So what if the possibility of a major wipe-out in shares looms? Let’s all buy houses! Today’s Markets and Money will continue the discussion we began yesterday. But before we can sort out what Australian investors should do in another major bust, let’s review what happened overnight.
First up is gold’s 1.27% decline in the futures markets. We’ve written about this in a special note that goes out later today. If you miss that note here’s the short version: don’t worry. The fear that China won’t buy IMF fold is a red herring. China is buying plenty of gold. But you might be surprised to find out who the seller is.
What shouldn’t surprise you is that fewer Australians are taking out mortgages to buy new homes. That’s what happens when prices rise, interest rates head up, and the government stops shovelling tax payer money into the market. You can only “bring forward” (steal) so much demand from the future.
The number of people taking out loans to buy new homes fell by nearly 8% in January, according to the Australian Bureau of Statistics. First home buyers fell as a percentage of new lending to 20.5%. That’s down from the high of May last year of 28.5%. And here in Victoria, only 525 Victorians borrowed money to buy a new home in January (see the table on page 10).
Don’t be discouraged, though. The Reserve Bank agrees with the realtors and housing industry spruikers that there is a housing shortage in Australia. RBA assistant governor Philip Lowe said in a speech in Sydney yesterday that constraints on home building are restricting the supply of homes in Australia. The shortage is one factor keeping prices up. Nothing was said about the lending boom.
Lowe said that, ”With population growth above average, and growth in the housing stock below average, it is not surprising there has been upward pressure on housing costs…If we are to build more dwellings, we need to ensure that planning guidelines and infrastructure provision can accommodate this.'”
Blah blah blah. We’re not going to rehash all of this again. But if anything, Australia has already sunk too much of its national capital into housing. Maybe investors have over-invested and locked out first time buyers while also damaging affordability. Who knows?
The river of liquidity that has floated Aussie house prices higher has its source waters overseas in the wholesale borrowing by Aussie banks from foreign lenders. This is what accounts for the financial sector’s massive share of Australia’s net foreign debt. Another global credit squeeze (the implosion of the shadow banking system) would block off those head waters. And where would that leave Aussie housing?
This is not to say or imply that homeownership is an unworthy goal. Yale Economist Robert Shiller points out in New York Times article that home ownership can promote good citizenship, a broad sense of equality, and even a sense of personal liberty in a society. That’s why in Australia and America, homeownership is THE personal financial dream.
But Shiller also points out those are cultural and not financial values. The desirability of homeownership shouldn’t be confused with the financial wisdom of it. The more leveraged a housing investment it is, the more vulnerable you are to getting wiped out on falling asset price falls. This is why nearly 16 million Americans are underwater on their mortgages.
In the mortgage boom years from 2004-2004, it wasn’t hard to get a loan-to-value ratio of 90% or higher with less than a 5% down payment. You didn’t have any equity. But the animal spirits of the housing bull encouraged people to believe prices would just keep going up.
They didn’t, of course. And instead of having equity, most of the borrowers ended up with a big mortgage and a falling asset. This is what soured so many mortgage backed securities and collateralised debt obligations. And the fact that Americans can walk away from underwater mortgages – letting the bank seize back the house, which is the collateral on the loan – in some ways made the financial gamble sensible for people. Maximum upside, zero downside.
You can’t walk away from the loan in the same way in Australia. But that doesn’t’ mean Australians aren’t gambling on higher house prices. Loan-to-value ratios are coming down as banks get more cautious (this restricts new lending as well). But they are still high. And first home buyers remain especially over-leveraged – facing higher interest rates on variable rate loans.
But you know all that. So we won’t yammer on about it. We’re just saying…house aren’t safe as houses, no matter what the RBA says.
So what is safe? Well, as a reader pointed out yesterday, cash isn’t bad. Here’s one response to yesterday’s essay:
I read you latest anti-deflationist polemic today. You raised many good points.
However, you conclude that the beginning of hyperinflation may be deflation.
I think you need to tell your readers that timing is absolutely critical. Because all longs on the inflation trade may well be utterly destroyed and wiped out.
It may well be that as the meltdown unfolds, there will be a sudden and massive asset implosion that will destroy many. In this case, the governments’ RE-actions will be rather slow and ineffective initially. Hyperinflation probably comes AFTER the meltdown. So Prechter is quite possibly right.
To own cash before the governments react to the implosion may well position people to make “once in a century” purchases of hard assets. Those who can time it will do more than survive.
You guys really need to outline several scenarios IN DETAIL, with the time-flows and mechanics in DETAIL.
It’s a good point. We’ll deal with it tomorrow. Although it’s going to be hard to predict the future…in detail. That won’t stop us from trying! Until then.
for Markets and Money