Property Market at “Inflection Point”

Oh goody goody goody. The housing finance numbers come out today from the Australian Bureau of Statistics. Yes. It's geeky. You'll have to forgive us.

In fact, so eager are we to see whether borrowers are borrowing and lenders lending that we considered holding up publication of today's DR until the report is released at 11:30 in Canberra. But as we were late with yesterday's DR due to a server crash, we're going to push on. Full results from the housing survey in tomorrow's episode.

Also, we're going to pass on commenting about yesterday's interest rate decision by the RBA. If this were a limbo contest, the Bank could still go lower. But as it pointed out in the statement accompanying the announcement that the cash had been lowered to 3%, "There has already been a major change in both monetary and fiscal policy in Australia. Market and mortgage rates are at very low levels by historical standards and business loan rates are below recent averages."

Translation: "There. We've done our bit. Over to you economy."

So where does that leave us today? It leaves us with a lot of volatility, that's where it leaves us. "With so much economic volatility," writes Dr. Marc Faber in his latest Gloom, Boom and Doom Report, "business operators avoid making any long-term capital spending commitments as the profitability of investments is highly uncertain."

Dr. Faber was writing a fictitious history of the decline of a Great Empire. He explained how during this collapse, "the absence of any transparency and consistency in the government's interventions, and of clarity about the outlook for the economy and asset prices, had-aside from increased volatility which favoured aggressive traders and large speculators-another consequence."

Investors refrain from taking long-term positions because there are so many known unknowns and even more unknown unknowns (although we conceded it is hard to put a number on the number of unknown unknowns, given their unknown nature, if you know what we're saying).

And then the misery compounds. "The collapse in capital spending was aggravated by the existence of enormous excess capacities, which had been built during the previous years when interest rates had been artificially low. Needless to say, with consumers hibernating due to their large debt burdens, declining capital investments had an additional negative impact on the economy."

Over in the real Great Declining Empire, there is definitely some hibernating going on. People are using their credit cards a lot less. Revolving credit use (credit cards) fell by US$7.8 billion in February. That's an annual pace of 9.7%. It was the biggest monthly decline since January of 1978.

Hmm. Fear?

Even industrial strength users of credit are kicking the habit. "The Federal Reserve's requests from borrowers for loans to buy asset-backed securities fell 64 percent from last month as investors balked at visa limits and possible political efforts to tax earnings," reports Bloomberg.

The Term Asset-Backed Securities Facility (TALF) is one of the Fed's many new credit addiction programs designed to make borrowing more appealing to investors, and to thaw out the market for asset-backed securities. It's not working. Or at least it's working less well. More on the Fed's assumptions about markets and prices below.

First though, we missed an article earlier this week about an insider's view of the Australian banking industry and property prices. In an article in Monday's Age, ANZ chief economist Bob Edgar says, "The reality is the banks are still expanding their lending, and I can certainly say in respect of ANZ there has been nothing decided from a policy perspective on lending less to property...But when you go through a risk assessment you would have to be a bit of a fool wouldn't you [not] to have some anxiety about property."

Anxiety about what? That things might change? And not for the better?

"We are at an inflection point on property for sure," Edgar continued. "Now I'm not creating or predicting a disaster [but] ... you would be very foolish to not say that conditions going forward are going to be tighter [than] what we have had for the last decade. What I would say is property developers probably should use less of a rear-vision mirror and more of a windscreen view of their projects going forward. Think about the conditions we see ... rather than the good times."

Banks are already preparing for a property smash up, according to the Sunday Morning Telegraph. "Mortgage lenders are slashing loan ratios (LTV) in a bid to protect themselves against falling house prices. In the past fortnight, Commonwealth Bank, Bankwest, ING, Challenger, Citibank and Suncorp have all cut their maximum loans from 95 per cent to 90 per cent of the property value - and may cut further. ANZ cut its maximum loan to 90 per cent last November. The move is designed to ensure the bank can recover the loan value, if the house has to be sold in the event of a loan default."

Why do this? The banks are cutting LTV ratios now so price falls don't result negative equity for leveraged borrowers. It's also banks just being a wee bit more prudent.

Finally, an academic paper from economists at Harvard and Princeton concludes that Ben Bernanke has it all wrong. The paper-called The Pricing of Investment Grade Credit Risk during the Financial Crisis by Joshua D. Coval, Jakub W. Jurek, and Erik Stafford-concludes that, "recent credit market prices are actually highly consistent with fundamentals.

"A structural framework confirms that bonds and credit derivatives should have experienced a significant repricing in 2008 as the economic outlook darkened and volatility increased. The analysis also confirms that severe mispricing existed in the structured credit tranches prior to the crisis and that a large part of the dramatic rise in spreads has been the elimination of this mispricing.

Hmm. This means the entire Fed/Geithner effort to restore normal pricing to credit markets is based on the wrong assumption that pricing is abnormal. It's not! The assets are just not worth as much as anyone on the bank side of the ledger wants to believe.

Perhaps this is why the Times of London is reporting that the IMF will raise its estimate of losses from the bad bank assets to US$4 trillion when it releases its report on April 21st. Not that IMF forecasts have not been terribly accurate up to now. But this would represent another $3 trillion in losses on top of the $1 trillion already realised (and offset with about a trillion in new capital raisings and government injections.

Some of the other conclusions from the academic report? It concludes that, "many major US banks are now legitimately insolvent. This insolvency can no longer be viewed as an artifact of bank assets being marked to artificially depressed prices coming out of an illiquid market. It means that bank assets are being fairly priced at valuations that sum to less than bank liabilities."

The bailouts, it concludes, are just a big transfer. Even the efforts to bring buyers and sellers together in the credit markets don't work. The paper says that "any taxpayer dollars allocated to supporting these markets will simply transfer wealth to the current owners of these securities."

And finally, the friendly people from the government are only making it worse. "Policies that attempt to prevent a widespread mark-down in the value of credit-sensitive assets are likely to only delay - and perhaps even worsen - the day of reckoning."

How long can Team Obama prevent that day from dawning? And how long before investors get wise to the Fed and get out of the markets? More on that tomorrow.

Dan Denning
for The Daily Reckoning Australia

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