvement in the work force, there is more.
Last year, Australian Bureau of Statistics work force data showed that of the 1.7-million women in a couple relationship who also had children aged under 15 years, 65% were in the work force. In 1974, just 41% of the equivalent group ere in the work force. That is a 59% increase over 29 years.
There has been some reduction in work force involvement by men over that same time frame, but nothing that even remotely offsets the shift for women. In 2003, 93% of men in a couple relationship and with children under 15 years of age were in the work force. In 1974 the equivalent percentage was 98%. So over the intervening decades there has been a 5% drop in mens' involvement in the paid work force.
Now we could at this stage, launch into an examination of how this confidence trick that housing was 'affordable' succeeded for so long. Factors such as economic rationalists' assumption that people are bound to fleece others, given the chance, and the willing gullibility of some Australians, doubtless played a part. But that examination would take more time than I have today and would risk obscuring key issues in a fog of conjecture.
The key issues are firstly (as prominent business commentator Robert Gottleibsen recently noted) that
'Whether we like it or not, Australian economic prosperity is hooked on the housing industry. Strong house prices have been one of our biggest single drivers of consumer expenditure, and if they fall sharply, it will cause a severe downturn.'
And secondly, that all this has occurred while economic rationalism and economic rationalists have been absolutely dominant in political and business circles.
Because of what economic rationalists have done and said, Australia'9s economic prosperity now depends on a lie.
The only way to conclude this review of economic rationalists' performance is to say that they have shown themselves to be everything they criticised in others. They are deluded. They are a threat to our economic wellbeing.
