Remember how Luke Skywalker destroyed the Death Star? At the crucial moment, the young Jedi switched off his targeting computer and used the Force to aim his laser torpedoes. It was one of the most important decisions of his life, and he made it, not on the numbers, but on instinct. In today’s market, home buyers seem to use much the same process. They don’t rely on the data, but on intuition.
That might sound silly but according to some economists, it’s often the way people make major economic decisions. Of course they have a different word for the Force — they call it ‘confidence‘. Consumers, producers, employees and employers, investors and borrowers — they all need to have it flowing through them. If they don’t, the economy won’t work. There’s more to decision making than data — or at least that’s the theory.
As anyone who’s studied Star Wars knows, there are two sides to the Force. And our economic Jedi Knights stress how important it is that our leaders don’t allow us to drift to the dark side. That’s called "talking the economy down" and it’s the kind of thing that makes young Jedi lose their nerve.
The Force is strong in first home buyers right now but seems to be lacking in other buyers. At his blog, Peter Martin has a fascinating series of graphs taken from the Reserve Bank’s latest Statement on Monetary Policy. They show that the recent surge in home loan approvals has been driven almost entirely by first home buyers. As a result, the prices of houses in the least expensive 20 per cent of suburbs have risen. At the same time, prices in the most expensive 20 per cent of suburbs have fallen substantially. Despite extraordinarily low interest rates, investors and other home buyers have not surged into the market the way that first home buyers have.
Does the government’s super-sized first home buyer’s grant explain the difference in behaviour? Probably. Home buyers don’t know how long the grant will continue after the budget comes down so it’s probably bringing forward demand. Banks and real estate agents are certainly talking up the idea of a brief ‘window of opportunity’. But could there be something else going on as well?
Sadly John Maynard Keynes died before Star Wars Episode IV reached the cinemas. So rather than talking about the Force, he invoked the idea of ‘animal spirits’:
… a large proportion of our positive activities depend on spontaneous optimism rather than on a mathematical expectation, whether moral or hedonistic or economic. Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits — of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.
From a social science perspective, invoking animal spirits always seems a bit dubious. Whenever an economist wants to say that something is caused by factors nobody understands, they put it down to psychology (because everyone knows that if psychologists knew what they were talking about, they’d be economists). As an explanation, it’s a bit of dead end.
But if we are going to talk about the Force, confidence or animal spirits, perhaps we could look at the possibility that first home buyers have different intuitions than other buyers. As far back as the 1920s, Walter Lippmann argued that people do not react to what they see, but to their interpretations of what they see. Behaviour is shaped, not just by the data or by media interpretations of the data, but by cognitive frameworks he called ‘stereotypes.’
Perhaps, life experience shapes people’s interpretations of events. First home buyers are, on average, younger than other buyers. It may be that people who began their working lives during the past decade don’t interpret the global financial crisis in the same way as older people. How would the world seem if you’d never lived through a recession?
A long time ago, in an Australia far, far, away, there were Prime Ministers who had first names like Gough, Malcolm, Bob and Paul. House prices rose gently but occasionally fell a little. Unemployment was unbelievably high, mostly above six per cent and occasionally going past ten. Interest rates were sometimes in double figures — apparently they once went as high as 17 per cent. It was a strange world. But what can you expect from a era filled with people in acid wash jeans who rode around in hotted up Toranas?
Many first home buyers know little or nothing about this bizarre world old people keep talking about. In the real world, house prices double every ten years, unemployment falls, wages rise, and interest rates look unsustainably high when they go over eight per cent. Naturally, in a world like this, you can’t waste any time getting on the housing ladder. If the bank says yes, it’s time to grit your teeth and jump in.
There’s an intuitive sense that that the best time to buy a home is as soon as you can convince a bank to lend you the money. If jobs are easy to find and your income will increase steadily over time, where’s the risk in buying now? It might feel a little scary, but the Force tells you you’ll get caught in a financial garbage compactor if you don’t move now. It’s a balance of fear thing.
As Keynes suggests, it’s not so much a matter of looking at the data as being conditioned by experience. A person’s sense of what’s likely to happen in the future is shaped by what happened in the past — or that relatively recent bit of the past that took place when they were paying attention. That’s why people who lived through the Great Depression became obsessed with pension entitlements. They looked at the future and their gut feeling was — what use are bank accounts and shares if things turn really nasty?
So perhaps the global financial crisis has spooked people who remember the last two recessions. When Lehman Brothers collapsed they felt a disturbance in the Force. They checked their super funds and looked around the office wondering who’d get tapped on the shoulder first. But younger people — people who weren’t even born when Star Wars hit the cinemas — remain relatively undisturbed.
Of course there’s no real evidence for the Jedi theory. The difference in behaviour could just be down to the first home buyers grant or the fact that people who already own a house behave differently to those who don’t regardless of how old they are. But if the first home buyers grant gets the chop in the budget, maybe we’ll get to see how strong the Force really is.
Yes if the FHOG gets the chop things might go a little soggy. Then again, if the FHOG has brought forward a lot of purchases, they might sag anyway. And the banks are withdrawing from higher LVR loans which also weighs down first home buyers and the more adventurous investors. All that said, I might jump in in the not too distant.
I think that what you are forgetting is not confidence but its opposite. People have bought houses that weren’t really ideal because they were scared of not getting a foot on the ladder which seemed to rise ever higher all the time.
Nicholas – That makes sense. If the grant is bringing forward purchases rather than bringing new buyers into the market, then (all things being equal) you’d expect demand to tail off even if the grant stays in place.
That’s why it would be so interesting if the grant was withdrawn and demand held up.
And you’d expect any kind of credit rationing (eg higher LVRs, more conservative valuations, a requirement to have a record of savings from income) to pull prices down.
Patrick – I think you’re right. Fear is an important motivation. And I suppose the same thing applies to fear as to the grant. Eventually either the stock of potential purchasers dries up or the banks tighten up on lending. Then the market has to rely on flow.
Speaking as a guy who makes a living from property developers, the supply of housing doesn’t seem to be increasing much.
And if I have understood you correctly, Don Arthur, the problem with fear is that it could largely stop the flow if another generation emerges which is afraid to buy houses having actually seen values plunge.
But I think fear is more likely to sustain the flow that you are so worried about – becauses houses still look ‘safer’ than a lot of other investments to a lot of people, not least because you can live in them.
Which would make the Force appear strong indeed, but would in fact be the Dark Side’s hand showing.
Patrick – I don’t have any real idea about what prices will do. But I am interested in the way that people try to explain their movements.
The stock/flow idea is this:
Imagine you’ve got a river which flows at a certain rate (assuming rainfall etc stays constant).
You dam the river and the flow downstream slows. Water backs up behind the dam.
You open up the sluice gates and the flow rises above the original rate.
How long can you keep the flow going at the higher rate?
Some people argue that the steep increase in house prices was like a dam stopping first home buyers from entering the market.
Potential first home buyers flow into the reservoir as they leave education, find jobs etc.
The first home buyers grant, low interest rates and/or fear force open the sluice gates releasing these potential buyers into the market, increasing demand.
And yes, it’s a flawed metaphor.
In which case I should rephrahse my comment: the combination of greater fear of other asset classes + general insecurity + actually lower prices might serve to lower the dam even further.