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My last post on the Com­mon­wealth Bank’s “there’s no hous­ing bub­ble in Aus­tralia” doc­u­ment focused sim­ply on the use of two dif­fer­ent data sources for the House Price to Income ratio; I left the argu­ments the bank made untouched.

Not so David Llewellyn-Smith, who ran a logi­cian’s eye over the bank’s doc­u­ment and found “log­ic” of Mon­ty Python “if she weighs more than a duck, she’s a witch” cal­i­ble. David pub­lished this post in the Hen­ry Thorn­ton blog, and he has kind­ly con­sent­ed to me repro­duc­ing it here.

Determined to be difficult

Every­one has seen the ads. A stur­dy and com­mon sense banker con­fronts a troupe of Amer­i­can adver­tis­ing hot shots. The banker responds with steady increduli­ty to their fast and loose attempts to mod­ernise his brand. He is the mod­el of pru­dence, jux­ta­posed against fad­dish spin doc­tors.

In the real world, Com­mon­wealth Bank (CBA) exec­u­tives are cur­rent­ly trav­el­ing inter­na­tion­al­ly (includ­ing to, pre­sum­ably, Amer­i­ca) to do more than dis­pense with a fic­ti­tious adver­tis­ing agency’s fool­ish ideas. They have, in the bank’s own words, gone “over­seas to meet with some of the Group’s off­shore share­hold­ers and oth­er investors inter­est­ed in Aus­tralia and the Aus­tralian bank­ing sec­tor.”

Though the goals of the trip are no doubt myr­i­ad, last week’s press release herald­ing their depar­ture came com­plete with a 19 page pre­sen­ta­tion that will be used on the trip to reas­sure inter­na­tion­al investors that there is no Aus­tralian hous­ing bub­ble. It includ­ed direct­ly refut­ed quotes from such notable hous­ing bears as Mor­gan Stanley’s Ger­ard Minack and GMO’s Jere­my Grantham. CBA man­age­ment has set sail on a bub­ble-bust­ing road­show.

Giv­en the stake we Aus­tralians have in this lit­tle exer­cise, it is fit­ting that we assess how the fun­da­men­tals of our hous­ing mar­ket are being rep­re­sent­ed around the world by our biggest bank. Is the pre­sen­ta­tion like­ly to reas­sure foot­loose glob­al investors, now acute­ly aware of the dam­age a hous­ing bust can do to their cap­i­tal? Per­haps, but only if they are close­ly relat­ed to the dun­der­head­ed Amer­i­cans that CBA uses so cal­lous­ly in its own ads.

The pre­sen­ta­tion begins with the argu­ment that “tak­ing into account geo­graph­ic dif­fer­ences, the ratio of house prices to income in Aus­tralia is not that much dif­fer­ent to most oth­er com­pa­ra­ble coun­tries.” The doc­u­ment pro­vides some nice slides and graphs mak­ing the com­par­isons clear. And they look rea­son­able enough, except that the sta­tis­tics aren’t explained. We don’t know what income mea­sures are being used, nor what medi­an prices.

Worse still, as Mon­ey Morn­ing uncov­ered Fri­day, the sta­tis­tics are cher­ry-picked from dif­fer­ent sources to ensure the most favor­able com­par­isons.

But the lack detail in the pre­sen­ta­tion is quick­ly for­got­ten as CBA’s argu­ments sink into a fal­la­cious morass. Accord­ing to the bank, “Aus­tralia is the 4th least dense­ly set­tled coun­try in the world — 83% live with­in 50 kms of the coast. Coastal loca­tions demand a pre­mi­um – Australia?s pop­u­la­tion con­cen­tra­tion in capital/coastal cities dis­torts com­par­isons to oth­er, more dense­ly set­tled coun­tries.”

You’ll for­give this writer if he points out that if 83% of Aus­tralians live in coastal cities then that sure­ly con­sti­tutes 83% of the hous­ing mar­ket. There is, there­fore, no greater mar­ket against which a pre­mi­um for coastal prop­er­ty can be justified–as opposed to oth­er nations, where an even spread of pop­u­la­tion means there is ele­vat­ed demand for coastal liv­ing as a reward for suc­cess. Nor has there has been a great Aus­tralian exo­dus to the coast from the bush in the past fif­teen years. We’ve always lived by the seashore.

The CBA argu­ment would still make sense if it were posi­tion­ing Aus­tralian cities in a con­text of glob­al demand for coastal liv­ing but it is clear­ly not doing so. CBA’s log­ic is sim­ply that because coastal prop­er­ty every­where is expen­sive, and Aus­tralia has large­ly coastal prop­er­ty, then Aus­tralian prop­er­ty is jus­ti­fi­ably expen­sive.

Aris­to­tle would turn in his grave.

CBA’s sec­ond argu­ment begins: “pop­u­la­tion growth has been a key dri­ver of Aus­tralian house price appre­ci­a­tion” and offers a series of graphs show­ing that growth above his­toric aver­ages as well as falling hous­ing starts since 2005.

This ratio­nale does help account for the 50 per cent or so rise in medi­an house prices from 2005 when the com­mod­i­ty boom prompt­ed skills short­ages and immi­gra­tion rose strong­ly. I say helps explain it, because that is still not enough. It’s a ker­nel of truth around which an invest­ment fer­vor gath­ered pace.

What CBA doesn’t men­tion nor explain is the pri­or 8 year burst in prices of approx­i­mate­ly 120 per cent, dri­ven large­ly through rock­et­ing demand for invest­ment mort­gages, up 308% over the peri­od.

To under­stand that, CBA turns to its third argu­ment, that there are “oth­er dri­vers of house price appre­ci­a­tion [that] are struc­tur­al, rather than cycli­cal in nature”. Accord­ing to the bank, “Australia?s low inflation/low inter­est rate envi­ron­ment has dra­mat­i­cal­ly increased the demand for, and acces­si­bil­i­ty of cred­it.” CBA then con­cludes “On RBA esti­mates, the reduc­tion in mort­gage rates dur­ing the 1990’s expand­ed the poten­tial hous­ing mar­ket by 600,000 house­holds. Absent a dra­mat­ic response from the sup­ply side, a large part of the lift in val­u­a­tion ratios is a per­ma­nent struc­tur­al shift.”

Those who inter­pret Aus­tralian house prices as a bub­ble would hard­ly dis­agree that a peri­od of his­tor­i­cal­ly easy cred­it is a major cause of asset-price growth. But for the pur­pos­es of CBA’s pre­sen­ta­tion, that is not the impor­tant point. The main claim is that this is a “per­ma­nent struc­tur­al shift” and it makes it with­out a jot of evi­dence. There is no analy­sis of infla­tion­ary dynam­ics in the Aus­tralian econ­o­my. No men­tion of the effect of com­mod­i­ty prices. No break­down of labor mar­ket trends. Noth­ing about capac­i­ty util­i­sa­tion. Nor is there is any men­tion that the sup­posed same “per­ma­nent struc­tur­al shift” was thought to have occurred in the US, where it was dubbed the Great Mod­er­a­tion and cul­mi­nat­ed in the moth­er of all cycli­cal busts.

The fail­ure to address this point with evi­dence is a key fail­ing in the report giv­en Jere­my Grantham has stat­ed that the Water­loo for the bub­ble will come with high­er inter­est rates.

The same fail­ing is also espe­cial­ly unfor­tu­nate giv­en that this pre­sen­ta­tion is like­ly to be aimed in part at the glob­al bond­hold­ers who deter­mine the inter­est rate at which CBA bor­rows its whole­sale dough and, there­fore, in part, Aus­tralian inter­est rates. For them, the bank isn’t argu­ing an objec­tive case for con­tin­u­ing low inter­est rates, it is assum­ing those rates will be forth­com­ing and argu­ing that that will sus­tain house prices. Need­less to say, this is dan­ger­ous­ly cir­cu­lar.

Unde­terred, the CBA pre­sen­ta­tion ploughs on. Next it claims that “the house­hold debt ratio in Aus­tralia is sim­i­lar to many oth­er devel­oped coun­tries”. Again it offers a pret­ty graph, this time of Australia’s house­hold debt as a per cent of house­hold dis­pos­able income as com­pared with the UK, NZ, Cana­da, US, Japan and Ger­many.

The prob­lem with this item is that Aus­tralia is sec­ond only to the UK, the oth­er mar­ket iden­ti­fied by Jere­my Grantham as hav­ing the last of the great hous­ing bub­bles. More­over, it is clear in the graph that Aus­tralia is in a much worse sit­u­a­tion than US house­holds and almost twice as bad as the sit­u­a­tion in Ger­many. If any­thing, the graph makes it star­tling­ly clear just how enor­mous Australia’s hous­ing bub­ble has become.

At this point, if I’m an inter­na­tion­al investor, I’m think­ing ‘we got­ta short these chumps’.

The presentation’s next argu­ment is based upon the demo­graph­ic dis­tri­b­u­tion of mort­gage debt, in par­tic­u­lar its con­cen­tra­tion in those class­es that can most afford it. It is fine as far as it goes.

The final two argu­ments are about strong eco­nom­ic fun­da­men­tals min­imis­ing “the down­side risk to house prices” and his­tor­i­cal­ly low loan-loss rates for Aus­tralian banks through var­i­ous hous­ing cycles since 1988.

Both of these argu­ments are fair enough but again rely on hid­den assump­tions. Aus­tralian bank’s loan-loss rates are low but the same con­sis­tent returns and small loss­es can equal­ly be explained by the work of Hyman Min­sky. Busi­ness­es that bor­row to repay oth­er debts dis­play just such a pat­tern, until investors cot­ton on and begin to with­draw funds. At that point the loss­es rock­et.

Now, let’s get real. The point of this analy­sis is not to pre­dict an immi­nent hous­ing crash. In fact, con­di­tions are not yet ripe for the reck­on­ing of the great Aus­tralian hous­ing bub­ble. It would have hap­pened in 2008 when glob­al mar­kets closed to whole­sale Aus­tralian bank debt, but was post­poned by a strong Fed­er­al Bud­get that sup­port­ed both the asset and lia­bil­i­ty side of the banks’ bal­ance sheets. The will­ing­ness of the Fed­er­al gov­ern­ment to sup­port the bub­ble means the reck­on­ing can only come when the Bud­get also finds itself under pres­sure from a more seri­ous and long-term cor­rec­tion in com­mod­i­ty prices or, as Grantham has hypoth­e­sised, from a burst of seri­ous infla­tion.

But in the mean time we might right­ly ask: Is CBA’s rep­u­ta­tion in glob­al mar­kets cur­rent­ly so at risk that it need resort to the spin pil­lo­ried in its own adver­tis­ing?