The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Tuesday, April 20, 2010

Rory Robertson on Steve Keen and Housing

Macquarie's Rory Robertson had a classic economics research note yesterday, which contained some sobering remarks on Steve Keen's current hike up Australia's highest peak:

Dr Keen marching towards Kosciuszko, apparently still none the wiser

*After losing our “down 40%” bet on house prices last year (see chart below), Dr Steve Keen quickly conceded and planned his walk for April. To his credit, he’s now well into his run/walk towards Mount Kosciuszko. Reportedly, he’s still is forecasting economic doomsdays to anyone who has time to waste. Often wrong, never unsure – and good luck to him.

*Amusingly, a journalist from Business Spectator apparently figured that walking long, straight stretches of main road for a week would be informative, so waved his loved ones good-bye to join Dr Keen’s entourage. I’m guessing it’s not quite as interesting as “Entourage” on TV.

*Anyway, after spending several days on the tedious walk across the flat towards Mt Kosciuszko, Business Spectator’s Rob Burgess now considers himself an authority on the bet.

*Apparently deciding that it was a five-year deal and that Dr Keen hasn’t really lost at all (so why is he walking?), Rob in a widely read commentary today claimed the bet “has four years to run… There’s no doubt the bet is still on – still for the taking”.

*That’s not quite right. Indeed, it’s exactly wrong. To recap, it was a simple peak-to-trough bet, with no time limit involved. Of course, Bloomberg and others accurately documented all this long ago (for example, see

*As reported here at the time, Dr Keen and I firmed-up the rules of the bet within days of it first being discussed in Canberra:

For the record, Steve Keen is keen to clarify that our bet is "peak to trough", as agreed, with no five-year limit (see attached). Obviously, I expect this distinction will not make a difference, with the ABS house price index likely to surpass its Q2 2008 level well within 5 years (from 28 October 2008 email, attached below; Eagle eyes will have noted that “Q2” should have read “Q1”).

* Also highlighted here way back then were the reasons why Dr Keen’s extremist view on house prices always was an uphill battle, to say the least:
We now have a bet, and I expect eventually to have a win. That's because falls in Australia-wide home prices will be limited by our lack of overbuilding, our much more disciplined mortgage market, and - especially - by the RBA's ability to drive mortgage rates lower… limiting the drop in average home prices is an unstated but obvious objective of increasingly easy RBA policy. …

Assuming that Dr Keen eventually will have to take that long walk, it will be because he greatly under-rated the quality of macroeconomic analysis undertaken at the RBA and in Canberra, and underestimated the power of low interest rates to support local home prices even in the face of today's alarmingly weaker global backdrop (from 27 October 2008 email, attached below).
*The fact that the downtrend in house prices underway in 2008 ended just a few months after the bet was agreed - rather than 15 years down the track as Dr Keen anticipated - simply highlights how wrong he was about the outlook for house prices (chart).

*Who knows, after a week trudging up the road with Dr Keen’s sympathetic sidekicks, Business Spectator might start reporting that “Dr Keen was right all along”, notwithstanding his extreme forecasts having proved wildly inaccurate.

*In any case, the lesson to be learned from this episode is that betting the house on an economist's forecast typically is not a smart move. Dr Keen himself is learning that the hard way. Unfortunately, Dr Keen recklessly encouraged everyday Australians to sell their homes at what turned out to be the peak of the global financial crisis, and the trough in local house prices.

*More generally, my observation is that those with the strongest views that the price of Australian houses "must" crash because they are "wildly overvalued" typically either don't own one (and so are very keen for prices to fall), don't really know what they are talking about, or both.

*In particular, when I hear commentators talking about the dismal Japanese experience as an obvious guide to what will unfold in Australia, I wonder if they actually know what day it is (chart).

*The "bubble crew" seem to keep missing the simple but profound fact that there’s been extraordinarily rapid growth in the number of actual people in Australia with incomes and/or wealth who want to own or rent houses in which to live - as opposed to living in tents and shipping containers – and yet the underlying long-term trend in homebuilding remains flat near 150,000 per annum. The sheer strength of demand via rapid population growth – alongside very low mortgage rates - has been an obvious upward pressure on home prices.

*Moreover, the “bubble crew” somehow have convinced themselves that the $7000 first-home-buyer “boost” (FHBB) had a much bigger effect on house prices than did the profound 4pp reduction in mortgage rates overseen by the RBA: “This latest house price bubble began when the government doubled and even tripled the First Home Owners Grant”.

*Next time you hear that story ask the story-teller what proportion of first-home buyers would have bought, even without the 7k gift, once the RBA starting cutting rates aggressively. The correct answer is: most of them. And then there’s the huge number of existing home-buyers who didn’t have to sell at the peak of the drama because the RBA quickly delivered to them funding costs lower than they’d ever dreamed.

Outlook for Oz house prices dampened by rates returning to familiar territory

*I have no strong view on the outlook for average house prices, except that those with extreme views will continue to be wrong. There clearly are both positives - rapid population growth alongside decent GDP and jobs growth, colliding with the flat long-term trend in homebuilding - and negatives, the latter dominated by ongoing RBA rate hikes driving mortgage rates higher.

*Governor Stevens' recent property warning on breakfast TV – “It's a mistake to assume a riskless, easy, and guaranteed way to prosperity is just to leverage to property" - should be viewed as fatherly advice, rather than as a stand-alone threat to crush house prices.

*We saw in the first half of 2008 that mortgage rates steadily increasing to decade-plus highs (chart, below) tended to force home prices down a bit, as leveraged buyers struggled to find the necessary extra cash.

*Given the rapid rebound in the Australian and global economies – driven by fast-growing Asia – and the recharging of our biggest-ever mining and commodity-price booms, the RBA probably has in mind a likely macroeconomic need to lift interest rates a good deal further over the next couple of years, so, when asked, Governor Stevens did the right thing and gave a "heads up" to anyone who might be mulling the idea of wandering out and borrowing big to buy an investment property or ten.

*It's not that the RBA is determined to stop house prices from rising - it's not. And it might be that rapid growth in housing demand - via our extraordinary mining and population booms - delivers higher home prices regardless of tighter RBA policy.

*Nevertheless, anyone with their eyes open is aware that unusually low funding costs over the past 12-18 months powered a good part of the double-digit house-price gains that have excited so much comment and talk of “bubbles”. Double-digit price gains probably will be much harder come by in the next year or two: after all, mortgage rates already are up by nearly 1.5pp from their lows - to a typical rate near 6.5% - and further increases almost certainly are in the pipeline.

*Indeed, another 2pp worth of higher mortgage rates over the next couple of years wouldn't surprise. That is, IF the global economy continues to grow solidly, global commodity and equity prices keep rising, and Australian unemployment trends down another percentage point - from 5.3% today into the low 4s - there is a real chance that mortgage rates could revisit their decade-highs near 9%.

*My bottom line is that mortgage rates within a couple of years could easily match the painful highs reached two years ago, before the collapse of Lehman collapsed global growth, prompting the RBA to collapse interest rates to support the economy, in the end making Dr Keen hopelessly wrong on house prices, not to mention 15% unemployment.