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Why Australians should worry about a housing crash

The start of the year prompts a flurry of forecasts, most of which turn out to be hopelessly wrong.

The problem with economic forecasting is that there are so many variables, not least of which is the unpredictable nature of human behaviour.

Orthodox economists typically assume a rational individual, which is one of the reasons why predictions from their models are usually next to useless.

We know from psychology, and from our own life experience, that people can be greedy, fearful, impulsive and otherwise captive to emotional reactions.

We also know that humans tend to exhibit herd behaviour — during a boom they suffer extreme FOMO (fear of missing out) and when there's a bust almost everyone rushes for the exits at once.

No-one wants to be the last wildebeest in the herd, finding itself singled out and surrounded by lions.

If you want a recent example of how speculative, mass insanity can take hold, you need look no further than the meteoric rise of a range of cryptocurrencies last year (and fall this year), some of which were literally jokes and many of which are scams.

If you want a less insane, but no less intense, example of speculative groupthink, you need only look in your own backyard, literally.

"House prices will only ever go up" is a phrase surely heard by every Australian many times during their life. Even when prices have fallen, the refrain simply changes to, "house prices always go up in the long term".

It's been true for the best part of three decades — in fact there are a lot of working-age people who don't remember the last time Australian property seriously wobbled in the wake of the late 1980s crash, 17 per cent mortgage rates and the early 1990s recession.

But, as they say in financial disclaimers, "past performance is no indication of future performance", in fact, it is often a warning sign of future underperformance.

One of three factors needed for a crash … maybe

This leads back to the danger of making predictions.

While academic economist Steve Keen has been much pilloried for his constant predictions of house price doom and gloom over the past decade, current forecasts assuring everyone that a crash is impossible or highly unlikely seem equally dogmatic.

The common refrain we hear from this group is that you need forced sales to trigger a housing crash and there are only three factors that could cause this: a dramatic rise in interest rates, a falling population or a steep rise in unemployment.

For one thing, this analysis ignores the fact that housing prices are determined by the latest transaction.

There will always be some forced sellers — moving cities, bigger families, personal financial difficulties, divorces and deceased estates — and if the current buyers aren't willing or able to pay as much, say because lending restrictions limit what people can borrow, then prices can fall heavily even though few properties are changing hands.

There will also obviously be people who bought their property at a much lower price and are still willing to sell into a market where prices are down 10 or 20 per cent because a) they're still making a big profit, and b) they're worried prices may fall further.

It also ignores new developments — most developers have finance to fund their project and will need to sell their finished units/houses to pay their debts, even if they have to slash prices to do so.

But this severe price correction isn't really a full-on housing crash, with its consequent economic fallout, unless the falling prices affect tens, or perhaps hundreds, of thousands of sellers who end up booking losses (including banks in repossession).

To get this you probably do need one of the above factors (rising rates, rising unemployment or a falling population) to turn a steep house price fall into a housing crash with mass forced and panic selling.

Range of plausible risks

However, the analysts who insist that none of these things are on the horizon are ignoring a range of plausible risks.

One is that a global inflation revival and overseas rate rises essentially force the hand of the Reserve Bank into lifting rates, or at least force the retail banks into raising mortgage rates as offshore funding costs rise.

However, with the Australian dollar back near 80 US cents and global inflation still very moderate, this doesn't seem like a short-term threat over the next year or two.

The much bigger risk is around employment.

It sounds ludicrous to suggest this given the 300,000-plus full-time jobs added over the past year, but even that very strong job creation has left unemployment at 5.4 per cent, which is far from low.

And the reality is that a large contributor to job creation over the past five years has been the record residential building boom.

As building approvals rose more than 40 per cent from around 155,000 in calendar year 2012 to about 220,000 in financial year 2016-17, employment in building and construction services jumped almost 30 per cent to 1.07 million people.

External Link: Construction workers in Australia

This figure excludes engineering (i.e. resources and infrastructure) but does include those who work on commercial construction, which is now undergoing something of a boom itself in some cities.

With more than 240,000 more people now employed in construction than at the start of the residential building boom, there is a lot of scope for a dramatic rise in unemployment should falling home prices cause further residential development to stall.

If building activity and employment fell back to 2012 levels, those 240,000 surplus workers would increase the number of unemployed by about a third.

Assuming the labour force remained the same size, that would quickly push the unemployment rate to 7.2 per cent.

Wider fallout from construction job losses

That's exactly the kind of jobless rate that would start causing widespread defaults on mortgages, potentially turning a home price fall and development downturn into a property crash.

And these figures don't include potential job losses in the other sectors reliant on the property market, such as real estate services and banking.

They also don't include the inevitable job losses in retail, hospitality and other services sectors as the growing number of unemployed dramatically cut their household spending.

A saving grace for Australia is that many of these workers are temporary residents from overseas who may return home if they lose their job and can't find another.

Yet this is no saviour for the property market, retail or services, all of which have relied on very strong population growth for sales.

Does this all seem unrealistically gloomy?

Maybe it is, but it's exactly what happened in Ireland, Spain and, to a lesser extent, the US during the financial crisis.

We now have recent case studies highlighting how the collapse of an over-inflated property market can lead directly to a severe economic recession — in fact, research has shown a real estate collapse and associated financial crisis tend to lead to most of the worst recessions.

To be certain this will happen in Australia is misguided, but to be certain it won't is folly.

Original Article

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