A housing bubble illustration

by Rebecca

Yesterday’s post on the Australian economy sparked some discussion of its housing market. I agree – Australia’s bubble is large relative to that in the US (interestingly enough) and Canada.

The chart illustrates the price to rent ratio in Australia, Canada, France, Ireland, the UK, and the US, which measures the trade-off between owning and renting. Across country, the housing indices are not perfectly comparable – for example, Statistics Canada measures the value of new homes, while the S&P/Case-Shiller index measures repeat sales of existing homes. Furthermore, countries often measure the owner-equivalent rents differently. Nevertheless, the trends are meaningful.

Australia’s bubble was (is) big, and relative to rents, home values recently turned upward. According to Steve Keen (thank you reader VtCodger for the link), government subsidies provided households the incentive to leverage up their balance sheets while the private business sector deleveraged. Basically, the crash is yet to come.

The recent uptick in the Australian price-rent ratio, i.e., jump in housing prices relative to rents, is interesting. Notice the same is happening in the UK and Ireland; however in their cases, seriously weak economic conditions are dragging down the CPI housing index (the denominator). (In the UK, prices are likewise rising, but rents are falling faster.) As rents slide, so too will the relative attractiveness of home ownership.

I expect that the same will happen in the US. In Q2 2009, the S&P/Case-Shiller home price index grew 1.4%, faster than did the owner-occupied rents index in the CPI. Owner-occupied housing (see CPI table here) inflation slowed dramatically in Q2; and given the long lag on core price fluctuations, there is a very good chance that it turns negative.

Rebecca Wilder

Tags: , Comments Off on A housing bubble illustration | |