The Joe Walker Podcast - 'Housing Bubble Week' & Joe's Speech To Mensa

Episode Date: May 12, 2019

I announce 'Housing Bubble Week' and share a speech I gave in Sydney in September 2018.See omnystudio.com/listener for privacy information.

Hello there, ladies and gentlemen, boys and girls, swagmen and swagettes. Welcome back to the Jolly Swagman Podcast. I'm your host, Joe Walker. And boy, do I have a treat in store for you all, beautiful people. This episode has two purposes. Firstly. I'm your host, Joe Walker, and boy, do I have a treat in store for you all, beautiful people. This episode has two purposes. Firstly, I'm going to be announcing Housing Bubble Week, and secondly, I'm going to be sharing a speech I delivered in Sydney in September of 2018, but first to Housing Bubble Week. So, starting tomorrow, six episodes in six days. That's right, one episode released per day, followed by a mandatory day of rest. That's how you do a good old-fashioned housing bubble week.

You're going to be hearing interviews with experts on housing markets at home and abroad, experts of all stripes, investors, economists, and even a guest or two you may not be expecting. These conversations I've been collecting over the last few months and they reflect my learning and the shape of my thinking on the Australian housing market. I really knew nothing about Australia's housing market two years ago. In fact, in 2017, in my naivety, I started feverishly researching how to buy an investment property. Fortunately, I didn't go through with the decision because I continued researching, but I've become increasingly convinced that the housing market is both the most important and underserved topic area in Australia's public discourse.

Now, the most crucial short-term economic question for Australia is really who wins the upcoming federal election, while the most crucial long-term economic question for the country is how do we improve productivity growth? But I think the most crucial medium-term economic question is what happens to Australia's housing market, or should I say housing bubble? A word of warning, this series will be biased. In that regard, it's going to be very different from the first podcast series I ran on this topic. Almost two years ago, I ran a series with my friend Angus, which was featured in the Australian Financial Review. I found two bulls and two bears. We had four episodes on the Australian housing market. The two bulls were John Flavell, the then CEO of Mortgage Choice,

and Peter White of the Finance Brokers Association of Australia. And the bears were Macro Research House founder of Variant Perception and investor Jonathan Tepper and economist Richard Holden. I wanted to give roughly equal time to the two broadly opposing opinion sets in the housing market. But since then, I've learned a lot and I'm back with a vengeance. And if that upsets you, then I'm sorry. Listen to another podcast. To paraphrase the phenomenal short seller, Soren Andal of Blue Orca Capital, who I think summed it up best, I am biased, so are you. And just because I'm biased doesn't mean I'm wrong. It's time to call

a bubble a bubble rather than drawing a false equivalency between the housing bull thesis and the housing bear thesis. The bull thesis, or perhaps we could call it the anti-bubble thesis now because it's certainly not looking optimistic anymore, is manifestly deficient. So I won't be aiming for faux impartiality on the question of the housing market when my beliefs lie clearly elsewhere. Australia's housing market is most probably a bubble. The more interesting questions are what are the unique dynamics of housing markets that might have led to this? How have other housing bubbles played out in history? And what's likely in store for Australia's?

So those are all questions we'll be dealing with in bubble week. It's going to be great. It's going to be big. It's going to be great. It's going to be big. It's going to be huge. It's going to be epic. You're going to enjoy. Now, the rest of this episode is a speech I gave in Pyrmont in Sydney in September 2018. It was a speech for Mensa, New South Wales, a small gathering.

It was at a pub. Some context, I'd had a couple of beers. I was speaking with no notes and I was still on my learning curve. So, any mistakes are mine, but please, please, please treat this as nothing more than the ravings of an amateur. There are a couple of little things I want to point out in advance. Firstly, I quote a figure in regards to Australia having the longest running housing boom in the world with prices increasing 6,556% over the 55 years to 2017. That is a nominal price,

not a real price. It is not adjusted for inflation. That's the first thing I want to point out. The second thing is, at times it sounds like I talk about informational cascades as an alternative to random walks. This will make sense when you hear the speech, but I want to point out that informational cascades are in a different conceptual category. They're more an alternative to efficient markets. Random walks describe price movements in efficient markets. Informational cascades don't describe price movements. With those two caveats in mind, please enjoy this speech

and please get ready for Housing Bubble Week. Talk to you soon. Ciao. Firstly, thank you all for coming. It's really nice to meet the Mensons. I've previously, well, I first signed up to the ACT branch and I haven't met anyone except for Claire in New South Wales. So it's great to meet you all

and great to have a few friends along as well, Megan and Henry and Blake. I've been thinking and researching about the Australian housing market on and off for the last 18 months we we first got a maverick Australian economist on the podcast called Steve Keen we spoke to him back in May and May of 2017 and that's sort of what triggered my interest in the Australian housing market and from that point it's been a process of tumbling down different rabbit holes and obsessively researching different aspects of the market and of economic history.

My podcast co-host Angus and I have done everything from interviewing investors and hedge fund managers, macro research house founders to going out to property auctions in Western Sydney and in the East as well. I remember back in January, sitting in the backyard of a four-bedroom brick home in Granville, sharing a hookah pipe with a Lebanese family as they were anxiously awaiting the auction of their house, which they had listed on the market for a little over $900,000. And it didn't ultimately sell at auction, but we scheduled about six auctions that weekend in Western Sydney and none of the homes sold needless to say but I have a lot of people to thank for the sort of ideas that I've formed

on the property market I won't list all their names but any sort of mistakes in this little speech of mine. And I'm going to send out a research brief, which is sort of the basis for these remarks. If anyone wants to leave their email address at the end of the talk, I can do that. So you can sort of check everything that I'm saying. So the other disclaimer, well, two more disclaimers before i start the the proper remarks one is that i'm acutely aware of the narrative fallacy in calling the australian housing bubble and i'm very sensitive to the fact that it's almost like the ultimate alpha move to short a housing bubble after after that sort of been romanticized by books and movies

like The Big Short. So I've been very cautious to constantly sort of check my biases and not fall into that trap the whole time. But I think a dispassionate analysis of the facts leads you to a pretty inevitable conclusion about Australia. The other disclaimer, obviously, is none of this is financial advice, so pure entertainment and my opinion. So, yeah, so let's get started, shall we? Australia's enjoyed the longest running housing boom in the world, at least until the end of 2017.

So house prices increased 6,556% from 1962. So that's the longest running boom in the world. And that's coincided with a historically unprecedented growth in GDP. So we haven't had a recession since, I'm sure some people in the room will remember, since September 1991. So 108 consecutive quarters of economic growth, which is unprecedented. And perhaps we should all feel very proud of that. But as Hyman Minsky, the Maverick economist I mentioned before we got started, once said, stability leads to instability.

And I think it's fair to say that Australia's become very complacent and that our growth has largely been driven by the housing boom which we blew at the end of the mining bubble to sort of tide our economy over and build a bridge to prosperity and now we're going to be paying the price for that very very soon so the the the question really is, what is a bubble? And the common sort of colloquial definition is that it's when market prices become unstuck from intrinsic value, sort of when they significantly depart. And it's like one of those things where there's no magic number, but you know it when you see it. Robert Shiller, the Yale Economist Nobel Prize winner, has another definition, which I like. He was famous for calling the US housing bubble.

And it's that there's an extra element to the definition, which is that the bubble necessarily needs to involve some form of speculation. So people are buying assets because they anticipate the appreciation of those assets. So in this case, houses. And I think Australia ticks both of those boxes and I'll explain why. In terms of the intrinsic value, the great thing about property is that you can value a home or value an investment property on the rental income and if you look at price to rent ratios in all of Australia's capital cities they're historically way out of whack so in Sydney and Melbourne they're around 40. Trulia the real estate website in the US once said that the best time to buy the best price to rent ratio was about 0 to 15.

And after that, it's more rational to just rent. So we're at about 40 at the moment, which I think that's the most direct sort of tell for whether you're in a housing bubble. But that other element that Robert Schiller identified of the speculation, it's interesting that there's sort of a quantitative way you can prove that Australians have been speculating on housing. And that is, if you look at the net rental yield, so how much investors bring in in rental income

after fees and maintenance costs and things like that. So the net rental yield, which is another way of saying the cap rate, which is real estate jargon, has sort of been at around 3.5% to 3%. In Sydney at the moment, it's about 2.7%. So it's been coming down. At the same time, the mortgage rate, so how much you're repaying, it's been about 4.5%. So, and this was pointed out by Bill Strong, a Miami hedge fund manager who's shorting our housing bubble as well. That means that your investors are losing money on the carry.

And losing money on the carry only makes sense in a context where you think you're going to make money on the appreciation. So this is like a national game of poker where we're sort of exhibiting level two and level three thinking we're thinking about what everyone else is going to do um and betting on homes that way so i think it's pretty clear that australia is in the the midst of one of the biggest bubbles in history and the the real question then is is whether and and more importantly when the bubble will burst

because um bubble is sort of different terminology to a boom a bubble is has negative connotations and implies or foreshadows that things are going to come to a sudden end and the really interesting thing about housing bubble so i sort of i'll give you my like philosophical and conceptual framework for thinking about um thinking about housing markets and this is when i was talking about like tumbling down rabbit holes in research i was thinking a lot of um of of all my reading on this a lot of people know michael lewis for the big short um has anyone read boomerang um so that was sort of his next book and he traveled around iceland ireland greece germany

uh and looked at the sovereign debt crises in all these countries after the global financial crisis and he traveled to ireland and met this ucd called Morgan Kelly. And Morgan was previously researching medieval population statistics, highly esoteric academic domain, but sort of came out of obscurity when he realized that the Irish housing bubble was getting way out of control. And as he described it, it was sort of like being on a ship and seeing an iceberg in the distance and walking over to the captain and saying, hey, isn't that an iceberg? For that, he was sort of roundly criticized. His first article in 2006, he got published in the Irish Times. I lived in Ireland for a year.

I remember the Irish Times. It doesn't have a large circulation. But he tried to publish another article in 2007 and no one wanted to wanted to accept it so he had to publish it again in the irish times um and he was also more or less told to go kill himself by the irish t-shirt or prime minister birdie ahern um there's a youtube video of that you can actually look up um so he was basically told to sort of get back in his box and what he said was that ire Ireland's no different to any other economy. Everyone believes that this time is different. But if you look, take an outside view

of what housing markets have done in OECD economies across time and space, usually the size of the boom correlates with the size of the bust so the the iron law of house prices is that the more they go up the more they fall and morgan wrote a paper which i regard as a classic of the genre called on the likely extent of falls in irish house prices which he published in february of 2007 in march 2007, prices fell for the first time by 0.6%. And from that point, the rest is history.

So Ireland suffered one of the worst housing bubble collapses in history. The effects of which they're still recovering from today. But the reason I raised Morgan is in that paper, he mentions an interesting idea, which is that house prices are not very well modeled as random walks. Has anyone heard of random walk theory of asset prices? So it sort of describes how the efficient market hypothesis works, which the term wasn't

coined by, but it was made famous by eugene farmer in a paper in 1969 the nobel prize winner from chicago university and basically the efficient markets hypothesis is the idea that uh prices reflect all available information so because of things like disclosure laws and modern telecommunications technology as soon as good news about a company comes out, people have an incentive to react to that as quickly as possible by buying the stock. Or if bad news comes out, selling the stock. And as quickly as possible, stock prices reflect that news. And so it's very hard to beat the market over the long term. Turns out that's somewhat of a half-truth.

But that's not really the topic of this discussion. But random walk describes what the efficient markets hypothesis looks like. And the theory is just that if stock prices reflect news and the news is fundamentally unforecastable, like you can't anticipate what the news is going to be or it's already priced into the stock price that means that the changes in prices are going to be sort of random like a drunk person starting at a lamppost and then sort of wandering home and you can't really predict what that's going to be and the um so the formula for the random walk So this is what it looks like. X of T equals X of T minus one plus epsilon T where epsilon is just sheer noise.

So that's the random walk in stock prices. And all I want you to remember is that that is not how housing markets work. So, housing markets are better modeled, and this is what Morgan Kelly, this Irish economist, said in his classic paper, better modeled as information cascades. And I'll explain what information cascades are. But the reason is that there's no easy way, there's no direct way to convey negative information in housing markets by short selling. And secondly, you don't get the instantaneous revelation of information that you do in stock markets because the transaction costs are so high, listing your home on the market, getting a real estate agent, etc.

So, housing markets are better modeled as information cascades and an information cascade is where it has a set of features. So firstly, people make decisions subsequently or sequentially. Secondly, there's sort of a decision space where you can either decide to do something or not. People have private information but some people have better private information than others. Other people might have. People have private information but some people have better private information than others. Other people might have erroneous private information and people take public actions. So, if I go downstairs and buy an espresso martini, I'm signaling through my public action that I have some sort of private information about the value of the espresso martini and maybe Henry sees that and he decides to sort of use that as a shortcut to making his decision and he buys an espresso martini as well.

All of a sudden Claire sees that Joe and Henry have both bought espresso martinis and it's quite persuasive that we must know something that she doesn't know and she'll buy an espresso martini as well and then after that Bob sees that Henry, Claire and Joe bought espresso martinis and he says well I don't have great private information but this is pretty good evidence that espresso martinis are not a bad drink and so he buys one as well and then Sue wins deciding what to buy and whether or not to buy an espresso martini. And by that point, there's a whole crowd and the herd mentality sets in. So that's really the best way to conceptualize housing markets. And it was funny, recently, I was rereading a book by a French philosopher called René Girard. And he was a teacher at

Stanford University. And funnily enough was the mentor, the intellectual godfather almost for Peter Thiel, the first outside investor in Facebook, co-founder of PayPal and Palantir. And Rene Girard has this incredibly deep idea which he, if you want to read about it, his book hidden since the foundations of the world um is a great expose but he talks about mimetic desire so mimesis which is based on the greek word for imitation and how everything in life we desire is derived from what other people desire and his model is basically you have a subject a a model, and an object. And if the object, say the object is a house, and it's being desired by the model,

suddenly the subject wants to imitate the model, to be like the model, and starts desiring the house as well. That's confirmation to the model that the house is a desirable object, and thus begins this sort of mimetic rivalry where you designate something as desirable to other people through your desire and obviously that has very good roots very good grounding in evolutionary psychology homo sapiens is a successful species because we can adapt so well and we can adapt so well because we can imitate other people and imitate people in diverse environments and so there is this

social contagion effect to housing markets so given that coming back to morgan kelly the other thing that he found was that the larger the boom, the larger the bust because the same mechanism that drives the increase in prices, the information cascade, the frenzy of the mob mentality also brings it undone and when the cycle becomes negative, people sell and there's fire sales and prices come down. And if you look across any economy in the OECD, how house prices work is usually you have a long-term trend, which is increasing over time with income and prices move around it like that in booms and busts. The other thing Morgan Kelly found was that, so he studied 18 OECD economies between 1970 and 2007 where they'd had price falls of more than

20% in their housing markets and he found that typically you give up 70% of the gain in the fall. So for Australia if we were using that rule of thumb that would equate to price falls of about 50%. So, that's how I approach housing markets conceptually and philosophically. And at that point, I usually say to myself, well, the burden of proof is on the bulls to tell me why it won't happen. Thank you for listening, you saucy little minxes. That is the, not the end of the speech, but we're going to leave it there. As I just said, the burden of proof is on the balls. But tomorrow begins Housing Bubble Week. It's going to be huge.

It's going to be big. Tell your friends, hold your horses, get ready, strap on your seatbelts. And if you want links, information, show notes to anything discussed in this here episode, in the speech I just gave, you can find them on my website, which is josephnoelwalker.com. That's my name, my full name, J-O-S-E-P-H-N-O-E-L-W-A-L-K-E-R.com. Until tomorrow. Ciao.