Morgan Stanley chief economist Gerard Minack has compared mortgage borrowers to Ponzi scheme investors, claiming they have been duped into taking on huge amounts of debt in the belief housing prices will always rise.
The housing bubble claim follows similar arguments made by US hedge fund manager Jeremy Grantham, with both claiming property in Australia is overpriced and a threat to economic stability.
“Owner-occupiers have played a game of financial chicken, competing for property by taking on increasingly imprudent amounts of debt,” Minack says.
“Investors have become Ponzi borrowers – Hyman Minsky’s term for borrowers who rely on capital gains to repay debt and interest – in the belief that housing is a sure-fire long-term investment. History shows that it isn’t.”
But property experts disagree, saying that although prices are beginning to slow due to higher interest rates, home owners are still enjoying a large amount of growth over the past year.
In the new research note sent to clients yesterday, Minack, a noted housing “bear” who spoke to SmartCompany last week, claims the major problem is the amount of debt being carried by a large proportion of the population, saying the “debt-fuelled housing market remains a major macro risk”.’
He uses data from a variety of sources, including the Australian Bureau of Statistics, to claim prices are now between 35%-50% overpriced compared to the long-term average over the past 100 years.
“I’m not persuaded by arguments that houses are sustainably priced; I’m not persuaded by the view that debt is not a problem; and I’m not persuaded that policy-makers could prevent collateral damage to banks.”
Minack makes some fairly negative predictions, saying that the “real return on residential property over the next decade is likely to be negative”, leaving home-owners with a significant amount of debt and not much equity to show for it.
Minack says that house prices can often show no growth for very long periods of time, pointing to prices in Melbourne which didn’t pass their 1891 peak until 2001. “Buying a bubble is an extremely bad investment,” he claims.
But this debt is the biggest threat to the economy, Minack says. He aims to debunk claims that debt is “safe” because 20% of the highest income earners hold around 50% of household debt, saying debt-to-income ratios always appear normal at the height of a bubble because debt levels rise alongside asset values.
“US experience suggests strongly that it is not safe. As it turns out, at the peak of America’s housing market, the top 20% of households held an even larger share of US household debt.”
“The essence of every asset bubble is that asset prices rise as debt levels rise. The process is linked: rising asset prices encourage more borrowers, and the higher asset prices often serve as collateral for additional borrowing. That is why debt-to-asset ratios do not look problematic at the top of most asset bubbles.”
So what’s going to stop these excessive prices?
Minack says prices will drop due to one of two reasons: either widespread job losses will occur, which he admits is unlikely, or landlords will start realising they have made a poor choice and will start selling off their properties.
This would be a significant problem for the economy, as Tax Office figures show the proportion of taxpayers who own rental properties grew to 13.5% in 2009 from 6.5% in 1989 – and two thirds say they are losing money.
Minack claims the best-case outcome will be that house prices remain flat for a longer period of time, similar to when Sydney prices remained flat in the late 1980s.
“Better to slowly deflate a bubble than to see it pop. If Australia could achieve a cycle where house prices are steady or see moderate nominal declines, while growing incomes at a trend 6% growth rate, it could reduce the over-valuation and financial risks associated with excess debt.”
He adds there is “no value to society from rising house prices… it is simply a wealth transfer to existing owners from potential buyers,” and says there is a strong case for policy-makers to cap housing prices as higher debt levels pose an extensive risk to the overall economy.
But Minack’s view isn’t shared by other property analysts.
Rismark managing director Christopher Joye says the price-to-income ratio is only 4.6 times, which is on par with other developed nations. He claims the RP-Data/Rismark index takes into account more variables than other surveys, making it a more accurate barometer of the market.
“Based on our estimates we calculate that at March 2010, the average dwelling price was around 4.6 times average disposable household income, which is not inconsistent with other estimates for peer countries.”
Joye also downplays the economic threat posed by significant debt levels, saying household debt is no more than in other developed nations.
“Household debt as a percentage of household disposable income is around 150%, and the RBA recently stated that this is alongside other developed countries.”
“Household debt in Australia is identical to that in New Zealand, Britain, Canada, and is less than in Norway and the Netherlands.”
And while Minack points out the amount of debt being taken out by households continues to grow, Joye counters that by saying they are obviously well equipped to handle it, with defaults being rare and a home ownership rate of about 70%.
But the experts do agree on one thing – prices are beginning to flatten. Metropole Property Investment Strategists managing director and SmartCompany blogger Michael Yardney says prices will slow over the rest of the year, but this is due to higher interest rates.
“Our property market is going to slow down, especially in Melbourne and Sydney where prices have gotten ahead of themselves. But look at the reasons why bubbles pop – unemployment, recessions or oversupply.”
“No one is suggesting unemployment will rise, it’s unlikely we’ll have oversupply and the one we have left is interest rates.”
Yardney says the fundamentals of the economy are sound, with high employment allowing mortgage owners to service their debts. Interest rates, he claims, will keep prices under control.
“Interest rates have slowed the market down, and like every cycle the boom comes to a halt. There hasn’t been a collapse, there isn’t a huge oversupply, and we don’t have home owners with huge amounts of negative equity.”
Patrick Stafford is a freelance journalist and a former deputy editor of SmartCompany.
