The House of Cards

The statistics are startling. Australians are carrying more personal debt than ever before. For every one dollar earned, on average, Australians have nearly two dollars of debt. We hold the dubious position of having the second highest level of household debt in the world. Much of this stems from our obsession with buying real estate.

Four Corners ABC, Monday, 21 August 2017

On Monday night, the Four Corners program on ABC ran a story called ‘Betting on the House’. It told a tale of two Australians.

There’s the east coast…and the west coast.

In Sydney, hopefulness ranged from cautious to unbridled optimism.

In Perth and surrounding areas, pessimism reigns supreme.

The program interviewed highly-leveraged property investors in Sydney.

One fellow had 25 properties, and a couple had five (with two more on the way). Both parties were eagerly looking to buy more.

My guess is that they were all under the age of 40.

How is it possible to amass property portfolios of this size?

A total reliance on debt and perpetual growth.

Provided the value of the properties continue to increase, sufficient equity will be created to secure further borrowings.

The loans are either ‘interest-only’ or ‘principal and interest’. In either case, none of the loans are being paid off.

In the early years of a principal and interest loan, precious little goes towards loan reduction.

Therefore, borrowing capacity is only available if the value of residential real estate continues to grow.

The east coast ‘wealth creation’ strategy is: Use equity to borrow, sit back, wait for prices to rise, use increased equity to borrow more; rinse and repeat.

The couple with the five properties happily shared the fact that they’re in debt to the tune of $1.2 million. The value of their properties amounts to $1.5 million. And they have two more highly-geared property purchases in the pipeline.

All that’s needed is a 10–20% downturn in the market, and their $300,000 equity will be dust.

On the east coast, belief is so strong that markets will never go down.

Over on the west coast, it’s a different story. The glory days of the mining boom are long gone.

The once buoyant property market has fallen hard. Four Corners attended an auction of a home that previously sold for $2.6 million.

It was passed in for $1.6 million.

An older couple (I’m guessing in their late 60s) spoke of their financial stress. A result of gearing up into residential property during the boom.

Why they agreed to be interviewed, I don’t know. It was heartbreaking to watch. They told of sleepless nights. Constantly worrying about the bailiff knocking on the door to evict them from their home.

What seemed like a good idea at the time has become their living nightmare. That one decision — based on the mistaken belief of ‘what has been will continue to be’ — has cost them their life savings.

Others in the west had their own tales of woe, battling to make ends meet in a tougher economic environment. The burden of servicing a mortgage and rising living costs was taking its toll.

The two Australias were worlds apart.

The program reminded me of the old saying ‘There’s no new way to go broke…it’s always too much debt’.

Perhaps Sydney is different because its economic base is more diverse…not so reliant on one sector. But no market is immune from a downturn. In fact, the more you believe that a market is unique, the more vulnerable it is.

Creating Instability

Stability creates instability. People take on more risk. They feel safe in the belief the trend will continue without disruption.

That’s a dangerous assumption…especially with the bank’s money.

Several years ago I wrote a book to my daughters titled A Parents Gift of Knowledge.

The book was part of my efforts to provide them with financial literacy.

In one chapter of the book, I warned them about the perils of too much debt.

This is an edited extract:

Control Debt otherwise “the tail will be wagging the dog”…

“Debt is like any other trap, easy enough to get into, but hard enough to get out of” — Henry Wheeler Shaw…

When it comes to debt you must and I stress must, remember that banks make their enormous profits from keeping people on the debt treadmill. 

The banks, credit unions, mortgage brokers etc. only stay in business because people borrow money. At all stages of your life these peddlers of debt will try to entice you into taking on more and more loans. You will receive flattering letters in the mail proclaiming what a fine upstanding person you are and how they would like to offer you an upgraded limit on your credit card or personal loan or increase your home equity loan. 

An unkind analogy would be to liken the banks’ operations to those of drug dealers, they get you hooked on debt and those who cannot resist the flattery or temptation end up dependent upon the goodwill of the lending institution to feed their debt habit. It is only when you have loaded up with too much debt and you lose your job or the economy gets tough the lending institution then says “we want our money back”. If you cannot meet their demand for repayment (in part or in full) the next step is receivership (bankruptcy). 

The lending institutions have a valid place in society, but you MUST, MUST borrow wisely and err on the side of being conservative and avoid becoming a “money slave” to the banks.

The four biggest companies in Australia are banks.

Unlike BHP or Rio, the banks produce nothing.

The banks facilitate — for very generous fees and margins — the shuffling of money.

The size of our banks is a reflection of our debt problem.

Don’t get me wrong; banks play an important role in society. We need strong banks. But this continual pursuit of growth — higher and higher lending targets — makes our banks weaker in the long run.

The major banks have around 60% of their balance sheets exposed to residential real estate. It won’t take much to shake the foundations supporting these pillars of society.

All that’s required is for people to change their attitude towards debt, and it’s game over.

What could possibly disrupt the bulletproof east coast property market?

Another collapse on Wall Street. China being forced to deal with its own debt crisis. Wage suppression. Job losses. Interest rate increases.

There are any number of triggers that could destabilise a highly-unstable (and heavily-indebted) market.

This week in The Gowdie Letter, my advisory service, I questioned the premise of our belief in perpetual growth. A belief stemming from our willingness to go deeper and deeper into debt.

Here’s an extract:

Like any Ponzi scheme, this driver of artificial economic growth must have its limits. Even if every household in the world borrowed as much as they could afford, eventually you’d run out of households that can borrow. That logic seems to escape the architects of this debt-funded growth model.

Investors in Western Australia have learnt the hard way about what happens when people decide ‘enough is enough’ and lose interest in borrowing to invest.

That even harder lesson is coming to the east coast. When it does, it won’t just be the sky-high property prices that come crashing back to Earth.

Bank shares will also be hit hard.

Given that our banks dominate the All Ordinaries, the Aussie share market would also suffer major losses.

When you join the dots, the Four Corners program should have been titled ‘Betting on the House of Cards’.


Vern Gowdie,
Editor, The Gowdie Letter

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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