How Housing Bubbles Destroy Productivity

Yves here. Even though the finding are from Australia, which has had a bigger and longer-lasting housing bubble than the US or UK, it’s not hard to see that the same factors are likely at play in other economies. Recall separately that a lot of research has found that increases in household debt are correlated with slower productivity growth.

By Leith van Onselen, an economist who has previously worked at the Australian Treasury, Victorian Treasury, and Goldman Sachs. Originally published at MacroBusiness

The Australian Housing and Urban Research Institute (AHURI) has released a new report exploring “the nature and magnitude of the relationship between house prices, household debt and the labour market decisions of Australian households”, which paints a sobering picture for the economy and financial stability.

The key conclusion from the report is that “households accumulate debt as house prices increase, leaving them vulnerable to housing and labour market shocks. House price increases also potentially promote or dampen labour supply and labour force productivity”. In other words, Australia’s housing bubble is distorting the economy.

The report notes that Aussie home owners tend to borrow more as their home’s value increases, and that this ‘wealth effect’ is greater than in the US or UK:

Overall, the results indicate that a $1,000 increase in housing wealth is associated with an increase in debt of approximately $240 per annum. This is a large response compared to the magnitudes found in studies in the United States and United Kingdom…

House price increases are associated with larger increases in total indebtedness for home owners with higher initial loan-to-value (LTV) ratios. Home owners with larger values of non-mortgage debt as well as higher LTV ratios are more sensitive to house price movements compared to other home owners…

The take-up of further mortgage debt among vulnerable highly leveraged households exposes them to income, housing and financial market shocks. The results are in contrast to the general belief in Australia that debt is held by those most able to service it—higher income and high-wealth households. Macroeconomic policy-makers should interpret high levels of debt and rising household debt-to-income ratios in Australia carefully.

Overall, the findings show that house price changes influence household debt through two channels: a direct wealth effect and an indirect collateral effect via the household’s borrowing capacity. That is, some households face borrowing constraints and, for these households, rising house prices increase the value of their property that may be used as security for a loan and thereby loosen the borrowing constraints…

Our results indicate that in response to increasing house prices, some home owners, especially home owners with low debt, engage in debt financing of consumption (involving extracting equity from their home). Other home owners, especially those with relatively high debt levels refinance existing mortgages or adjust existing debt portfolios.

The report also found that rising house prices dampens labour force participation and hours worked, thus presenting a downside for the economy as productive workers withdraw from the labour market, as well as making it more difficult to counteract the impacts of an aging population:

The most important responses are in labour participation and hours of work by women, both partnered and single. The effect is strongest among the older cohort of women and is associated with early retirement for those experiencing above average housing wealth gains.

Younger partnered men and women exhibit a reduction in hours of work in response to the gain in housing wealth. That is, these gains in wealth effectively fund time away from work to undertake non-market activities such as providing household care for children, ageing parents, undertaking volunteer work or enjoying more leisure.

AHURI notes that its findings have important policy implications for macroeconomic stability:

The take-up of further mortgage debt among highly leveraged households exposes those households to the risk of significant loss if house prices fall or if interest rates rise. This, in turn, may pose a systemic risk for the macroeconomy.

An economic shock, emanating in either financial, labour or housing markets, may lead to widespread defaults that would cause the shock to spread across markets and threaten the performance of the aggregate economy.

Therefore, policy-makers may need to consider limits on, or regulate the risks associated with, the continued collateralisation of debt in a potential deflationary environment.

There are also implications for retirement incomes:

The analysis reveals that higher house price growth is associated with early retirement for women (though not for men). Consequently, public policies that contribute to house price growth can induce earlier retirement among home owners, particularly if equity withdrawal to fund consumption is facilitated.

As well as implications for labour force participation and productivity:

Productivity growth is the foundation of sustained improvements in the standard of living and hence represents a prime concern of policy-makers. The results of the research presented in this report highlight two ways in which housing and housing finance-related policies might influence productivity growth.

First, results indicate that housing policies can play a potentially important role in driving labour market participation decisions in Australia, and hence should be considered in conjunction with other labour market policies to encourage employment participation…

Second, as house price growth tends to affect labour supply, while simultaneously making it more difficult for renters to become home owners, policies that dampen house price inflation (e.g. new housing supply) may also contribute to labour force productivity growth.

And that’s why Australian multi-factor productivity stopped growing at the turn of the millennium.

The full report can be found here.

Print Friendly, PDF & Email


  1. PlutoniumKun

    This seems so obvious it would take a huge collective effort from all mainstream economists to not notice it.

    I recall a discussion among some economists in Ireland back during the housing boom when someone noticed that the number of high spec Mercedes and Audi’s registered every year exceeded the number of people whose incomes (as indicated by tax returns) who could possibly afford them. Right wing economists simply pretended this wasn’t an issue, while left wing economists considered this proof of widespread tax avoidance. But to anyone who’d been keeping their eyes and ears open, it was pretty obvious that what was happening was that people were converting housing equity into expensive toys, with obvious implications when a reversal occurred.

    Among other things, this process is highly counter cyclical. During a housing crash everyone focuses on mortgages people can’t pay off anymore – but anecdotally I think the biggest stressor for households are ancillary debts built up on the basis of housing equity – car loans, credit card loans, etc.

    The reality is that a financial system whereby peoples greatest store of wealth is their home is a highly inefficient and unstable one. But the grip of the property speculation system on most of the worlds major economies seems almost impossible to break. In good times, there is just too big a party to call ‘halt’. During bad times, governments (as here in Ireland) find they have no other way out of a hole than to actively stoke up another housing bubble (sorry, ‘bring forward a recovery in the housing industry’).

    1. BecauseTradition

      But the grip of the property speculation system on most of the worlds major economies seems almost impossible to break. PlutoniumKun

      “Loans create deposits” but only largely sham* liabilities wrt the general public so the accounting is a sham to start with. I suggest we fix that.

      *Because the population does not have a risk-free alternative to government insured private banks such as a Postal Savings Service or equivalent would provide – physical cash and a safety deposit box hardly qualify.

      1. PlutoniumKun

        I agree that people need safe alternatives for long term savings, but unfortunately I don’t think that’s the only solution. Japan, for example, has an excellent post office savings system, much used and beloved by Japanese people, but that still didn’t stop the 1980’s bubble from wrecking the economy. Although perhaps significantly, the Japanese bubble focused more on commercial development than housing.

        While individual greed is a factor, its important I think not to focus on individuals – we can all only work within the existing financial situation. People invest their lives in houses because traditionally it has been one of the best ways for people to make money and have a financial cushion. We think this is the way its always been, but certainly in the English speaking world this is primarily a post war phenomenon linked to moderately high levels of inflation and relatively low interest rates (inflation is an excellent way of wiping out peoples debts, which of course is why our elites hate it so much).

        1. BecauseTradition

          Japan, for example, has an excellent post office savings system, much used and beloved by Japanese people, but that still didn’t stop the 1980’s bubble from wrecking the economy. PlutoniumKun

          I wonder why the Japanese use it since a quick Google reveals Japan has had deposit insurance since 1971 and since government provided deposit insurance is credited with killing the US Postal Savings System, such as it was?

          1. PlutoniumKun

            A lot of it was simply tradition – Japan Post was seen as a very solid institution. I would guess that it offered better long term rates as well thanks to its size and scale. It essentially funded the Governments deficit, one reason why Japan never had to borrow abroad.

            I should have noted by the way that its partially privatized now – this is a very hot political topic in Japan. Even with all the opposition it was just too lucrative for the government to ignore the potential of selling it off.

            1. BecauseTradition

              I would guess that it offered better long term rates

              Ah, the mystery is solved since risk-free deposits should pay AT MOST 0% otherwise the government is providing welfare proportional to wealth.

              Even with all the opposition it was just too lucrative for the government to ignore the potential of selling it off.

              Then Japan does not understand that it is monetarily sovereign. How the banks have deluded the world!

        2. John Rose

          Everyone talks about Japanese stagnation but I have seen no information on homelessness resulting from it. The Japanese people seem to be doing just fine. Is lack of growth of an economy so bad in that case? After a certain level of income there is no evidence of increased satisfaction coming from further increases. Capitalism needs growth, not people.

          1. PlutoniumKun

            There certainly is a lot of homelessness in Japan, although I don’t know any figures for it. Homelessness in Japan is very ‘Japanese’ – people living neatly and carefully under bridges, sleeping over in 24 hour gaming cafes, queuing up to shower and clean in the specially provided facilities in every public park.

            Japan has an admirable tradition of egalitarianism which means that much of the pain of a declining society is spread widely, not on the poorest, although they certainly suffered. For an excellent overview of the physical decline in Japan outside the major thriving cities, I’d recommend browsing the now defunct Spike Japan website.

        3. Larry

          As a rational being, I have “purchased” a home for a few reasons, none of which relate to ROI. I was renting a single family home outside Boston, 1100 sf, 3 beds 1 bath. It was fine, until the kids started getting bigger and we wanted a place for Grandman and others to stay when they came over. I scoured the rental market, but in my area there isn’t much available that fits the bill of 4 bd, 2 ba w/good public schools in my area. I found almost nothing, or rentals that were hopelessly expensive. So I plunked down on a home and tossed down a 20% deposit. I certainly don’t expect to see this as an investment. I’m paying a different landlord (the bank) for the privilege of renting a home, only now I have all the downside risks of maintenance. I just replaced a 30+ year old boiler and water tank set up. Fun. But what else am I to do to stay in my area of Massachusetts in a home of a suitable size?

          And this points to a problem of housing policy. Towns in my area actively try to prevent too many families from moving in by discouraging multi-family and larger rental unit construction. They don’t want too many kids moving to town. Kids are expensive because a large burden of education costs fall directly on the town. Better to have businesses and empty nesters in town paying property tax and being “low burden” on town services. Honestly, the biggest construction boom in all of my immediate area is town house villages aimed at boomers at or near retirement who want to stay close to the grand kids. Maybe those are the rental units of the future.

        4. Yves Smith Post author

          The Japan bubble was not about commercial development.

          It was land valuations. All the value in commercial real estate in Japan was in the land, which never traded, due to punitive taxes and the enormous cultural value Japanese attach to land. For a company to sell real estate was like a parent selling his children. It would be seen as an admission that it was going bankrupt.

          Japanese banks would lend 100% against the inflated, fictive value of land in Tokyo, Nagoya, and Osaka. I saw this first hand.

          1. Skippy

            Sorry Yves…. that was flippant… amends…

            Tho’ I would like to hear you thoughts on the matter because its fundamental to the process of evaluation and the perception of “property” as defined by land in the pre-postmodern application e.g. is air productive and how does one arrive at its value.

            Disheveled Marsupial…. this lends to the assessment of stuff like Gates frictionless capitalism and its virtual status in a cloud e.g. markets in a vacuum.

      2. ben

        The masses speculate in property because it is their main access to leverage. This isn’t about saving, this is about something for nothing. Only of course it’s not free, all the next generation pay.

    2. Colonel Smithers

      Thank you. Well said.

      Loans are also being taken out to pay food, utility and medical care bills.

      I live in mid-Buckinghamshire and commute to the City daily – and have done since the late 1990s apart from when working overseas. I have noticed a surge in the number of commuters using the Chiltern and Metropolitan lines in the last few years, many of whom I recognise in the City and at Canary Wharf, and the area, market towns a generation ago, getting built up. Few, if any, of my colleagues can afford to live in London, even in the suburbs where foreign investors are moving to avoid tax on thresholds associated with central London, and readily admit to being tired and less productive at work. I am / do. Many of these commuters have small children, so need to pay for child care (not cheap with limited availability) as well as train fares (about £450 pcm and another £150 pcm if one wants parking). One won’t get a small house (say two bedrooms) in mid-Bucks for less than £350k. I know many couples doing what one calls middle class jobs, e.g. lecturing at university, who rent, at least £1250 pcm, that type of property. Foreign investors are moving in now, but are buying properties like golf courses and farms for gated community development.

      1. paulmeli

        “Loans are also being taken out to pay food, utility and medical care bills”

        A short-term solution to a long-term problem, not enough income. What could go wrong?

        1. Colonel Smithers

          Thank you. With regard to healthcare, doctors will often suggest going private to get an operation done quickly.

      2. Ivy

        Commuting time is a tax. There is only so much reading, WiFi, sleeping and other activity that may be done while realizing that one’s choices are severely limited, leading to a lower quality of life. Sadly, there are few alternatives and those are often less palatable.

    3. Colonel Smithers

      Thank you. Well said. I remember recall conversations with London cabbies in 2009 and 2015, who for reasons not explained, mentioned the number of BMWs and Mercs in what they felt to be working class areas. Both suggested credit binges. I had been picked up at my City and Canary Wharf offices and was on the way to the west end and City airport when these conversations took place. One sees the same in Buckinghamshire. It’s either credit binging or well paid City people are moving further out, but are moving into suburbs not usually associated with City money. At the same time, one sees the tarmacking of front lawns, so what were nice and leafy places becoming less so. Cars are rarely kept in garages. One estate agent was puzzled that I kept a front lawn and the car in the garage. He drove a car usually associated with City traders, not bad for someone aged about 30 in mid-Buckinghamshire.

      1. PlutoniumKun

        Purely anecdotally, I keep hearing from English friends stories of people on very low incomes driving around very expensive cars, all obtained by various complex loans and leasing deals. I know one young woman who regularly complains to me about about her feckless mother in Nottingham who is always trying to leech money off her mentioning that she (the mother) drives a new Audi. I have no idea how someone who is semi-employed at best could get a lease deal on an Audi, but it does seem possible. At least in Ireland right now the banks are still so damaged from the bust (i.e. they are insolvent in all but name) this isn’t yet an issue. I’m sure loans based on inflated housing assets is at least one reason. I can’t help thinking that real consumer debts in the UK are much greater than official figures suggest, although how this is hidden I’ve no idea.

        1. Colonel Smithers

          Thank you. I agree with you about consumer debt. Colleagues who work or have worked in consumer finance wonder too about the figures. I have heard similar stories of fecklessness from mum who works in local gov’t, going back to audit after being an admin manager in social services for a few years. BTW, mum is 72 in a month and works full time. She does not have to, having worked in the civil service and local gov’t for 40 years, but likes to be busy and has never thought about retirement. She reckons that a quarter to a third of colleagues are working beyond official retirement age, mainly due to necessity.

    4. Moneta

      The sad part is that many young couples jump in thinking long-term so they buy these new builds, taking on mortgages of 400K+ where everything will need to get redone in 10 years. They are playing a game where the rules have changed… planned obsolescence vs. materials that used to last 40+ years & collateral mortgages instead of conventional mortgages.

      1. PlutoniumKun

        One of the very obvious things you will see if you travel in northern European countries such as Germany, the Netherlands, Finland, etc., is that the general quality of housing design and construction is significantly and visibly higher than you will find in the US, UK, Ireland, Spain, Australia. There are many reasons for this, but I think one is counterintuitively that there is less investment money available for home buyers. You have much more complex mixes of tenure (far more rental, more public housing, more housing co-operatives, etc.), while most home owners buy because they want to live long term in a particular area. Houses are built to last as buyers/investors see them as long term investments and don’t want lots of complex regular maintenance costs. The notion of buying a house to flip in a few years simply doesn’t exist.

        1. visitor

          In those countries, the largest investors in real-estate are the retirement and pension organizations, and life insurance companies; they are by law obliged to invest in safe long-term assets.

          The consequences are as you describe, with other important ones:

          1) they can extract economies of scale when constructing or renovating apartment buildings;

          2) they have accumulated so much experience in those projects that they are not fooled by the firms they contract — they avoid the shoddy handiwork that individual buyers are neither trained nor experienced to detect or prevent.

      2. Larry

        This is why I bought a nearly 200 year old home. Sure, there’s some upkeep, but you can restore wooden windows. Good luck with vinyl windows.

  2. FromColdMountain

    Many of my friends consider me poor, because I do not own a house or a car, and I barely have enough money to buy food at the end of the month. But show them that they are poor as well. They only have wealth, which is is an illusion and fragile.

    They hate me when I show them the truth that they are as poor as me. I show them anyway because I love them, not because I want them to like me.

  3. Arizona Slim

    In addition to the problems outlined above, I think that housing bubbles are destructive to the collective good of our society.

    Think of the cures to diseases that weren’t discovered because too much money was going into the FIRE sector. Or the worthy startups that weren’t funded because of similar levels of malinvestment.

    Hell, I can even think of a guy who was quite a talented fiber artist, could have made something of that career, but no. He gave it up to become a real estate agent. And a sleazy one at that.

Comments are closed.