Emma Pearson: Hello Emma Pearson reporting for the Finance News Network. Joining me today from the University of Western Sydney for a closer look at the property sector and its role in the global financial crisis, is Associate Professor of Economics and Finance, Steve Keen. Steve welcome to FNN. You teach economic and finance, what have you been telling your students about property bubbles, toxic assets and their role in the global financial crisis?
Steve Keen: Well I have been telling them for the last 20 years that the economy is best explained by what’s called the ‘financial instability hypothesis’. And that predicts that you will have asset bubbles which are debt financed, driven by euphoric expectations at various times in the trade cycle, which will then burst and then you’ll have an economic downturn following after that. So that’s been a sort of theoretical model I have been putting forward in contradiction to the model they get taught in standard finance courses, where they get taught about efficient markets and how debt doesn’t matter and debt doesn’t affect a company’s value etc, etc, and I have been saying that, that’s all nonsense. And what’s amazed me of course is just how right my theories have turned out to be and how painfully right, and of course now when I’m teaching the students I now talk about the whole area of the madness of CDO’s and stuff like that, and in other courses they are taught how to write derivatives.
Emma Pearson: Reserve Bank deputy governor Ric Battelino, recently said that Australian housing is likely to hold up better than housing markets overseas, is he right?
Steve Keen: We would need to defy the trends that occur in every other western nation for that to be correct. Maybe we won’t fall as far as America, maybe we won’t fall as far as England, maybe we might fall more, but we are certainly going to fall. And I think that that’s the belief that we can continue having rising house prices here compared to consumer prices, which has become locked into our mentality here, is just a sign that we have been living in a bubble where for 50 years that that has been true. But it’s something that can’t be true for 500 years…there has to be a turning point at some point, and this is what the Reserve Bank I think is ignoring by saying that housing prices are fairly valid at the moment. I mean the argument they made was the relationship between house prices and incomes, and they were looking at disposable income and the disposable income before the payment of interest. Now I admit there’s an argument you can go one way or the other and say maybe you should have it before, maybe after, but any other indicator you look at shows that there has been a continuing house bubble past 2003, where as the Reserve (bank) tries to claim our bubble peaked in 2003 and has been falling since then. On one indicator you can find that argument, that’s the one they used in the paper (SMH article) Anthony Richards gave a couple of weeks ago, on every other indicator our bubble peaked in 2008. Now I think when you’ve got something as complex as the property market, you should take as broader view as you can of the stats, and that peak in 2008 is not only the biggest in our history, but it’s even bigger than the peak in the American market when you look at the same – what are regarded as key indicator – and that’s the ratio of house prices to the CPI. And you look at America, the ratio of the house prices to the CPI which the Case Shiller index puts out, started at 100 in 1890, averaged 103 right out to 1995 and peaked in the 200’s. Choosing ours at the same base we were slightly above that American market as of about 18, 1990, maybe 10 per cent higher. We have reached three times that level. So we have a much larger ratio of house prices to CPI in Australia than in America. Now I simply don’t believe that it can continue growing when it’s already at world record levels. So I think they have to come down I think he’s is wrong.
Emma Pearson: Australian house prices are amongst the most expensive in the OECD. What needs to be done to improve affordability?
Steve Keen: The prices have got to fall. I mean it’s as simple as that. We have this crazy schizophrenia in this country where on the one hand we’re trying to maintain house prices because a large part of people’s apparent wealth is tied up in the price of housing, and at the same time where trying to make it easier for first home buyers to get into the market – what do we do? We throw money at the first home buyers, they get an extra $7,000, let’s say let’s just take what the maximum because if $21,000 a year, $21,000 as a base deposit, they go and leverage that into the $300,000 or $400,000 worth of buying - and there is plenty of evidence coming back from agents now that first home buyers have been enticed into the market by the First Home Buyers Grant, have bid up prices by about double the size of the First Home Buyers Grant itself. So rather than the money going to first home buyers it’s been transferred to developers, they had stock they wanted to get rid of, and anybody in the market who’s expecting prices to fall and is therefore selling out. So we can’t have it both ways, we can’t have ever rising asset prices and more affordable housing. And the thing is we’ve pushed the former far more than we’ve pushed the latter, they have to fall.
Emma Pearson: The Rudd Government has announced a banking industry assistance package for households facing financial hardship, which may see mortgage repayments out on hold for the 12 months ahead for those who suffer temporary hardship through enforced unemployment. What affect will this have on the residential property sector?
Steve Keen: Well for a while it means anybody who loses their job in the next year and therefore loses their capacity to service their mortgage, won’t be forced out of their house which is a good thing, and they won’t be forced to put their house on the market – which is also a good thing. But like most of these measures that have been enacted during this crisis, the officials who enacted them believed it would be a temporary blip, it’s just a question of getting to the other side of the crisis and then normality will resume on the other side of the crisis. So it’s seeing, for example in terms of how the banks have performing, its seeing what they’ve got as a liquidity crisis rather than solvency. Ok, so you need a bit more cash now, but you’re actually fundamentally solvent and we just get you over the hump and your ok. Our financial system is insolvent. Period. Globally. Particularly in America and England, I think ultimately here as well. So the belief that you can get over it by having a little liquidity blip I think is false. Equally in the case of unemployment, the idea is that somebody will lose their job now, get it back in the next year and when 12 months time when that’s expired they’ll be back with a full time job able to service the mortgage. I think those people will be unemployed for four to five years. And that situation when you get to the crunch point where they’re supposed to then go back to repaying the mortgage with of course the interest they didn’t pay in the mean time added to the principle, they will be just as unemployed, probably less financial as they were before hand and then the banks will be forced to confront the necessity of reducing that debt. But I think that the policy itself is a good step. It’s the first thing I have seen done in this crisis by the government that I think is starting to address the long term issue, and that is we have got into this crisis by borrowing far too much money and leveraging asset prices as a result of that. The only way out of the crisis is to abolish some of the debt, and this is the first step in that direction by the Australian government.
Emma Pearson: Is this likely to keep prices higher for longer when in past recessions prices have fallen in line with other assets?
Steve Keen: Well what’s more likely to happen is that it will slow down the rate of decline of prices because you won’t have a total flood of properties turning up on the market. Of course that’s only the banking sector that’s doing this, the non-bank lenders are notorious, as soon as you miss a payment - bang they’re on to you. So there’s plenty of people out there with non-bank loans who may be far more vulnerable than the people with bank loans. But what’s more likely to happen is it will slow down that rate of decline and then of course you’re going to get to the one year, it’s going to expire, and I think 90-95% of the people who are given this relief are still going to be unemployed. And at that point the bank’s got a decision, do we continue rolling it over again? Do we continue capitalizing the debt? Or do we liquidate and put the house on the market. Now I think ultimately we have got to change the whole legal structure of this because it isn’t truly the borrower’s fault that they took on this much debt. Really the responsibility for this massively excessive level of borrowing has been the lenders pumping that money out. And we’ve been sucked into borrowing that money because of the belief that house prices always rise and it’s an investment strategy blah, blah, blah. The reality is, it’s irresponsible lending and the lenders should where the pain for it not that borrowers.
Emma Pearson: And Steve what is your outlook for the property sector for the next 12 months?
Steve Keen: Look it could well rise over the next three to six months courtesy of the First Home Buyers Grant, that’s really the only thing that’s keeping the property market up right now. But that’s got a little quandary, two little quandaries. First of all the First Home Buyers themselves are going to be very vulnerable to a downturn in employment, so that’s the major thing that I’m looking at. But in terms of the actual market itself, the fist home buyer market stops bang at $500,000. There are only a trivial number who are buying houses beyond that level. So it’s pushing up houses below the $500,000 mark to the $500,000 point. But once you’ve pushed the stock up to that level it’s not going to go any further. And then of course what you’ve got happening at the top end of the market is you’ve got a plunge in prices, people being forced into liquidation sales courtesy mainly of the damage margin loans have done and so on driving down the upper section of the market. Between the million and the half million mark, which is where the majority of the population is, that’s the area that’s going to suffer badly from unemployment as well. And I think a lot of those people are going to see themselves losing their jobs and then go from being able to quite comfortably service their mortgages right now given the fall in rates, to being completely incapable of doing it and then the market will join the American’s in a downward trend.
Emma Pearson: Last question. Where would you invest if you were looking?
Steve Keen: At the moment all I would be doing is piling up cash. Because the people who make a killing out of a depression and this is a depression we’re going into, the ones who make a killing are those who are in cash. And the real question is not what you do with your money now, but what you shouldn’t do with it. Because you could easily dive in and think you’re buying assets on the cheap and see them fall by another 50% or 70%. Now let’s go back to the Great Depression and look at what happened with share prices there. You had the Dow peaking at I think 388, and then falling to 42, 45 over the next three years. Now anybody who bought in the mean time between that roughly 400 peak and roughly 40 bottom, would have seen their money go down till the 40 was hit, then the recoveries come after that stage. Its people who waited and were cashed up all the way through and then bought assets near the bottom, normally after the rise started; they’re the ones who made the money. So my philosophy at the moment, I’m just saving up money, putting it in a bank account and when I’m fairly confident that things have gone to the bottom then I might come back in. But I don’t expect to see a bottom in this particular downturn for three to five years.
Emma Pearson: Steve it was lovely to meet you, and I look forward to talking to you again.
Steve Keen: You’re welcome.
