I’ve been meaning for ages to write a post about house prices, but haven’t come up with an analysis that satisfies me. Still, here goes.
On most standard measures. Australian house prices have been far above their long-run equilibrium value for at least five years, and the gap seems to be widening. But the length of the strength of the boom has convinced most people that high prices are here to stay, at least until they are replaced by even higher prices.
If this belief were suddenly reversed, and the prices returned to say, 2000 levels (even adjusted for changes in prices and incomes since then) there would be an awful lot of financial distress, with hundreds of thousands of households having negative equity.
This is already happening in the US and to some extent the UK. Compared to the US we have nothing like the volume of bogus subprime loans. On the other hand, price increases have been even greater, so there’s more room to fall.
If there is a really dire economic scenario facing the Rudd government over the next few years, this is it. By contrast, a slowdown in the export boom and a gradual deflation of the housing bubble would be a much better outcome.