Saturday, November 20, 2010

Hope is kindled...

This is music to this bloggers ears, or at least, eyes. From The Australian (h/t the Lorax):
A senior Treasury official has sounded the alarm over Australia's property market.

He has warned that the prospect of a sudden and dramatic drop in prices is "the elephant in the room" and should not be ignored by the federal government.

While the government and Reserve Bank insist Australia does not have a housing bubble - as some economists and the International Monetary Fund suggest - it remains such a worrying concept that Treasury has privately sought reassurance from its analysts that prices are not artificially high and that Australia does not face the kind of house price collapse that has hit Britain and the US.

Documents obtained by The Weekend Australian under Freedom of Information laws show the Treasury officials preparing the so-called Red Book of briefs for the incoming government were as divided as private sector economists about the strength of the property market.

Phil Garton, the manager of Treasury's Macro Financial Linkages Unit, sent colleagues a draft paper on the rise in household debt, prospects for further growth in the debt-to-income ratio and the potential implications of slower household debt growth.

His email prompted an exchange with Steve Morling, currently the general manager of the Domestic Economy Division, who argued the paper should "make a bit more about the risks".

"The elephant in the room is house prices or more specifically the risk of a precipitous drop in them, perhaps from an external shock or perhaps from their own internal dynamics when affordability constraints or capacity debt levels see prices and expectations of house prices start to move in the opposite direction," Mr Morling wrote on June 15.

"(I) know there are very supportive fundamentals, but prices rose by 50-60 per cent in three to four years in the early part of this decade, with largely unchanged fundamentals, so they can have a life of their own.

"And given what's happened elsewhere I'm far less sanguine about this - and the interplay with debt - than in the past."

Mr Garton agreed that there would be risks if the fundamentals of low interest rates, unemployment, and financial deregulation "reversed significantly". But he maintained the price growth in the early 2000s was based on a "lagged response" to improvements in the fundamentals, and questioned how Australia could have maintained a bubble for more than six years.

Mr Morling said other bubbles had lasted that long, and the fundamentals were often used to justify price rises - including in Britain where a debate over lack of supply drove property prices higher "before the British property bubble burst".

"(I) think price expectations can take over from the fundamental drivers that you have identified for extended periods, including generating house price falls," he wrote.

Well, more power to Mr Morling!

We already know that Treasury is aware of the clear and present danger in the banks reliance on short-term financing to fund the the bubble. And we know that Mr Morley's concerns made it through to the Red Book itself, making clear that his views are shared at the most senior levels. Several months ago the SMH revealed that:
Auastralian banks' reliance on overseas funding and the high level of household debt loom large as a ''significant'' economic risks, Treasury has told the government in a normally secret briefing.

The nation's top economic advisers yesterday released the incoming government brief known as the Red Book after a flurry of freedom-of-information requests. While the document painted a bullish picture in which the resources boom drives a return to full capacity, the frank commentary also said debt was a vulnerability.

''A key risk for the Australian economy is our reliance on short-term external debt, largely intermediated through the banking system,'' the brief said.

''Among Australian financial institutions there has been some shift away from short-term funding since the crisis, but exposure to financing risk remains significant.''

The following paragraph was blacked out, but later on the Red Book also highlighted the dangers of the property-led surge in household debt.

''Highly indebted households, together with high dwelling prices, further heighten the vulnerability of the economy to shocks. While household finances are in good shape overall, and arrears rates and other financial stress measures remain much lower than in the early 1990s, households are more exposed than previously to adverse shocks.''

None of this, of course, means that the government won't attempt to kick the can down the road with policies designed to reflate the dirigible. And The Australian's story continued to recount how "... the Treasurer retained the view that Australia did not have a property bubble".

However, it is no small thing that senior Treasury ranks have broken with the Pitchford (Ponzi) Thesis - that we can accumulate debt forever so long as it's private sector. Once minds have broken the group think, new possibilities are possible.

1 comment:

Carol Commins said...

DLS, nice post. I agree this is good to see/hear. I am analyst in a bank and I follow the RP Data/Rismark house price index data, whcih is by far the best. Rismark have been bearish since late 2009 calling no growth in the second half of 2010. A while back Chris Joye also released analysis showing that house prices could be expected to fall if the RBA raised rates in line with what economists were suggesting. RP Data/Rismark's data has shown house prices coming off boil for last few months too. It's all lining up!