Peak Debt

http://www.smh.com.au/news/national/...351125207.html

"The general manager of Australian Property Monitors, Michael McNamara, said he coined the term "peak debt" to echo the "peak oil" theory, which suggests the production of oil has peaked and is running out. Likewise the capacity to borrow will simply run out, he claims."

He is being "economical with the truth". After I found that the Hubbert Curve, the derivative of the logistic curve (and made famous by geophysicist Hubbert in relation to "Peak Oil"), fitted the Aus debt to income curve well, on searching the internet I found others had coined the phrase "Peak Debt" about a year earlier.

You can see the discovery and evolution of the idea here (when Cracker works):
http://cracker.com.au/viewthread.asp...tegoryid=11061

Note that:
"cracker.com.au is owned and operated by Fairfax Digital, a subsidiary of John Fairfax Holdings",
and Michael McNamara works for:
"Australian Property Monitors, a property analysis group owned by the publisher of the Herald, Fairfax Media".

-------------------------------------------------------------

You can draw these graphs yourself from publicly available data.

The first graph entitled "Aus Hubbert Curve Fit : Housing Borrowing to HouseHold Net Income" uses:

-----------------------
D02 LENDING AND CREDIT AGGREGATES>Credit, of which>Housing>(incl securitisations)
http://www.rba.gov.au/Statistics/Bulletin/D02hist.xls column L

divided by:

G12 GROSS DOMESTIC PRODUCT - INCOME COMPONENTS>Household income and outlays>Receipts>Total household income
http://www.rba.gov.au/Statistics/Bulletin/G12hist.xls column Q

(Both quantities expressed in [conveted to] in $ per year.)
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The ratio of Credit / Income is fitted with a Hubbert Curve (http://en.wikipedia.org/wiki/Hubbert_curve) using non-linear regression (minimization of the sum of squares of the difference between actual and predicted values) of the curve parameters:
Bottom: base of the curve
Height: top of curve minus base
Offset: year at which curve peaks
Stretch: half width of the curve at inflection point

The predicted values at each Year are calculated as:
=Bottom+(4*Height)*EXP((-Year+Offset)/Stretch)/((1+EXP((-Year+Offset)/Stretch))^2)
 

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I haven't read the actual mathematics of it, but I disagree that there is a peak debt. Peak oil assumes that oil is finite. Personally I don't agree that we've hit peak oil because I think there are still untapped reserves elsewhere.

As for peak debt, surely it's dependent on interest rates and general market sentiment. Banks can choose to lend or not lend (limited, very loosely, by things like Basel II ratios). People can choose to borrow further on their assets or not. People can choose to spend or not.

Theoretically, debt can keep growing as long as sentiment doesn't change. What in practice would happen is that increasing debt will also increase inflation, deflating the 'value' of the debt in real terms. Left to itself the market could probably continue the debt binge longer than we think, but of course central banks would never let inflation get that far.

In practice, the central banks will target inflation (this is actually a fairly recent policy), raise rates, and hope that consumer sentiment doesn't move too far down.

I think there is a 'psychological' equilibrium for every level of debt. Look at Japan: it keeps sinking back into recession because the psychological equilibrium is pretty low. Consumer sentiment is what will determine what is 'peak' or not, with the central banks waving flags on the sidelines.
Alex
 
What in practice would happen is that increasing debt will also increase inflation, deflating the 'value' of the debt in real terms. Left to itself the market could probably continue the debt binge longer than we think, but of course central banks would never let inflation get that far.

Alex

And inflation would increase incomes? Hence the use of debt divided by income to remove as much as possible the effect of inflation of the $ values.
 
Quote from the article:

Steve Keen, associate professor at the school of economics and finance at the University of Western Sydney, agreed, saying household debt was roughly 25 per cent of disposable income in 1990, and that proportion had risen to 150 per cent. "We can't keep on doing that forever," he said.

Can't quite put my finger on it, but this statement doesn't sit well with me.

If anything it illustrates how people alter their spending patterns due to choice or necessity (ie. in this case to buy RE). It also shows that perhaps as a proportion of income, perhaps their "disposable income" has increased significantly.

I may be reading this wrong though :rolleyes:
 
Quote from the article:

Steve Keen, associate professor at the school of economics and finance at the University of Western Sydney, agreed, saying household debt was roughly 25 per cent of disposable income in 1990, and that proportion had risen to 150 per cent. "We can't keep on doing that forever," he said.

Can't quite put my finger on it, but this statement doesn't sit well with me.

If anything it illustrates how people alter their spending patterns due to choice or necessity (ie. in this case to buy RE). It also shows that perhaps as a proportion of income, perhaps their "disposable income" has increased significantly.

I may be reading this wrong though :rolleyes:

Only if interest rates were zero and principal was never to be paid back could debt to income ratio keep increasing forever.
 
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It is entirely possible that the debt vs income ratio can keep on going up forever because of

- inflation
- cost of basic needs (food, clothes etc) do not increase to the same extent
- definition of the median home will change from a 3 br house to townhouse or units
- or simply the home ownership level decreases and more people will be renting indefinitely
 
It is entirely possible that the debt vs income ratio can keep on going up forever because of

- inflation
- cost of basic needs (food, clothes etc) do not increase to the same extent
- definition of the median home will change from a 3 br house to townhouse or units
- or simply the home ownership level decreases and more people will be renting indefinitely

Who will lend the money?

I think you may mean that debt "can keep on going up forever" and I agree.

I disagree that the ratio of debt to income "can keep on going up forever" - unless real interest rates fall to zero or less and principal is never paid back - highly unlikely unless we have hyper-inflation followed by mass defaults.
 
Just read the article in detail. As usual (and when did the Herald swing this far to the left?) they keep harping on about how property is growing faster than wages which cannot continue. Why not? It has so far, and there are good (not necessarily fair) reasons:

1) Population growth. Outer suburbs become middle suburbs become inner suburbs. With population growth you can't expect the same person (say, the average wage earner) to keep being able to afford the same suburb over time. The city gets bigger, pushing people out. Houses gain redevelopment value as they are replaced with townhouses and units.

2) Wage growth isn't even. As economies go from manufacturing to knowledge based (as it did from agricultural to manufacturing based), some people have much higher wage growth (lawyers, bankers, etc). Many of these jobs exist BECAUSE of outsourcing of manufacturing. I'm not saying that's fair, but that is reality. If this continues, you will have a bigger group of higher income earners to afford said expensive properties, while lower income earners will get pushed out of the city. i.e. they won't be spending more and more on their mortgages, they'll just move further and further out and have a longer commute.

We keep saying that you can't expect to be able to afford the same suburb as our parents, because the city is a lot bigger now and the suburb has changed from the outer suburb it was for our parents to the inner city suburb that it is today. Yet that's exactly what the Herald article is saying we should be able to do.

The Herald article conveniently ignores population growth. More importantly, it doesn't ask the question: if people are putting more and more money into their mortgages, there will come a point where they will either not buy or cut down on other stuff. Result: recession and a fall in property values. In other words, property prices CAN keep going up if we have a combination of making lending easier, grow the population and increase income inequality (see New York and London for more extreme examples). If we can't, the market drops back to a new equilibrium.
Alex
 
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And inflation would increase incomes? Hence the use of debt divided by income to remove as much as possible the effect of inflation of the $ values.

I would argue in our current system inflation and wage growth are no longer so clearly aligned. However, inflation WOULD devalue the currency (and debt as well) so that nominal prices can keep rising. Of course, in practice the RBA would never let inflation go that far, and would risk blowing the economy to keep inflation in check.
Alex
 
I would argue in our current system inflation and wage growth are no longer so clearly aligned. However, inflation WOULD devalue the currency (and debt as well) so that nominal prices can keep rising. Of course, in practice the RBA would never let inflation go that far, and would risk blowing the economy to keep inflation in check.
Alex

I agree that "our current system inflation and wage growth are no longer so clearly aligned."

Even so, I have difficulty visualize our economy where debts are not 1 to 2 times annual income but 10 to 20 times. I do not say it is impossible to get to that situation - just that to me it seems highly improbable.

So I'm trying to find the mosy likely evolution of debt to income going forward over the next few decades - important years to me.
 
Just read the article in detail. As usual (and when did the Herald swing this far to the left?) they keep harping on about how property is growing faster than wages which cannot continue. Why not? It has so far, and there are good (not necessarily fair) reasons:

1) Population growth. Outer suburbs become middle suburbs become inner suburbs. With population growth you can't expect the same person (say, the average wage earner) to keep being able to afford the same suburb over time. The city gets bigger, pushing people out. Houses gain redevelopment value as they are replaced with townhouses and units.

2) Wage growth isn't even. As economies go from manufacturing to knowledge based (as it did from agricultural to manufacturing based), some people have much higher wage growth (lawyers, bankers, etc). Many of these jobs exist BECAUSE of outsourcing of manufacturing. I'm not saying that's fair, but that is reality. If this continues, you will have a bigger group of higher income earners to afford said expensive properties, while lower income earners will get pushed out of the city. i.e. they won't be spending more and more on their mortgages, they'll just move further and further out and have a longer commute.

We keep saying that you can't expect to be able to afford the same suburb as our parents, because the city is a lot bigger now and the suburb has changed from the outer suburb it was for our parents to the inner city suburb that it is today. Yet that's exactly what the Herald article is saying we should be able to do.

The Herald article conveniently ignores population growth. More importantly, it doesn't ask the question: if people are putting more and more money into their mortgages, there will come a point where they will either not buy or cut down on other stuff. Result: recession and a fall in property values. In other words, property prices CAN keep going up if we have a combination of making lending easier, grow the population and increase income inequality (see New York and London for more extreme examples). If we can't, the market drops back to a new equilibrium.
Alex

Agree with your reasoning except (you knew it, right?):
Increases in income will tend to decrease the debt to income ratio.

It is the dynamic evolution of the debt to income ratio that interests me because it affects affordability and wealth and the distribution of wealth.

Regarding the rest of your post, I believe that our capital cities are too big to be nice anymore.

[BTW: I should state that I have never had any debt, apart from the odd fiver. My wealth is in the top few percent - so I benefit in various ways from others having debt. I also think that mort-gages are death-pledges to many and that as a community we would be better off with far less of them.]
 
Incorrect links

I've just noticed that the Sydney Morning Herald link in the first post is abdridged and therefore wrong - sorry. Here are working links:

Brakes fail on housing stress
Michael McNamara
July 3, 2007

"Australia is fast approaching peak debt. By 2016 we will spend so much of our discretionary income on mortgages there will be nothing left for putting food on the table. We will be paying 15 times our yearly income to buy a home, if wages, debt and house prices keep growing at the present rate. That's what I call really living beyond your means."

http://www.smh.com.au/news/opinion/brakes-fail-on-housing-stress/2007/07/02/1183351123599.html


Home prices set to surge again, fuelling debt crisis
Catharine Munro and Jessica Irvine
July 3, 2007

"The general manager of Australian Property Monitors, Michael McNamara, said he coined the term "peak debt" to echo the "peak oil" theory, which suggests the production of oil has peaked and is running out. Likewise the capacity to borrow will simply run out, he claims."

http://www.smh.com.au/news/national...ing-debt-crisis/2007/07/02/1183351125207.html
 
Agree with your reasoning except (you knew it, right?):
Increases in income will tend to decrease the debt to income ratio.

It is the dynamic evolution of the debt to income ratio that interests me because it affects affordability and wealth and the distribution of wealth.

Regarding the rest of your post, I believe that our capital cities are too big to be nice anymore.

[BTW: I should state that I have never had any debt, apart from the odd fiver. My wealth is in the top few percent - so I benefit in various ways from others having debt. I also think that mort-gages are death-pledges to many and that as a community we would be better off with far less of them.]

Doesn't this asssume that when incomes increase people DON'T increase their debt/borrowings etc. - which is more than likely. Give people more $, they'll spend it. So debt to income ratio could stay the same, just at higher figures?
 
Doesn't this asssume that when incomes increase people DON'T increase their debt/borrowings etc. - which is more than likely. Give people more $, they'll spend it. So debt to income ratio could stay the same, just at higher figures?

You are right - I was just making the obvious point in a round about manner that a ratio has a numerator and a denominator - the ratio decreases if you decrease the numerator (debt) or if you increase the denominator (income).

Experience in recent decades, particularly, is that the wealthier have become wealthier while having above average debt. Now trend appears to be the for the poor to have above average debt. Perhaps debt will simply seem to become passé - perhaps as the result of something more fundamental such as demographic changes eg aging.
 
Incidentally, I actually expect a recession soon which will hurt property prices, but I also believe that long term, with economic and population growth, property prices CAN increase faster than average wages. So I'm certainly not saying you're wrong, Nullagine, but there is another side.

Even so, I have difficulty visualize our economy where debts are not 1 to 2 times annual income but 10 to 20 times. I do not say it is impossible to get to that situation - just that to me it seems highly improbable.

So I'm trying to find the mosy likely evolution of debt to income going forward over the next few decades - important years to me.

I agree it seems improbable, but not because of any structural limitation. Look at Japan: the debt levels are ridiculous, businesses that should have gone bust long ago are there because the banks don't call in their loans.

So while I think there is no theoretical support for peak debt, in practice what WILL limit it is that I think inflation would get out of hand way before we hit those sorts of levels, and increased interest rates will rein it in. My experience in London is that 1) the average property is much smaller and older than the Australian average and 2) it's even more expensive. Given certain situations (by no means guaranteed to happen in Oz, BTW), debt CAN keep growing. Instead of the house on a quarter acre block, the average Oz property might become a 2 bed unit, say.

Agree with your reasoning except (you knew it, right?):
Increases in income will tend to decrease the debt to income ratio.

It is the dynamic evolution of the debt to income ratio that interests me because it affects affordability and wealth and the distribution of wealth.

I think we're going to have less equal income distribution as time goes on. i.e. some people will have fast increases in income to allow them to afford the properties, while some people will not, pushing them out. You see this in places like Manhattan: ridiculous prices but equally ridiculous salaries. The ordinary people just move out or are heavily subsidised by the govt (rent control in the case of New York. In the case of Hong Kong, for example, fully half the population, I think, live in government subsidised housing).

I don't believe you can analyse this sort of thing based on the average, simply because the COMPOSITION is changing. That is, while the average might be increasing at 5%, you can have the middle hollowing out. Add in population growth and it means average analysis by itself can be misleading.

Regarding the rest of your post, I believe that our capital cities are too big to be nice anymore.

That's a personal opinion, though. Obviously people still want to live in capital cities, if only because that's where the jobs are. In any case, it depends on how much money you have. Even in Tokyo, Hong Kong and London, you can buy VERY nice places.
Alex
 
You are right - I was just making the obvious point in a round about manner that a ratio has a numerator and a denominator - the ratio decreases if you decrease the numerator (debt) or if you increase the denominator (income).

Experience in recent decades, particularly, is that the wealthier have become wealthier while having above average debt. Now trend appears to be the for the poor to have above average debt. Perhaps debt will simply seem to become passé - perhaps as the result of something more fundamental such as demographic changes eg aging.

I'd agree with that. Rich or poor, debt seems to be much more accepted as just another part of life these days (eg. credit card debts etc). Especially I guess if you compare to 40-50yrs ago - but again I guess that also comes down to the issue of ease of availability. But even the last 10yrs I'd say debt has become more common place.

Incidentally, did I understand you right that you have never had any debt (even for IP's)? How did you manage to accumulate your wealth without going into debt - your own business?
 
I think we're going to have less equal income distribution as time goes on. i.e. some people will have fast increases in income to allow them to afford the properties, while some people will not, pushing them out. You see this in places like Manhattan: ridiculous prices but equally ridiculous salaries. The ordinary people just move out or are heavily subsidised by the govt (rent control in the case of New York. In the case of Hong Kong, for example, fully half the population, I think, live in government subsidised housing).

I agree completely. We need also to consider that although "the rich get richer while the poor get poorer", there is an ever increasing number of people who have the means to buy the property they want. Hence the ever increasing demand for quality, inner city suburbs. The population is growing, and I think Australians, in general, are probably wealthier than they have ever been. I can't imagine living like my parents had to - but good on them for doing what they had to do.

I also wonder what effect the Baby Boomers supporting their adult children is having on the market. Once upon a time you rented while you saved, and eventually got you deposit to a point where you could afford a small house. With shared equity loans, gifts and handouts from Baby Boomers to kids, perhaps this is distorting the market also.

My firm opinion is that regardless of how high prices become, there will always be those who can afford them, and those who will find ways to borrow for them. My plan is to have already bought the assets that these peoples' hearts desire (but now, while they're still easily affordable).
 
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