I recently wrote an article on the challenges of forecasting, arguing that economists would be better served by positioning themselves as financial doctors rather than reliable prophets of the future (see here). Yet the temptation to pretend we really know what states of nature will materialise, and for a credulous media to recycle these statements as credible estimates, is likely to be always overwhelming.
If there is one part of our economy that analysts tend to get consistently wrong, it is housing. At surface level it is beguilingly simple: why it is just bricks and mortar, after all. How complex can that be? And since many people own a home, they tend to think that this imbues them with expertise as to the changing dynamics associated with the 8-9 million other homes that they do not own.
But as I noted in one of my very first posts for Business Spectator, the individual home is an awfully poor proxy for the wider asset-class. Many pundits therefore suffer from an ‘anchoring bias’, which was clearly manifest in 2008. At the time, we came across countless highly intelligent and knowledgeable individuals who would tell us that Australian house prices had slumped 15-20%. When we explained that this was inaccurate, and that values had only declined by, say, 1-2%, they expressed disbelief.
The problem was that these folks, who were typically punters from the financial services industry, were looking at house price falls in, say, Bondi, Bellevue Hill, and Vaucluse, and using these suburbs as a benchmark for the rest of the country. Yet with a median price of more than $1 million, these areas are representative of only around 5% of the national housing stock. They therefore tell us little about the remaining 95% of homes.
I used to also see the anchoring bias influence discussions of 1991. As soon as the GFC hit, one would read war-stories in the media about what happened to house prices during the last recession. We were regularly informed that they fell by a head-thumping 20-30%. But again this was wide of the mark.
According to ABS data (or any other publicly available index), Australian house prices actually rose modestly by 2% per annum during the last downturn. Including net rents, the growth was even more impressive. The folks reflecting on 1991 were relying on isolated experiences in Toorak, the Mornington Peninsula, Palm Beach, Point Piper, and very risky ‘development’ sites, and using them as a guide to what happened in the remainder of the market (the one exception was Melbourne housing, which did suffer seriously during the 1991 downturn). Unsurprisingly, many of these super high net worth regions bore similarly big price falls as a consequence of the GFC. But the vast bulk of Australia’s $3-4 trillion housing stock did not.
Housing’s superficially crude characteristics often persuade people to make sweeping statements about it. This has also historically resulted in a cottage industry of ‘housing experts’ who more often than not have very limited analytical capabilities. They nevertheless willingly supply all manner of sensationalist fare to the media. In the past, these individuals were filling a ‘missing market’. Since housing has never been an ‘institutional’ asset-class, it has lacked the detailed analysis that we see in other sectors, such as shares.In any event, the GFC and subsequent recovery have been highly cathartic events for sorting out the cranks. Not only were most of the so-called experts (including many big-name economists) caught short by the anodyne nature of the 2008 correction, virtually everyone failed to forecast the recovery in 2009 (a few exceptions were ourselves, ANZ, BIS Shrapnel, and CommSec). The extraordinary rebound in 2009 was fuelled by a range of factors, including:
* Five to six years of very low house price growth after the end of the last boom in 2003, which resulted in a downward shift in our capital city house price-to-income ratio (between 2003 and end 2008 house prices grew at nearly half the rate of disposable incomes and nominal GDP according to the RBA);
* The sensible reduction in variable mortgage rates from their eye-watering 9.6% peak in August 2008 to historically low levels;
* A growing underlying housing shortage that is officially recognised by the Commonwealth Government, the Treasury, the RBA and every mainstream economist, which has been driven by a trend decline in housing starts per capita since records began in 1966 (the only folks that deny an underlying shortage exists are either certifiable or spuikers pushing CFDs and sharemarket investments that want to get mums and dad out of home ownership);
* A flight to safety as the extreme volatility of listed equity investments, which fell by 40-50% during the GFC (just as we saw in 1987, and for the global equities market, in 2001), was once again hammered home (ie, you cannot just focus on raw returns—risk, or the probability of loss, is their oft-neglected trade-off);
* The government’s fiscal stimulus (aka the ‘first time buyers’ boost’), which was, contrary to many claims, an intelligent short-term intervention. It was smart because it was relatively small (circa $2.5bn) and afforded positive momentum to one of the most important parts of the economy: housing investment has a very high 2.9x ‘multiplier’ according to the ABS while the $1 trillion of outstanding mortgage debt is the single most significant balance-sheet exposure our banks possess (and the Feds were naturally keen to do everything possible to shore up the banking system during what was a global ‘credit crisis’); and
* Finally, Australia’s very high rate of population growth, which is the strongest in the developed world and has helped lubricate the demand-side of the market.
We have for a few months now been anticipating a slowdown in the pace of recovery. The 2009 bounce-back certainly surprised on the upside. As mortgage rates normalise to around 7-8% in 2010, once could reasonably expect a return to more tempered rates of growth in line with, for example, disposable incomes (and note that ‘incomes’ includes all earnings from savings, investments and labour exertions).
