By Philip Soos, Steve Keen’s Debtwatch

Recently, Australian property analyst Terry Ryder, in an article on Property Observer, voiced complaints about housing bubble advocates. His issue is “waiting for someone who subscribes to the bubble theory to actually define it. So far, nobody has. The term implies that something has been over-inflated and will burst.” Of course, Steve Keen has already done so in his voluminous and critical work reaching back for over a decade.

If Mr. Ryder has difficulty in finding someone who has constructed an accurate definition of an asset bubble, the work of the late U.S. post-Keynesian economist Hyman Minsky is recommended reading. Minsky stgeloped a theory called the ‘financial instability hypothesis,’ theorising that financial markets are not very efficient and continually misallocate substantial amounts of credit into asset markets, creating pyramid schemes or bubbles (Minsky called them Ponzi schemes, named after the fraudster Charles Ponzi).

He defined three types of finance: hedge, speculative and Ponzi. Hedge finance: income flows from an asset are sufficient to pay down both principal and interest on the debt used to finance the asset purchase, and asset prices are based upon fundamental or intrinsic value. Speculative finance: income flows cover only interest repayments, not loan principal, requiring debt to be continually rolled over from the current time period to the next. Businesses or individuals may experience financial stress, but it is not widespread and fundamentals valuations are kept largely in check. Ponzi finance: income flows cover neither principal nor interest repayments. This leaves asset owners completely reliant upon escalating capital values in order to realize substantial capital gains at sale to meet the cost of principal and interest. Prices are completely delinked from fundamental valuations at this stage, resulting in an asset bubble.

Simply put, if gross rental income pays down neither interest nor principal repayments of mortgage debt on aggregate (including other property-related costs) and is sustained over a number of years, a housing bubble exists by this definition. Even better, there is plenty of evidence to show that the residential property market is currently experiencing said bubble. The following figure shows a long-term housing price index for Australia, adjusted for inflation and quality.


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Figure 1: Australian Median Capital Cities Housing Price Index 1880-2011, 1880=100

Source: Stapledon, Nigel D. (2007). “Long Term Housing Prices in Australia and Some Economic Perspectives,” PhD Thesis, University of New South Wales.

The 1996-2010 period is easily the largest boom on record. This meteoric surge in housing prices, however, is not proof in itself of a bubble; more evidence is needed. Data from the Australian Tax Office shows that, on aggregate, residential property investors have been running substantial net income losses since 2000-01. The same would hold true concerning owner-occupiers and imputed rental incomes.

Figure 2: Residential Property Investor Net Rental Income 1993-94 – 2009-10

Source: ATO.

The reason for these sustained net income losses is the combination of general running costs with interest and principal repayments, as shown in the next figure.

Figure 3: Deductions and Repayments as % of Gross Rental Income 1993-94 – 2009-10

Source: ATO.

In 2009-10, the negatively geared cohort, who comprise 63% of the residential property investor market, are precariously positioned under a staggering amount of mortgage debt. The following figure shows a breakdown by income tax bracket.

Figure 4: Deductions and Repayments as % of Gross Rental Income 2009-10[5]

Source: ATO.

The reason why costs outweigh gross income is because Australians have burdened themselves with the largest household debt increase in history to engage in an orgy of residential property speculation.

Figure 5: Household Debt as % of Nominal GDP 1861-2011[6]

Source: RBA.

In conclusion, Minsky’s financial instability hypothesis helps to integrate the occurrences of why housing prices and the proportion of household debt to the economy (GDP) have boomed while net income losses are sustained. That Australia’s residential property market has resembled Ponzi finance for the last ten years is nothing short of astonishing (longer if counting 2010-11 and 2011-12 as there is a substantial lag in making tax data available). The market would have collapsed during the global financial crisis in 2008 were it not for a fresh First Home Owner’s Boost (FHOB) re-inflating housing prices to a new, higher peak.

Although Mr. Ryder claims that bubble advocates are “publicity-seekers” and “shallow, lazy and like the sound of their own voices”, outbursts of ludicrous pettifoggery should not deter the presentation of sound evidence.

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Philip Soos is a researcher employed at Deakin University, working towards a doctorate in political economy. You can download his 2011 paper “The End of Australia’s $2 Trillion Housing Party” here. For more commentary on Australia’s debt crisis read DebtWatch