Banks and Debt: Society fools itself with Supply vs Demand theory

The price society pays for listening to the bankers that feed the debt.

Lindsay David – Author Print: The Central Bankers Bubble

When it comes to house prices, 99.9% of Australian’s believe that because demand outstrips supply is the prime reason as to why house prices in Australia are as high as they are. Unfortunately, the greatest flaw in this theory is that the assumption is that when it comes to the housing market that banks and debt do not exist.  In other words, just because there are a  large sum of buyers seeking to buy a house relative to the available (sufficient) supply that the price can climb infinitively. Lets look at two hypothetical property markets as an example.

City A City B
Median Household income $70,000 $70,000
Median House Price $210,000 $700,000

Now here is where Australian society has made a dangerously flawed assumption. The Australian herd assumes that just because a city such as the hypothetical City B has a significantly higher house price that there is less housing stock available in the marketplace relative to demand than City A. And based on this assumption that supply is incredibly limited that homebuyers are able to magically come up with the necessary funds (based on the absolute assumption that desperation to secure a roof over their head is higher in City B v City A) available to purchase a median house at 10x the median income without debt. What the overwhelming majority of the Australian public… (including the economists at the big banks and RBA) dont understand ‘or will not acknowledge’ is that it is almost near impossible for housing in both City A and City B to be as expensive as it is even if there was screaming demand relative to the available supply without banks and debt. But when banks in one city are prepared to lend more than banks in another city relative to incomes, you will generally find house prices are higher in the city where the banks lend more.

City A City B
Median Household income $70,000 $70,000
Median House Price $210,000 $700,000
Deposit 30% 20%
Total Deposit $63,000 $140,000

Now as per the above, if the banks in City A are only willing to lend households 210% of their income to purchase a home, that would mean there is a good chance (give or take a few % points) that the median household would only be able to acquire a maximum of $147,000 of debt (on top of their deposit) to purchase a house. Theoretically, even if there was an actual dire shortage of houses available in the marketplace, you would find that more often that not the only way to drive house prices higher would be if the median homebuyer was able to come up with a larger deposit. Lets assume that the median homebuyer in City A were to come up with an $70,000 deposit versus a $63,000 deposit. It would mean that the homebuyer would be able to pay $7,000 above the median house price.

But in City B there is a distinctive difference (spread) between the median income generated by the median household and the median house price when compared to City A. All things being equal between the two cities where there are just as many homebuyers in each city desperate enough to get into the housing market. If the banks in City A are only willing to lend a median income homebuyer $147,000, but in City B banks are willing to lend a median to homebuyers $560,000, which city do you expect to have higher house prices if both property markets share the exact same level of demand?

So the next time you hear a chief economist from one of the major Australian financial institutions mention the importance of supply and demand– remember, they (and the banks they work for and lend significant sums of debt to homebuyers year after year) assume that the banking system has no involvement whatsoever in the housing market and has not made an impact on the price of a house through flooding the housing market with debt.

Artificial leveraged demand created by the Australian banking system in what is a nation where housing is completely unaffordable is what drives prices in Australia sky high. Funny how no major financial institution, research agency or government entity such as Treasury or the RBA will never address the demand side of the Australian housing market. Just the good old, ‘we have a housing shortage’ and the population is desperate….creating artificial desperation. 

Lindsay David is the author of Australia: Boom to Bust and  Print: The Central Bankers Bubble. David recently founded LF Economics and holds an MBA from IMD Business School

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