Bubble, Bubble, Soil and Rubble

What is up with Australia’s house prices? Everything, it seems.

I of course have some personal bias in the matter, being one of many potential Australian first-home buyers ‘in the market.’ But even leaving aside my personal gripes, it must be said that Australian housing prices are ridiculously inflated.

There are a number of possible causes propping up Australia’s bubble, such as ludicrous tax breaks for negatively geared speculators, the Government’s recent theoretically-dubious first home owner’s grant, and an overly optimistic level of consumer sentiment. But regardless of the root cause(s), the bubble is ominously, undeniably there.

Don’t believe me? Just ask Professor Stephen Keen.

In October 2008, Professor Keen bet Macquarie banker Rory Robertson that Australian house prices would fall by more than 40 percent over the course of 2009, with the loser having to walk the 224 kilometres from Canberra to Mount Kosciuszko. To Keen’s credit, he took his loss not as a failure, but as an opportunity to raise awareness about Australia’s housing crisis and the possible coming double-dip in our nation’s remarkable economic recovery. Kicking off this afternoon from Parliament House, the University of Western Sydney Professor of Economics will run and walk up to 30 kilometres every day, accompanied by dozens of loyal (and somewhat eccentric) followers brandishing shirts with graphs and slogans such as “I was hopelessly wrong on house pieces. Ask me how!”

While the bet was made and is being carried out in good spirit and cheer, and raising a fair bit of dough for charity on the side, the whole saga underlies some fundamental questions about the Australian economy. For one, does Rory (who is obviously quite a cluey guy) really believe that we aren’t in a real estate bubble, or did he simply correctly predict that it wouldn’t pop in 2009?

I, for one, am inclined to believe the latter. In fact, modern behavioural finance theory suggests that it can actually be rational for a sharp investor to invest in an asset bubble, even if she realises that prices are over-inflated above and beyond their true levels. Why? Because irrationality breeds irrationality, over-exuberance breeds over-exuberance, and consumer sentiment follows the herd. Of course, if you believe the bubble is going to pop at some point, you’ll have to time it to get out of your investment before the crash. But, just like haggling at a street market, you can push it a far way to grab a bargain before knowing when to quit. Besides which, Australia is facing a massive housing shortage, which will continue to bolster these ridiculous prices.

Still, the prospect of a housing collapse has scared the financier in me, and I’ve stopped looking at real estate for now. Such a deflation would resonate throughout other areas of the Australian economy, and would more than likely trigger a double-dipping effect of the global crisis. Even the Governor of the Reserve Bank of Australia, Glenn Stevens, warned last month of the risks of taking out large loans in order to jump on the housing bandwagon, implying that the current housing growth rate was unsustainable.

Perhaps I should head up to Parliament House this afternoon and join Keen for the first leg of his trek. Whether he’s right or wrong, it’d be useful to hear the insights of a man who has been nominated, along with ten other notable economists, for the Revere Award for Economics –which is awarded to the three economists “…who first and most clearly saw the Gobal Financial Collapse coming and whose work is most likely to prevent another GFC in the future.”

Maybe I’ll be able to get some tips on when he thinks things might start to turn, and what I should be doing to prepare for the calamity. At the very least, the exercise will do me good in the future.

Particularly if I have to sell my car to pay the mortgage.