The Financial Crisis: Bubbles Deflating Worldwide

The mortgage meltdown is much more than an American affair. Real estate bubbles have developed in all major English speaking countries - US, Canada, UK, Ireland, Australia and New Zealand.

Over the past year, house prices have dropped 12 percent in the United Kingdom. The annual decline is approaching 10 percent in Ireland, while median house prices have dropped six percent in New Zealand. In each of these countries, the price declines started after the United States. Further, each of these nations has experienced massive nationwide housing inflation, in part, I believe, as a result of highly restrictive land use policies. These policies, often known as ‘smart growth’ have made it virtually impossible to build new housing on the fringe of urban areas inexpensively.

Where prices will finally settle, no one knows. Some analysts soothe the market claiming that the bottom is near. But many, including The International Monetary Fund, predict the worst of the mortgage crisis is yet to come in the United States. Similarly, former chairman of the council of economic advisors, Martin Feldstein suggested last week that prices would fall to their pre-bubble levels, as did I in this space as well. That’s what bursting bubbles is all about – prices that drop to pre-bubble levels.

Canada is another story. Like the United States, housing costs remain within historic norms where there is traditional land use regulation, while restrictive land use regulation has led to a housing bubble in some markets. This is especially true in Vancouver, where there has been some minor price softening in recent months. Bank of Nova Scotia officials have indicated that they do not expect the kind of bubble bursting in overpriced Canadian markets that has occurred in the United States, at least partially because there was a lower volume of profligate lending (subprime, etc.) in Canada.

Janet Albrechtsen, a columnist for The Australian writes in The Wall Street Journal that the Australian financial system also is healthier than America’s, at least in part because of more stringent mortgage regulation. If her analysis is right, Australia could be spared the mortgage meltdown that is engulfing America, the United Kingdom, Ireland and New Zealand. Thus, far, there is little indication of declining house prices in Australia.

That does not mean there is no bubble. Even with strong banks, Australia has a problem. A housing bubble as pervasive as the United Kingdom has developed in Australia, despite its wiser financial regulation, House prices have risen to from two to three times the historic Median Multiple (median house price divided by median household income) norm of 3.0.

The Australian bubble, like in the United Kingdom, Ireland and New Zealand (as well as parts of the US) has been spurred by overly restrictive land use regulation, which forces land prices up and causes them to explode even with moderate increases in demand. In response, the Median Multiple has increased to more than double the historic norm in all major capital cities. As a result, younger and future Australians have to pay far more of their income for housing than those who came before. So, while superior regulation may have kept Australia’s banks healthy, the prospects of many younger members of society have been greatly diminished. They will have been the victims of the largest inter-generational transfer of wealth in the nation’s history.

Despite Ms. Albrechtsen’s optimism, it is not yet clear that Australia’s bubble will not eventually burst. Certainly falling commodity prices could hurt the employment situation, particularly for middle and working class Australians who are now struggling to pay ever higher percentages of their incomes for housing. Australia may have remained ‘the lucky country’ so far in terms of real estate. But whether that will persist in the coming months is still open to question.

Note 1: http://www.demographia.com/dhi.pdf.

Wendell Cox is a Visiting Professor, Conservatoire National des Arts et Metiers, Paris and the author of “War on the Dream: How Anti-Sprawl Policy Threatens the Quality of Life.”