by Kris Sayce on 25 March 2011

Money Morning reader David wrote us an interesting note about the fall of house prices in the UK:

“I remember living in the UK sometime around 2006 – 2007 and house prices, like Australia now, were overvalued. As soon as property went on the market they sold at crazy prices…

“Just as you predict here in this email house prices crashed about 18 months after their peak.

“The media blamed it [falling UK house prices] on the world financial crisis, which did have an impact but they were already on their way down.

“So many people forget a house is only worth what someone is prepared to pay for it.”

As time passes there’s always the tendency to compress events. Looking back now, it’s easy to think all the economic problems started in September 2008… around the time Lehman Brothers collapsed.

But that’s not the case at all.

For starters, the stock market peaked in October 2007. By the end of September 2008 – before Lehman collapsed – the Aussie stock market had already fallen 27% from the peak:

Source: Google Finance

Of course, the Aussie market fell another 35% before reaching rock bottom in March 2009.

Or take the fall in US house prices. That didn’t start in September 2008. In fact, it didn’t begin in October 2007 either.

In August 2005, The Times ran the headline, “US heading for house price crash, Greenspan tells buyers.“

His warning came just a few months before his retirement. After years of propping up bubbles and keeping interest rates at dangerously low levels, Greenspan was obviously thinking about his legacy… making sure in years to come he could say, “I told you there was a bubble.”

The Times wrote:

“In a pre-retirement speech to fellow central bankers at Jackson Hole, Wyoming, Mr Greenspan said that people were investing in houses as if they were a one-way bet, not allowing for the risk of price falls. He said ‘history had not dealt kindly’ with investors who kept ignoring risks.”

No bubble here, move along

“Thankfully” for the US housing industry, but not for those thinking about taking a plunge into the housing market, future Federal Reserve chairman, Dr. Ben S. Bernanke was on hand. Two months after Greenspan’s comments, Bernanke downplayed fears of a house price collapse.

In a testimony to the US Congress, Dr. Bernanke said:

“House prices are unlikely to continue rising at current rates… a moderate cooling in the housing market, should one occur, would not be inconsistent with the economy continuing to grow at or near its potential next year.”

In other words, in October 2005, Dr. Bernanke thought the US housing market would [cough] plateeeeeeeeau. Sound familiar?

One year later, The Washington Post headlined, “Housing Slump Slows Economy“. It wrote:

“The cooling housing market sent a chill through the economy in the third quarter, helping to slow growth to its weakest pace in more than three years.”

Interestingly, the Post also wrote:

“Heading into the final campaign stretch, President Bush [Ed note: remember him?] and other Republicans have emphasized the good economic news, such as the low 4.6 percent unemployment rate…”

[Needle scratches off record]

What’s that? The unemployment rate in the US was just 4.6% in October 2006. More on that in a minute…

Then by the end of May 2007, MarketWatch reported that “U.S. home prices fall for first time since 1991“.

It noted:

“U.S. home prices dropped 1.4% in the first quarter compared with a year earlier, the first year-over-year decline in national home prices since 1991, according to the S&P/Case-Shiller index…

“A year ago, home prices were rising at an 11.5% pace. Prices have been falling for the past three quarters.”

MarketWatch even included a chart showing the price growth and price decay:

Source: MarketWatch

Unemployment lags house price falls

Before I go on, back to that US unemployment number. Take a look at it on the chart below [Ed note: click on the image to view annotations]:

Source: Google

In a nutshell, this timeline disproves one of the key arguments made by spruikers – an idea we’ve never believed anyway – that Australian house prices can only fall if there’s a major shock to the economy.

The chart above proves that isn’t the case.

The S&P/Case-Shiller index revealed house price growth was in a steep decline from early 2006… and went negative in the first quarter of 2007.

During that period, what was the US unemployment rate? That’s right, it was around 4.5%. That’s lower than the current Australian unemployment rate. It also tells you the US unemployment rate is just as rigged as the Australian unemployment rate.

At that time there was no major shock to the economy. In fact, the first of the big financial firms to collapse – Bear Stearns – didn’t collapse until March 2008. A full year after house prices had started to fall.

And even if you take the first signs of trouble at Bear Stearns – the USD$3.2 billion “self” bailout of two of its hedge funds – that was only in June 2007… months after house prices started to sink. And still long before the market received a genuine shock to the system.

As I wrote in yesterday’s Money Morning, in response to Jessica Irvine’s terrible Sydney Morning Herald article:

“All that’s required for house prices to fall is for people to think that house prices will fall. Just in the same way that share prices can fall when they reach a peak. Sellers look to get out first before everyone else gets the same idea.”

This is what’s playing out in Australia right now.

Housing discounted by half!

Each day we’re getting letters into the Money Morning mailbag with examples of falling property prices. Money Morning reader Rick sent us a flyer showing a Port Adelaide development having slashed up to 59% off the original listing price of some properties.

Or this one with a 51% discount to the original price:

Source: Brock Harcourts

And if that wasn’t a sign of desperation, check out what the vendor is prepared to do in order to shift a dog of a commercial property:

“A single waterfront commercial property – offered at a price representing extraordinary value discount by 59%. All State Government ‘Stamp Duty Conveyance’ to be paid by the vendor saving thousands of dollars.”

Wow! Desperate? You bet it is.

Today, Money Morning reader Katie sent us an article from The Advertiser in Adelaide, “Glut gives homebuyers an edge“:

“The number of homes for sale is at levels comparable to peak spring season, forcing greater competition, industry experts say.”

You know what more competition means don’t you? That’s right, it causes prices to fall.

Money Morning reader Phil, sent us this from Smartcompany.com.au, “Expert tips property prices on Sunshine and Gold coasts to fall 7% as region becomes a ‘basket case’”.

And the rest. Only 7%? We don’t think so. Try 40% in both those areas.

Few people are even thinking about buying investment properties or holiday homes at the moment. And we’ll guess the Sunshine and Gold coasts rely on these buyers for a big share of the annual property turnover.

Gold Coast prices to fall by 70%?

In fact, the article quotes Louis Christopher – the only property guru we’ve come across who seems to make any sense:

“For the Sunshine and Gold Coasts especially we’re going to see a decline, but it could potentially be worse [than 7%]. We’re seeing similarities to the Florida markets here, and they corrected by 70%.

“We’re not saying it’s going to be the same as that… But could we end up with a cumulative decline? Absolutely, we’re heading that way.”

Zoiks! Mr. Christopher doesn’t think Queensland properties will fall by 70%. But why not? Why shouldn’t they? There’s no reason they shouldn’t.

Still holding that Queensland property? I’d do the numbers if I were you. If you’re mortgaged up to the eyeballs, you might want to offload it while you can.

So much for the – what Jessica Irvine calls – “some large external shock”.

Can you see any large external shocks where you are? No, me neither.

What I can see, is an economy and a consumer that’s fast running out of money… borrowed money that is.

The mainstream press and the Reserve Bank of Australia (RBA) can put any spin on it they like, the facts are facts, house prices are plummeting and over-leveraged homeowners are already copping it in the eye.

Not that the RBA will admit that. In its recently released Financial Stability Review, it states:

“Between August 2008 and April 2009, the average standard variable mortgage interest rate fell by almost 4 percentage points. There is evidence to suggest that some households used this period as an opportunity to pay down their mortgage ahead of schedule, for example by maintaining the size of their regular repayments despite required repayments falling. Around 58 per cent of the households with mortgage debt reported being ahead of schedule on their mortgage payments as at the 2009 survey…”

When extra repayments aren’t extra repayments

This is a good one. The only problem is that it omits an important fact. Notice this is a survey of households, not of banks. Ask banks the same question and they’ll quote a much, much lower number.

Why? Because as Money Morning reader Andrew points out:

“To the point on “people being ahead on their payments” providing a buffer to tough times in housing, people should recheck to see if that buffer can be accessed if they lose their job, or if the value of the property falls. I’m fairly certain the former is explicitly written to most bank contracts (it was in my NAB one), and that the latter could fall into the ‘terms subject to change’ clause.”

The fact is, people only think they’re ahead on their mortgage. With most banks, even though interest rates had fallen, unless you contacted the bank to ask for the monthly required payment to be recalculated, the “extra” repayments don’t actually count as extra to be withdrawn.

The “extra” just went towards repaying more of the principal.

In other words, it’s not available for re-draw, and if you did want access to it, you’d have to withdraw it from your so-called equity… which as we know, equity is just a smart banking trick of making you think a debt is an asset.

So forget this nonsense about home owners being ahead, because most aren’t… it’s just that they think they are.

But even more than that, the mainstream have fallen into the trap of thinking the large external shock must come first. Wrong. What comes first is the slowing and then contraction of credit.

It is the slowing and the contraction of credit that causes the shock, not vice versa.

Simply because – as we’ve written before – any economy built on Ponzi finance will ultimately become a victim of Ponzi finance.

That is, as less credit is created and less credit is demanded due to borrowers being maxed out, there is less air being pumped into asset bubbles.

Ponzi schemes must always have an ever greater net inflow of new money. As soon as that inflow slows, credit slows, price growth slows, and the consumer begins to see reality.

House prices can’t grow when credit is slowing and then contracting. If you want to call that a large external shock, then you can. The evidence is already around you that this is already happening.

If you’ve been looking at unemployment numbers as a sign of a future shock, I’m afraid – as experience in the US shows – you’ve been looking in the wrong direction.

Unemployment will rise, but only after house prices have already fallen.

But don’t panic, because our old pal, Peter Switzer writes:

“The judgement is in on the housing bubble in Australia and the decision is that there is no bubble but we are “uniquely positioned” with house prices 25 per cent to 35 per cent overvalued. But the question is when will this be reversed?”

He’s referring to a report from Goldman Sachs – you know Goldman Sachs, the firm that needed emergency cash flows from Warren Buffett and the US government to bail it out of bets it had made on the US housing market.

As always, I encourage you to make up your own mind. Which sounds more credible? The evidence I’ve give you above and in previous editions of Money Morning, or the idea that Australian house prices are overvalued by 25-35%, but there’s no bubble because Australia is “uniquely positioned”.

Which is just another way of saying, “Australia is different.” Er, no it’s not. The bubble-deniers really do need to lift their game… it’s getting quite embarrassing now.

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