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Let's conclusively prove that house price falls PRECEDE rises in unemployment
Topic Started: 17 Jul 2012, 08:22 PM (849 Views)
Bobby
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Let's conclusively prove that house price falls precede rises in unemployment

One of the great urban myths you will hear around property in this country is that spikes in unemployment are required before house prices will fall. This is patently false and the data is provided below to prove that the relationship is actually the other way around. That is, house price falls lead an economy into recession resulting in higher unemployment.

It is interesting that very learned men have in recent times also made the claim that higher unemployment was required to cause house price falls. For example, here is respected economist Adrian Blundell-Wignall of the OECD actually making that claim, despite correctly identifying that Australia is in the midst of a large housing bubble:

http://www.propertyobserver.com.au/australian-capital-territory/the-first-time-unemployment-starts-to-rise-australian-house-prices-are-going-to-be-falling-oecd-official/2012071355571

(My emphasis throughout)

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“The world is so globalised and interconnected that if it goes down, things will get much worse for Australia,” Dr Blundell-Wignall said on a visit to Australia, as reported by the Australian Financial Review this morning. “The biggest problem for Australia that worries me personally is house prices.”

The first time unemployment starts to rise, house prices are going to be falling.


It is interesting how urban myths can pollute the finest economic minds. Anyhow, Gavin Putland of the Land Values Research Group (LVRG) provides conclusive data to disprove this urban myth in the following article - 40 years of housing bubbles and recessions. I'd recommend that you bookmark this website too: http://blog.lvrg.org.au

http://blog.lvrg.org.au/2010/10/40-years-of-housing-bubbles-and.html

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The argument that a strong economy will prevent any substantial fall in home prices is easily debunked by considering the quarterly change in real GDP (the yellow curve at the bottom of the graph) in relation to home prices.

The recession and home-price slump of 1974 have an obvious common trigger, namely the deliberate credit squeeze of late 1973. Thereafter, economic weakness generally followed, rather than preceded, falls in home prices. The recession of late 1975 occurred while home prices were still falling from the 1974 peak. The double-dip recession of 1981–3 followed the home-price peak of early 1981. The “recession we had to have” followed the home-price peak of 1989. The dip in economic growth in 2004, and the subsequent period of ordinary growth in spite of the historic improvement in the terms of trade, followed the home-price peak of late 2003. The near-recession of late 2008 (which was a recession by almost any measure except the official one) followed the home-price peak of late 2007.


In other words, house price slumps are the triggers for periods of economic weakness that result in higher unemployment. Gavin's work and that of Prof Keen are clearly complementary because Gavin also identifies that the greatest indicators of house prices are loans for investment and owner-occupied established homes:

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If the strength or weakness of the economy as a whole does not predict slumps in home prices, what does? To our knowledge, the best predictor is a substantial simultaneous downturn in loans for investment homes and loans for owner-occupied established homes.
...
In short, it seems that while a fall in sales of established homes usually portends a fall in prices, a fall in sales (or associated lending) caused by the scheduled withdrawal of a subsidy doesn't count.


Similar to the work of Prof Keen, house prices are intimately related to the rate of credit growth for investor and owner-occupied homes. Further, that credit acceleration (or lack thereof) also has an intimate relationship with unemployment, as proven below by Prof Keen:

http://www.debtdeflation.com/blogs/2012/02/10/rba-rates-decision-roy-morgan-unemployment/

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Mortgage debt is now decelerating strongly, and taking house prices down with it.


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...credit growth is now decelerating in Australia, and causing unemployment to rise despite the offsetting impact of the resources boom.


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It is the presence of a strong and positive credit impulse, causing additional debt-fueled aggregate demand, which results in strong employment in this country. With both owner-occupier and investor financing figures plumbing 35 year lows, house prices will continue to drop, resulting in spiking unemployment. You can bank on it.

Anyone banking on house price rises is arguing against very hard data showing significant relationships between finance growth and house prices, and the fact is that housing finance figures are currently dead. Further, there is very solid data which shows that house price falls precede rises in unemployment. Therefore, with house prices falling quite steeply, we can expect an increase in unemployment in the near term.

Here's why house price falls precede rises in unemployment: the wealth effect

We have proven that house price falls precede rises in unemployment, but the next obvious question is - why? The answer my friends can be found in the wealth effect. From Wikipedia:

http://en.wikipedia.org/wiki/Wealth_effect

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The effect would cause changes in the amounts and distribution of consumer consumption caused by changes in consumer wealth. People should spend more when one of two things is true: when people actually are richer, objectively, or when people perceive themselves to be richer—for example, the assessed value of their home increases, or a stock they own goes up in price.

Demand for some goods (especially Inferior goods) typically decreases with increasing wealth. For example, consider consumption of cheap fast food versus steak. As someone becomes wealthier, their demand for cheap fast food is likely to decrease, and their demand for more expensive steak may increase.


In other words, you don't have to actually be richer in order to spend more. If you are only rich on paper, for instance when someone tells you your home is suddenly worth 100K more than it was 2 years ago, then you will often consume more given your new level of perceived wealth. Remember, this is not money in the bank because these people with over-valued homes haven't cashed out and made their windfall capital gain, but that is irrelevant. The principle is all that matters - in rising markets people get horny for consuming and it appears that there is also a shift to greater consumption of premium goods under this scenario. Fancy bogan transport, Miele kitchen renovations and 132" HD plasmas anyone?

Leith Van Onselen shows us the way with his take on the wealth effect:

http://www.smh.com.au/business/how-stagnant-house-prices-are-sapping-spending-20110524-1f1uf.html

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Feedback loops are an important concept in finance and economics. In a nutshell, positive feedback loops are pro-cyclical in that they act to make an economy more volatile by accentuating booms and then busts.
...
Positive feedback loops come in various forms. With respect to the Australian housing market, there are two positive feedback loops that can dramatically impact the Australian economy via their effect on the level of credit growth, aggregate demand, and employment:

1.mortgage hypothecation – the process whereby increases (decreases) in home values result in decreases (increases) in bank capital adequacy requirements, leading to increases (decreases) in mortgage lending; and
2.wealth effect - the process of rising (falling) asset prices leading to rising (falling) consumer confidence, borrowing, household expenditure and employment.


Banks love booming ponzi markets because it drives higher house price growth and lower capital requirements - which ultimately means more lending can occur. You can see how this feedback loop is strongly reinforcing. However, the obvious risk on the downside is clear; lending drops off, house prices tank and banks need higher capital ratios.

Can you see how the housing market and the broader economy is all about group psychological processes and cognitive biases? It has nothing to do with bullshit equilibrium markets dictated by supply and demand fundamentals, but everything to do with how everybody feels about their own personal wealth and circumstances. Consequently, if house prices are booming and you're told your crack shack that you bought for 150K 15 years ago is suddenly worth 650K, then you may wish to go out and splurge at IKEA on some vibrating water-beds or get that laser surgical treatment that Warnie has been promising can save you from future chrome dome ridicule. Conversely, if house prices are tanking, you will go into your shell like the fabled turtle and be very frugal in your spending because you feel relatively impoverished.

Here is the key figure from the RBA showing how Australians hammered home equity in the noughties and splashed cash drawn from our over-priced ponzi homes for all manner of crass binge consumerism:

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Leith also notes research by Citigroup that found:

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A 10% increase in wealth translates to 1.7% growth in final consumption expenditure in the following quarter. This means that when house prices go up, people spend more. The problem for retailers has been that most peoples largest asset is their home, and property values have been falling, or have been at best flat in recent months.


In effect all this spending artificially boosted economic activity and consequently unemployment was low and income growth was strong. However, now that the negative wealth effect is in play with falling house prices, we can expect consumption to be weak, along with unemployment pressures to rise in the face of subdued credit growth. As Leith points out, mining will not save us under these circumstances because the majority of us do not directly realize any benefit from the mining boom.

Research by Deutsche Bank that supports the positive feedback loop outlined above.

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In regards to the ‘wealth effect’ discussed above, Deutsche provides the below chart plotting the household savings rate against private sector wealth. As you can see, much of the decline in the household saving rate (the flip-side of which is increased borrowing) since the early 1980s can be attributed to a rapid increase in wealth over that period, much of which was due to rising home values. Figure 1 also shows the negative wealth shock seen during the GFC, and the associated increase in saving.


In short, this figure again confirms that if your wealth goes up (perceived or otherwise), there is a significant drop in the savings ratio and vice-versa.

SUMMARY

Behavioural economics has a big role to play in explaining the large gaps left by current models of the Australian housing market and the impact on broader economic activity. While credit growth figures are clearly related to house prices and future unemployment, it is evident that it is group psychological pressures which determine consumer behaviour at large. Therefore, it is to be expected that the perception of 'negative wealth' across the nation in the face of falling house prices will drive cautious consumer behaviour, pushing the economy closer towards a recession until such time as house prices change their established downwards trend in place since the middle of 2010.

Given the multiple risk factors facing the Australian housing market, sustained house price rises are unlikely to eventuate soon, and on that basis (and in accordance with IMF research outlined much earlier in this thread) an extended recession can be expected; particularly as our housing bust is occurring in a severely over-indebted household environment, which has also been empirically proven to result in worse economic downturns.
'Chess is war over the board. The object is to crush the opponent's mind' - Bobby Fischer

Beware the Real Estate Astroturfers, for they are among you!
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Daniel Birke
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Bobby
17 Jul 2012, 08:22 PM
sustained house price rises are unlikely to eventuate soon, and on that basis (and in accordance with IMF research outlined much earlier in this thread) an extended recession can be expected; particularly as our housing bust is occurring in a severely over-indebted household environment, which has also been empirically proven to result in worse economic downturns
+1

And because the govt and RBA are "out of ammo" there's nothing they can do to prevent the recession this time.

The recession will be evident by years end. Two quarters of -ve GDP will soon become 2-3 years of -ve GDP with no bottom in sight for housing.

We're just like the USA, only a few years behind!
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Trojan
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Daniel Birke
17 Jul 2012, 11:13 PM
And because the govt and RBA are "out of ammo" there's nothing they can do to prevent the recession this time.
How did you come to the conclusion the Australian govt and the RBA are out of ammo?
I put trolls on my ignore list so if I don't respond, you are probably on it ....
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peter fraser
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Bobby
17 Jul 2012, 08:22 PM
Let's conclusively prove that house price falls precede rises in unemployment

One of the great urban myths you will hear around property in this country is that spikes in unemployment are required before house prices will fall. This is patently false and the data is provided below to prove that the relationship is actually the other way around. That is, house price falls lead an economy into recession resulting in higher unemployment.

Urban myth? I've never heard that myth, perhaps it's a myth that the myth exists.

Bobby of course lower house prices can cause a recession and higher unemployment, but conversely higher unemployment can cause a recession and thus lower house prices.

It isn't the case that there is only one path to a recession, and I very much doubt that anyone here ever thought that was the case, or ever denied that a positive feedback loop could be set in play under the right circumstances.

Exactly what was your point? Why would you believe that we don't understand that? Many of us may not believe that we will see that outcome, but very few if any would believe that it can't happen.
Edited by peter fraser, 18 Jul 2012, 01:09 AM.

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