Housing busts preceded by high leverage more severe and protracted: IMF

Based on analysis of advanced economies over the past three decades, housing busts preceded by larger run-ups in household debt tend to be more severe and protracted.

This is one finding presented in the International Monetary Fund, World Economic Outlook April 2012, titled Growth Resuming, Dangers Remain.

Australia is not absence from the list of advanced economies who have witnessed a rapid rise in household debt. Down under, we have almost quadrupled our household debt as a percentage of household disposable income over the past thirty years causing many to question if this level of debt burden is sustainable.

Most of this debt has been piled into our residential property market, which has now experienced price declines for five consecutive quarters while the growth of housing finance falls to levels not seen since records started some 35 years ago.

According to the IMF report, in the five years preceding the Great Recession (GFC) of 2007, advanced economies recorded an average household debt to income increase of 39 percentage points. A quick look at the Reserve Bank of Australia figures suggest Australia’s household debt to income ratio increased by a bit more than 37 percentage points.

Chapter 3 of the IMF report sets out to determine the relationship between household debt and the depth of economic downturns.

It found the declines in economic activity after a housing bust are not simply reflective of the decline in the asset price and the associated destruction of household wealth. It is a combination of the former and pre-bust leverage that ultimately explains the depth of the contraction. Simply put, the more household debt, the bigger the bust and this holds true regardless of a banking crisis or not. Economic downturns following high debt housing busts are also more protracted, with declining consumption lasting for at least five years.

According to the report, in economies with high household debt, household consumption can fall by more than four times the amount that can be reasonably explained by falling house prices alone. This is caused, in part, by more pronounced de-leveraging, as households try to repair their weak balance sheets. In low debt housing busts, as could be expected, there is no discernible decline in household debt to income ratios.

De-leveraging can result from a number of factors including a realisation that house prices were overvalued, a tightening of credit standards, a sharp revision in income expectations and an increase in economic uncertainty. Uncertainty can also lead to an increase in household savings, at the expense of consumption.

High debt busts typically cause greater falls in real GDP and larger increases in unemployment.

As unemployment rises due to falling consumption, the ability of households to service their large debts diminish causing defaults and foreclosures starting what the IMF call a ‘self-reinforcing contractionary spiral’. Estimates presented in the report suggest a single foreclosure can lower neighbouring house prices by 1 per cent, but a wave of foreclosures could wipe as much as 30 per cent off local prices.

Negative equity can also have a role to play, with a U.S. study finding homeowners with negative equity spend 30 per cent less on maintenance and home improvements, than those that don’t. Maintenance and home improvements either retain or increase the relative value of the home.

Similarly, as supply exceeds demand or as foreclosed homes sit vacant on the market, months of neglect and deterioration further reduce values. Vacant homes and unemployment can also result with social issues such as high crime rates making areas less desirable to purchase in.

» World Economic Outlook, Growth Resuming, Dangers Remain – International Monetary Fund, April 2012.


  1. Few people have been saying this for a while, even people in this blog. I think this blog was set up to inform people of this, emphasis on think Admin ;~D). No one wanted to look this way.

    Now that the IMF says it, I wonder if people at least not respond with “you’re a doom and gloomer”, when they’re told.

  2. I have been studying the house prices in a wealthy Melbourne beachside suburb for two years. In the last two months, 22 houses for sale (that is one in four) have reduced their prices by 6-15%. And that is before negotiations begin! The average drop is 8%. This is just the beginning. Many million dollar houses are coming onto the market, suggesting the owners can no longer service their mortgage.

  3. Hardly rocket science is it?? Since we now “all” regard a roof over the head as just another asset class to be treated, well, just like any other asset – we should expect the same effect on the downside of over-leverage as has been seen numerous times in e.g. shares – people were ever-so-keen to leverage themselves up to the eyeballs when buying in to the “Dot.Com” bonanza was all the rage, and Companies who had literally provided neither services nor products were almost arbitrarily assigned million-dollar “values”. We all know how welll (NOT) that ended, but it seems we are too eager to forget history, and repeat the same old mistakes time after time.

    Providing the Aussie economy doesn’t completely crater, what are the best that we’ll be seeing this all over again in a few decades time – to the tune of “but it’s DIFFERENT this time” – just like in the end, it was NOT different here from everywhere else right now.

  4. I can tell you exactly what caused the housing crash in Australia. Someone had this fictitious idea of as worldwide recovery in their head and jacked up interest rates prematurely for no reason whatsoever. This is the sole reason for the housing crash artificially high interest rates compared to other major cities around the world.

  5. Tony, we couldn’t possibly blame moronic, greedy homeowners living beyond their means, without even anticipating the possibility of rates rising, could we? Nah, let’s blame the faceless public servants like any good bleeding heart, nanny stater would. Couldn’t possibly expect people (adults) to take responsibility for their actions could we?

    I reckon if you think hard about it, you might actually find the cause for the ‘housing crash’ is in fact running low interest rates for too long.

    BTW in terms of a ‘housing crash’ I think we haven’t scratched the surface yet.

  6. Tony, its not the interest rates but rather the ease of credit and a favourable tax environment.
    Rate moves are not about the speed of the car but rather about swerving wildly to dodge the obstacles.

    /Don’t get run over.

  7. While low interest rates, favorable tax environment and ease of credit contributed towards this problem the cause was unethical investing behaviour by residential property investors facilitated by decision makers that enginerd this event to transfer wealth to the elite. I wish that people will wake up and realize that both this government and the past government intentionally created this problem. Both these governments are controlled by the same people and so it does not matter who you vote for. Do you really think the government cares about us?

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