Webdiary - Founded and Inspired by Margo Kingston

John Pratt: When will the bubble burst in Australia? Why does a house cost twice as much in Australia? Our interest rates are above 8% while in the US interest rates are now at 3% Its easy to see why the average Australian is struggling to buy a house."

Understanding this question will be the key to Australia avoiding a recession. Unfortunately for Australia nobody in power seems to have any idea why such things are occurring. Rather than running about blaming the previous administration the current government should be attempting to solve the current problem. If Australia enters a recession it will be this present administration's fault - and their fault alone.

The US median home price fell to $201,100 from $210,900 a year earlier, the NAR said. The price of the median single-family home was $198,700 in January, the lowest since $197,700 reported in January 2005.

US Treasury debt prices extended losses after the data, which many analysts said was indicative of the expected protracted downturn in the sector.

The listless homes market is adding to woes about the national economy, with many analysts predicting a near-term recession.

On Monday, the National Association of Business Economics said that 45 per cent of its economists forecast a national recession before the end of the year, while a survey from the Federal Reserve Bank of Chicago traced three months' of below-average growth for the economy.

The housing slump is likely to have a "major negative impact" on consumer spending this year, according to more than 60 per cent of the economists polled by the NABE.

The US Federal Reserve has cut benchmark interest rates by a cumulative 2.25 percentage points since mid-September, taking the overnight borrowing rate to 3.00 per cent, the lowest level since June 2005.

Still, investors remain restless over a global credit crunch that began in the homes sector but has cast a shadow over bond insurers and the spending power of consumers.

The median price of a family home in the US is now $198,700. Compare that to the median in Australia.

A report to be released today reveals that Melbourne's median house price grew faster than in any other Australian city in 2007, jumping by almost $100,000 to $463,488 and closing in on the prices in Sydney and Perth.

When will the bubble burst in Australia? Why does a house cost twice as much in Australia? Our interest rates are above 8% while in the US interest rates are now at 3% Its easy to see why the average Australian is struggling to buy a house.

From The Financial Times:

What rankles are the “undeserving rich”: those who take risks with other people’s money but never suffer the consequences of their mistakes; those who receive massive pay-offs even when they have failed; those who evade taxes while benefiting from public goods. Here surely there is a case for more considered intervention.

In the meantime, here is a suggestion for suasion rather than compulsion: send all rich taxpayers a copy of Andrew Carnegie’s “Gospel of Wealth”. The essay, first published in 1889, addressed what Carnegie saw as the problem of his (and our) age: the proper administration of wealth, vital so that “the ties of brotherhood may still bind together the rich and poor in harmonious relationship”.

Unsurprisingly from the man who crushed the Homestead steel strikes, the ruthless capitalist had robust views about making money. Great inequality was the price of progress. It was pointless to criticise the inevitable. “Much better this great irregularity than universal squalor,” he wrote. Carnegie had no time for indiscriminate charity – arguing it only fed the vices it was intended to cure – and wrote that higher wages for the poor would mostly be wasted on the “indulgence of appetite”. By creating their fortunes, the rich had shown they were more capable managers of money. They would therefore spend it more responsibly.

Such views would horrify many readers in the developed world today – although they are widely echoed by Russian oligarchs and Chinese tycoons. But perhaps Carnegie’s most telling argument was that the rich had an immense responsibility to administer their money wisely during their lifetimes for the benefit of all. Like him, they should give away the vast bulk of their wealth to provide “ladders upon which the aspiring can rise” – in his case an astonishing endowment of libraries and parks.

While wealth creation and distribution should remain free, Carnegie supported high inheritance taxes. “Of all forms of taxes this seems the wisest,” he wrote. “By taxing estates heavily at death the state marks its condemnation of the selfish millionaire’s unworthy life.”

Much has changed since Carnegie’s day. Great fortunes are made in ways that Carnegie would have probably considered unworthy. The state now plays a far bigger role in the economy. Inspired by his example, a magnificent tradition of philanthropy has flourished in the US and to a lesser extent Europe. Pro-business politicians now denounce “death taxes”. But Carnegie’s conclusion still provokes thought and should inspire action: “The man who dies rich dies disgraced.”

As the divide between rich and poor grows ever wider, it is time to rethink ways of taxing the rich to feed the poor.  

From today's Age:

It started with a trickle in Sydney's west and quickly spread to Melbourne's battler suburbs of Mentone and Melton as it grew into a wave of house repossessions that is now claiming about 800 homes every week around the country, because families can no longer afford their mortgage repayments.

Now analysts are warning another 300,000 households are at risk, particularly if the Reserve Bank, as widely predicted, goes ahead with another rate rise next month - and that's regardless of whether the banks decide to pass on the estimated 35 to 40 basis points they are still carrying from the higher cost of credit.

"The American subprime virus has arrived in Australia," says Jonathan Pain, chief investment strategist with HFA Asset Management. "In an age of globalisation no nation can be viewed in isolation."

After years of global credit expansion, the new world order is one of credit contraction. What started in the US subprime mortgage market has now infected most other structured investment vehicles and threatens many of last year's private equity deals, corporate bonds and bond insurers.

The situation is not as severe in Australia as it is in the US and Europe, but credit is starting to dry up, as was starkly illustrated by the troubles encountered by RAMS Home Loans, Centro Properties Group and MFS Limited.

Indeed most lending by Australian banks comes directly from deposits, which are rising, but about a third is sourced from the troubled overseas capital markets that have virtually closed down.

“In the 1920s, Americans consumers and businesses relied on cheap credit, the former to purchase consumer goods such as automobiles and furniture and the later for capital investment to increase production. This fueled strong short-term growth but created consumer and commercial debt. People and businesses who were deeply in debt when price deflation occurred or demand for their product decreased often risked default. Many drastically cut current spending to keep up time payments, thus lowering demand for new products. Businesses began to fail as construction work and factory orders plunged.”

Sound familiar anyone? See any price deflation going on? The Wilshire 5000 has only lost about 2.5 TRILLION dollars in value in the last two months or so. What about the loss in home equity? Another trillion or two? Who knows, but I think you get the point. We are seeing almost to the final utterance the same play we saw unfold in 1929. Were those folks any more prepared for the Great Depression than we are today? I'd argue that while they were perhaps a bit better equipped to provide for their own sustenance that American society in the 1920's was as complacent as we are today. When the realization of history's coup de grace hits, we will be caught as unaware as our ancestors were back in 1929.

Webster's defines complacency as “1.satisfaction or contentment 2. smug self-satisfaction” There is probably not a better word to describe the current state of perception with regard to economic and financial malady.

Could it happen in Australia? 

Queensland’s biggest ever building company collapse occurred because of links with marketing and investment companies known as “wealth creation companies”, Housing Minister Robert Schwarten says.

The Queensland Building Services Authority (BSA) last week suspended the licence of Sunshine Coast-based Real Property Constructions (RPC), following an investigation into the company’s finances.

The company had to cease work immediately, leaving 233 customers with incomplete homes.

Mr Schwarten today told state parliament that wealth creation companies could be better called “wealth destroying companies”.

...............

Since mid-2004, the Australian stock market has been in a bubble, averaging 20% growth compared to a 9% average over the previous two decades. The US growth rate has been 13% compared to the equivalent average of 11%. Both countries have experience bubble economies with similar reflections in their stock markets, Dr Keen suggests. But the big difference is in housing.

Our bubble, suggests Dr Keen, makes the US bubble (now burst) look "positively anaemic"

"Ours began earlier, climbed higher, grew faster, and is still growing - whereas the US's market is clearly in free-fall."

Both have or had been driven on the misconception that housing prices can forever rise faster than consumer prices, such that leveraged housing speculation is a guaranteed "road to riches". But once such a bubble bursts, as all bubbles eventually do, all one is left with is overvalued assets, much higher debt, and a compromised financial sector. This is exactly what's happened in the US.

Are Australian houses overvalued? Well across the developed world house prices are currently falling, except in Australia, despite Australia raising interest rates. A recent JP Morgan report suggests another RBA rate rise could put 750,000 mortgage holders under threat of delinquency, and 300,000 of those under threat of default. And while Australia did not fall into the real subprime mess, including the infamous problem of Adjustable Rate Mortgages, the truth is Australia's household debt to GDP ratio was only half of that of the US in 1985, but is now the same.

Australia has an overinflated stock market and an overinflated housing market. Is Australia's bubble about to burst? With the cost of living about to increase due to rising cost of food, energy and interest rates many will be forced to sell their shares and their houses. A depression on a scale bigger than that of the 1920's is possible. Howard was right - maybe 2007 was as good as it gets.

The meltdown in the US subprime real-estate market has led to a global loss of 7.7 trillion dollars in stock-market value since October, a report by Bank of America showed Thursday.

The crisis, which has spread beyond US shores to banks and other sectors worldwide, is "one of the most vicious in financial history," according to Bank of America chief market strategist Joseph Quinlan.

Quinlan said in the report that the losses are worse than any in the past few decades, including Wall Street's Black Monday of 1987, the 1999 Brazilian real currency crisis and the collapse of hedge fund Long Term Capital Management (LTCM) in 1998.

An analysis by the US bank showed that in the most recent episode linked to subprime, or high-risk, real estate loans to people with shaky credit, world market capitalisation was down 14.7 percent three months after a peak in late October.

That compared with a similar loss three months later of 13.2 percent after the LTCM crisis, 9.8 percent for Black Monday and 6.1 percent for the Brazil crisis.

The losses were also greater than those suffered after the September 11, 2001, terro attacks, the Asian financial crisis starting in 1997, Argentina's default on its debt in 2001 and the 1994 Mexican peso crisis.

"It could take months or even years before Wall Street and others get a handle on the true cost of the US subprime meltdown and the attendant global credit crunch," Quinlan said.

Every day more money is taken out of our wages and put into superannuation, trillions of which have now been lost. The future fund is also hemorrhaging all in the hope that the markets will recover. What if they don't?

Prof Roubini's, 12 – steps to financial disaster.

Step one is the worst housing recession in US history. House prices will, he says, fall by 20 to 30 per cent from their peak, which would wipe out between $4,000 billion and $6,000 billion in household wealth. Ten million households will end up with negative equity and so with a huge incentive to put the house keys in the post and depart for greener fields. Many more home-builders will be bankrupted.

Step two would be further losses, beyond the $250 billion-$300 billion now estimated, for sub-prime mortgages. About 60 per cent of all mortgage origination between 2005 and 2007 had “reckless or toxic features”, argues Roubini. Goldman Sachs estimates mortgage losses at $400 billion. But if home prices fell by more than 20 per cent, losses would be bigger. That would further impair the banks’ ability to offer credit.

Step three would be big losses on unsecured consumer debt: credit cards, auto loans, student loans and so forth. The “credit crunch” would then spread from mortgages to a wide range of consumer credit.

Step four would be the downgrading of the monoline insurers, which do not deserve the AAA rating on which their business depends. A further $150 billion writedown of asset-backed securities would then ensue.

Step five would be the meltdown of the commercial property market, while step six would be bankruptcy of a large regional or national bank.

Step seven would be big losses on reckless leveraged buy-outs. Hundreds of billions of dollars of such loans are now stuck on the balance sheets of financial institutions.

Step eight would be a wave of corporate defaults. On average, US companies are in decent shape, but a “fat tail” of companies has low profitability and heavy debt. Such defaults would spread losses in “credit default swaps”, which insure such debt. The losses could be $250 billion. Some insurers might go bankrupt.

Step nine would be a meltdown in the “shadow financial system”. Dealing with the distress of hedge funds, special investment vehicles and so forth will be made more difficult by the fact that they have no direct access to lending from central banks.

Step 10 would be a further collapse in stock prices. Failures of hedge funds, margin calls and shorting could lead to cascading falls in prices.

Step 11 would be a drying-up of liquidity in a range of financial markets, including interbank and money markets. Behind this would be a jump in concerns about solvency.

Step 12 would be “a vicious circle of losses, capital reduction, credit contraction, forced liquidation and fire sales of assets at below fundamental prices”.

These, then, are 12 steps to meltdown. In all, argues Roubini: “Total losses in the financial system will add up to more than $1,000 billion and the economic recession will become deeper more protracted and severe.” This, he suggests, is the “nightmare scenario” keeping Ben Bernanke and colleagues at the US Federal Reserve awake. It explains why, having failed to appreciate the dangers for so long, the Fed has lowered rates by 200 basis points this year. This is insurance against a financial meltdown.

Professor Nouriel Roubini is from New York University’s Stern School of Business.

Chris Shaw, your post has excellent video on the extent of the problem. 2008 might be the year of the perfect storm: global financial meltdown, Peak Oil, and Climate Change. If we survive the next ten years all this will be blamed on the Rudd Labor government.

Interesting times.

For a time I traded Futures on the US market.

When the compulsory super scheme was announced I wrote to various people advocating that as the scheme was to be ‘compulsory’ there ought to be a government-run option that people could opt into that returned no less than the inflation rate each year, and that all super funds ought to have to invest a given percentage of the funds they held into this option.

Further, I suggested that all funds ought to have to provide periodic — at least yearly — reports establishing the value of each fund. That upon the inevitable periodic losses that the funds could not charge any fees of any sort until the fund recovered to that reported level, and then only from the returns earned above that figure. Predictably, I was ignored!

I disagree with the view that investing money in the financial markets is ‘gambling’. Long term investments, properly managed will make money — or historically that has always been the case!

In today’s market, trading Futures there is certainly money to be made by the small — think minuscule! — trader.   Provided that the trader does understand the market, does have developed and practiced skills. In the current volatility it ought to be ‘money for jam’!

For a fund trader the market is much more difficult. In fact I don’t understand how a fund trader can function in the current conditions.

There is much talk that the recent ‘dips’ have been ‘corrections’. In my view this is a misunderstanding of the market. While the ‘dips’ have been big enough to be considered ‘corrections’, they have not been of sufficient duration to qualify as such.

I believe that we are seeing a classical ‘top’. A little different from what we expect historically, but merely reflecting the underlying change in the market conditions.

I believe that the US economy  is heading for a major crash. This will of course bring down the world markets. However, while the US economy will take years to recover, if in fact it ever again reaches the present levels, the rest of the world will stabilise quite quickly.

Growth will naturally have slowed, which I think is in fact a positive, but economically things will continue without too much disruption.

There will be pain!  ‘Paper profits’, will be wiped off. Many will feel ‘robbed’. The theoretical values of property and shares will have been sharply cut.  But if the reality, I owned a house, I still own a house, is applied then its previous ‘value’ is of no significance.

To the question: how safe is our super?. To be blunt, it isn’t! Whether it is invested in stocks or in bricks and mortar, it is going to decline, and decline substantially, in value. The question is, where else would you park it?

Gold? At $900 odd per ounce?  Not my money!

In long term bank deposits?   Perhaps.

Chris Shaw, thank you for those clips. I'm 60% of the way through, and all that I can say is that I am seething with anger - how dare so many people be so irresponsible with other people's lives and livelihoods? Sure, it was ever thus, but given the interconnectedness of all things (which I thought proponents of globalisation were supposed to support) isn't the way that they are behaving akin to cutting off their noses....? However, I suppose they don't look in the same sort of mirrors that apply to the rest of us.

PS: All those who want to call me a dewy-eyed romantic - look out. Never was - on the contrary, was described as a cynic at the age of eleven - but Chris's post gets to me. If it doesn't do the same to you well, poor fellow my country. 

Some weekend viewing.

Five YouTube instalments of a UK Channel 4 program about the Great Malfunction:

1
2
3
4
5

- or if you prefer something with a humorous twist, the great Bird and Fortune dish it out in their inimitable style.

How exactly do I become a share fund manager?

A business where the government forces people to give me money.  And then I have no accountability for what I do with it.  That this passes without comment is simply breathtaking.

Betting people's health and income in old age on the stock market is unbelievable.  It is a sickening abnegation of responsibility. 

THE federal agency in charge of the Future Fund says the Australian shares component of its portfolio lost between $600 million and $700 million during the recent market downturn.

But officers of the Future Fund Management Agency told a Senate estimates committee yesterday that the overall portfolio had grown by $65 million in the past seven months because about three-quarters of the portfolio remains in cash.

The Future Fund was set up by the former Coalition government of John Howard to cover $140 billion of public service superannuation liabilities by 2020.

The government is now gambling on the stock market. Over $600 million has been lost. This is money that should have been building schools, hospitals and roads. Who knows how long the current bear market will last? Who knows what financial shocks Peak Oil or Climate Change will bring? Who knows how deep the current credit crisis will run? How safe is your super?