Debunking bubble economies - Australia pt2

This is a follow up on yesterday's post.

Here are some quotes from a report published on the 29th of January 2009 by the infamous Christopher Joye, the one who created this alternative metric for house value because housing in Australia is different from anywhere else in the world.

All of the Demographia International Housing Affordability Survey findings are based on one extremely simple metric known as a “house price-to-income” ratio. In short, Cox & Co. assume that you can “value” housing markets using this crude measure.

The first problem here is that there is no statistical evidence that there is any stable or predictable long-term relationship between median incomes and house prices. Notwithstanding this, Wendell Cox claims, “The [house price to income ratio] in Australia is 6.0, double the 3.0 historic maximum norm and well above levels of just a decade ago.” In fact, the median incomes used for the purposes of creating these house price-to-income ratios are likely to be quite different to the incomes associated with the marginal home buyer (where the median income used in their ratio includes much lower income and higher credit risk households).

The RBA has recently published some long-term analysis on the subject across a variety of countries. It is useful noting upfront that the RBA’s estimate of Australia’s house price-to-income ratio in 2007 of 5.5x is lower than the Demographia finding. The second interesting point deriving from the RBA analysis is that contrary to some of Demographia’s claims, Australia’s house price-to-income ratio has actually declined since 2003 when it peaked at 5.9x (see chart below). Given that house prices in 2008 have decreased slightly while nominal disposable household incomes rose by a strong 9.5 per cent in the year to end September 2008 alone, our house price-to-income ratio should have declined quite substantially.

Australia has always experienced rates of capital growth that have been higher than most other nations since 1971 (according to IMF analysis) for idiosyncratic reasons related to the demand and supply drivers of housing in this country.
[...]
A second major flaw in the Demographia approach is the attempt to compare house price-to-income ratios across countries. There are, however, significant differences between most countries’ property markets that result in divergences in their relative performance. That is, there is no reason to believe house price-to-income ratios should be constant across nations. These differences include their:

– Relative population growth rates (very high in Australia, but much lower in the US (projected to be less than half Australia’s rate) and UK (currently less than half Australia’s rate) and negative in Japan);

– Mortgage default rates — the 90 day default rate on Australian home loans is about 15 and 30 per cent of the level of equivalent default rates on US and UK loans despite historically higher interest rates;

– Tax treatment of housing (in the US, for example, capital gains tax is levied on owner-occupied housing while mortgage interest repayments are tax deductible; neither applies to Australia).

– Size of their public housing markets (the public housing market share in the UK is far larger than Australia, which in turn has a much bigger private rental market).

– Rates of home ownership (54 per cent in the Netherlands, 42 per cent in Germany, and 35 per cent in Switzerland, but about 70 per cent in Australia).

– Responsiveness of housing supply to changes in demand (low in very supply-constrained countries such as Australia, but higher in many countries such as the US, which has had a problem of excess supply).

– Urbanisation or the share of their population living in their largest cities as measured by the so-called “Zipf curve” (very high in Australia but considerably lower in the US, UK, Russia, Japan, India, Germany and China).

I managed to also find this chart, which shows the price-earning ratio of housing in various bubble economies — unfortunately, it's quite old, and does not reflect the continuous frothing of the Australian real estate prices since 2008:

(click for source)

And also, for those who still think that the fundamentals drive the house of real estate in Australia, here's a quote and a chart from Dan Denning's Daily Reckoning (Feb 2010):

Did you know that Australia has the highest household debt to disposable income ratio in the world? It's even higher than America's. Bigger homes. Bigger waistlines. Bigger debts. Australia is in the middle of its own credit boom, complete with all the social consequences. And the financial consequences

Again, things are probably far worse now that the bubble is a lot bigger.

More in the next episode :-)