Wrong on House Prices, Ask Him How

University of Western Sydney academic Steve Keen made a name for himself with forecasts of economic doom, predicting a 40% decline in Australian house prices. Keen put his money where his mouth is, selling his unit in Surry Hills in October last year for $526,000. In November last year, Macquarie Bank’s Rory Robertson raised the stakes, proposing the following wager:

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.

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.’

Following this week’s release of ABS data showing capital city house prices up 6.2% for the year-ended in September, Keen conceded defeat and will be putting on his hiking boots and tee-shirt.

What does Keen say when we ask him how? ‘I didn’t know the government was going to be stupid enough to bring in the first home buyer’s boost.’ The increased first homeowner’s grant has certainly inflated house prices, transferring wealth from taxpayers to incumbent property owners, but it would be a gross exaggeration to say this prevented a decline in house prices of 40%.

So where did Keen go wrong? For a start, he neglected the supply-side of the housing market and the growing shortage of dwelling units that is putting upward pressure on prices. More seriously, Keen made the mistake of assuming that he knew something that everyone else didn’t. The efficient market hypothesis tells us that this is unlikely and we cannot reliably predict future movement in asset prices. Keen inadvertently demonstrated the veracity of the idea that asset prices are informationally efficient. Rory Robertson made the more reasonable assumption that house prices reflect fundamentals and was vindicated.

According to RP Data-Rismark, the median Sydney unit price rose 8.3% in the year-ended September. With a little help from Treasurer Swan, Keen’s bet against the market has so far cost him nearly $44,000 in forgone capital gains on his former unit.

Dr Stephen Kirchner is a Research Fellow with the Economics Program at The Centre for Independent Studies.