Property bubble leads to crash landing

WHEN it mattered, the US Federal Reserve, US banks and rating agencies failed the risk-management test — in much the same way that Australia is now failing it.
This is because none of these bodies comprehends the manner in which the real estate market leads the economy. Many considerations flow from this, because businesses and individuals borrow against the value of their property assets. So when real estate bubbles burst and banks and mortgagors are left exposed, analysts flounder with such hogwash as "business cycles and recessions are a natural part of the financial landscape". Another knee-jerk reaction to systemic failure is simply to blame banks and borrowers. It seems anything will do, rather than tackle the fundamental flaw in risk management.

Here is an unyielding truth. A country cannot go into recession unless there has been a real estate bubble. US land economist Homer Hoyt documented the fact back at the beginning of the 19th century. The Land Values Research Group recently defined and studied the effects of property bubbles in Unlocking the Riches of Oz: A Case Study of the Social and Economic Costs of Real Estate Bubbles, 1972 to 2006, which is freely available at www.lvrg.org.au. It concludes that the current residential bubble has hyper-inflated since 1999 and is about to burst, despite sophisticated financial derivatives, hedge funds, collateralised debt obligations, credit default swaps, all brought into existence to "insure" that it not burst. The failure of derivatives will compound the upcoming financial threat.

It is sobering, too, to note that the relative scale of our real estate bubble is greater than that in the US. It is therefore irresponsible and incorrect to blame a potential recession in Australia on some sort of spiritual emanations from US subprime mortgage lending. The truth is that we have an enormous debt bubble of our own and suffer the same vast hole in credit management that has again been exposed in the US. This will resolve itself with extreme prejudice to Australian society and requires immediate attention.

We may only solve the problem by shifting taxes off "goods", such as earning incomes, onto "bads", such as real estate speculation and escalating land prices. This, rather than the Reserve Bank continually raising interest rates, may actually get to grips with inflation and avert the folly of accepting bubble-inflated land prices as "security" for loans.

Although the relationship between Australia's total land values and gross domestic product has varied since 1911, it has averaged 1-to-1. Although it got to 1.56-to-1 in the 1930s Depression, it now stands at a menacing 2.5-to-1. This mirrors situations around much of the Western world, except France, which doesn't put real estate speculation on an untouchable pedestal as we have been inclined to do.