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Debt and housing crises

17 December 2014  |  Investing

HousingIf there is one certainty about crises it is that they are usually caused by too much debt, not fluctuations in supply and demand. This is the point made in an AFR article. Debt creates uncertainty in the global environment, and suggests that the Australian housing market is vulnerable.

Here is the global effect of debt. At first, regulators usually argue that they cannot interfere (just as the Reserve Bank is now arguing that it cannot interfere in the property market to any extent):

Bubbles by definition tend to be speculative, driven with harder landings. But when Alan Greenspan chaired the US Federal Reserve Bank, he was criticised for not taking action to deflate the bubble evident in the housing market and underwritten by dodgy mortgage practices.

His response was that it was not possible to differentiate between a bubble and a cycle in an active market place. His view was that the regulator should stand aside and mount a clean-up and restoration after the episode if necessary. In retirement Greenspan has revised his view to acknowledge that if you have a bubble inflated by debt, then proactive intervention could be warranted.

 

The extremes of debt put the ball very definitely back into the regulators' court. Once the crisis hits, it is the regulators who have to fix it:

The GFC, and earlier 1990s-era crises in Latin America and Asia, reflect the unprecedented and continuous extension of debt on a global basis. While central banks can create liquidity, they are much less powerful when it comes to directing where that liquidity should go.

The Bank for International Settlements (BIS), one of the few institutions to provide an early warning of the approaching global financial crisis in 2007, is once again sounding the alarm. The head of its monetary and economic development department, Claudio Borio, recently highlighted the degree to which markets now rely on central banks.

“The markets’ buoyancy hinges on central banks’ every word and deed,” Borio said. “The highly abnormal is becoming uncomfortably normal. Central banks and markets have been pushing benchmark sovereign yields to extraordinary lows – unimaginable just a few years back. Three-year government bond yields are well below zero in Germany, around zero in Japan, and below 1 per cent in the United States. And, as all this is happening,” he added, “global growth – in inflation-adjusted terms – is close to historical averages. There is something vaguely troubling when the unthinkable becomes routine.”

 

What is certain is that there has been a debt boom in Australian housing. If it does degenerate into a crisis, it will hit the banks and the housing market. The Australian economy is depending on the health of the housing market. Here are the graphs:

Egan_Soos_01

 

This the the rise after taking into account inflation:

 

Egan_Soos_05

 

This is the debt explosion. If debt is behind crises, the conclusion is fairly clear:

Egan_Soos_06

 

 



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