Property market mania – ABC transcript.

Here’s an abc transcript – it’s an interesting read.

from: http://www.abc.net.au/pm/content/2003/s927891.htm

Property market mania
PM – Tuesday, 19 August , 2003 18:22:00
Reporter: Stephen Long

MARK COLVIN: Before the US sharemarket’s so-called ‘tech wreck’, the mania for internet investments saw the market lose its head and throw traditional measures of value out of the window. Now a leading visiting economist says the housing market is showing the same signs in the US and, he suspects, in Australia.

In fact, in a new paper prepared for Australia’s Reserve Bank, Professor Karl Case, of Wellesly College, Massachusetts, argues the property market is gripped by a mania akin to the Tulip mania of the 17th Century. His Co-Author is Yale University’s Professor Robert Shiller who famously identified the stockmarket bubble of the 1990s in his book Irrational Exuberance.

After Professor Case addressed a Reserve Bank conference on asset prices today, he spoke to our Finance Correspondent Stephen Long who began by asking him what signs he saw of an Australian property bubble?

KARL CASE: That’s a hard question to answer directly. But I think there’s an awful lot of exuberance – the cocktail party conversations, television shows, auctions with a lot of people – it seems to be a topic of conversation which is usually a symptom that there’s something going on with expectations.

STEPHEN LONG: Why do you think it is that people build in such unrealistic expectations about continued growth in home prices?

KARL CASE: Any time an asset market increases in value and people make a lot of money, and they see other people making a lot of money they get happy about it, they get excited about it.

I lived through one of these booms in Boston in the 80s. I made more money living in my house in the mid-1980s than I made working. And when you observe other people doing that you want a piece of the action.

We surveyed 2,000 buyers – people who bought in the middle of 2002 – and we asked them about their expectations, and if you look at the answers it suggests that they form their expectations of what’s going to happen to the value of the house by looking at what’s happened in the last few months/last few years.

And if the housing market has inflated a lot, if prices have gone up substantially, then they believe that will go on forever. So, in other words, if I look backward and house prices go up one year 5 per cent, I’m willing to pay substantially more than that because I’m going to get 5 per cent per year in the future, you’re off to the races and you can get very rapid acceleration of prices that are not based on reality.

STEPHEN LONG: So in effect, irrational exuberance in the housing market?

KARL CASE: That’s exactly right.

STEPHEN LONG: One of the concerns we have is that people are redrawing on their mortgages to fund consumption. Have you found that that is something that occurs when we have this kind of property market?

KARL CASE: Absolutely. People spend based on their income and their wealth. And when the value of their property goes up there’s considerable evidence that it leads to more spending. So it reduces the savings rate and it increases the amount of consumer spending in the economy.

STEPHEN LONG: And what’s the problem with that? What does it lead to?

KARL CASE: The bubble can burst. If it is a bubble then there are potentially serious problems if the bubble bursts. There’s also negative wealth effect, that is to say, people who lose home equity spend less, and that drives the consumption spending in the economy down.

STEPHEN LONG: Do you think that we are likely to see that in Australia?

KARL CASE: Well, any time you see a market running way ahead of the rest of the economy it can’t go on forever.

STEPHEN LONG: If we do have a housing bubble, how do you think it will end?

KARL CASE: Here’s the way housing bubbles stop: somebody blows a whistle that only dogs and buyers hear. Buyers stop looking, stop making offers, sellers tend to hold out because they know what their house is worth – of course, what a house is worth is what somebody’s willing to pay you.

But they don’t see it that way – they saw one down the street sell for $450,000 and they know that’s what it’s worth. So they hold out, they won’t lower their price. So transactions dry up. The difference between offering prices and asking prices widens, time on the market goes up, and the market simply stops.

Then if the economy is slow or if the market doesn’t come back in a short enough time period then people ultimately have to sell, investors will sell and prices will start to fall, and prices can fall dramatically – in Los Angeles they fell 30 per cent in a period of about 18 months a few years back.

STEPHEN LONG: The Reserve Bank’s recently commented here that these sorts of bubbles generally end either through very, very high interest rates causing dampening of the market, or through an economic contraction. How severe can that economic contraction be?

KARL CASE: Again, speaking of the city I know the best that lived through a contraction caused by in part the real estate market – we lost 11.5 per cent of our jobs in that region – which is enormous.

In a typical recession in the United States we lose 1.5 per cent of the non-farm payroll jobs, and in this recession of 1991 in New England we lost 11.5 per cent of the jobs – that’s enormous.