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Australian housing bubble

Will it burst?

28% of mortgage borrowers are first-home buyers and their average initial debt has risen by $50,000 to $300,000 over the past year.  Of course over the past year the standard mortgage interest rate has fallen from 9.10% to 5.60% so the annual interest payable on a $250,000 loan a year ago was $22,750 whereas the interest payable on a $300,000 loan today is $16,850 so that, if anything the interest cost of borrowing has fallen.  In addition since house prices have dropped somewhat over the past year borrowers are getting more bang for their buck.

Of course it might be the case that levels of indebtedness were excessive a year ago. It is also very likely to be the case that future interest rates will be unlikely to persist at current levels if the financial crisis eases.  A burst of inflation with markedly higher interest rates of say 12% per annum would leave those with $300,000 mortgages paying a mind-boggling $36,000 annually just to service interest.  That would be a blowout in interest payments of nearly 60% and that would burst the bubble.  Given the amount of money and debt floating around in the international economy how many economists would assign a zero probability to the chance that we will shortly experience a burst of inflation and much higher nominal interest rates?

16 comments to Australian housing bubble

  • JimS

    For an inflation-fighting central bank, wouldn’t an increase in personal debt increase the potency of future interest rate increases? That is, assuming consumer good demand is a function of disposable income (which sounds reasonable), and increased consumer debt increases the elasticity of disposable income to interest changes, then won’t future interest rate increases decrease consumer demand by more than in the past?

    I can’t see the future cash rate up around 9%, given this.

    Good point, though. If `surprise inflation’ is seen as a way to restore banking solvency (by decreasing real debts), the potential for Fisher-consistent increases in variable mortgage rates (and sticky wages) would surely send many mortgagees underwater.

  • Bek

    Six month ago or so everybody was talking about recession. Now, it looks like we will switch to inflation problems according to IMF Chief as well found .

  • Bek

    Html tags are just killing me. Simply click the dot at the end on my previous post for IMF chief’s statement.

  • Uncle Milton

    We are in a recession and are likely to be in it for some time. Interest rates are staying where they are, They might even go down a bit more.

    Where is the inflation going to come from that will put interest rates to 12%? Even if the economy roars back to life, the RBA will stop inflation before it starts. Rates might go to 9%, tops.

  • hc

    Uncle Milton, You obviously don’t agree with Arthur. I’d be interested in your critique of AL.

  • The price of the type of dwellings that first home buyers are getting in debted for haven’t dropped. They have at least held steady and in many cases have risen in Melb.

    Those first home buyers are buying units that a year or so ago were worth $300,000 and are now going for $350,000 as buyers who a year or so ago were looking at $450,000 – $500,000 places move down in the market due to shakier jobmarket etc.

    The places that have dropped in price are the higher priced places – the bottom end has risen due to (relatively) cashed up buyers moving down plus calculating the First Home buyers handout into price and then adding a few thou for irrationality.

    They are vulnerable more to job losses in the economy sensitive industries (sales etc) than any huge rises in interest rates. But a bit of an interest rise plus job losses will be a killer. I also reckon a lot of these units won’t hold that value down that end of market.

    Still at say $20,000K a year payments a two bed room unit is as cheap as renting.

  • hc

    FXH, I don’t have detailed data but this how others see aggregate average trends.

  • harry – that graph could be like it is and my statements still be true. Whole of Melbourne prices like that are too smoothed to be all that useful.

  • Matt C

    Harry, doesn’t inflation usually help debtholders and hurt creditors. Sure, most, but not all, are on variable rates. Even in this case though inflation should boost wages as well, so your alarming figures are somewhat distorting. Further, houses are good assets to hold in an inflationary environment so there is unlikely to be panic selling.

    This is not to say that the bubble won’t burst. But I don’t think inflation would do it, more likely to be job losses (or indeed lower than expected inflation).

  • hc

    It certainly does Matt so that people who can make the repayments will do well. The issue is that many home borrowers are current income constrained – wages may not adjust immediately – so nominal as well as real interest rates matter.

  • Uncle Milton

    Harry, Laffer is all worked up by the huge expansion of the money base by the Fed. But that was in response to the equally huge fall in velocity. In the wake of the crisis, banks simply stopped lending. Remember, MV = PQ. Laffer evidently thinks that velocity is picking up and so there the liquidity created by the Fed will be inflationary.

    In other words, Laffer thinks that Bernanke is an idiot who would let this happen. A more plausible view is that the Fed will start will withdrawing the emergency loans they made post Lehmann. These loans are short term and have to be rolled over frequently. When the financial system normalises, the Fed will just not re-lend.

    But what if the Fed makes a big error of judgment and inflation takes off in the US? The $US will depreciate. Ours will appreciate. We won’t import their inflation. That’s the advantage of having a floating exchange rate. You can run your own monetary policy and set your own inflation rate.

  • Bob

    The central banks are very devious in nature. A housing market crash in Australia will be very good for them.

  • Rationalist

    One source of inflation could be a wages breakout as a result of ambitious wage claims by Unions (like the early 1980s).

  • hc

    I think, Rationalist, that such a breakout is a necessary condition for an inflationary explosion.

  • Iain

    There are two dimensions to this that may impact the housing market in Australia. The first is the level of quantitative easing that has taken place globally. This may result in a jobless boom generating inflationary pressures – the obvious remedy will be to raise interest rates to dampen inflationary pressures. The second is the inability of US to continually sell large volumes of debt – this may result in a global battle for investor funds and consequently lead to a global uplift in interest rates. These may not be mutually exclusive events. The implications of the aforementioned for those with high levels of debt are obvious.

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