Steve Keen on debt

There’s been a lot of discussion recently about Steve Keen‘s work on debt, presented (among other places) in this paper for the Centre for Policy Development last year. I made some comments at the time, as follows:

I’m generally in sympathy with the arguments presented here. However, having made similar arguments for a long time and having been continually surprised by the durability of the asset price boom/bubble let me offer a couple of counterarguments/cautions:

(1) The increase in house prices can be partially explained (on the supply side) by the increase in the size/quality of the average/median house and, particularly in the last decade, by increases in the cost of labour and materials

(2) On the demand side, given the above and the fixity of land, some increase in prices would be expected as a result of population growth and income growth. If you suppose that housing is a superior good, this would imply that the value of houses should grow faster than GDP, and probably that debt would also rise relative to GDP.

(3) Looking at the big picture of the rise in debt, it has gone on for so long (40+ years) that it must cast some doubt on arguments based on the claim that bubbles always burst. I still think the arguments are valid, but the objection can’t just be dismissed

(4) A fuller version of the optimistic story would say that credit markets have become steadily more efficient with the result that households are able to manage much larger volumes of debt. A plausible version of this story might include the concession that the debt growth of the past decade has outrun the capacity of households and markets to manage it, implying the need for a painful correction as is now happening in the US, but also allowing for a continued upward trend in, or stabilisation of, debt/income ratios.

On balance, having thought through all this, I still think the story in Steve Keen’s piece is the right one. But it’s important to confront the opposing argument in its strongest possible form.

Obviously, the opposing arguments I wanted Keen to respond to look a lot weaker now. Whatever qualifications I might still want to make, Keen got the basic points right, and those who are criticising him now should concede this.

51 thoughts on “Steve Keen on debt

  1. Consequently shouldn’t you now be extremely critical of the Federal approach which throws the kitchen sink at propping up the highest property vauations in the world on any metric?

    Both the blanket uncapped guarantee and the inexplicable first home owners wasteful splurge for exixting homes seem to be aimed at propping up unrealistic valuations, real estate agents and mortgage brokers?

  2. I don’t see how you (Thertises) are drawing a connection between the bank guarantee and the home grant. A bank guarantee is likely to encourage saving, not spending, I would have thought.
    Keen has supported the first and criticised the second. We know Prof Q supports the first. So far their positions look consistent.

  3. Thanks John,

    I have been waiting for a respected economist to address Keen’s points for some time. The economic community on the whole appears to either pretend he doesn’t exist or attack him personally.

    As a baby economist, I’m heartened that you agree that there is strength to his argument. I can’t see its inherent weakness.

  4. Can’t find it so James can you point me in the direction of Keens support for the guarantee?

    There is no bastard who doen’t support some form of guarantee but as we know the devil is in the detail and the laws of unintended consequences?

  5. On point 1), it is true that a certain amount of the increase in prices can be attributed to an increased size of homes, as well as increased costs of building homes.

    The high cost of building homes (not just labour and materials, but also taxes and charges) has the effect of putting a floor under house prices. If it costs a lot for a new house and land package, people are more willing to pay higher prices for existing homes.

    But none of this is likely to stop house prices falling substantially. The bottom line is that if people’s incomes and other expenses are not sufficient to sustain property prices, it doesn’t really matter whether anyone thinks that the quality of homes justifies the price. There simply won’t be enough people able to pay.

    Given that the ratio of average prices to average incomes is very high in Australia (about 7:1), an economic downturn would mean even less income propping up existing house prices. There is no way this is sustainable.

    The other thing is that the increased size of many dwellings, combined with smaller families and a reduction in the average number of residents per dwelling, effectively means that there is a lot of spare capacity in the housing market. In the event of an economic downturn and more people unable to pay mortgages or rent, people will change their lifestyles and behaviour. More people might move in with another family member or combine households. Some people will sell up and move to smaller homes. Some people might take in a boarder etc.

    All of this will have the effect of expanding supply and suppressing demand. So the idea that supply-side constraints and excess demand will put a floor under house prices is illusory.

  6. I also am sympathetic with Steve’s analysis, but wonder..

    ..might increasing female workforce participation over the last few decades have also played a role? When both partners are working, couples have more ability to take on mortgage debt and hence can make higher bids for houses. If so, house prices might never return to long-term trend levels.

  7. It seems to me that the reason why many economic commentators choose to ignore Keen is that they want to talk things up, and few commentators want to say how serious things really are.

    Australia’s personal debt levels relative to income, and house prices relative to income, are actually higher than in the US and most other countries prior to their current problems.

    As a nation, our economy is leveraged to the hilt. We are exceedingly vulnerable to a correction. It seems we have gambled heavily on the current resources boom continuing. We may be about to lose that bet.

  8. John, you ignore the complaints about his predictions of the future. Watching him on television, and listening to him on the radio, he does seem much too fond of the dramatic statement.

    For example, he says the best case scenario is (I think) a recession for several years. Worst case (again from memory) is a decade-long Depression. That is, he is saying we will now get at the very least 12 consequitive quarters of negative growth.

    And house prices will drop by 40% – no ifs or buts.

    It is these statements that he is being criticised in the mainstream media about. Are you really saying his critics ‘should concede’ that these things are true?

  9. Ian, you are correct that increased female workforce participation has played a part. Affluent two-income couples are often able to pay more for houses.

    The only problem is that if the economy tanks and many people lose their jobs or have lower-paid jobs or work less, they will no longer be able to afford the repayments.

  10. #1 I posted on the FHOG a week or so ago saying “I’m less impressed by the increase in the First Homeowners grant. In the long run, this scheme has been part of the problem of high housing costs, not part of the solution. Maybe the government has information suggesting the possibility of a rapid collapse in the housing sector, in which case some sort of emergency stimulus might be necessary. But the medium term direction of house prices has to be down”

  11. #9 I don’t watch a lot of TV, so I’m going mainly on what Keen has said in print over a longer period. It may be that he has gone a bit OTT, but most of those who criticise him should start by admitting that they never saw this crisis coming.

  12. ditto kymbos #3

    I have been a fan of Steve keen and the asset price inflation thery for most of the decade. Sold both my properties up by the early noughties, to put my money where my mouth is.

    Obviously consumer by sellers remorse these past five years or so. It seems that the commonwealths financial (interest rate), fiscal (home grants and capital gains tax breaks) and now factoral (immigration) policy are all aimed at and predicated on boosting property prices. I call this plus the massive super handouts to geezers the “wealthfare state”.
    Like Pr Q I expect the asset price bubble to burst. But only a recession will do it since institutional forces are tending to boost debt based asset inflation. Owner resistance to liquidation pressure is impressive.

    At the moment a recession appears to be odds-off. Although a slow down in Asian growth and a rise in global interest rates might cause property market capitulation.

    Even then the govt and populace will throw everything at the property market to keep a high floor on prices. More home grants, tax breaks, bail-outs, raids on super, infrastrucure splurges – you name it.

    The Great Australian Dream will not go down without a fight. Neighbours Home and Away last stand.

  13. John says “If you suppose that housing is a superior good, this would imply that the value of houses should grow faster than GDP, and probably that debt would also rise relative to GDP.”

    True. But the converse is also true. If there is an economic downturn, and average incomes fall, the value of houses should actually fall by a greater level than average incomes or GDP.

  14. # 13 Jack, when the US government bailed out failing financial institutions some suggested these institutions were “too big to fail”.

    Now it seems many people believe that the Aus housing market is too big to fail.

    It really is amazing when you consider the number of subsidies and distortions that are there to prop up the housing market (CGT exemptions, FHOG, lower interest rates, high building costs restricting supply). Now there is pressure to raid super funds to prop up housing.

    The problem is that the more money that is tied up in propping up real estate values, the greater the fallout will be when the crash finally comes. By propping the market up in the short-term (by increasing the FHOG), the government is actually creating a bigger problem in the long run.

  15. John, whilst mortgagees are employed and meet their monthly obligations there are no real problems but the future does look bleak and mortgagees should take out some form of ‘mortgage protection insurance’ to ensure they ride out the storm. For as Keen says, the ‘good times could come to a very sudden end’ at any time.

  16. “Maybe the government has information suggesting the possibility of a rapid collapse in the housing sector, in which case some sort of emergency stimulus might be necessary. But the medium term direction of house prices has to be downâ€?

    So why not just fess up that the residential property valuations on which the banks capital positions are based is bullshit and go straight to the Gordon Brown plan now?

  17. is it possible that people unable to afford single -family dwellings will solve the problem by house/flat-sharing? this will supply the income necessary to sustain mortgage levels with rent, while reducing demand for new dwellings.

    ‘share’ ads will give some insight here, if tracked for a while. we can watch slum-formation ab initio, a great treat for sociologists.

  18. #9, Having read some of Steve’s work – and seen the interview you mention – I believe that he accurately stated HIS view on the best and worst case scenarios. Secondly, on his blog site he states why he thinks a 40% fall is in order. Sure, his views are outside of those of “the mainstream” (much of which is affected by conflicts of interest). However, the mainstream scenario range – at least on the short to medium view of the economy – keeps moving towards his. What has been questioned recently, particularly by Gerard Henderson, is that he is not honestly presenting his views in order to gain increased notariety. I see absolutely no evidence of that. Rather, I see many vested interests trying to dampen debate and perpetuate a myth – by personally attacking people with sincere intentions and backed by robust analyses – in order to protect business, financial and political positions.

  19. In my area the house prices have doubled in the last few years. Sound houses have sold at a reasonable price only to be knocked down and replaced with two smaller but newer houses. It has been a bonanza. The houses sold as fast as they were built. The prices on the houses are still as high but they are not selling at all and at the moment tbere are a huge number in the area with many more on the way. I can’t see any other way of selling them except by reducing the price, which on a new building must be difficult. But when a buyer is looking at a $4,000/month payment in an uncertain world then sales are likely to slow.

    Unfortunately in order to get people’s attention those with knowledge may make extreme statements. However Gerard Henderson’s personal attacks do nothing to counter Steve Keen’s arguments that housing prices are likely to drop.

  20. Pr Q, would like to hear your views on the medium to long term affects on the economy if the Govt throwing the kitchen sink at house prices keeps them elevated as suggested by #13.

    My thoughts are that it would have serious economic consequence. It is consistently argued that income tax rates need to be competitive to attract mobile skilled labor. Cost of living is at least as important. RBA graphs show we have the most expensive houses in the Anglophone world (prices relative to income) even BEFORE the bubbles popped in the US, UK and elsewhere.

    Mostly I am concerned about the social issues of high house prices. The economic consequences of the bubble popping are frequently stated. But the economic consequences of the bubble not popping also need to be discussed.

  21. ‘Before Perpetual’s freeze today, some 24 funds in the mortgage and property sector holding $14.4 billion of savings on behalf of 93,000 investors had suspended redemptions. Any other fund in the sector still open must be seriously considering its options.

    More to the point, any fund which is not covered by the guarantee is vulnerable to redemptions given the climate of fear although it must be said that mortgage funds are most at risk.

    The guarantee is turning out to be a disaster and if the banks are permitted the luxury of a AAA- Government guarantee on their wholesale funding alongside a guarantee on their depositor bases there must be some quid pro quo or the outrage will go on for years.’

    And so it goes John. 20k, the lot, on the run, Trunbull truffles, top the rodent’s 7K etc….here we go here we go… but he’s going to Washington to talk to George Bush. I’m loading the 4WD.

  22. Well Steve Keen is my pinup boy from amongst the economists. He’s been more on the money (unfortunate expression I guess) than any other I’ve heard.

    I’m an horrendous pessimist as readers of this blog will know. I pretty much see pessimism as realism and have seen it that way for a long time.

    There are several major world industries which are tanking or about to tank. Housing is the obvious one though it will survive in the long run. However, automobile manufacturing will crash soon. The airline industry will crash. Tourism will pretty much fold. Imagine a world economy with these latter three in irreverisible contraction. 12 years (not quarters) of negative growth seem easily possible under this scenario.

  23. Agree generally with John, but the elephant in the room is demographics. The BBers own most of the housing and productive capacity, but what’s it worth when they want to sell collectively to to their offspring to fund retirement? A mate died recently in a specialised business and I had to help his daughters fire sale it all. This will be the norm soon and the scrap vultures are having a field day at present, although scrap steel prices tell the economic story now. Essentially steel-making requires a percentage of scrap to season the kilns and prices have collapsed from $300-$350/tonne to $50-$75/tonne for baling and heavy scrap. Most of this is back-loaded to China utilising empty containers so you can work it out for yourself. The party’s over.

  24. And if you thought falling interest rates were the salvation of home prices, Fujitsu Consulting Group has some bad news-,25479,24539549-5017313,00.html

    ‘The report found 15 per cent of households had experienced a reduction in overtime payments in the past three months, and 35 per cent of people employed by small businesses had seen their hours reduced.

    “The findings are very concerning as it shows that despite the potential for more rate cuts in coming weeks, the spectre of falling employment is off setting the potential benefit,” Fujitsu managing consulting director Martin North said.

    The “double whammy” of unemployment and the higher cost of living were driving more people into stress, he said.

    “This will lead to further house price reductions in many suburbs,” Mr North warned.

    Mortgage stress is tipped to rise 27 per cent to more than one million by March – that is based on a further 1 per cent decline in official cash rates and unemployment rising from 4.3 per cent to 4.7per cent.

    If unemployment reached 5per cent, Mr North estimates stress levels would rise above 1.4 million.
    And the alarming predictions are not just confined to the battlers. Affluent stress is also on the rise due to the further stock market falls, margin calls and rising costs of living.’

  25. The usual lines I read/hear for why our real estate won’t devalue is…

    a) Less available than needed, which is not the case in the U.S.A (which I find a bit hard to believe)

    b). China will save us etc…

    c). High migration, therefore return point to point a.

    d) More land should be released by the gov to reduce prices (the usual line from the IPA etc, but they seem to conveniently ignore in some states the land is held by developers or that it is so far away that nobody wants it. They also ignore the environmental impact).


    Steve Keens arguments seem to me (a non economist) if history is anything to go by. But, is there something “new” that will save sort this problem out.

    Thoughts anyone…

  26. Codger: “:The guarantee is turning out to be a disaster …”

    Compared to what’s been happening elsewhere this rather sounds like complaining about the lack of cushions in the lifeboat.

  27. I don’t think the new home buyers grant extension is intended to “prop up” home prices, I think it’s intended to permit a gradual decline in real prices over several years through inflation as well as declines in nominal prices.

  28. Relax Codger. If you’ve got those funds in the mortgage trusts, this morning Swanny reckons you should just pop down to Centrelink. See, they’re always thinking about your welfare.

  29. while its generally true that demographics (and gov’t regulation) drive property prices up, that can’t explain the huge increase over CPI in the last 8 years. It’s not like our population suddenly doubled, or the government suddenly declared half of every city was a national park. Only a bubble explains that, and bubbles burst.

  30. With John’s kind permission I’d recommend this article to you all-,10117,24544580-401,00.html?from=public_rss
    It’s an example par excellence of the nature of the intractable problem of global financial interrelatednes that faces us and our leadership now(and perhaps how some of us can be too critical of leadership on that score at present)

    It starts off with someone, somehow detecting some radioactive lift buttons and then look at who and what gets involved in the chain of sorting out responsibility and ultimate prevention in future(as if the scrap boys need this headache currently) Just like the world financial system at present.

  31. It’s why I couldn’t possibly entertain a global CO2 ETS by the way. Our solution to that must be a national, global exemplar in that regard.

  32. You can over-analyse this stuff….

    It’s pretty simple – buying and selling property is a relatively free market. It’s all about supply and demand. The price of housing will go up if demand is greater than supply and vice versa.

    In Australia – we are supply constrained. Most people want to live in the capital cities and not out in the fringes. The supply of quality suburban housing is fixed.

    Therefore the price of housing is driven mostly by demand. Demand is driven by two factors – incomes and cost of credit.

    In the past decade we’ve ‘never had it so good’. Incomes have risen and interest rates have been low – therefore demand has been strong. House prices have gone up. surprise surprise!

    Property prices are likely to fall from curent levels – but not dramatically. Keen’s 40% seems wildly pessimistic! Supply will remain unchanged – but demand will modestly fall. Incomes will drop but interest rates will remain low. Peoples capacity to pay the current price will probably remain quite good.

    Hardly the environment for a property price collapse.

  33. Andrew@34 “Peoples capacity to pay the current price will probably remain quite good.”

    I guess it depends on how you define “people”.

    For those that have ridden the asset boom from the beginning, or those with rich parents or a couple of hundred thou inheritance from great grannie, there may be “good” capacity to pay for shelter. For the rest of us, it actually is a day to day struggle.

    I can only speak for myself but there’s no way I can afford a mortgage anywhere near where I need to live for my work here in Canberra.

    With every prospect that the price of other essentials such as food and fuel are going to keep rising, it’s just not an option. I currently pay a below median $385 a week in rent for a tiny two bedroom place and with a new family to support I am unable to save anything on my salary (which @ $58k+ I actually thought was pretty reasonable).

    Luckily, my wife is able to work, so we can meet the bills and we can even save a little for the future, but most probably this won’t be for a house. It just doesn’t make sense financially to go into as much debt as we’d have to to own a place of our own – at least if I want to keep working where I do.

    I think what we’re seeing is a tragic stratification of wealth in this country, and the real estate bubble has fuelled it. Unless it unwinds in a big way, or salaries increase proportionally, it seems to me that home ownership will remain nothing but a dream for a larger and larger proportion of future generations of Australians.

  34. Mike @27,

    Can you explain why you find it so hard to believe that the US over-built while we under-built?

  35. Scott@35

    yes of course… ‘people’ is actually made up of lots of different individuals all in vastly different individual circumstances. My use of the term ‘peoples’ is meant to represent the average Australian ‘working family’.

    I agree with your overall sentiment – it’s certainly getter tougher to get ‘in’ to the market. I’ll have to start saving for my kids house deposit now!

  36. I entered the market by buying a unit in Canberra in 2004 and have seen its price increase substantially. After moving to Melbourne I rented the Canberra unit out for a very significant amount.

    I’ve also bought a primary place of residence house in Melbourne this year and was able to hold to hold onto and keep renting the unit. My wife also has a unit in Canberra she still owns which also increase significantly and is renting out.

    We are both working, rents are high and interest rates are falling so have the best of both worlds and are paying down the loans reasonably quickly.

    No spare cash to invest in shares so not affected by sliding equities. Property’s holding up well and would expect to continue to. You have to put your money somewhere, its as good a place as any for mine and its also gives you the security of a roof over your head.

    Those letting pessimism influence their investment decisions and where they live are being left behind and making it hard for themselves in the long run.

    Selling your house like Keen is nonsensical for mine (if he could get someone to buy it at his unrealistic (?) price that is)

  37. And another thing if Keen really thinks prices will fall 40 per cent he better hurry up and accept any offer he’s getting on his unit at the moment lol

    Talk the talk, walk the walk

  38. Andrew @ 34,

    Everything there solid, but the elephant in the room is the cost of energy and its cascading influence. It did not take much of a (in real terms) increase in petrol prices to destabilise property prices in the the pre credit crash period. For the very same reasons that you underline (fixed supply low cost of finance) every one has bought to the maximum, driven I believe by the passion for the McMansion along with position, and the scope for absorbing cost shocks is minimal. The relief valve in the twenty first century is primarily technological leverage and industrial automation. This in conjunction with access to cheaper labour has flooded our lives with optional goods that we use credit to obtain. The first reation to a cost shock is to drop optional purchases and dilute extended credit. Industry quickly adapts by reducing materials and automating further thereby reducing apparent prices to maintain through put. Property prices stagnate for a period before resuming there upward march once the community has adjusted to the new reality.

    I would suggest that keens forecast is realistic if peak oil is indeed past and energy technology does not fill the gap in pace as fuel supplies are competed for more aggressively. However, if you look at the potential impact of the Aptera (hybride electric car featuring a huge reduction in physical weight [read resources required] for the same effective functionality) formula it is entirely probable that the effects of global warming (if solar power is effectively utilised) and peak oil can be side stepped. In which case Keens prediction can only be correct if global warming then obsoletes significant areas of real estate along with their buildings as its full effect sets in.

  39. sdfc@36,

    For a few reasons.

    1) Building construction in Australia has been going full steam ahead. Maybe this still is not enough for our rapidly growing population, but is America any different? It has a high migration rate (illegal and legal) and a young population (by first world standards – as do we) who are looking for homes.

    2). As has been pointed out many times, the sub prime mess is due to money being lent to people who could not pay it back. The houses being shown on “The News Hour with Jim Lehrer” were pretty much all occupied at some point.

    Of course these are just questions raised from my casual view of the situation (what I read in the press etc). The people who study this (independently and without bias) are the ones who best understand what is really going on here and how it might be similar to America.

    With regard to Steve Keen opinion, he will almost certainly be wrong in some of his conclusions – only time will tell, but his main criticism of how debt has been ignored may well be valid. After all, the median income for a single person has not increased to any great degree (be sure not to mix this up with how a bank may define a “households” income), but the debt level we carry most certainly has (either in real estate and/or other stuff like plasma screen tv’s etc.). In this respect we are far closer to America than Europe. In Italy, for example, the idea of loaning money to buy a tv is almost unheard of. In Australia people seem more than happy to.

  40. sdfc@36,

    A quick edit,

    Housing construction has been going full steam ahead in Australia for about half a decade (if not more). Such a large part of our population works in housing/building related work that it will not take a big shift in housing and building construction to cause stress in the economy.

    Furthermore, if the overpaid people in the housing/building construction industry have over invested (with big loans) in real estate or other things (because they believed that the good times will never end) then they themselves could find themselves in the crunch.

  41. All I can say Mike is check the numbers.

    You can get the Oz figures from the ABS building approvals report which shows approvals have beene sluggish over the past four years. If you plot building approvals against the civilian population numbers from the labour force report you will see there has in fact been an underbuild in Australia.

    The US housing starts numbers from will show you the US built a bucket-load of houses.

  42. I would have thought the Australian fundamentals derive from a demand cocktail driven by available credit, employment growth, demographics & tax driving prices higher because of constrained supply.

    This link to a paper last year from someone at the Cleveland Fed maybe of interest.

    It was linked from this comment today from someone at the Atlanta Fed blog.

  43. It’s always interesting that whenever anything intellectually challenging, different and non partisan is posted comment evaporates …. and it doesnt matter whether its John Quiggin or Tim Blair …..

  44. A bit OT, but there was a Steve Keen who played rugby league for Cronulla in the 70s. He was a real hard man. Got some very lengthy suspensions for bad acts.

    This wouldn’t be the same bloke would it?

  45. JQuiggin wrote…

    (1) (2) On the demand side, given the above and the fixity of land, some increase in prices would be expected as a result of population growth and income growth. If you suppose that housing is a superior good, this would imply that the value of houses should grow faster than GDP, and probably that debt would also rise relative to GDP.

    Perhaps, but not necessarily, by much.

    I was listening to Counterpoint on ABC Radio National this afternoon and nearly fell off my chair when Michael Duffy’s guest noted that house prices in Germany hadn’t changed in real terms since the 1970s!

    It’s true!

    Apparently, the reason for this is that incentive to invest in new housing is provided in the form of local taxes being provided to planners who providing more housing. Planners thus have incentive to encourage more people to live in the houses they build. What a brilliant idea.

    The result is that the perverse incentive for ordinary people to invest their wealth in this artificially inflated investment class doesn’t exist in Germany. As a result, although it’s cheaper to own a house in Germany, home ownership is lower in than what we see here and renting can be a desirable option.

    It appears that capital in Germany is more sensibly directed to useful things for the national economy like the manufacturing industry.

  46. Nice to see some level comments on Steve Keens’ work and his views. Bernard Keane (crikey) and Henderson are a pair of arrogant pricks who would rather bag him outright than actually take a closer look at the amount of work Steve has put in on the subject of debt over some years now. To label him “doomsayer celeb” and other like terms is just purile, he is not doing this for attention. He is totally sincere in every aspect of his work, he is not doing this for notoriety. Steve is my uncle, I know the kind of person he is and it irks me to think that so many of his peers straight up dismiss him and his work as nonsense. Steve puts an unbelievable amount of energy and focus into his work, and it is nice to see that at least certain respectable media entities are taking him seriously now.

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