Keen's misstep: Rory responds

After losing our "down 40 per cent” bet on house prices last year (see chart below), Steve Keen quickly conceded and planned his walk for April. To his credit, he's now well into his run/walk towards Mount Kosciusko.

Reportedly, he's still forecasting economic doomsdays to anyone who has time to waste. Often wrong, never unsure – and good luck to him.

Amusingly, a journalist from Business Spectator apparently figured that walking long, straight stretches of main road for a week would be informative, so waved his loved ones good-bye to join Keen's entourage.

Anyway, after spending several days on the tedious walk across the flat towards Mt Kosciusko, Business Spectator's Rob Burgess has lobbed himself into the debate.

Apparently deciding that it was a five-year deal and that Keen hasn't really lost at all (so why is he walking?), Rob, in a widely read commentary, yesterday claimed the bet "has four years to run… There's no doubt the bet is still on – still for the taking”.

That's not quite right. Indeed, it's exactly wrong. To recap, it was a simple peak-to-trough bet, with no time limit involved. Of course, Bloomberg and others accurately documented all this long ago.

As reported to my readers at the time, Keen and I firmed-up the rules of the bet within days of it first being discussed in Canberra.

For the record, Steve Keen is keen to clarify that our bet is "peak to trough", as agreed, with no five-year limit (see attached). Obviously, I expect this distinction will not make a difference, with the ABS house price index likely to surpass its Q1 2008 level well within 5 years (from 28 October 2008 email).

Also highlighted way back then were the reasons why Keen's extremist view on house prices always was an uphill battle, to say the least:

We now have a bet, and I expect eventually to have a win. That's because falls in Australia-wide home prices will be limited by our lack of overbuilding, our much more disciplined mortgage market, and - especially - by the RBA's ability to drive mortgage rates lower… limiting the drop in average home prices is an unstated but obvious objective of increasingly easy RBA policy. …

Assuming that Dr Keen eventually will have to take that long walk, it will be because he greatly under-rated the quality of macroeconomic analysis undertaken at the RBA and in Canberra, and underestimated the power of low interest rates to support local home prices even in the face of today's alarmingly weaker global backdrop (from 27 October 2008 email).

The fact that the downtrend in house prices underway in 2008 ended just a few months after the bet was agreed – rather than 15 years down the track as Keen anticipated – simply highlights how wrong he was about the outlook for house prices.



It actually dawned on me recently that Keen may not know what the term "peak-to-trough fall” actually means. He wanted it, still talks about it, but somehow doesn't realise that it's been and gone.

That is, ABS house prices fell by just 5.5 per cent from the relevant Q1 2008 peak, before quickly retracing their losses in 2009 and zooming 10 per cent above their previous high. And yet Keen and his mates think – apparently seriously – that he's still in the game! Extraordinary.

Who knows, after a week trudging up the road with Keen's sympathetic sidekicks, Business Spectator might start opining that "Keen was right all along”, notwithstanding his extreme forecasts having proved wildly inaccurate.

In any case, the lesson to be learned from this episode is that betting the house on an economist's forecast typically is not a smart move. Keen himself is learning that the hard way. Unfortunately, Keen recklessly encouraged everyday Australians to sell their homes at what turned out to be the peak of the global financial crisis, and the trough in local house prices.

More generally, my observation is that those with the strongest views that the price of Australian houses "must" crash because they are "wildly overvalued" typically either don't own one (and so are very keen for prices to fall), don't really know what they are talking about, or both.

In particular, when I hear commentators talking about the dismal Japanese experience as an obvious guide to what will unfold in Australia, I wonder if they actually know what day it is.

The 'bubble crew' seem to keep missing the simple but profound fact that there's been extraordinarily rapid growth in the number of actual people in Australia with incomes and/or wealth who want to own or rent houses in which to live – as opposed to living in tents and shipping containers – and yet the underlying long-term trend in home-building remains flat near 150,000 per annum. The sheer strength of demand via rapid population growth – alongside very low mortgage rates – has been an obvious upward pressure on home prices.

Moreover, the 'bubble crew' somehow have convinced themselves that the $7000 first-home-buyer "boost” (FHBB) had a much bigger effect on house prices than did the profound 4pp reduction in mortgage rates overseen by the RBA: "This latest house price bubble began when the government doubled and even tripled the First Home Owners Grant”.

Next time you hear that story ask the story-teller what proportion of first-home buyers would have bought, even without the $7,000 gift, once the RBA starting cutting rates aggressively. The correct answer is: most of them.

After six years and 3pp worth of rate hikes over the 2000s suppressed Australian house prices, the huge mortgage rate cuts overseen by the RBA in the crunch always were going to be highly supportive. For starters, just think about the many, many thousands of existing home-buyers who didn't have to sell at the peak of the drama because the RBA quickly delivered to them funding costs lower than they'd ever dreamed.