Pick a bubble, back a shortage…

So the media has pretty much entirely come around to my point of view. Property has made a come back. The next bull run has begun.

But not happy to leave us with a good news story, the media has gone and run ahead of the game again. Suddenly we’re back into bubble territory.

“Housing Bubble Trouble” – The Age, 22/9/2013

That’s effectively got to make it the shortest bull run in history. Just a matter of months after the doom-merchants had realised their positions had become untenably ridiculous, the boom cycle had run its course, and we had a bubble on our hands.

Turn it up.

What do they take us for?

Even the RBA was out hosing down the media during the week. RBA Assistant Governor Malcolm Eddey said all this talk of a bubble was “unrealistically alarmist.”

That’s polite central bank speech for bulls#*t.

But that’s just the way it is. The media is always fishing for the next disaster story. The next little girl locked in a basement. It’s what sells.

We don’t buy papers to be told everything’s fine. We buy papers to be informed (=scared).

But even though it’s all alarmist rubbish, I still wanted to take a look at this bubble story. I’d bet my last two cents this isn’t the last we’ve heard of it.

Because remember we’ve had people making a song and dance about the bubble since the before the millennium clocked over.

But I want to make the case that there was no bubble. There never was, and there never will be. (ok, I don’t know about never, but not in the next few years anyway.) And the price rises we’ve seen all make sense in the context of the fundamentals – especially those most basic of fundamentals, supply and demand.

And this isn’t just an academic exercise. The stakes are high. Why? Well it’s not just about whether you and I make money out of property over the next ten years. This is about whether Australia remains the lucky country, or falls into an Irish bog hole.

Remember what happened in Ireland? A property market crash there wiped out the banks. The banks held the government to ransom, said if you don’t bail us out we’re taking the economy down with us. The government caved in, and the bail-out package wiped out the government.

I don’t think that will happen here, but it’ not because we’ve got better government or less greedy banks. Oh no.

Because it is true that our banks have a huge exposure to property. Take a look at this graph from the IMF. What it shows is that over 60 percent of the Australian bank loan book is made up of real-estate loans.

That makes our banks the most property dependent banks in the world. And this list includes countries where there arguably are bubbles emerging, like Canada and Norway.

Now our banks are also some of the best capitalised banks in the world, and our regulators have, so far and relative to some other countries, been on top of their game. So I don’t think there’s any real risk here. But it does highlight what’s at stake.

If there was actually a bubble, and that bubble burst… if a whole lot of mortgages went sour and people started defaulting on their loans… then the banks would be in real trouble.

And if one of them went down, even one of the minor or regional banks, because they’ve all got their hands in each other’s pockets, the whole system would get the wobbles.

And then it would be up to government’s to bail ‘em out of that mess. The government’s got deep pockets and a good credit rating now, but saving a banking sector isn’t cheap. Just ask Ireland.

And this is why we’ve had so many people worried about whether the housing market’s gone bubble or not. The stakes couldn’t be higher.

And of course it’s not hard to see bubbles if you’re looking for them.

This chart here neatly sums up some of the bubble-blowers main arguments. It comes from one of my favourite bubble-blowers, Leith Van Onselen at Macro Business.

What it shows is house price growth, relative to other ‘housing fundamentals.’ We all know the story. Since the mid 80s house prices have grown quickly, much faster than the economy itself (GDP).

And house prices have grown faster than the cost of the physical house itself (construction costs), faster than the return on investment (rents), and faster than our ability to pay for them (disposable income).

The argument then runs that the fundamentals don’t justify the price. On all these measures, house prices seem over-valued.

Why would house prices grow faster than GDP, if not for a bubble? Why would people invest more in an asset than the returns justify, if not for a bubble? Why would prices run way ahead of the physical cost of the house itself, if not for a bubble?

It’s all very neat.

But it’s all very wrong.

Because there’s an answer to all of those whys: supply and demand.

The dynamics of supply and demand dominate all of these factors. And so if demand is running way ahead of supply, it is possible to have sustained increases in price, even if the “fundamentals” are not keeping pace.

And I’d argue that the last 30 years have been characterised by mismatched supply and demand.

Demand has been increasing strongly, thanks to population growth, demographic dynamics, and financial revolutions that have made property much more attainable to the average citizen.

But at the same time, supply hasn’t kept up. New construction levels fall further and further behind the population growth rate every year, and zoning restrictions tie up and limit the supply of buildable land.

And the more the gap wides, the higher prices go. There’s no bubble here. Just simple, text-book supply and demand. And it only shows prices going higher still….

Don’t believe me? Over the next week, I’ll take a closer look at supply, and a closer look at demand, and you can decide for yourself.