It is well known that China’s credit boom created Australia’s iron ore/coal boom, which created the terms of trade boom, mining boom and the national income boom.
This in turn maintained high rates of employment (incomes) which promoted leveraged investment into Australia’s favourite investment class, property.
So it’s not too much of a stretch to see that China gave property another (last?) leg up in a bull market that’s stretched nearly 25 years. Throw in supply side issues from poor government planning, high building costs etc, etc, and you have a property price bubble that you could argue is built on fundamentals.
The fundamentals in this case being strong and rising national incomes, lack of new housing supply, cheap credit and the high cost of labour/supplies/regulations. But that’s the point…bubbles are always built on strong fundamentals. The problem is that this argument then becomes so blithely accepted that most don’t see when fundamentals stop being supportive of further growth.
We bring this point up for a couple of reasons. Early this week we sent this story around the office. It’s about a nondescript suburban home in the Sydney suburb of Eastwood that sold for $2.385 million.
Now, anyone who knows the suburb of Eastwood knows that’s a pretty outrageous price. Eastwood is middle class suburbia. It’s not the ‘north shore’ and not western Sydney. But over $2 mil for a regular house? Really? Oh, apparently the block was big.
So that’s a pretty decent anecdote about the level of craziness going on in Sydney’s housing markets. Historically low interest rates may not necessarily stimulate economic growth just where it’s wanted, but they do unleash a frenzy of speculative interest in an asset class where it’s deemed impossible to lose.
And then there was housing bull Chris Joye’s article in the Financial Review, where he stated that he was very worried about the state of the housing market. Joye’s been a pretty vocal bull for many years but now he’s concerned about the level of speculation that low interest rates are bringing about.
And he should know. He is a director of Yellow Brick Road Funds Management, which among other things is a fledging mortgage provider. Perhaps the quality of the applicants for new loans is beginning to cause alarm?
Anyway, here are a few quotes from Joye’s article. The worrying message that they contain won’t really be news to long time readers, but it does show the sort of thinking that is starting to slip into the mainstream’s consciousness.
That is, dangerous household leverage and a dangerously leveraged banking system:
‘households have not really deleveraged despite much spruiking about our "cautious consumers”. Australia’s elevated household debt-to-income ratio, which looks set to climb further, is not far off the all-time, pre-GFC peak.
‘This highly leveraged consumer is an artefact of Australia’s even more leveraged banking system. The major banks are leveraged about 80 times across their $1 trillion home loan books. Put differently, they are only holding about $1.25 of true loss-absorbing capital against every $100 – as opposed to the "risk-weighted” value – of their assets.’
‘…the banking system is under tremendous pressure to maintain its internationally lofty returns on equity.
‘Although default rates are modest, APRA has discovered a worrying rise in the share of home loans approved with risky loan-to-property value ratios.
‘A stunning 33 per cent of new home loans are today being advanced with LVRs greater than 80 per cent. In some countries they don’t even allow banks to lend at these levels, period.’
Now, keep these points in mind when considering the Australian Prudential Regulation Authority (APRA)’s latest warning to the banks to maintain an adequate capital buffer and to not let lending standards slip.
But you can warn all you want. When interest rates reach historic lows, you begin to scrape the bottom of the barrel in terms of creditworthy borrowers. Because with each step down in rates, new marginal borrowers come into the market.
The problem is not banks lowering their lending standards (although that doesn’t help)…the problem is ultra-cheap money. It’s as simple as that. And ‘eventually’ those people now scrambling to get into the Australian property market will painfully understand this simple fact.
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