Does 'prophet of doom' still predict housing crash?

A large portion of Australians’ net worth is tied up in real estate, so any talk of a property crash is typically greeted by most people with disdain.

Few know this better than Australian economist Professor Steve Keen (pictured), whose bold and unpopular predictions of hefty house price falls have made plenty of headlines in the media.

Referring to Keen as the “Prophet of doom”, in 2010 the Sydney Morning Herald reported that Keen pocketed $540,000 when his Surrey Hills apartment sold in October 2008, having “lost his bet that property prices would fall by 40%”. At the time, in his best case scenario, Keen foresaw a recession worse than the early 1990s, the newspaper said. 

As recently as May 2019, urban.com.au reported that Keen’s response to Peter Switzer’s question of how long before house prices would fall by 40%, was “five years”.

But Keen, the former head of the School of Economics at Kingston University London and former associate professor of economics and finance at the University of Western Sydney, has tempered his strident views recently and now expects Australian property prices to fall about 20% over the next 18 months.

This is in line or similar to the views of other economists. NAB chief economist Alan Oster said NAB’s current forecast was for house prices to drop 4% this year, and 14% next year.

ANZ has predicted house prices to fall about 20% by the end of 2023 as has Carlos Cacho, chief economist at investment bank Jarden.

MPA caught up with Keen, who lives in Amsterdam, to discuss rising interest rates and cost-of-living increases and their impact on house prices.

Keen, who refers to himself as a “critic of conventional economics”, said his work involved developing an alternative to mainstream economics. His main focus is on the role of energy in manufacturing, how it’s ignored by mainstream economics and how to bring it into account.

Confirming this wasn’t a forecast but rather than expectation, Keen said house prices in Australia would fall around 20% over the next 12 to 18 months. 

“The level of fall before governments start to respond to the pain is of the order of 20%,” Keen said.

Read more:  House prices forecast to tumble

Essentially, Keen said he regarded house prices as a bubble, inflated by too much household credit.

When household credit is rising, such as during periods of record-low interest rates, aggregate demand in the economy also increases, he said. When there’s rising levels of new mortgage debt, house prices rise, and conversely when levels are going down, house prices fall.

“It’s not the actual credit – it’s change in the credit, which drives change in house prices,” Keen said.

Due to low interest rates and government policies, there’s been a huge increase in credit over the last 20 to 30 years, he said.

In the current environment of rising interest rates and uncertainty, he said credit was going backwards.

“People will either stop taking out mortgages or they’ll sell their houses and be forced to sell that way to reduce the debt,” Keen said.

“That’s going to produce negative credit rather than positive credit – and that’s what gives you falling house prices.”

When the economy performs well, Keen said politicians were inclined to take credit for it, which fed the house price bubble. According to Keen, governments were reluctant to disturb this motion, as to do so would impact the overall wellbeing of the country.

“It isn’t just a private sector hassle, it’s also governments artificially inflating it,” Keen said.

“It’s an awful situation and I’d rather see public policy get us out of it, but I think it’s something we’re globally stuck with, until such time as it becomes obvious that’s not the most important issue.”

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Each time there had been a potential fall in house prices, the government’s response was to pump more money into the market through first home buyer schemes, or through lowering interest rates, Keen said.

After being unconcerned about consumer price inflation for about “two decades”, Keen said central banks were now acting by pushing up interest rates, increasing costs for borrowers.

“Now they’re worried about it and their immediate response is to whack up interest rates … of course that destroys the housing market,” he said.

When considering what’s driving up house prices, most people think of the factors of supply and demand, and that by increasing supply, prices will reduce, he said.

“They know that when they’re saying it, governments have no control over how many houses are built. National governments are saying local councils are controlling developments, so to me it’s a complete fob off by the politicians,” Keen said.

According to Keen, falling house prices are likely to spark concern among politicians, when he anticipates constituents will require them to act.

While Keen said he expected a price fall in the order of 20%, he expected governments would then step in to “rescue the bubble again”. 

In Keen’s view, government homebuyer schemes such as the Shared Equity Scheme, where the government contributes an equity share of up to 40% for a new home (30% for an existing home), are only viable in an environment where house prices continue to rise.

“It’s locking governments into wanting rising house prices … if you had borrowed $1 million and the government buys one third of it for you, that makes the price close to $1.5 million: it’s just another way to keep house prices inflating,” Keen said.

A housing affordability policy paper, put together by Keen, said the dominant policy under Labor and Liberal governments had been to add to the demand side of the market. Keen said this was achieved by giving grants to first home buyers and encouraging house purchases as investments.

“However, these grants and tax credits are only a fraction of the sum needed to purchase a house: the overwhelming proportion of the purchase price comes from mortgage debt,” it reads.

Since the 1970s, personal debt had not grown relative to GDP, but mortgage debt had risen “almost six-fold” since the first government interventions into the housing market, Keen said in the paper.

“This increase in mortgage debt is the primary cause of higher house prices. Since new mortgage debt is the main source of house-buying power, there is a causal link between rising levels of new mortgage debt, and rising house prices.”

Among the policies outlined in the paper to tame house prices is the introduction of a law limiting the maximum amount that can be lent to buy a house, to a multiple of its rental income.

Keen proposes it would start near the current ratio but would be progressively reduced until the maximum amount that can be borrowed is “10 times its annual rental income”.

“The key to taming runaway house prices is to tame runaway bank lending,” Keen said.

“We have to reduce the levels of private debt.”

CoreLogic figures show property values in Australia rose 22.4% in the 12 months to January 2022 (11.2% over the year to June).  In the last three months, national values fell by 0.2%, marking the first quarterly decline since October 2020.