The Aussie economy is built on property
House prices fall. That line alone used to earn us plenty of derision and hatemail.
But now, everyone is asking themselves how far they will fall.
According to The Age, Macquarie Bank expects property price declines of between 15 and 20% in Sydney and Melbourne.
AMP Capital predicts a 20% fall in the two cities between now and 2020.
Investment bank Morgan Stanley sees a fall of 15% in Australia-wide house prices.
I think all three are wrong. Because falling house prices will trigger catastrophic effects. A 20% decline is just the beginning. The initial shock.
The trouble with a bubble is that it relies on self-sustaining momentum. The expectation of gains at the end of the bubble is based on past gains, not fundamentals. That sucks in the very weakest sort of investor at the end.
Financial ruin is looming
When the worm turns, the marginal seller is a panicked seller.
A seller who relied on gains becomes a seller at all costs when those gains end.
And that gives you the nature of the crash which follows – the panic.
Because property is tied to debt, the fear becomes far worse than in other asset classes.
Property owners can lose more than their initial stake in property by going into negative equity.
Not only can retirement dreams and self-managed super funds be sunk, but financial ruin looms for interest-only buyers and anyone who bought recently.
Think about it like this…
The people who relied on the ability to sell their property to repay their debt are forced to sell when prices turn.
And the Royal Commission has exposed there may be plenty of those.
People who can only afford their debt on paper – the paper submitted to the bank by their mortgage broker.
And those who borrowed interest only-loans too. Which is a huge portion of Australia’s mortgage market. The ABC reports:
‘Over the next three years, interest-only loans worth a combined total of about $360 billion will roll over to interest plus principal — and that means borrowers will face higher repayments.
‘The kind of nightmare scenario is where a lot of people need to sell at once, and that’s when you see a kind of fire sale mentality, and could see very significant downward pressure on prices,’ said Professor Richard Holden from the University of New South Wales Business School.
‘That puts the banks under stress, and their balance sheets under stress, and it could lead to significant financial instability.’
Six months ago, Professor Holden said there was a risk the Australian housing market could face a US-style meltdown, and he maintains there is a risk that downward pressure on prices could lead to financial instability.
My point is, the housing bust has barely begun. Once the selling begins, it becomes self-reinforcing, just as it was on the way up.
News.com.au explains why in household terms:
‘HUNDREDS of thousands of Aussie households face a $7000 hike in home loan repayments as new rules bite hard, and it could cause trouble across the whole economy.
‘Every year for the next three years, up to an estimated 200,000 home loans will be moved from low repayments to higher repayments as their interest-only loans expire. The median increase in payments is around $7000 a year, according to the RBA.
‘Interest-only are known as riskier loans, but they became a big deal in Australia quite recently. In 2015 it reached the point where nearly 40 per cent of new home loans were interest-only. Borrowers weren’t paying back the money they borrowed (the principal), just the interest.’
Not only are these people facing higher interest bills, they haven’t built equity. And likely have negative equity by now given the declines.
The Age has this to calm your nerves: ‘APRA data also show that only around 18 percent of new housing debt in Q2 2018 was close to the largest loan size allowed, 90 per cent or more of the maximum. This is not an indication of severe credit curtailment.’ It sounds like a frightening amount to me…more than enough to trigger a plunge.
The 20% drop that investment banks are forecasting only takes house prices back to 2015 levels, thanks to the surge in prices recently. Which makes me worried the drop has to be far larger before the mortgage market clears out those who have to sell.
Don’t forget, it’s not just property that’s at stake. Other forms of wealth linked to property are, too. Banks make up a huge chunk of our super holdings. Additionally, our wealth is largely held inside the financial system.
The Aussie economy is built on property
But it’s not just wealth that’s in trouble.
Australian financial services are about 9% of our economy – the biggest single sector…for now. 4% of Australia’s workforce is in the sector, and they’re paid well. They contribute a disproportionate amount to taxes and consumption. And property investment…
For now, the media claims there is no issue. Unemployment is very low. So people will continue to pay back their mortgages.
This is bizarrely ignorant. The Royal Commission’s discoveries show how employment is not the issue. Whether you can or can’t afford your mortgage and have to sell out is not just determined by your job. It is determined by how much debt there is.
If income figures had to be falsified en masse to get loans past lending standards, then the problem is too much debt, not the lack of jobs.
The surprise factor in all this was always going to be Chinese demand. When I lived in Melbourne between 2010 and 2014, I used to drive past the clusters of Chinese auction bidders each Saturday. Apparently, their numbers have halved since.
Source: Macrobusiness blog
There will be no Chinese rescue this time.
Until next time,
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