Given the huge numbers of Irish who’ve chosen to emigrate to Australia, we continue our watch on its housing bubble, which has seen prices run up three times higher than wage inflation over the past decade, while Australia’s central bank slashed interest rates. The market continues to follow a trajectory eerily like the Celtic Tiger when property was ‘your only man’, credit terms were slack and borrowing costs were a mismatch to Ireland’s heated market.
The Reserve Bank of Australia, unlike the Irish Central bank, has had control of interest rate policy but has manoeuvred itself into a trap. If it cuts rates to give support to a softening market it stokes the bubble, if it raises rates it could trigger a fearful market rout and a bank collapse given that its top four banks have variously between 40% and 50% of their housing loans out on an interest only basis.
The Australian regulator’s requirement for its banks to price up interest only debt, in theory over several years, ought to assist bringing these nose bleeding ratios down, but slow wage growth looks like a show stopper. A sustained burst of real wage inflation is the only way out and there is little sign of it just yet in most developed economies, a theme we will turn to in a follow up piece.
In a classic bubble pattern, the penultimate phase is characterised by a soft-landing hypothesis promulgated by insiders, hoping to talk back up a market dip. By that measure it has started as ‘experts’ line up to reassure buyers that the current decline in prices in key markets like Sydney, whose home values have shot up 74% since 2012, is a mild correction before low single digit growth next year. A cooling of the housing market, however, is more likely to presage a structural problem and not a temporary cyclical dip in prices based purely on the gap between wage growth, runaway house prices and bank exposure to mortgages that have zero capital repayments.
The UBS report this week tracks -0.6% turn in Sydney prices in the third quarter, accelerating -0.5% in the last month. This resonates with falls in Darwin of -4.4% and -0.7% for Perth, while Melbourne rose 2% over the quarter but UBS reminds readers that the slowdown ends 55 years of home value growth. Australia itself hasn’t experienced a recession, defined as two quarters of back to back negative economic growth, for 26 years.
Australians, for the most part, have no folk memory of either a recession or a burst, but neither did the Irish, the Swedes, the Canadians and many before them, it just didn’t seem possible, until it happened. Each time incumbents, determined to keep the party going, believe that this time is different, that economic gravity can be defied.
As the market turns for the first time, they are reaching into the old bag of tricks; it is different because there is demographic support, because the population is growing, it is different because the economy is doing ok, it is different because the regulator has finally tightened credit, it is different because real wage growth is near, because the banks are sound, because next year looks great, because there’s plenty of land.
The truth is very different. As soon as the ‘soft-landing’ drug wears off, when consumers see that the temporary fall in prices heralded by experts isn’t temporary but is continuing, that there is no bounce, that canny and seasoned long-term investors are quietly selling, the psychology can shift dramatically. When market prices are so high relative to income capacity, when the four main banks have pushed interest only debt to nearly half their loan book, when the interest rate cycle turns, all it takes is a match to light the dry timber of the pyre.
Tighter credit conditions in China is removing some market support as the movement of funds towards Australian housing developments cools quickly. Chinese investors are thinning. Heavily leveraged developers sitting on undeveloped sites are getting nervous, looking for exits. As soon as players begin to perceive that next year’s prices will be lower it becomes a self-fulfilling prophesy, that’s when stoic banks turn panicky, pull credit and the final phase commences, the market rout.
Is a collapse baked into the cake at this point, is regulatory action targeting interest only buy-to-let loans too little too late?
No one knows for sure, but next year will be crucial. If Australia rides it out with flattened prices and very many years of real wage growth, it will make a textbook classic on how to manage a near burst -but if not, Australia may become the biggest OECD country to require an IMF bailout since Britain over four decades ago.
A really bad outcome Down Under might cause a contagion in other elevated markets and is the stuff of an economic Halloween. Light a votive candle for the Australians and for heaven’s sake tell any friends and relatives there thinking of jumping into the market, to take a cold bath.
If you’d like to discuss any aspects of the above please do give us a ring on 045 409364 or email firstname.lastname@example.org.
Eddie Hobbs, Nov, 2017
This month exclusively available from www.jackandjill.ie Eddie Hobbs book, The Pivot, is available to pre-order and is about the excess debt in the global financial system and how to prepare Plan B.
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