Thursday, November 27, 2008

Rory Robertson vs Steve Keen

Who's going to climb Kosciusko?

Macquarie's Rory Robertson writes:

"I was in Canberra yesterday, presenting at the Federal Treasury and the Parliamentary Library. Over the past year, I've often been the most pessimistic person in the room. My second presentation yesterday, however, followed one by Dr Steve Keen (google, if you are keen), whose high-profile forecast of a 40% drop in Australian home prices has put the wind up many homebuyers and potential home-buyers, not to mention some offshore investors.

Never say never, but a 40% drop in Australian home prices is a highly unlikely event, effectively requiring a meltdown of our financial system despite the combined efforts of the RBA and Canberra. Happily, Australia is not the United States. US home prices are down by about 20% from their mid-2006 peak, while our home prices fell by 2% in Q3, driven by the 150bp increase in mortgage rates overseen by the RBA between July 2007 and July 2008 (now more than fully reversed).

To make it interesting, I offered Dr Keen a challenge...

On the maybe 1% chance that he is right, and capital-city home prices do indeed fall by 40% within the next five years - starting from Q2 2008, and as measured by the ABS - I will walk from Canberra to the top of Mt Kosciusko (that's maybe 200km followed by a 2228-metre incline).

If Dr Keen turns out to be less than half right, as I expect, and home prices drop by (much) less than 20%, he will take that long walk. Moreover, the loser must wear a tee-shirt saying: "I was hopelessly wrong on home prices! Ask me how."

We now have a bet, and I expect to record an easy win within two years. That's because falls in Australia-wide home prices will be limited by our lack of overbuilding, our much more disciplined mortgage market, and - especially - by the RBA's ability to drive mortgage rates lower (something the Fed until this week had been unable to do; see latter part of chartset, attached).

Critically, the RBA knows that it was 15-20%-plus drops in home prices that poisoned the US and UK banking systems and economies. And so that must not happen here; accordingly, limiting the drop in average home prices is an unstated but obvious objective of increasingly easy RBA policy.

I'm still guessing that the RBA will cut by another 100bp next Tuesday, to 4.25%. A 100bp cut is more likely than a 75bp cut is more likely than a 50bp cut, I'm thinking without overwhelming confidence (given that most of us were badly wrong-footed three weeks ago).

To me, there would be a neat symmetry in reversing six years of monetary tightening - from 4.25% to 7.25% - in just four meetings over just three months, in response to the sharpest deterioration in global growth prospects in decades. Moreover, with global equity and commodity markets having rebounded nicely from last week's disturbing new lows, a 100bp RBA cut delivering a standard mortgage rate of 7% or less might allow everyone to go into the pre-Christmas season with freshly elevated hopes that everything ultimately will turn out okay.

Assuming that Dr Keen eventually will have to take that long walk, it will be because he greatly under-rated the quality of macroeconomic analysis undertaken at the RBA and in Canberra, and underestimated the power of low interest rates to support local home prices even in the face of today's alarmingly weaker global backdrop."

RORY'S UPDATE Friday November 28:

"Hi there. Sorry to interrupt. For the record, Steve Keen is keen to clarify that our bet is "peak to trough", as agreed, with no five-year limit . Obviously, I expect this distinction will not make a difference, with the ABS house price index likely to surpass its Q2 2008 level well within 5 years.

Anyway, all good fun, and thanks for all the feedback. Thanks especially to those who've offered to join me on the walk to Mt Kosciusko - one even to cook each evening! - but cool your jets. I'm not expecting ever to have to take that walk!"