Australia residential property

The following is a list of signs manias and financial crises by Edward Chancellor from GMO investment management.

1. Great investment debacles generally start out with a compelling growth story.
2. Blind faith in the competence of the authorities.
3. A general increase in investment is another leading indicator of financial distress. Capital is generally misspent during periods of euphoria. Only during the bust does the extent of the misallocation become clear.
4. Great booms are invariably accompanied by a surge in corruption.
5. Strong growth in the money supply is another robust leading indicator of financial fragility. Easy money lies behind all great episodes of speculation from the Tulip Mania of the 1630s – which was funded with IOUs – onward.
6. Fixed currency regimes often produce inappropriately low interest rates, which are liable to feed booms and end in busts.
7. Crises generally follow a period of rampant credit growth.
8. Moral hazard is another common feature of great speculative manias. Credit booms are often taken to extremes due to a prevailing belief that the authorities won’t let bad things happen to the financial system. Irresponsibility is condoned.
9. A rising stock of debt is not the only cause for concern. The economist Hyman Minsky observed that during periods of prosperity, financial structures become precarious.
10. Dodgy loans are generally secured against collateral, most commonly real estate.

Australian residential property has been a darling asset class for investor since financial crisis. Unlike many other developed nations, the resilience of the property sector has fuelled another round of significant property price thanks to government intervention.

I have long argued that the commentary about the supply and demand imbalance is not a sufficient condition for property boom. More importantly the long rising price is greatly owing to the deregulation of the banking sector and availability of cheap debt.

Australian property market has yet to reach the signs of mania and bubble described above. However, it is certainly on its way there.

A very simple sign of over-exuberance comes from observations in daily life.
Many of baby boomers such as my uncle believe that equity is very risky and property is safe and only goes up and never comes down.
Another example is that some mechanic I know has turned away from his business to focus on property investment.

It was no surprising for baby boomers to believe that property price won't drop as this has largely been their experience up to date. It is not uncommon to extrapolate future from historic experience.

However, headwinds are ahead of us not behind us as many believes after GFC. The reason is two-folded.
1. As baby boomers come to retirement, the spending will significantly reducing coming off the peak of their wealth and income phase. This will place significant pressure on property prices.

2. Level of household debt. Australian household debt has reached unprecedented level despite the GFC. In some sense, Australia households are in worse position than U.S. and U.K as they are yet to realise the consequence of the level of their debt.

So who will be winners and losers from this property mania.

In the short term, there will be a wealth transfer from the later generations to baby boomers i.e. gen X and Y to baby boomers.

In the long run, some future generation will benefit from property prices declines. The million dollar question is which future generation.