Doesn't Michael Pascoe know that the RBA and the big boys can only acknowledge disaster after it would be profoundly impoosible to deny it and still maintain a shread of credibility, many reports aren't predictions, they are expectation management...
House prices NOT tipped to slide
What a dangerous thing an economist with a model can be, capable of scaring the horses, wrecking the financial system and generating internet traffic.
Yesterday's strange call by JPMorgan that Australian house prices will fall by 14 per cent in the next year is a case in point. It provided a scary headline that certainly had readers clicking their mice and probably worried some home buyers. I don't know what the horses thought.
And it was most likely hopelessly wrong. If it's a choice between JPMorgan's model echoing the Dr Steven Keen's doomsday scenario on one hand and the combined efforts of the Reserve Bank of Australia, the Australian Prudential Regulation Authority and Macquarie Bank's Rory Robertson on the other, my money is on the latter.
The RBA and APRA also run economic models, on, I suspect, more powerful computers than JPMorgan's Australian office - and they're not worried about house prices at all.
The most public faces of the house price debate have been Robertson vs Keen thanks to their bet on the issue with the loser having to walk to Mt Kosciusko. We reported Robertson's debunking of Keen's 40 per cent forecast three months ago and since then the Macquarie interest rate strategist has strengthened his case with the help of the official family.
The JPMorgan milder version of doom - just a 14 per cent crash - first and foremost fails the historical test of what happened here in the last recession - average house prices actually rose. JPMorgan's model might claim house prices fall by 1.25 per cent for every one per cent rise in unemployment, but the real world doesn't.
The are a number of reasons why the Australian housing market is fundamentally different from those of the US and UK, including our tax policies, that we had a housing boom that topped out in 2003, monetary policy that was rising ahead of this global recession, economic counter-measures put in place early in our slow-down, our banks not completely losing the plot, our home loans are not non-recourse and that we have something like a shortage of housing, as opposed to the over-building that occurred elsewhere.
For hard-core buffs of housing number crunching, papers by the RBA's economic analysis department head, Anthony Richards and financial stability department head Luci Ellis should leave your equines quite relaxed and confident.
Of course it's not good news at the top of the market, but despite all the attention given to Mosman, Toorak, Peppermint Grove and Noosa, that's only a small fraction of total Australian housing and doesn't matter very much in the overall economic scheme of things.
Certainly APRA is very relaxed about any impact the housing market might have on Australia's banks. Indeed, the rivers of gold flowing from residential mortgages to the banks is one of the key ingredients in our financial system's present stability.
Yes, rising unemployment is not good for maintaining house prices, but sharply lower interest rates are. Of those who do lose their jobs, relatively few will actually face foreclosure. Most Australian workers actually don't have a mortgage and of the rest, most have built up a healthy equity buffer to see them through a period of unemployment - which is why our big banks are prepared to capitalise repayments for a year.
On the other hand, as Rory Robertson has repeatedly stressed, monetary policy does work: lift interest rates as the RBA did during the boom and it creates pent-up demand; cut interest rates as the RBA did as the economy slowed and that pent-up demand is unleashed.
But mere history and all the work done by much larger teams of economic thinkers with bigger computers won't stand in the way of a headline and an economist with a model with a nasty prediction.
Which brings one to the whole question of economic models and their serious flaws.
It was a couple of elementary, almost childish flaws in the models used by dopey credit rating agencies that enabled the sub-prime crisis to occur, that falsely blessed rubbish loans with AAA ratings. Fitch had a model that simply assumed house prices rose every year. And when they didn't, the model - and the US economy - clearly failed.
But not only is it likely that things that are too good to be true aren't true, things that are too bad to be true generally aren't true either.
One of the nicest jobs of putting models in their flawed place was done by the Bank of England's executive director for financial stability, Andrew Haldane, in a February speech on risk management. With dry British wit, take it away Andrew Haldane:
"Back in August 2007, the chief financial officer of Goldman Sachs, David Viniar, commented to the Financial Times:
'We are seeing things that were 25-standard deviation moves, several days in a row'
To provide some context, assuming a normal distribution, a 7.26-sigma daily loss would be expected to occur once every 13.7 billion or so years. That is roughly the estimated age of the universe.
A 25-sigma event would be expected to occur once every 6 x 10 to the 124th power lives of the universe. That is quite a lot of human histories.
When I tried to calculate the probability of a 25-sigma event occurring on several successive days, the lights visibly dimmed over London and, in a scene reminiscent of that Lit-tle Britain sketch, the computer said 'No'."
Suffice to say, time is very unlikely to tell whether Mr Viniar's empirical observation proves correct.
Fortunately, there is a simpler explanation - the model was wrong.
Of course, all models are wrong. The only model that is not wrong is reality and reality is not, by definition, a model.
But risk management models have during this crisis proved themselves wrong in a more fundamental sense. They failed Keynes' test - that it is better to be roughly right than precisely wrong. With hindsight, these models were both very precise and very wrong.
For that reason, 2008 might well be remembered as the year stress-testing failed.
Failed those institutions who invested in it in the hope it would transform their management of risk.
Failed the authorities who had relied - perhaps over-relied - on the signal it provided about financial firms' risk management capabilities.
And, perhaps most important of all, failed the financial system as a whole by contributing, first, to the decade of credit boom and, latterly, the credit bust.
Michael Pascoe is a BusinessDay contributing editor.
This story was found at: http://business.smh.com.au/business/house-prices-not-tipped-to-slide-20090603-bv6p.html
http://business.smh.com.au/business/house-prices-not-tipped-to-slide-20090603-bv6p.html?page=-1
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