Housing - Bubble a Myth?

Following on from yesterday's post we thought we'd highlight a leter to the Editor of the AFR by Housing Industry Association Chief Economist Harley Dale yesterday that we missed. Now Harley is clearly an advocate for his industry but, having had close contact with him in our past, we can vouch for his credibility and deep understanding for all things housing.

Writing to the AFR he said "Australia continues to grapple with the incessant hyping up of a fictious housing bubble...the reserve Bank of Australia does not subscribe to the bubble view nor does Treasury....Australian house prices have been driven by strong demand and low supply." We agree and indeed if we were to look at the population to housing equation more deeply we would see the strength in this argument. But as followers of Minsky we do have some sympathy with the overall view that house prices may have skipped ahead a little as we noted yesterday.

But the key point to our mind for those who are incessantly talking about bubbles and particulalry those from offshore who want to be among those prescient soothsayers who called the future crash in Australian house prices is, as Harley notes, "Those claiming that Australia's housing market could go the same way as the united States have no understanding of reality. Australia's market is vastly different to the US." Certainly the bears will say that "bubble deniers alway say that" and they are, up to a point correct.

But to our mind there are many differences between Australia and the US. Leaving aside 5.1% employment, a surfiet of housing demand and a strong banking system the most important point  for us is full recourse lending. We flippantly suggested yesterday that this full recourse lending may not protect the banking system longer term as stigmas change  but this would only be at the margin. Rather we think the role institutions play is completely misunderstood and under appreciated in the analysis of the Australian Housing Market particulalry with respect to talk of a bubble and its inevitable implication that people will become distrssed sellers thus driving prices down sharply.

To this end a paper published by Burcu Duygan-Bump of the Federal Reserve Bank of Boston and Charles Grant of the University of Reading (Household Debt Repayment Behaviour: What Role do Institutions Play?, Economic Policy. Vol. 24. No 57. pp 107-140. January 2009) is worthy of note. The research into default behaviour is scant and this was done in reference to Europe but it has implications for Australia and full recourse loans.

The authors found  "arrears are frequently associated with subsequent adverse consequences, such as future unemployment or bad health. Second, we find that arrears are often precipitated by an adverse shock to the household's income or health, but that there are large differences between countries in how households react to these events. Finally, we show that these differences can be partly explained by local financial and judicial institutions, as captured by contract enforcement and information sharing indicators. In other words, we show that while adverse shocks are highly important, the extent to which they affect repayment behaviour depends crucially on the penalty for defaulting." Spotlight's emphasis.

So full recourse loans and both the willingness of the lender to enforce their rights and the strength of the judiciary in achieving same make a big difference in the level of defaults. This brings us back to the conditional probability idea we talked about yesterday. What is going to cause the causes that cause the cause of the default? The paper gives us some clear pointers as well and we note that there is a certain reverse causality between mortgage stress and job losses. So to this end the Australian Governments initiative with Australian ADI's to implement a protocol of working with customers in difficulty looks to be a pretty solid circuit breaker as well on the road to default.

We been around and studied markets long enough to never say never but Harley Dale is right, the focus should be on providing more affordable housing not trying to prick a supposed bubble one that may not even exist.