Former treasurer Wayne Swan has thrown down the gauntlet to Australia’s remaining neo-liberals, by declaring that trickle-down economics had been thoroughly discredited by the global financial crisis.

Mr Swan’s retelling of the history of that crisis is essentially correct – that his government’s stimulus package preserved hundreds of thousands of jobs and averted a recession, and that we must avoid US-style “inequality”.

However, in his address to the National Press Club on Thursday, he failed to mention the central lesson from the early stages of the GFC – that the dangers of private debt must be judged against the incomes of borrowers, not against asset prices.

The sub-prime crisis that kicked off the GFC 10 years ago was based on that sudden realisation. As the chart below shows, it is one that Australians are yet to face up to.

The sub-prime stage of the GFC happened because loose regulation created a build-up of debt, held by people who simply couldn’t afford it.

Low-paid workers in the US were servicing huge mortgages, and when things got tight, they simply refinanced their rapidly appreciating properties and spent some of the equity.

Meanwhile, authorities believed that since the values of the assets involved were higher than the debts, everything was hunky-dory.

Then boom! One of my US-based colleagues managed to sell his home just ahead of the crash for $850,000, and later saw it back on the market at $150,000. Asset values simply weren’t what they had seemed.

Slow learners

Ten years on, the Reserve Bank and the Department of Treasury continue to ignore that lesson, and constantly underplay the risk private debt poses to the nation.

Mr Swan, too, needs to say more about this problem, not least because it is adding to the “inequality” he wishes to avoid.

To do so, however, he would have to face up to his government’s less successful policies during the GFC.

In 2009 the Rudd government’s boost to the first home owners’ grant set a policy direction that the Reserve Bank and Treasury cheered all the way.

It involved pumping the housing market with grants, low interest rates and loose prudential regulation, to create a ‘wealth effect’ and get things moving again.

It was successful on one level, but the ugly side-effect was a weakening of the financial position of millions of Australians.

That last statement will be flatly rejected by the boffins at the Reserve Bank, who argue that average wealth across the country has improved.

But they are seeing the household balance sheet the way regulators saw the balance sheets of households in the US, Spain, Ireland just before 2007.

Measures of debt

In the chart above, generated from the RBA’s own data, the red line represents the relationship between housing debt and the value of housing assets.

Since the Howard government came to power in 1996, that ratio has risen so that debts are now about 50 per cent larger compared with the value of the properties they are secured against.

That’s not good, but it’s not shocking. It’s the rosy ‘balance sheet’ view espoused by the RBA and Treasury.

The other view – the one that captures the stark lessons of the GFC – is the grey line at the top.

That shows how debts have doubled relative to worker’s incomes over the same period.

That ratio must, somehow, come down again.

The gentle way to do that would be for wages to rise and for breakneck credit creation to slow.

But there’s not much chance of that on current settings.

On Wednesday, the Bureau of Statistics released data showing wage growth of just 1.9 per cent across the past year, which only just matches inflation.

Employment data on Thursday was more hopeful, with the key metric of ‘hours worked’ across the economy rising faster than the size of the workforce – 2.5 and 2.2 per cent respectively.

A few more hours at the same real rate of pay won’t change much, when the nation’s stock of housing credit leapt ahead by 7.2 per cent over the same period.

Mr Swan said on Thursday: “Our future political stability and economic prosperity demands an understanding that a strong working class and strong middle class are the sources of economic growth, not merely a result of it.”

Quite true. But they will not be “strong” while we measure the debts of middle Australia against shaky house prices, rather than their stubbornly flatlining incomes.