Bernard is an economics columnist for the NZ Herald

Bernard Hickey: Short, sharp lesson due on prices

Auckland house investors can learn from The Big Short, which outlines America's housing crash.
Auckland house investors can learn from The Big Short, which outlines America's housing crash.

Making a movie about collateralised debt obligations and credit default swaps that is both compelling and accurate is quite some achievement.

That's why I thought Michael Lewis' book on America's financial meltdown, The Big Short: Inside the Doomsday Machine could not be turned into a cinematic experience.

But The Big Short has a verve and flair that has helped it win awards and Oscar nominations.

And it took me back in time and stirred up all those old feelings of shock and bewilderment and wonder from 2007 and 2008 when the world's most sophisticated financial system was melting down.

The movie is actually set mostly through 2005 and 2006 when the US housing market and economy was rollicking along with the near-universal belief that house prices would never fall and that all the debt owed on those houses would never go bad. The Big Short is the story about those outsiders who recognised the emperor had no clothes and who then worked out a way to make massive profits out of what they saw as the inevitable collapse.

It is mostly a story about how hubris, laziness and "group think" can corrupt an economy and financial markets to the point where intelligent and normally sensible people end up rationalising and defending extraordinary things.

The crowd in 2005 and 2006 were saying America's house prices were justified and sustainable. They argued the record-high house price to income multiples made sense because of the permanent financial magic of very low interest rates. House prices had never fallen much and never would fall. These bonds were incredibly safe. This market was different. It was immune from the cycle or the "downs" that often follow "ups" in most markets.

Mortgage brokers, real estate agents, bankers and even the US Federal Reserve chairman Alan Greenspan dismissed the naysayers with a smugness and certainty that was frightening in retrospect. Sound familiar?

I sat in the movie theatre cringing. All the language of the crowd sounded exactly the same as those who defended Auckland's housing valuations this week when Demographia called out Auckland's house prices as more expensive than London and Los Angeles when measured versus incomes.

Auckland's house prices have never fallen much, they said. Auckland was an international city, like New York and Hong Kong, which made it different this time. Auckland was a special place where people desperately wanted to live. And this would never change.

Auckland is different from America's housing markets in many ways. Home owners can't just mail their keys to their banks and walk away debt-free. The supply of new houses is not cheap and easy, as it was in many US states.

New Zealand interest rates are expected to stay low, or even fall, over the next few years, and mortgage rates were rising through 2005 and 2006 in America. The debt underpinning Auckland's housing market is much simpler and cleaner than the US loans. New Zealand's banks know who they have lent money to and have much higher lending standards. They also have much more of their own money at stake and the Reserve Bank has forced them ask for higher deposits.

Yet there are plenty of similarities. The debt under America's housing bubble was only sustainable with very low interest rates forever. Anyone supremely confident about Auckland's housing market simply needs to answer the question: how would it cope with 10 per cent mortgage rates and a 10 per cent unemployment rate. Unlikely right now, but plausible over the long run.

The Big Short forces you to look at your world with fresh eyes. I'd recommend it for anyone sure that Auckland's "Big Long" is a sure thing.

- Herald on Sunday

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Bernard is an economics columnist for the NZ Herald

Bernard Hickey is the publisher of Hive News, a Wellington-based political and economic subscription news email service. He also writes for and appears regularly on Radio New Zealand, Radio Live, TVNZ and TV3. He has been a financial journalist for 25 years, having worked for Reuters, the Financial Times Group and Fairfax Media.

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