It's not all disaster and doom though!

Dr. Brock also suggests that deficits can end up boosting productivity and growth in the long run-as long as government spending is eventually curtailed and as long as the spending actually leads to new growth, rather than just more consumption. He also has a bit to say on "stimulating" pent-up demand and how big government deficits can lead to higher interest rates. We think it's a fairly even-handed treatment of a subject we prefer to be high-handed about.

A quick look at the markets shows us that we're not out of the housing collapse woods yet. Falling U.S. home prices are still having an impact on global financial and commodity markets. In the U.S. April housing starts were down 12% from March to the lowest level since 1959. Applications for permits to build new homes fell to a record low as well.

The Dow and S&P both closed lower and copper, which has been surfing the whole "green shoots" recover/Chinese stockpiling theme slipped too. Oil managed to close over US$60 while gold slipped to $925.

You wonder why anyone is building houses in America at all. Unlike Australia, there is a huge surplus of housing inventory in the States. America over-built its housing stock to epic bubble levels during the boom. It's that inventory-in addition to the millions of homeowners that currently have negative equity-that lead us to believe that median U.S. house prices are headed lower and have not, Alan Greenspan to the contrary, bottomed.

House prices are generally a local phenomenon. For example, the median house price in Saginaw, Michigan is $30,300. Meanwhile, in Honolulu, Hawaii it's $570,000. Nationally, it averages about $169,000, down about 26% from 2005. In the areas that over-built and over-lent (Florida, California, Nevada, Arizona) prices are off more than 50%.

But what did all America's local housing markets have in common? A mortgage boom that went global. Local lenders may have originated loans. But through the wonders of securitisation and mega-banks, those loans were sold to investors, freeing up even more money to make more loans.

In fact, one of the points Dr. Bock makes in his essay is that leverage drove the excesses of the mortgage boom far more than "greed," the bogeyman du jour. Government regulators could reduce leverage and insist on higher capital ratios to rein in speculative excess. But that would dent future campaign contributions.

It's much easier and far more popular to rail against executive pay, while not tinkering with the rules that give financial firms and their directors the ability to take big risks with borrowed money. Plus, if you're in government, you have to make sure you don't burn any bridges with your future private sector employers.

Had it not been possible for investment banks and financial institutions to use off-balance sheet vehicles to lever up 40-1 on assets-and use all that borrowed money to speculate in collateralised debt obligations and credit derivatives-the American mortgage boom could never have gone global.

Of course there were many other credit-backed booms in other asset classes, markets, and countries. It's simplistic to blame the 5% contraction in global GDP since the crisis started all on American sub-prime borrowers. All over the world investors believed the same things: house prices always rise, leverage is an easy way to get rich with borrowed money, and that government intervention in the markets can stave off a real reckoning of the real mistakes people made with capital.

The good news is that American house prices are falling to a level where even your editor would consider having a look. The same can't be said, we're afraid, with Australian house prices. Which brings us to a note we got overnight from Chris Newton from the Housing Industry Association. In the interest of fairness, we'll reproduce it in its entirety below.

Dear Mr. Denning,

I note the quote that you attribute to me in the last sentence of your article entitled, 'China Performs a Kind of Financial Alchemy'. You have abbreviated my actual quote.

In a HIA press release issued 18 May 2009 I stated as follows, "notwithstanding current economic conditions for many aspiring home buyers there has never been a better time to enter home ownership".

My comments were made in the context of an improvement in housing affordability, which is now at a seven year high.

Assessments of housing affordability do not provide any assessment of future price movements.

Yours sincerely,

Chris Lamont

Fair enough. We don't think including the worlds "not withstanding current economic conditions for many aspiring home buyers" improves your case much, especially when it comes to affordability, though. The press release on the HIA site also says, "Over the March 2009 quarter the average home loan repayment fell by 11 per cent to $1,831 per month, significantly lower than the previous amount of $2,056. A further improvement in affordability is expected in the June quarter."

It seems correct to measure affordability by the size of the monthly mortgage payment. But if homes are only 'affordable' now because of historically low-interest rates, does that mean they are really affordable? Interest rates will surely rise again (see why below). Doesn't this mean the buyers who get in at the lower end of the market (where prices have risen to compensate for the first home buyer's grant) will face much higher monthly payments in the near future?

Of course anyone is free to take any interest rate risk he'd like. But we have serious doubts that new home buyers have put a lot of thought into how much it would cost them to stay in a house if interest rates doubled from these levels. They don't hear a lot about that in the press. They do hear a lot about how affordable houses are now.

The two other factors in "affordability," we reckon, are the stability of your income and the price of the house. And on those two counts we'd also be concerned. The IMF, the Australian Treasury, and our bartender at the George Public Bar on Fitzroy Street all think unemployment will be higher by the end of this year, not lower. There is ample evidence that house prices have more to do with employment as they do interest rates.

Ultimately, to be absolutely clear, we think the current economic conditions suck. With Australian house prices still at such large multiples of incomes, with unemployment rising, and with the accumulation of government deficits set to put upward pressure on interest rates, it's hard for us to believe this is the best time in seven years to buy a house. But who knows? Anything's possible.

Dan Denning
for The Daily Reckoning Australia

• Australian House Prices Are Severely and Seriously Unaffordable
• Majority of Australians Believe House Prices Will Rise in Next Twelve Months
• Reserve Bank Agrees There is a Housing Shortage in Australia
• House Prices Down and Aussie Market Enters Second Wave of Rebound Rally
• Aussie Housing Market Actually Leads the U.S. by Three Years