Here’s a riddle for your Thursday: how much of Australian retail consumption has been/is being supported by high house prices?
It’s a little research project we’re working on and if you have any suggestions, don’t be shy about sending them into to email@example.com. Why bother?
It’s a given that increases in household wealth support higher consumer spending. For one, when people see their share portfolios or housing investments go up, they are, in fact, richer on paper. This may give them more disposable income to actually spend. Or maybe they just feel richer and spend more freely (the wealth effect).
But one thing we recall seeing at the peak of the U.S. housing bubble is a massive increase in borrowing against home equity. Home equity lines of credit (HELOCs) were a popular way for lenders to expand the lending boom and for borrowers to “cash in” on rising house values to support consumption. The house was an ATM.
Is that true in Australia? We’re looking for evidence that either confirms or refutes the thesis. But we’re having a hard time finding credible data. One area that you might look at, based on the U.S. experience, is refinancing activity. Why?
As rates bottomed in the U.S., and then as the fear that rates would rise took hold, millions of people refinanced their homes to take advantage of low rates. Often the refis captured much higher house prices, which meant the new mortgage was larger than the old mortgage, albeit it a lower interest rates (and much less actual equity for the borrower).
Many mortgage providers offered cash-out refinancing options which allowed you to “extract equity” from your asset, an asset which was rising in value anyway. A telling sign of the top in U.S. home prices was when refi activity eclipsed new mortgage finance. There weren’t as many new buyers. Just existing buyers trying to reshuffle the financing furniture in order to support consumption and put off the mortgage day of reckoning.
Granted, we have no idea if anything like that is happening yet in Australia. But we’re having a look. In the meantime, median house prices were up 3.1% in the June quarter, according to data from the Australian Bureau of Statistics. The year-over-year gain in capital cities, according to the ABS was 18.4%.
That data is in conflict with data from RP Data Property reports. The RP data showed just 0.1% rise in house prices in the June quarter and a 0.7% fall in prices for the month of June alone. The RP data includes units and townhouses as well as stand-alone homes. That drop, if confirmed, would be the first monthly drop in 17 months.
Of course you know our position on the whole thing: Australian house prices are just one of many manifestations of leveraged asset bubbles worldwide that are now deflating with the credit depression. It has to make Aussie banks incredibly nervous.
On the one hand, they have large exposure to commercial and residential real estate. On the other, much of their domestic lending is dependent on wholesale borrowing internationally, where the cost of capital is going up faster than the Reserve Bank is raising the cash rate. And there’s an election this month, which makes it really hard to raise mortgage rates independent of a hike in the cash rate without inviting a “super profits” tax down on your head from agile political pick pockets.
But for all this worry that falling asset prices will lead to falling retail spending, lower GDP growth, and bigger government budget deficits, by far the most interesting housing bubble going right now is in China. Chinese regulators are instructing banks to conduct an honest-to-goodness stress test in which banks reckon the impact of a 60% fall in residential house prices.
Wow! Sixty percent? That travishamockery of a European stress test didn’t even assume a default on sovereign debt, just lower growth and falling bond prices. The Chinese appear to be seriously wondering what would happen if a large portion of last year’s $1.4 trillion in new lending turns out to be lost or non-performing.
Bloomberg reports that, “A deep slump in China’s property market may further slow the nation’s economy, which grew at a less-than-forecast 10.3 percent pace in the second quarter. China is still the fastest growing major world economy. Concern that China’s economy may cool due to a real-estate slump erased an early rally in U.S. stocks.”
The prospect of loan losses as a result of house price crash in China would be bad news for Chinese banks. And while we concede there’s probably a lot we don’t’ know about the Chinese property market, Caixin analyst Andy Xie reckons there are enough empty apartments in China to house nearly 200 million people, which is a lot of people and suggests a lot of bad loans.
Of course, only in China could you say that it may be possible to absorb that amount of space through internal migrations off the farm and into the city. In other words, if you really worked at it, you could say that that much surplus housing inventory isn’t an issue in a country that has so many people on the move. Sooner or later someone’s going to buy it and move in, right?
We’ll see about that. But in the meantime, the issue for Australian investors – and companies like Rio Tinto, which is set to spend nearly a billion dollars expanding its iron ore capacity in the Pilbara – is whether China’s housing boom has been boosting demand for coal and iron ore and what would happen to that demand if the boom goes bust.
Remember, last week we relayed the startling statistic that Chinese banks could struggle to recoup nearly 23% of the loans made to finance local government infrastructure projects. This aspect of China’s credit boom may have been even more supportive of base metals and iron ore prices. And if it goes, then the index of commodity prices published by the RBA this week (with a heavy bias to the contract prices of coal and iron ore) might look more like a “M” this time next year.
If you read the RBA release you’ll see that the big increase (51%) in the index is largely based on estimated increases in iron ore, coking coal, and thermal coal prices. It’s an expectation that things will keep chugging along. These estimates, in turn, are used by both political parties in Australia to estimate the amount of revenue generated by royalties and/or the Mineral Resource Rent Tax. Both parties reckon a return to surplus based on the increases in commodity prices.
Hmm. Has anyone reckoned what would happen if prices fell as they did in 2008 and beyond?
Granted, with oil hovering at US$82, gold nearly $1,190, and speculators in the position to take advantage of easy money in the US and Japan to invest in higher yielding assets, it may not seem like commodity prices can actually fall. But if the big driver behind commodity prices for the rest of this year is speculation and not fundamental demand (because bubbles are popping all over the joint) then would you be an investor in resource shares right now, or just another speculator?
Mind you, there’s nothing wrong with speculation, as long as you know that’s what you’re doing. It’s when the price signals you’ve been given turn out to be bogus (because of funny money) that many people find out they were actually speculating and not really investing. See Bill’s note below on prices.
All that said, we reckon shares would certainly be a better inflation hedge than bonds over the long term. But you might have to wait an awfully long time for a rebound in corporate earnings to start pushing share prices up. We meant to expand on this discussion this week with a look at various “alpha” and “beta” strategies for the share market. But we’ve almost run out of week.
For now, we’d say that all this anxiety about deflation and falling prices and the inability of monetary policy to produce inflation is just a prelude. The inflation will come when the Fed finds unconventional ways to get money into people’s pockets by by-passing the banks altogether. There are ways. And then? Stay tuned!
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