The Housing Bubble Isn’t Finished with You Yet

The American property market is surging. House prices are on the move once more, with one big city index up 13% year on year. Even building permits hit a five year high. And this time interest rates are so low that people don’t just buy houses they won’t be able to afford when interest rates go up; they are also buying $1000 taps to put into their unaffordable houses, reports Bloomberg.

Banks are forecasting next year’s house price gains will only be around half as good. Just 6%. But Reuters reports that it’s not all rosy behind the scenes. Home equity lines of credit are seeing increasing defaults. What’s a ‘home equity line of credit’? It’s money you borrow against the equity in your home. So a second mortgage on the same house

It turns out that many Americans used these loans back before the financial crisis to take advantage of high house prices. Home equity lines of credit are usually ‘interest only’ for the first ten years. Well guess what? The ten year anniversary is coming around for about $221 billion worth of these loans over the next four years. And the additional payments that kick in are hitting borrowers hard – sometimes tripling the monthly payment. The problem is, with lower house prices, people can’t just sell up and walk away. The sale wouldn’t cover the mortgage because they haven’t been reducing the principal over the last 10 years.

Even lenders are running scared, reports Reuters:

‘At a conference last month in Washington, DC, Amy Crews Cutts, the chief economist at consumer credit agency Equifax, told mortgage bankers that an increase in tens of thousands of homeowners’ monthly payments on these home equity lines is a pending "wave of disaster."

The strangest thing is that people didn’t just use the loans to jump into the housing market:

‘Banks marketed home equity lines of credit aggressively before the housing bubble burst, and consumers were all too happy to use these loans like a cheaper version of credit card debt, paying for vacations and cars.’

Credit cards are so yesterday. (We just received our first one in the mail.)

So perhaps the US housing bubble isn’t finished with you yet. When interest rates rise and everyone tries to sell out, we could be in for another disaster.

But it’s actually the Australian housing bubble we wanted to tell you about today. One specific part of the Australian housing bubble that makes it different from every other housing bubble around the world.

Here are two quotes. The first is from the Sydney Morning Herald, talking about the quality of Australian lending standards:

Australian banks should not forget the lessons of the housing market collapses in economies such as Spain, Ireland or the United States, the nation’s banking regulator says. The chairman of the Australian Prudential Regulation Authority, John Laker, last night said the regulator had been engaging "quite assertively" with banks to ensure credit standards did not slip.

Luckily, they haven’t slipped yet according to APRA. But what information is APRA relying on when it says that? The banks’ lending statistics. And those, believe it or not, are even bigger lies than statistics usually are. Here’s the second quote. It’s a transcript from an ABC program last year:

MICHAEL WREN, FORMER FINANCIAL ADVISOR: I got a phone call from a business development manager from Macquarie Bank. This guy rang me up and said the application was going to fail and asked if I had any extra information I could give him.


ACTOR PLAYING MACQUARIE BANK BDM: Isn’t there something extra you can tell me?

MICHAEL WREN: No, everything I said was included.

ACTOR PLAYING MACQUARIE BANK BDM: There must be something more you can tell me to get this loan across the line.

MICHAEL WREN: No, no; it’s all in the application form. It was – all the details are there.

ACTOR PLAYING MACQUARIE BANK BDM: Well you know you’re gonna miss out on your commission.

(End of re-enactment)

STEPHEN LONG: What do you think he was really asking you?

MICHAEL WREN: Stephen, I really – I really hate to, hate to, to guess what was in his mind, but it was fairly clear that he wanted me to say something about their assets and income that wasn’t true that would enable him to then value their assets and income differently and to approve them as candidates or clients for this investment.

Sure, Australian current affairs TV shows are a questionable source. But it turns out this isn’t an isolated story. Court cases, Financial Ombudsman determinations, Credit Ombudsman decisions and settlements outside of courts have all found mortgage brokers and bankers fiddling with the data APRA relies on when it says ‘Australian lending is prudent’. Heck, an Australian Broker poll found that 85% of mortgage brokers claimed banks encouraged fraud pre-GFC. Does anyone think that fraud isn’t going to bite at some point?

The genius of the story is that there is no data that says there’s a problem. The manipulation occurs on the very first document that exists regarding the quality of the loan. So an unknown proportion of Australia’s loans are sub-prime but masquerading as prime. It’s a secret sub-prime crisis.

That APRA, ASIC and the rest of the court jesters are ignoring this basic fact is going to be damning when it gets out. When they say nobody predicted it, our blood will boil. If the ABC can figure it out…

The good news is that Australia’s property system is so arcane that document manipulation can end up being reason enough for a court to cancel a mortgage. Hundreds of borrowers who find that their lender misrepresented their borrowing capacity are cancelling their loans! And they get to keep their homes.

Hopefully the banks will continue to take the hit on all this rather than borrowers having to foreclose. That’s what we’ll be talking about at the Mises Seminar this weekend. Say hello if you’re going to join us.

But, chances are, the government will have to step in if the amount of people cancelling their mortgage surges. By the way, our Money for Life Letter guide on how to find out if you can cancel your mortgage is still available to subscribers. You can find out more here.

Of course, even without the statistics being manipulated, housing in Australia is looking frothy. 14% of loans in the September quarter had a loan-to-valuation ratio of 90% or more. The banks are reaching for marginal borrowers. And after they’ve reached them, who’s left to push up house prices by borrowing more? Nobody.

And there’s a reason they’re pushing mortgage securitisation these days – they don’t want to be on the hook for their poor lending.

At some point the crowded theatre story will kick in. Those who had their borrowing capacity fudged will leave the housing market first. It will spook a few investors into selling. And that will spook even more, until eventually everyone charges for the exit at once. The effect on the Australian economy could be horrific.

We’ve never understood speculating on house prices in the first place. After inflation, tax, interest, costs and adjusted for the incredibly dangerous risk of house prices falling, it seems like a terrible deal. Unless you can make your mortgage disappear. Then it’s a terrible deal for the bank.


Nick Hubble+
for Markets and Money

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Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like.

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