Steve Keen says housing bubble is bursting


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Joining me today is Associate Professor of Economics and Finance from the University of Western Sydney, Steve Keen. Steve welcome back. Now let’s start with house prices. You previously have forecast prices will fall by between 10-20 per cent over the next five years, and by as much as 40 per cent over the next 10-15 years. What’s your current forecast, and what underpins this? 

Steve Keen: I’m still expecting the same range. I always said 10-15 years of my horizon after about a fall of about 40 per cent. And, it was always simply when I made that call my analogy was Japan because Japan also had a property bubble, a huge one back in the 1980s, it burst, and house prices fell and fell and fell. And, when I made the call, roughly 40 per cent over 10-15 years was a reasonable summary of what’s actually happened with Japan. Now it’s actually a 70 per cent fall, roughly, in nominal house prices over about 18 years, which is huge. So by analogy I said 40 per cent. Now looking at the data if anything we have even more of a bubble than Japan had, and therefore if bubbles can be compared, and I think they can, then we’re looking at certainly 40 per cent over 10-15 years and in the short term, the 10-20 per cent fall is quite likely.

You recently blogged that housing prices dropped 1.7 per cent in the March quarter, the biggest fall since the Global Financial Crisis. What are you expecting for the next quarter?

Steve Keen: I think you’re not likely to see falls of above 2.5 per cent per quarter, but you’re likely to see falls bouncing around between that 1.5-2.5 per cent level. And, the real force behind this, and this is, finally I’m getting some traction on even the property lobby listening to this point, what causes house prices to rise is rising debt, and what causes them to fall is falling debt. So actually to keep house prices rising you need accelerating levels of debt. We are now seeing decorating mortgage debt. So, we’re still getting a slow rise out of the level of mortgage debt but it’s rising much more slowly and that actually means just like a car that’s still going forward, but going forward at a slower speed, it’s actually decelerating. And, that deceleration is translating very quickly into falling house prices. And, the deceleration has only just begun and it’s got a long way to go and I think that’s what’s going to continue driving house prices down.

Let’s say house prices fall 20 per cent over the next year or two. What are we likely to see?

Steve Keen: I think, obviously the government will dive in and try to rescue it. Both parties here, I call them tweedledum and tweedledee, that’s not original but it’s certainly apt. And, they both claim that they want to have affordable housing, but really they’ve both had economic policies which, whether they’re conscious of it or not, have been dominated by encouraging people to borrow and speculate into a rising asset markets and that causing general economic largesse. So they want to have accordable expensive housing, that’s their policy. And, when they see house prices falling they’ll dive in and try to rescue them. It’ll take them about two years to do it I think. They can’t dive in as fast as they did last time around, but that was what the American’s did as well. Now, that’s slightly attenuated the fall in house prices two years out. But, inevitably what you have, when you had a burst on a speculative bubble, people have simply been buying house prices not because they want to live in them or because they want to make money renting them, but because they want to get the capital gain. As people realise the capital gain is gone, and if you talk about a 20 per cent fall, that’s a large hit to people who bought in the last four or five years, and those that bought before that want to sell now before they lose the gain they’ve made, you get a huge overhang of unsold properties. And, that’s what’s happening, we’re getting the beginning of that overhang now. As that grows, even if the government tries to do something, if it can’t cause house prices to start rising once more, then the same effect will come back again. And, as the American’s are seeing now, house prices will continue falling. So, it’s a bit of a bounce and then back down again, the bounce caused by government intervention.    

In addition to government intervention, will we see mortgagee sales or are banks more likely to increase their Loan to Valuation Ratios (LVRs) to avoid putting customers on the street and properties on the market?

Steve Keen: This is one reason I made a call about what is going to happen to the banks, given this whole thing as well. Because, every other banking system in the world has told us, “Trust us, we’ve be responsible lenders, and if house prices fall it won’t affect us anyway”. We then see the data later, they’ve been irresponsible lenders and house prices falling pushed the banks into a credit crunch. I expect the same thing to happen here. So, when that start to happen, with the banks, rather than boosting their LVRs suddenly become what they should have been all the time along, what they pretended to be, which was responsible lenders and they dropped their LVRs. So, they won’t be increasing LVRs to try and keep the bubble going, they’ll be too afraid of bankrupting themselves in the process. What will happen is, in Australia they’ll try to avoid mortgagee sales and they’ll go for pressuring people to sell when they can no longer service their mortgage but, before their actually pushed out with a mortgagee sale. Because the banks now, if they but a mortgagee sale out they get at least a 25 per cent hit below the current market price. 

Are interest rates impacting housing prices?

Steve Keen: If you put them up really rapidly they’ll burst a bubble, and that’s what the Reserve Bank did back in 1990. And, they drastically increased interest rates at the time far too high, far too quickly and that burst the bubble in 1990, which was a housing bubble as well as a stock market bubble. And, that then led to the ‘recession we had to have’. So, if you really put it up, yes you can cause enough pain to drive things down. But, in terms of minor little movements in interest rates causing as neoclassical economists, not me, love to say, “equilibrium reaction”, by the population to go in the other direction, that’s nonsense. Other thing which really annoys me is people who claim to be academics in this area, and policy makers, ignore this. If they say it’s a halving of interest rates means you can get a doubling of prices, they’re ignoring the fact that if you have a doubling of prices, the amount of debt you have to pay back rises dramatically and servicing it over a period of time makes it a non-linear relationship. So if you have a halving of interest rates, that might justify a 20 per cent increase in housing prices, not a doubling. And of course what’s happened, people have fallen for that argument. That would only be true if the bank’s said, “Here’s a mortgage loan, don’t worry about ever paying it back, just service it, forever”. No. They’ll do it temporarily, but they want their principal back thanks very much. So, the argument they use is a spruikers argument. 

While with the Reserve Bank of Australia, in March the RBA’s governor Glenn Stevens said he wasn’t particularly worried about the level of house prices in Australia, as house price to income ratios were "not exceptional by global standards." Steve, what’s your response to this and should we really be worried if the country’s central bank isn’t?

Steve Keen: Yes we should be, because central banks haven’t been worried anywhere in the world before these crises struck. In fact, they were virtually triumphful. If you read what Ben Bernanke had to say about the state of the economy right up till 2007, and my favourite quote comes from 2004, he’s talking about what they call ‘the great moderation’, this is a tendency for the rate of inflation and the rate of unemployment to both fall at a time, from 1990 forward. And, they took the credit, they being neoclassical economists like Ben Bernanke and Glenn Stevens, took the credit for this and said it was good monetary policy that caused this, and this is a quote from Ben Bernanke, “welcome change in our economy”. Well, it all collapsed in 2007/2008. Rather than unemployment trending down, it blasted to the stratosphere and inflation went to deflation, and that was completely unexpected by neoclassical economists. So, they took the credit for this sort of stuff. They didn’t see the crisis coming. Glen Stevens is showing the same behaviour. They do not see these things till after they’ve happened, then they claim nobody could have seen them coming. When, they’re have been people like myself mainly warning about this in my case since 1995, publically loudly since 2005. But these things can be seen, and it these naive economic theories that central bankers, including Glenn Stevens, follow that leads to them not being able to see these phenomena.     

If prices fall what impact will this have on rental prices?

Steve Keen: When these things happen people go back to their Mums and Dads. When you have a collapse like this you get an increase in population density, not because people want to have larger houses, but because the kids say, ‘I can’t finance a mortgage anymore, Mum and Dad can we move in with you”. Or, visa versa with the Mum and Dad investors these days, moving in with the kids. That’s certainly happened in America, there’s been an increase in population density there. That therefore means that even though there’s a plunge in the level of properties being built and investors selling properties to get out of them, you actually often have an increase in rental availability and rental prices fall.      

Will it ever be a good time to buy?

Steve Keen: I think what you have to do is get to the stage where you actually buy a house to live in, not to speculate on. And, with landlords, if they buy them to make an income from, buy them to make a profit from the rental income, not that of capital gain. Now that implies you’ve got to wait until housing prices have fallen something of the order of that 40 per cent that I’ve mentioned before hand, maybe even more, before it becomes possible for a landlord to borrow money, buy a house, and earn enough money from the rental income to more than service the mortgage and then you have a European situation for rents, which is what we need in this country. That’s why I think Germany hasn’t had a crisis, by the way.   

Given we all need a roof over our head, what would you recommend we do?

Steve Keen: At the moment, rent. If you live somewhere and you already own a substantial slab or it, in terms of equity terms, and
you service it and you’re confident about your job, stay where you are. In terms of my current situation, I’m renting and my partner owns her own place. And, if we actually combine together, then if we had to take out a mortgage, which I would probably avoid, but if we had to, the service and the cost of that mortgage would be less that the cost of the rent I’m paying. So, that’s a sensible personal decision to do it. It’s got nothing to do with gambling or asset prices because when we buy that place it will be to live there permanently, not to gamble on it and buy four or five investment properties. That’s not my way of behaving.

Last question Steve, you're well known for talking about house prices, what else are you working on now?

Steve Keen: House prices are a tiny part of my interest. And, I’ve only been dragged into this because when I said that thing about the 40 per cent fall, the property lobby went for my jugular. Well, I don’t appreciate that, I go right back. So, that’s made me a loud mouthed expert on house prices in this country. But, my main interest is in developing an alternative, realistic basis for economic theory to the neoclassic nonsense that dominates the profession and our central banks and our treasuries. And, that’s what I’m mainly doing. I’ve just written a second edition of my book, Debunking Economics. And, if anybody wants to know why you shouldn’t trust an economist, with the possible exception of me, that’s the book to read. And, I’m also building mathematical models, the monetary models of the economy, where the models explicitly monetary. And, nobody’s done that successfully before, I’ve managed to do it. And, the whole idea is to build a monetary approach to economics. Now, as bizarre as that might sound, that’s the innovation I’m doing now. Economists should have done this 100 years ago. So, I’m trying to get us to catch up with the 21st century.    

Steve Keen, thanks as always for your views.   

Steve Keen: You’re welcome.


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