for the bulls

Full article here. Looks like Money Market has been reading HC

Your editor has barely touched the housing bubble recently.
We must be losing our touch.
So, after a pause it’s time to get back on the horse.
Money Morning reader Michael sent us a media release from the Real Estate Institute of Australia (REIA). The headline was, “No housing bubble in Australia”.
The headline doesn’t surprise us, we'd expect that.
We were tempted to take their word as gospel and give up our claims that Australia is facing the mother of all house price crashes.
But we resisted the temptation. Instead we decided to take a look at what the REIA had to say. The following selected quotes caught our attention.
Here’s the first one:

“What we are experiencing in the housing market is normal growth for house prices. If Australia was in the midst of a so-called housing bubble, then we have been there for some time. REIA’s data highlights that historically, median prices, compared to income, have been relatively stable for the past ten years, taking into account normal fluctuations.”

And now for the second:

“Over the period Dec 1996 – Dec 2009, median house prices increased from around $160k to around $500k; a trebling in thirteen years steadily.”

It then prints the following table which completely contradicts the first quote:

Source: REIA

Although the REIA has presented the data rather cleverly. You look at the “House Prices Quarterly Average Growth Rate %” column and then at the “Median Family Income Quarterly Average Growth Rate %” column and you could be forgiven for thinking that the numbers are pretty similar.
Or at least that the difference is so small it’s negligible.
The problem is they aren’t. Not when you factor in compounding over thirteen years.
To show you what I mean, take a look at the chart below:

Source: Based on REIA numbers

Importantly, take a look at the following chart which shows the ratio of median house price to median household income:

Source: Based on REIA numbers

The ratio of house price to median household income has increased from around five-times income to nine-times income.
In simple terms house prices are much, much higher today when compared to household income than they were fourteen years ago.
But the key fact is that it shows how irrelevant are the claims made by spruikers about dual income households having pushed up prices.
The reason that fallacy is disproved is that if it was merely a second income pushing the prices up then the ratio would be relatively constant.
Put it this way, if there are two people living in separate homes each with an income of $30,000 and they each own a home worth $60,000, then it’s a ratio of two-times income.
If they then move in together and can now afford a house worth $120,000 then it’s still a ratio of two-times household income.
In 1996, according to the Australian Taxation Office (ATO), the median household income was $31,374. By March 2010, according to the average growth rates indicated by the REIA, that average median household income is $57,138.
Now look, we’re just going by the numbers provided by the REIA and the ATO, but there’s absolutely no way that anyone could come to the conclusion that property prices aren’t out of whack at the moment.
The number of income earners that comprise the household is irrelevant. What we’re comparing is the total household income in 1996 with the total household income in 2010 and then measuring the ratio against the median house price for those periods.
The result is that thanks to easy credit – not more women entering the workforce – house prices have tripled in fourteen years whereas incomes have barely doubled. Importantly, the impact on the ratio of house prices to incomes has blown out to nearly nine-times incomes from five-times incomes in 1996.
In fact there’s a reasonable argument to suggest that the spruikers are putting the cart before the horse. House prices haven’t risen because more women are entering the workforce, instead women are forced to enter the workforce due to the housing bubble.
Households need two incomes to afford a house, whereas in the past one income was enough.
But what we love most about the REIA press release is the comment that, “What we are experiencing in the housing market is normal growth for house prices…”, followed by the statement that “Over the period Dec 1996 – Dec 2009, median house prices increased from around $160k to around $500k; a trebling in thirteen years steadily.”
Ha, ha… a steady trebling in prices in just thirteen years. Apparently that’s “normal growth” for something to treble in value in a short period without it being a bubble.
I mentioned above the excuse put forward by spruikers about two-income households. That because more women are now in the workforce that helps to explain rising house prices.
But hold the front page. Late breaking news is that they had two-income households in the US, UK and Ireland as well. I know Australia is supposed to be different, but we’re not unique when it comes to having two people in a household working.
Two income households didn’t stop the US, UK and Irish property collapse. And it won’t stop the Australian property collapse.
It’s just another shameless attempt by the spruikers to have you believe that somehow Australia is different. Yet time and again their myths are exposed as being baseless.
But Michael Pascoe over at The Age has been doing some of his own mythbusting. Or rather he believes Reserve Bank of Australia (RBA) deputy governor Ric Battellino has been busting myths.
The reality is of course that Battellino has done no such thing. He’s merely confirmed the existence of Australia’s housing asset bubble, and how risky the Australian housing market is.
So risky in fact, that in our view Australian housing is Australia’s riskiest investment right now. I mean, we know for a fact that Australian residential property is historically just as risky as shares, but thanks to the massively inflated bubble it’s now streets ahead on the risk scale.
In a speech on 15th June Battellino said:

“First, at the same time as the household debt ratio has risen, so too have the assets held by households.”

Battellino then claims that if you exclude housing assets and just look at financial assets, these are also higher compared to the 1990s and so by that comparison there isn’t a housing bubble.
Well, that’s clearly a false argument. Because who’s to say there isn’t also a bubble in “financial assets”? There has been a massive bubble, and plenty will tell you that the financial asset bubble is yet to pop – we’re one of them.
He’s obviously trying to dismiss the fact that easy credit by the RBA and the retail banks have helped to inflate the bubble to epic proportions.
Frighteningly, Battellino makes another grave error. It’s this:

“Second, the available data suggest that the increased debt has mostly been taken on by households which are in the strongest position to service it. For example, if we look at the distribution of debt by income, we can see that the big increases in household debt over the past decade have been at the high end of the income distribution. Households in the top two income quintiles account for 75 per cent of all outstanding household debt.”

We’ll argue that one.
In fact we’d say the opposite is the case. It isn’t necessarily a good thing that the top two income quintiles have 75% of the debt. It just means that the wealthier you are the more leveraged you can become.
It doesn’t mean that they’re any more capable of honouring those debts.
As an example, a small business operating a milk bar might be able to get a loan for two-times annual profits – as an example. That’s 1:1 leverage.
A massive Wall Street bank on the other hand can get leverage of 100 to 1 or more. Now, remind me, which caused more strife when things went pear-shaped a couple of years ago? Which was taking huge bets on inflated asset prices?
And no, don’t say it was the cumulative effect of lots of small bad debts. That was part of it, but the ultimate cause was the cheap and easy money accessed by the investment banks who were able to leverage up and take massive punts on the performance of those smaller debts – ie. Subprime loans.
To illustrate what I mean, take a look at any home loan calculator and punch in a few numbers. If you earn $30,000 per year with no other debts and no dependants, the Commonwealth Bank will lend you $78,107 to buy a house, or 2.6-times income.
Change that to $300,000 per year and the Commonwealth Bank will lend you $1.5 million, or five-times your income.
The more you earn, the more you can borrow. You don’t need to be a rocket doctor to figure that one out, just a bit of common sense.
But it’s also the power of leverage. Something which Battellino doesn’t seem to understand.
Look at it this way. What’s the maximum loss the Commonwealth Bank can take if the low income earner defaults? $78,107.
What’s the maximum loss the bank can take if the high income earner defaults? $1.5 million. A loss that’s almost twenty-times larger.
Or to put it another way. A 10% drop in property values means the low income borrower takes a $7,800 loss if he or she is a forced seller, or 26% of his or her income. If the high income earner takes a 10% loss on the property that’s a $150,000 hit, or 50% of his or her income.
Do you see what I mean?
The spruikers are pretty good about pointing out the benefits of leverage when prices are soaring, but they go strangely quiet or provide misleading numbers when it comes to the risks.
Claiming that high debt to income levels are fine because it’s all the rich dudes that are doing the borrowing is absolute nonsense. Yet it’s lapped up by the likes of Pascoe, who wrote:

“What also helps is the analysis of who has taken on the bulk of the extra debt – people who can afford it.”

Yeah right.
But what the debt figures wouldn’t show is the unseen debt liability. Battelino had this to say – which unsurprisingly Pascoe lapped up:

“If we look at the distribution of debt by age of household, we see that the increased debt has mainly been taken on by middle-aged households. The proportion of 35-65 year olds with debt increased significantly through to 2008, as households have been more inclined to trade up to bigger or better located houses, and to buy investment properties.”

And – we could add – a big portion have also used their homes to go guarantor for sons and daughters on a housing loan for the 100% loans and interest only loans provided by the banks.
In other words, not only are the 35-65 year olds taking out more debts which those in their age group wouldn’t have taken out thirty years ago, but they’re compounding it by using the inflated valuations to guarantee the debt on the inflated value of another property!
Doesn’t that ring any alarm bells for the spruikers, the banks and the mainstream press?
Clearly not. The housing bubble continues to grow, while the spruiking lies are getting more and more desperate.