What is it that determines house prices? Supply & demand, availability of credit, government subsidies, taxes, or a level of value in the buyers head? I think it’s time we try to put a little discipline into the debate. Clearly many things go into determining house prices but with a little thought we can perhaps understand a little more about the drivers.
My approach came from a little mind experiment that established an anchor point. Think of a situation where a typical suburban house is being auctioned. There are two bidders only but one is borrowing 100% of the final purchase price, the other 0%. The borrower has an approved loan based on his “median” income and only access to further funds to pay costs of purchase. The bidder with no borrowing requirement has access to unlimited funds. Who wins the auction? If our bidders are acting rational, the bidder borrowing funds sets the price by bidding up to his maximum borrowing capacity but the other bidder with access to unlimited funds wins the auction by bidding $1 or some minimal amount more.
This may sound an unusual situation but if we think about the number of auctions that are occurring around Australia each weekend, my mind experiment could easily be the typical average situation that determines median house prices if sufficient demand exists for each property being bid. Logic also tells me that the auction result is the same in any combination of situations where bidders were borrowing funds, the bidder with the lowest borrowing requirement wins the auction but the bidder borrowing the most sets the price. Following this line of logic, there would seem to be a maximum price that needs to be bid for a house, which is determined by the maximum that the most heavily geared bidder can borrow.
From this simple mind experiment, I propose that there is parameter in a geographical region known as the Maximum Median House Price (‘MMHP”). Actual Median House Prices (“AMHP”) are simply a function of MMHP when the Effect of Demand (“ED”) pushes AMHP towards or away from the maximum. Or, AMHP=MMHP*ED
Having created the simple equation for AMHP, we can focus on separating the determinates of MMHP and ED.
So what determines MMHP? Being experienced in mortgage lending criteria and factors that affect the net borrowing amount, my list is as follows:
- Median household income
- Income tax and medicare levy
- Henderson poverty index or living expenses
- Mortgage Repayment (P&I and IO payment, bank cost of funds)
- Mortgage serviceability (bank specific but this is the lowest common denominator))
- Deposit Requirements (amount, whether genuine savings and capitalized costs)
- Amount of government cash subsidy (eg. FHOG both state and federal)
I’m sure that I’ll get some serious push back on the list above but I’ll strongly defend the list which clearly says that the MMHP has little to do with the house. The house, whether old or new, merely fits to what the MMHP is at any point in time. Houses may be made of bricks & mortar or wood, but they’re also full of air!
Those of you mathematically inclined would quickly see that the MMHP can be relatively easily put into an equation which could calculate the MMHP for any Australian region on an ongoing basis. The data is available to do this calculation but not easily or readily, but technology is bringing closer the time when databases will exist to allow the calculation to occur and be readily available.
However, as I have asserted on prior occasions the banksters have maximized the amount of available credit and therefore the MMHP beyond any point which is sustainable and thereby putting the whole financial system at risk. This has been done by under weighting certain lending risks outlined above, and consequently being allowed to undercapitalize their balance sheets and use mortgage rehypothecation to ramp up the availability of cheap credit. Nevertheless on its own the MMHP is not the sole issue to be addressed.
- Assuming that MMHP is calculable, to obtain AMHP we need to look at the demand factors or ED. Here’s my list of factors that effect ED which of course are much more problematic than factors affecting MMHP.
- Purchase taxes (stamp duty etc)
- Upfront borrowing costs (fees and mortgage insurance)
- Deposit Requirements (double direct effect and demand effect)
- Income tax effect (capital gains, -ve gearing)
- Availability of new land
- Infrastructure costs and taxes on new land
- Regulation on development and redevelopment of land and housing
- Australia’s beliefs, delusions and intelligence
Demand factors are very complex and interwoven but again useful data is available on most of the factors at any point in time. But what would you do with it? Well I argue that the Australian population acting as a single entity without any conscious decision has done an enormous amount in working out how the factors provide the ED.
Vested interests in all levels of governments and the private sector have fine tuned the ED factors over 15-20 year period to create maximum demand and therefore MMHP in all significant regions by late 2010. How was this done? Each party controlling an ED factor maximises its return by manipulating the ED factor to achieve maximum benefit whilst maintaining maximum belief and delusion in the “value” of housing.
Of course, evidence now suggests that the beliefs and delusions have changed in a number of regions where AMHP have come off their MMHP which also can lead to the creation of the crash spiral as banks change the calculation of MMHP, chasing down the AMHP. Once the contagion spreads, the whole country catches the crash spiral virus.
I have a major problem with Australia’s AMHP and MMHP scenario which we now find ourselves in.
Whilst a large part of the population may have gamed the ED to their advantage it’s the banks and the different levels of government that control nearly all of the factors of MMHP and ED that must take responsibility. To exploit the system to a point where an over inflated MMHP is reached across the country, is a grossly irresponsible act against current let alone future generations.
As George Soros says, “If you see a bubble forming get on board”. So good luck to all those who’ve ridden the expansion. But for those sitting on large amounts of “equity mate”, that’s all the credit you deserve. The whole scheme was not of your making. You’re just one of the factors used by the banks and governments to their certain advantage. The countless spin that housing is a great investment, housing shortages will continue into the foreseeable future and most of all governments at all levels will ensure that house values will be maintained as the nation’s priority. All of it appealing to human greed, delusions and a strong belief in the nanny state. But if you haven’t cashed out on those property investments don’t count those chickens yet.
This is not a conspiracy but a cabal of firstly, banksters, regulators and politicians that work with a common theme to maximize the MMHP, for their own benefit but with the spin that it’s for the common good. Then secondly, federal, state, and local governments, in tune with the banks and the property industry to whip up a frenzy of demand whilst managing to extort taxes, fees and profits from borrowers by filling the gap between what the AMHP should be and the artificially created MMHP. That’s the actual ED.
The relentless march continues and the question of who’ll pay for this plays to the beat of the drudging footsteps.