Award for worst piece of economic analysis this year

I am virtually certain it would go to this piece by Phillip O’Connor from the University of Auckland. I mean, I thought this is the sort of award that would always go to NZPA, as they have to quickly release something that sometimes misses the point. However, a Senior Lecturer from Auckland has managed to illustrate to me how bad analysis can be.

Now in case other people can’t see some of the issues with his “analysis” I will discuss some things under the flap. And to be honest, I’m writing this in sheer shock – I have never met an economics lecture this off track. Maybe it is because I went to Victoria University – where the lecturing is top rate 😉

The “fact” that higher interest rates have led to higher house prices

In one of the largest, most ridiculous, methodological and statistical mistakes I have seen in a very long time O’Connor states the following:

Higher mortgage rates have lead to higher house prices. In fact, a mathematical measure of co-movement, the correlation coefficient, where +1 is perfect co-movement and -1 is perfect opposite movement, has a value of 0.79. This indicates that house prices and mortgage rates are strongly moving together.

And then goes to state that it is A FACT that higher mortgage rates have led to higher house prices.

Now, the first thing to remember is that you can only analyse data when you have an implicit model – his implicit model is that only interest rates can impact on house prices, and that house prices have no impact on interest rates. This is a bad model, a terrible way of trying to figure out causation (which requires some theory and maybe knowledge), and is A RIDICULOUS application of ceteris paribus – as it is painfully obvious that other variables that are involved in the relationship have changed, and we need to correct for that.

So his implicit model is incomplete, and I would say wrong, and his data analysis is weak and biased.

So what is missing:

  1. Causation – trying to figure one is driving the other,
  2. Other variables that could be moving at the same time, and causing both to move up,
  3. Lucas critique – does he think that he is capturing the deep parameters of the model, or could a change of policy (which he might hint at) going to throw out his relationship.

An implicit model, and some actual econometrics, would help to clear this up. I mean what f’ing mechanism does he think leads from interest rates to house prices – if he doesn’t tell us, and then incorporate that into his analysis the whole thing is a load of crap.

Aren’t you being a bit harsh

I have no doubt that my tone is harsh – very harsh. But this man is a Senior Economics Lecturer at what some people view our top university. And he has made a set of mistakes that would probably see a first year student at Vic fail.

At the start of his article he says we can’t assume all else is equal all the time – then he goes on to assume it, in an inappropriate case, mix up his causation, and then dare to mention the word “fact” (which is a VERY bold word to use in economics).

I am being so harsh because I am embarrased – people in this position should be telling me the multitude of methodological and statistical errors I make, not embarrasing the discipline.

Trust me – these are the sort of errors that we have to work so hard to convince the public we aren’t making. We do a LOT of work trying to distill truth out of messy numbers, and trying to make explicit the different assumptions we are making. The sort of economics shown in that article is not welcome.

But what if he is right, and house prices fall!

OMG, of course house prices are going to fall (have fallen) – falling job security, tightening credit markets, and a realisation that house price gains were unsustainable will do that for you. Looking at the movement in these variables MAKES MORE SENSE than looking at the interest rate – it is called thinking before making an empirical model.

Think about it yourself – if interest rates were lower, would you now sell your house for less? If your mortgage was costing you less, would you get more desperate to sell your house?

I’m going to go have a stiff drink …

Update: Tom M further criticises the piece on his blog Defective equilibrium. Glad to hear that he is a student at Victoria University of Wellington – as it illustrates to me that my old uni is still teaching top quality analysis 😉

Update 2:  As people have been repeatedly trying to point out to me – the lecturer is from accounting/finance.  As a result, it is not a black mark on the economics department – it is a black mark on whichever of those disciplines he teaches.  As a result, the reputation of Auckland, and New Zealand, economists is saved, hooray!!!

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  • DanT

    Matt,

    I should point out that he is a Senior Lecturer in “Finance” at the School of Accounting and Finance. BIG distinction here. So you don’t need to feel quite as personally insulted 😉

  • causation vs correlation, wow, rookie error…

  • Reminds me of this
    http://www.xkcd.com/552/

  • Miguel Sanchez

    Must be from the accounting side of the department… a finance guy would have calculated the beta.

  • @DanT

    According to the website he is in the accounting and finance school, in the business and economics department. My hope is that he is focused on the “business” side – as that is pretty much meaningless …

  • @agnitio

    Very rookie …

  • @Tom M

    I love that comic 🙂

  • @Miguel Sanchez

    An accounting guy surely wouldn’t have written that either – as he is in the business and economics department in the accounting and finance school my suspicion is that he is a “business” lecturer …

  • To all those who thought they weren’t good enough at econ to get a Phd; you were wrong!

  • @rauparaha

    In fact – it seems to include people that would fail Quan 102 😛

  • @rauparaha

    Definitely 😀

  • Do recall that the starting salary in the US for a newly-minted PhD in Finance, at a University (not consulting), is about $150K US. Salaries in Accounting in the US aren’t far away from that either. Then note that we have a very egalitarian salary structure across disciplines in New Zealand. While somebody in Accounting or Finance will be paid a bit more than somebody in Critical Feminist Poetry Analysis and Deconstruction, he won’t be paid a lot more. Glenn Boyle’s article here is relevant.

  • @Eric Crampton

    Pay peanuts get monkey’s aye – Glenn Boyle’s article is very good 🙂

    However, surely it doesn’t head to that level – I know Vic doesn’t have any lecturers that would say things like that (in the economics department) and I suspect Christchurch wouldn’t either …

  • @rauparaha

    That graph is awesome and warrants a post itself!

    @Eric Crampton
    My favorite paper by Glen. Loved the sign off from his ISCR newsletter article desribing the paper

    Glenn Boyle is the Executive Director of
    ISCR. He is also a professor of finance –
    the most ‘underpaid’ discipline in
    New Zealand universities – so there is a
    signif-icant possibility that he is himself
    somewhat bananas.

  • @Matt Nolan
    Then again Matt, I’m sure if you asked someone from the marketing school at Vic or Canty they might make equally shoddy asertions about peoples intertemporal consumption preferences:

    http://www.stuff.co.nz/business/industries/economy/2306373/Lattes-movies-paying-off-debt

  • @agnitio

    Hey hey hey – at least they wouldn’t be recognised as part of the economics school!

    Also – that shoddy analysis at least has some backing. If someone spent less now they would have more later – the policy conclusion just sucks. This guy from Auckland made an error that would lead to a 1st year failing their assignment – I give our management and marketing schools more credit than that 😉

  • Nigel

    It is true when he says that the two are often observed to move together.

    But his conclusion seems to be that if you wan’t to lower house prices, you just need to lower interest rates… humm….

    I think house prices would have fallen much further had interest rates stayed at mid-2008 levels.

  • @Nigel

    Indeed – again the guy has confused correlation with causation. A senior lecturer should understand the idea that you need a theory to frame data before you can make conclusions. Seems that isn’t the case in Auckland …

    To be fair though, all the graduates I’ve met from Auckland have been very clued on – so its probably just this guy 😉

  • @Nigel Kearney

    Both graphs provide the same sort of “sharp” “incisive” logic don’t they 😛

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  • @Nigel Kearney
    That’s the article rauparaha linked to above, I think it’s brilliant:D

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  • Kimble

    Do you think it is possible that the article was posted one day late?

  • @Kimble

    That would have explained a lot.

    However, I’ve seen a previous article saying that the exchange rate follows a magical cycle before with a similar lack of regard for “logic” or “thought”. As a result, I suspect this might be the real deal …

  • Miguel Sanchez

    I feel as though such a prestigious and hotly contested award should have its own name – perhaps the Econ-Oh-My Award?

    …and in a shock result, Phil O’Connor splits the vote between his ‘house price’ and ‘exchange rate’ efforts, and BERL romps home with the prize. (Just kidding guys.)

  • @Miguel Sanchez

    Last year BERL claimed that higher interest rates have caused inflation – an argument that is possible to make, but seems to be based on some pretty steep assumptions:

    http://www.tvhe.co.nz/2007/09/07/even-economists-struggle-with-inflation/

    http://www.tvhe.co.nz/2008/06/20/discusssions-on-how-to-screw-up-a-terms-of-trade-increase/

    Last year I would have given the award to this methinks – as it kept getting airplay without being properly discussed. However, if that had to compete with this years effort from Phil it would have been blown out of the water for this award 😉

  • Jiani

    Hey Matt! He is from “Accounting and Finance”, which used to be across the street from us (the Econ Dept) before the new Owen G Glenn Building was completed. So phew… 😉

    As far as I know, undergraduate finance courses don’t usually teach much quantitative analysis, which is an application of time series econometrics. Banks or finance companies are usually after PhD in Econ to crunch numbers etc… 🙂

  • @Jiani

    Hi Jiani – I see I got the department and school mixed up. Silly me. Thanks for pointing that out 🙂

    Very good – I would have been devastated if this logic had come from an economist! It also wasn’t consistent with the type of logic I had seem from economics graduates in Auckland – so I’m glad that is sort of cleared up.

    However, if he is a finance lecturer that is still very bad – finance is a sub-set of economics after all. I hope Miguel is right suggesting he is from the accounting side of the office. No offensive to accountants of course – it is just that accountants do less statistics than the other aforementioned disciplines.

  • Let me see, the demand curve for mortgages slopes downward, so higher interest rates means a lower quantity demanded for mortgages and fewer people taking out mortgages and thus less demand for houses. I can see how that would increase house prices!!!! 🙂

  • @Paul Walker

    😀

    I don’t think he wanted to use the model of supply and demand when performing his in depth analysis!

  • Miguel Sanchez

    I meant offence to accountants. 😉

  • @Miguel Sanchez

    I know too many intelligent, hard working, people who are accountants to go around attacking their discipline – although instead of working maybe I should have said drinking 😛

  • I think someone should send him an anonymous email witht hese two (very similar) wikipedia articles:D

    http://en.wikipedia.org/wiki/Correlation_does_not_imply_causation
    http://en.wikipedia.org/wiki/Spurious_correlation

  • Miguel Sanchez

    Aw c’mon, nobody got my crack at finance lecturers either! Beta? Anyone? Anyone? Bueller?

  • @agnitio

    Count me out – writing the post was inflamatory enough

  • @Miguel Sanchez

    We got it – we just laughed on the inside 😉

    Unlike the previous metaphor that I missed completely 😀

  • anon

    I also thought it was an April fools until I read his article. Bonkers analysis but the graph was good. At least one central bank was raising interest rates to try and reign in the asset bubbles. If the NZ central bankers had replaced Greenspan around 2002, we may not have the current problem….

  • PhilBest

    This was very thoroughly aired on interest.co.nz:

    http://www.interest.co.nz/ratesblog/index.php/2009/04/02/opinion-why-lower-interest-rates-wont-lead-to-higher-house-prices/

    At the end of the thread, Philip O’Connor makes a very interesting statement of where he stands, considering that I suggested near the start of the thread that he was being mischievous. The point he was trying to make, was the “correlation” between LOW interest rates and HIGH house prices, which is pretty much “received wisdom”, is actually completely invalid.

    I am very sorry that his subtlety has been completely missed because he has an extremely valid point, which supports the argument that Hugh Pavletich and others including myself have been making for years. I have made a fuller development of the argument of what is really responsible for the recent severe house price bubbles, on THIS “thread”:

    http://www.interest.co.nz/ratesblog/index.php/2009/04/09/housing-special-why-the-march-housing-market-surge-is-an-indian-summer/#comments

    (And no, I am not Philip O’Connor and have never known the guy).

  • Hi Phil,

    “The point he was trying to make, was the “correlation” between LOW interest rates and HIGH house prices, which is pretty much “received wisdom”, is actually completely invalid”

    Firstly, he doesn’t make that point – and he doesn’t really show any evidence to prove it. If that is what he was trying to say he should have said it – not said patently ridiculous things like “higher interest rates caused higher house prices”.

    “I am very sorry that his subtlety has been completely missed because he has an extremely valid point”

    Even if this was his point – it was communicated poorly. It wasn’t subtlety it was bad writing.

    But lets even give him that, and say that was his point. He didn’t actually give any evidence of this case – at all. You can’t talk about a “relationship” unless you have a fully specified model – and even in his reply he did not admit this.

    You can have two graphs moving in different directions, but once you model them and include relevant variables you find that they are actually positively related – if you don’t fully specify what you are looking at your conclusions will be spurious. A second year stats student would know that – and would be careful about it, why isn’t a senior lecturer?

    “I have made a fuller development of the argument of what is really responsible for the recent severe house price bubbles, on THIS “thread””

    That is fine. We all agree that there was a housing bubble.

    Personally I put it down to expectation formation – and given that and my implicit model higher short term interest rates were the right move.

    However, none of this excuses that article – the guys said “Higher mortgage rates have lead to higher house prices”. That is inexcusable. His “defence” that he was being cheeky is not sufficient – and betrays a confusion about how exactly empirical models work.

    Economists work SO HARD on empirical models, and not trying to make spurious conclusions. Which is why the looseness of this piece annoyed me – and still annoys me.

  • PhilBest

    Hey, thanks for that quick response, Matt.

    Yes, I am not merely “annoyed” that that very valuable point was made so clumsily. We badly need to get a sensible debate going about the true cause of the housing bubbles.

    What Philip O’Connor says, far too late, at the end of the thread on interest.co.nz, is THIS:

    “…Saying “higher interest rates caused high house prices,” is wrong, of course. But why do I read in the press, and hear so much, that “lower interest rates will HELP house prices”? This statement implies causality, and appears to be accepted by *everyone*. I challenge that statement in this blog. Believers in “lower interest rates support house prices” DO NOT EVEN HAVE CORRELATION ON THEIR SIDE! Their mistake is far far more serious than “correlation does not imply causality”: they believe in a relationship that is complete fantasy and does not exist in the real world…..”

    I think he is right, and I think that in that comment, he has contributed a valuable part of the jigsaw puzzle that is property price bubble analysis. What do you think of the analyses I link to in my later argument, that eliminate all other causes except land rationing? I think that most analysts are looking in the wrong place, like the guy in the joke who was looking for the wallet he had dropped, only he was looking for it where the light was better than in the place he actually dropped it.

    I agree 100% with your “expectation formation” conclusion. But I defy you to find that “expectation formation” regarding house prices, occurring anywhere other than where there are conditions of land use rationing.

    One of the problems analysing what the historical literature calls “housing bubbles”, is that the term is also used for “supply” manias, where too many houses got built.

    I am arguing that property PRICE bubbles, with home affordability deteriorating and prices increasing way out of proportion to incomes, have developed subsequent on “Green” land use restrictions.

    “Bubbles” where house building occurred at too high a rate, had a positive effect on affordability. Hugh uses the term “building boom”, to describe this. These “booms” contain their own safety valve; the economic fallout from them will always be limited to the comparatively small (percentagewise) “malinvestment” in building too many houses.

    But the price bubbles that are a result of land rationing are a different beast altogether. They feed their own mania, and will only blow up when a range of economic factors have played out, by which time the whole economy is nearly destroyed. We can have years of declining productivity and declining real incomes (when the cashing out of property value increases is removed) along with property prices ramping up year after year?

    I gather from Steve Keen’s recent analysis of the Australian situation, that they have actually had both a boom and a bubble; driven by greed-crazed speculators who bought up overpriced new houses. We have the absurd situation that existing home owners use the increasing value of their own homes, as security to buy more overpriced homes. What eventually happens to first home buyers in this situation? Can anyone say “Ponzi”? The result will be interesting as it unwinds.

    The same situation possibly applied in some of the other parts of the world such as Ireland and Spain where “enough” new homes have been built but prices remained severely unaffordable. This is an absurd defiance of all laws of supply and demand. Clearly there is serious interference occurring with the “supply” mechanism.

    The case is clear that only a completely free supply of land would prevent such a situation from starting in the first place.

    I would argue that to periodically have an oversupply of housing, with low prices as a result, is of substantial net benefit to society and the economy. No “planners” are going to get it right; and avoiding PRICE bubbles is clearly of all importance to our economic future.

    We avoided them up till the last decade or so, simply because we were not sucked in by Green conservation mania and “local community” “empowerment” policies, and we constantly had new homes being supplied on land at affordable prices.

  • PhilBest

    I would further argue that the inhabitants of particularly desirable areas should NOT be “entitled” to prevent further in-migration to their area through policies that make property unaffordable.

    This is just as basically anti-human as the “Green” conservation policies are. It says in effect, that if these policies are the only right ones, that not only are humans not wanted here, they are not wanted anywhere. I am not joking or exaggerating. Sanctimonious Californians condemn Texas for its policies of cheap housing, growth, and high energy living (due to the heat and aridness).

    If these sanctimonious and anti-human (essentially fascist) policies were in the trashcan of history where they belonged, California would be a lot more populated and the people living there would have smaller environmental footprints than if they were forced to live somewhere unpleasant like Texas. As usual, the sanctimonious policies have the exact opposite consequences than what they are alleged to be in the purpose of in the first place.

    Greed and selfishness are clearly seriously destructive of humanity whether they occur on Wall Street or in green and pleasant neighborhoods.

    New Zealand could, and should, have ten times the population it does have.

  • PhilBest

    But I presume you do follow these debates on interest.co.nz? Hugh P. and myself are slowly gaining ground with the skeptics……..

  • “But why do I read in the press, and hear so much, that “lower interest rates will HELP house prices”? This statement implies causality, and appears to be accepted by *everyone*.”

    As I said above: […] the demand curve for mortgages slopes downward, so higher interest rates means a lower quantity demanded for mortgages and fewer people taking out mortgages and thus less demand for houses.

    Less demand for housing will lower its price. Holding all else constant, the reserve of the above mechanism will be what happens when interest rate are lowered.

    If empirically you don’t see this happening it will be because the all else constant requirements doesn’t hold. For example, if demand for housing (and mortgages) is increasing enough then you could see a positive correlation between mortgage rates and house prices in the short term.

  • PhilBest

    I said earlier:

    “….If these sanctimonious and anti-human (essentially fascist) policies were in the trashcan of history where they belonged, California would be a lot more populated and the people living there would have smaller environmental footprints than if they were forced to live somewhere unpleasant like Texas…..”

    And I should have added; we wouldn’t have financial meltdowns resulting from housing bubbles.

    Paul Walker, that comment is good sense too.

    I have commented before, that interest rates should be driven by economic fundamentals and house prices should be driven by economic fundamentals. Interfere with the laws of supply and demand for housing, and you set off a chain of economic events whereby the economic fundamentals are swamped, to the detriment of the productive sector and its requirements for capital, and to the detriment of monetary policy effectiveness.

    Have you followed my longer arguments about this?

  • Hi Phil,

    This post isn’t on the cause of the bubble – so I’m not really going to discuss that here. I do think that land zoning is an important issue – but it is one of many issues that have led us to where we are now.

    “occurring anywhere other than where there are conditions of land use rationing”

    Well bubbles occur all over the place even without rationing – all we need for a bubble is the belief that someone else will pay more. Vernon Smith has shown this occuring in lab experiments where people KNOW the final payoff – as a result, I suspect that it has to do with expectation formation, and issues that economists may not fully understand in this area.

    Other features have fed the bubble for sure – and the poor zoning in some regions will hold prices higher than they “should be”. However, this isn’t a bubble persee – this is just an inefficient allocation of resources that has led to a higher price.

    As a result, the bubble is a result of demand – movements in supply are more fundamental.

    Now – Aussie and NZ are different to Ireland and Spain and the US, as we have high building costs and undersupply, while they are oversupplied. As a result, there is more of a “foundation” for prices here – but this foundation is built on waste and inefficiency rather than true value. When the building industry starts running again, prices will fall again.

    “But I presume you do follow these debates on interest.co.nz”

    Sorry, I only have the chance to really look at things when it is an Infometrics article – otherwise I’m quite caught up in the current crazy environment.

    “avoiding PRICE bubbles is clearly of all importance to our economic future”

    I’m not convinced about this persee – educating people around how to save and value assets is what we should be doing, not trying to prevent bubbles themselves.

    Bubbles are fine – as the people who get burned are the people that made dumb calls. As long as people have the tools to analyse the risk, this doesn’t matter.

    Now in the US people didn’t have information about the assets behind their CDO’s – this was the problem, not the fact that they had a housing bubble.

  • PhilBest

    Matt, thanks for taking the time.

    I have done many hours of research into this, and as I say in the essay I link to, I think that people like Hugh Pavletich and Wendell Cox and Alan Moran and Oliver Marc Hartwich are right, and we are making a mistake to write off their research in favour of areas of economics that we might be more comfortable with.

    You say:

    “…..As a result, the bubble is a result of demand – movements in supply are more fundamental…..”

    Yes, but is it not obvious that $40,000 sections on the edge of the urban area will be a safety valve for any price bubble? But where supply has to involve $240,000 sections, no less, there you have a major predictor of the potential for the size of the bubble. I do not accuse land developers of gouging, in many cases they are taking huge risks buying and holding land outside the “zone” for long periods of time, and risking bankruptcy if the whims of planners do not follow their guesses. (The scope for corruption is huge).

    You say:

    “….Aussie and NZ are different to Ireland and Spain and the US, as we have high building costs and undersupply……”

    We do not have high building costs, as the submissions to the Commerce Committee Inquiry on housing affordability from the NZ Master Builders Federation and the Reserve Bank pointed out. Almost ALL the increase in the price of new homes has come from increases in fees and meeting regulatory requirements, and from land rationing premiums.

    You say:

    “……there is more of a “foundation” for prices here – but this foundation is built on waste and inefficiency rather than true value….”

    The NZ Master Builders Federation would be deeply offended. So would Hugh Pavletich. You are absolutely right that this “foundation” is not built on true value, but it is not built on waste and inefficiency either. It is built mostly on the rationing premium, but councils fee gouging has not helped either.

    “…..When the building industry starts running again, prices will fall again…..”

    What mechanism is going to bring LAND prices down? Because that is the problem. Land zoned for residential use commands a premium, compared to other uses such as agriculture, of up to 3000 per cent. It is not at all necessary for this to be the case, and was not the case historically, before “green” conservation and local community empowerment and planning for urban limits and density became fashionable.

    Hugh Pavletich has years of experience in property development and has also spent years researching this issue in tandem with the experts at the Demographia Institute. One of the things that makes me sick, is hearing the apologists for the land rationing status quo, accuse Hugh of having “vested interests”; as if Hugh’s desire to bring sub-$200,000 new homes on the urban fringe to first home buyers is somehow a vested interest to be condemned, while the vested interests in maintaining the status quo of $400,000-plus new homes are somehow honourable. The difference is almost entirely in land prices. As recently as 1992, the relationship between land prices and incomes was closer to the first situation than the second.

    Please take it from me if you do not have the time to do the research. The consequences of our modern world’s ever-deepening land rationing policies are drastic in numerous ways, and the destructiveness of the economic bubbles that result from the lack of a “safety valve”; i.e. low-cost new supply; is the biggest consequence.

    You say:

    “……Bubbles are fine – as the people who get burned are the people that made dumb calls. As long as people have the tools to analyse the risk, this doesn’t matter…..”

    And young people wanting to buy their first homes, listen to who…..? We are talking about bankruptcies and destroyed lives and marriages and relationships and families and traumatised kids. And there are social penalties in the first place from having declining levels of home ownership in younger generations, due to affordability issues. Bob Day, in “The tyranny of urban planning: home truths about home affordability” discusses this is detail. Robert Bruegmann, in “The Housing Bubble and the Boomer Generation”, describes the assumption of huge mortgages by the young, while the older, baby boomers cash out their equity increases, as “the greatest intergenerational wealth transfer in history”.

    Lastly, you say:

    “…..Now in the US people didn’t have information about the assets behind their CDO’s – this was the problem, not the fact that they had a housing bubble…..”

    Excuse me, they did have the information; all they needed was “these CDO’s are based on mortgages, and everyone knows that these are safe investments because property prices never go down”. The CDO’s would be safe today if they had not been entwined with a property price bubble. CDO’s based on mortgages outside of California, New York, Florida and one or two other States, would be safe today. CDO’s based on mortgages taken on in a housing building BOOM would be safe today.

    As I have said again and again, the unique factor to this time, was a supply-restriction induced house price bubble. The UK has had them before, because they had the supply restrictions decades sooner. There have been stock market bubbles over and over again. The housing bubbles you refer to have mostly been construction booms in which prices were kept low precisely by the availability of further land at all times. That is not to say there cannot be localised bubbles, but obviously economy-wide PRICE bubbles should be avoided at all cost in the future. And as I say, some wasteful over-supply, with house prices kept low, is probably on net a good thing.

  • PhilBest

    What I really fear, Matt, is that with the aid of new low base interest rates, NZ will be back to “business as usual” regarding property; and all we will be doing is tracking the US experience from about 2002 onwards, only starting from a net household debt situation that is already worse than the US when its bubble burst.

    We can kiss any real economic recovery goodbye when most of our potential productive investment money remains sucked into the black hole of a housing price bubble. These bubbles actually worsen the likelihood of income increases enabling a catch-up of the fundamentals that underly home affordability. Business investment simply could not match the returns,(temporarily) from property investment. Interest rates that would prevent a property bubble would kill business. Reserve Banks are pushing on a string once the bubble mentality takes over.

    We are surrounded by people talking the house buying market UP again, and persuading us that the time is good again for making that purchase. This is balls. It is economic Darwinism. Here we are, with some of the world’s most unaffordable house prices, a situation that developed mostly in 4 years, 2002-2006; graphs that show what can only be described as one of the world’s worst house price bubbles; here we are surrounded by house price bubble collapses all over the rest of the world; here we are with our economy in recession; and we are talking home buyers INTO the market and talking price expectations UP?

    I am personally acquainted with various family friends who I have been unable at any time, even with all my background knowledge, to persuade them that buying a house 2 years ago or now, was not and still is not a good idea. We still see on interest.co.nz, comments from people who should know better, that “NZ is different”; “Buy”! “Buy”! “Buy”!.

    You tell me what is going to fix this?

    “…..When the building industry starts running again, prices will fall again…..”

    You tell me what mechanisms are going to result in new homes hitting the market at a price that reflects the value of land for other uses, plus development costs, plus profit. Where are the $40,000 sections now, even after half the property development industry has fallen over? Why are even the bankruptcy sale prices attached to an invisible skyhook?

    Some commenters are pointing out that homes are for sale in Atlanta Georgia for US $20,000, and using that as evidence of a housing bubble crash in Georgia. But this is missing the point. Brand new homes on the urban edges of Atlanta were always available for as little as US$120,000. Oversupply and economic downturn has resulted in bankruptcy sales for a little less than this. But tumbledown old dumps in ghetto areas were also always available for $40,000 or less. Why would a first home buyer pay 7 or 8 times average annual income for a tumbledown old dump in a ghetto area, when there are brand new homes available for 3 times average annual income? This is the option that has been denied to the first home buyer in California – or NZ.

    Or look at it this way. A subprime mortgage in Atlanta might be an unemployed solo mum with a mortgage of US $40,000 or $50,000. A subprime mortgage in California is a professional yuppie couple with a mortgage of US $500,000. Where do you think the problem of toxic CDO’s has really originated? Some of the studies I link to in my essays on interest.co.nz point out that California is responsible for 45% of all the mortgage related losses of equity in the whole USA so far – and New York is responsible for another 10% and Florida for another 10%.

    New Zealand is tracking California, not Georgia or Texas. A high proportion of our mortgages ARE what the USA would call “subprime” – we are just insensible to it. Our younger and poorer people are being screwed by having to pay hundreds of thousands of dollars for ANY home, whether on the outer limits of cities or for tumbledown old dumps in ghetto areas. Californians could emigrate to Texas much more easily than Kiwis can escape the property price trap. Are you aware that California spent years leaking population on net even as their house prices escalated, while Texas attracted large in-migration while houses remained well-supplied and cheap?

    What do you think the flow-on effects are throughout NZ society, of unaffordable housing?

    That is why I argue that the inhabitants of particularly desirable areas should NOT be “entitled” to prevent further in-migration to their area through policies that make property unaffordable. If greed and selfishness on Wall Street requires legal restriction to prevent damage to whole economies resulting, then so does greed and selfishness in green and pleasant local communities. People have to live somewhere, and these selfish policies at root are saying to people of the next generation and poorer people, “…do us a favour……don’t exist….no, you can’t live THERE…….no, you can’t build THAT….yes, that is the cheapest accomodation you are allowed to live in…”. The bottom 3 rungs have been knocked out of the social mobility ladder. But “combating inequality” is all about “transferring wealth” via taxes and government spending, isn’t it…. not about ensuring that homes are affordable.

    But Hugh P. tells us that there is good cross-party progress in getting a grasp of these issues in our current parliament. I wish him all the best, the consequences are of paramount importance economically and socially.

  • Ah !! so this is where the smart young things of the economics profession here in NZ reside on the web. Thanks to PhilBest drawing this blog to my attention.

    I think something you guys need to ask yourselves is – has the performance of the economics profession here in NZ and around the world, with respect to these housing bubbles – been satisfactory?

    Put another way – is the economics profession playing a constructive role in exploring solutions, so that we dont have a repeat of these housing bubbles going forward?

    I am looking forward to the day when you guys focus your attention on the structural problems of our housing markets.

    Put simply – to rate as affordable – urban markets should not exceeed the 3 Multiple and to ensure they stay in the affordable catagory, new starter supply of an acceptable standard needs to be going in on the fringes at the swing Multiple of 2,5.

    And the hugely important fringe DEVELOPMENT RATIOS (I have yet to hear one economist in this country even mention these) should be 17 – 23% serviced lot / the balance the actual house construction.

    Normal urban markets with population growth around the 1% mark – should oscillate from a floor Multiple of 2.3 through the swing Multiple of 2.5 and top out at the ceiling Multiple of 2.7 – to get optimum performance out of the residential construction industry.

    Why dont some of you guys actually research the existing housing churn rates of the affordable 2 plus million housing unit of Houston with the 1.6 million plus unit NZ market? The grossly inflated numbers of our market here are way way higher – pumping massive additional liquidy in to the economy. Yet – according to the US Dept of Commerce BEA – the Houston GAP is threee times NZs GDP as well.

    The above are just two of what I would consider extremely simple aspects of the massive structural distortions that need to be researched further.

    And heres a little quote to finish up on chappies and chapettes from the woman Savant with the highest IQ in the world. There was an excellent article in the FT about here recently –

    “We gain knowledge by reading – but wisdom by observation.”

    We sure as hell desperately need copious quantities of wisdom in the economics profession.

  • PhilBest

    Thanks for that, Hugh. That was well put. I have recently realised that most economists have to earn a living by focusing their abilities day after day, year after year, on some narrow task for which their employers pay them. There seems to be precious little extracurricular “big picture” study taking place in that profession. What there is, will be found predominantly in “think tanks” like AEI and CATO rather than among the ranks of employed day job economists.

    The work that is being done by those like Hugh, focusing on the land supply issue, is of tremendous value and can only get more and more recognition as time goes on. Quite frankly, our economies will only continue to suffer until this vital factor is recognised, and meanwhile any country that sets a good example, like hopefully NZ will thanks to Hugh’s rapport with the current government, will serve the rest of the world well by forcing the economists and politicians to take notice.

    Notice that the latest OECD report refers to NZ’s need to get investment moving away from property and into things that increase productivity. I couldn’t agree more. See what I said on THIS thread:

    http://www.interest.co.nz/ratesblog/index.php/2009/04/09/housing-special-why-the-march-housing-market-surge-is-an-indian-summer/#comments

  • Hi Phil and Hugh,

    I am not sure if there is anywhere we are fundamentally disagreeing.

    Land constraints have held up prices – but even so house prices have risen at an even greater rate. Without construction we might lose the “froth” – which economists are terming a bubble – but the land constraints are seen as fundamental, and as an issue involved with policy and relative price changes.

    In the long run most economists expect this to be solved as well – leading to another round of house price declines.

    Overall, dropping house prices do hurt homeowners – but on the other side they benefit people buying houses. Changes in house prices alone do not concern me.

    What does concern me is when people are fooled into believing the current house price is actually wealth – as then they make poor decisions. Another issue that concerns me is when CDO are made, and the risks associated with them are not clear – as that is an asymmetric information problem.

    Regulators, and economists, will need to keep a strong eye on these issues going forward – I’m sure this is where we can all agree.