The recent OECD Economic Survey for Australia comes in with a warning label for the government.
That is: ‘prepare contingency plans for a severe collapse in the housing market. These should include the possibility of a crisis situation in one or more financial institutions.’
What’s the problem?
After years of spectacular growth property prices are now plummeting. Both Sydney and Melbourne have dropped 9.6% and 5.8% respectively from their peak last year.
While they don’t see it likely that there will be a flood of mortgage defaults, the fact that property prices are falling could shake consumer wealth and, in consequence, consumer spending.
This could affect the banks and send ripples through the whole economy.
While the OECD thinks that Australian property will make a soft landing…they concede that these are ‘rare’.
As they wrote: ‘Financial supervisors and bank regulators should be prepared in the event of a hard landing in the housing market.’
But, if the Spanish property boom and bust is anything to go by, we think that mortgage lenders could have more to worry about than just decreased consumer spending.
Are you prepared for an Aussie housing collapse? Find out here before it’s too late.
Spain went through its own property bubble between 2002 and 2008. The country saw property values rise six times higher than the average salary during that time.
There was a large influx of immigration. This, coupled with the fact that getting credit was easy, helped inflate property prices.
But, once it popped, everything collapsed.
Unemployment soared and property values plummeted.
All of a sudden, people were unable to make their mortgage repayments. Finding a buyer was tough, property had become toxic. And even if you did, you were selling at a loss.
The wave of defaults left banks sitting on a large stock of repossessed homes, which were left empty for years…
…and then came the court cases.
10 years on and Spanish banks and consumers are in the middle of a battle…yep, still.
You see, during the frenzy people had to be quick to snap up properties — and mortgages — or they risked losing out. Sound familiar? This brought in a lot of…ahem… ‘irregularities’, which are now coming into question.
Like the ‘base clause’. You see most interest rates for mortgages in Spain are calculated from the official Euribor rate plus an added differential, which is usually about 1–2%.
So for example, the Euribor is currently at -0.369%. If your differential is 1%, your mortgage interest rate payment would be a low 0.631%. But, if your mortgage has a ‘base clause’ of 5%, your interest rate would always be a minimum of 5%, no matter how low the Euribor went. In other words, you wouldn’t benefit from negative interest rates.
Most people didn’t notice this clause until rates went down to negative…and they couldn’t benefit.
Some courts are now ordering banks to repay overcharged amounts. Litigations have become so common that they are still affecting earnings. Many major Spanish banks have lost quite a bit of value since the height of the property bubble.
10 years on and we are still seeing the negative effects of the property excesses.
Aussie banks are reluctant to lend
Now in Australia, property sales are slowing, prices are falling and banks aren’t so keen on lending.
Banks exposed to property could have a hard time maintaining the same profitability as in recent years.
Yet, as we have seen with Spain, mortgage lenders are not only exposed to the property fallout but also to any legal action that could come in the aftermath of the frenzy.
UBS is already contemplating this as one possible scenario. One where they see prices collapsing 27–30% and a wave of lawsuits.
This is how UBS sees this this devastating scenario play out, courtesy of The Australian Financial Review (AFR):
‘The nuclear option is the most severe of five potential scenarios outlined by the investment bank’s increasingly bearish analyst Jonathan Mott.
‘Titled Catching a falling knife, the note asks whether the likely impact of the Hayne royal commission on the supply of credit has been factored in to the share prices of the banks. […]
‘Under the “deep recession and mortgage mis-selling” scenario, recommendations from the Hayne royal commission for the banks to obey the law and verify all borrower income and expense information sees credit dramatically curtailed, triggering a chain of developments.
‘As credit dries up, expectations for house price falls rise leading to a slump in demand, “sentiment in the housing market turns from FOMO (fear-of-missing-out) to FONGO (fear-of-not-getting-out)”.
‘UBS says banks would first cut dividends before suspending them as the falls accelerate and credit losses rise. Home owners slide into negative equity, signing up to mortgage mis-selling class actions in record numbers.’
There are already a number of class actions in the works already. A housing downturn and the possible legal action could mean more trouble ahead for mortgage lenders.
Editor, Markets & Money
PS: Author and economist Harry Dent sees a ‘wealth wipeout of epic proportions’ coming to Australia. He thinks the next economic upheaval is very much at our doorstep. To find out more click here.