Grantham, chief strategists and co-founder of US investment firm GMO, which has more than $120 billion in funds under management, said yesterday that Australia had two of the remaining housing bubbles in the world (Britain has the others) and has warned prices will dive as interest rates rise over the coming months.
But the claims have been questioned by several leading commentators, including Reserve Bank deputy governor Ric Battellino.
Who is right? Are we really about to see our bubble burst dramatically? Time for a SmartCompany Q&A.
Right, so who is this Grantham guy and why should we care what he says?
Grantham has made his name studying and predicting bubbles, most notably the subprime collapse. Back in July 2007 – when markets were riding high and the GFC was still some way off – he boldly predicted the following (in his own words): "In five years I expect that at least one major "bank" (broadly defined) will have failed and that up to half the hedge funds and a substantially percentage of the private equity firms in existence today will have simply ceased to exist." Just over a year later Lehman Brothers was gone.
Okay, that's pretty impressive. So what does he say about Australia?
His argument is that the ratio of house prices to incomes has become completely out of whack. Grantham says that house prices are typically 3.5 times family income, but in a bubble prices increase to six or 7.5 times income.
"Australia is having one [a bubble] now. You are near 7.5 times family income... which suggests you are twice the size that you should be," he said yesterday.
"Sooner or later rates will go up, and the game is over."
That doesn't sound great, given that everybody is predicting rates are going to keep rising.
No, but we must point out that not everybody shares Grantham's view.
Is the RBA worried about a housing bubble?
It seems not. Yesterday, RBA deputy governor Ric Battellino gave a speech that looked specifically at the issue of Australia's level of household debt and said "it is reasonable to conclude that the household sector has the capacity to support the current level of debt" although he did note that increases to the debt levels carried by Australian households could expose them to "shocks" that could hit the economy.
He also raised some questions about the method used by Grantham to compare house prices to family income, arguing – as many commentators have – that the figures are somewhat distorted by that price measures are focussed on more expensive areas in the city.
"The ratio of house prices to income that are published for Australia tend to focus mainly on prices in the cities, and they are quite elevated. But, if you look across the whole country, the ratio of house prices to income is not that different from most other countries," he said yesterday.
And is this right?
That house price index produced by RP Data and Rismark suggests when house prices across the country are compared with household incomes, the ratio is actually 4.4 times – above the long-term average, but nowhere near as high as Grantham suggests.
Well, this is sounding better and better. Are there any other arguments against Grantham's bubble call?
There is the standard arguments supporting the idea that the "fundamentals" of Australian housing remains strong – good population growth, strong demand for housing and relatively low supply.
The other argument relates to exactly how high rates would need to go before Australian households start to feel the pressure that would cause Grantham's big bust. Yesterday he talked about rates going to 10%, which is a fair bit higher than the current standard variable mortgage rate of about 7.5%.
If the RBA was to continue with its strategy of lifting rates by 25 basis points, we'd need to see another 10 rate rises before the mortgage rate hit 10%. It's not inconceivable, but it is likely to take some time for rates to get that high, particularly given the fragility of the global economy.
And what does Mr Grantham make of those arguments?
Not much. His point – and it's a good one – is that the one thing bubbles have in common is that "every one of them is considered unique or different". In the end, however, measures such as the ratio between house prices and incomes tend to revert to their long-term levels, eventually. As he says, if Australian prices don't come back to normal levels (compared to incomes) it "will be the first time in history".
So should we be worried about the bubble talk?
Grantham's statements do look a bit overly dramatic, but his expertise in bubbles needs to be respected. And we should also note that the RBA has made it a priority on a number of occasions this year to point out that while households appear to be able to support current debt levels, there is some danger that an increase in household indebtedness could leave people vulnerable to "shocks" such as rising rates or unemployment.
But right now, the housing market appears to be doing all the right things. While conditions clearly became a little overheated at the start of the year, falling clearance rates and lending data would suggest everybody recognised this and backed off appropriately in the face of rising prices and rates.
But as we've said before, buyers need to consider the bubble battle in terms of their own circumstances. How much debt can you personally afford to take on? How will you cope if rates were 2% higher? How have prices in the area you want to buy in performed and how will they perform? How secure is your job? The key is for every property owner to be comfortable in their own situation.
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written by leithvo, June 16, 2010
written by lalarose, June 17, 2010
But since most of us live in the cities, and do have to put up with house prices that are 7.5 times the family income, it IS unsustainable and we ARE different. We are different to 'most other countries' because we have such a massive gulf between cities and rural and lots of our country is uninhabited. You can't compare us and say that we are in line when we have such a small population as well. There are 20mil people living in London ... and 23mil spread across our entire continent.
I am a Gen Y and have no immediate hope of buying into the property market. I do hope that the bubble bursts so that we can enter the market ... what happens if we can't?
written by geoffpayne, June 17, 2010
1/A great percentage of Australians own their own home. They don't have a mortgage.
2/ The actual cost of producing a new block of land or building a house, only has a small profit margin. The property's cost is not to much higher than its current market value. If there where super profits in developing property everyone would be doing it or the Government would put a super profits tax on it.
3/ Demand for property will continue because the extra 350,000 people in Australia each year need somewhere to live.
4/ The other major pressure on property in Australia is from gerneration Y. Who are finally leaving home (a 10 year delay in the market) and starting thier own family.
5/ First home buyers have always find it hard to buy a house. The opportunity cost is a lifestyle choice.
written by Nick Christian, July 16, 2010
John Kennith Galbraith - "The Great Crash"
When you start to convince yourself many times over and over that 'this time is different' you'll start believe it - then its too late!
Your comments are typical of "the dream asset that will always appreciate" mantra.
All I can say is good luck guys. Many will learn the lesson well - the hard way.
The Intelligent Adviser
