Housing bubble has RBA backed into the corner

If you can believe the real estate spruiker, emergency low interest rates have put a fire under Australia’s housing market. And as Australia already suffers the side effects of a large housing bubble developed over the past decade, investors will need to use extreme caution as signs emerge Australia’s central bank has just lost control of monetary policy.

Housing bubbles around the world were created early last decade by an abundance of cheap credit, the very same conditions present today. Government policy from both sides prevented a long overdue correction in our overheated housing market (‘PM appeals in vain to the shafted generation’), but the effects of an unsustainable domestic economy persist and have forced the RBA to drop the official cash rate to an emergency low of 2.50%, a level not seen in 60 years.

A change to the official cash rate has, to date, had little stimulatory effect. In the years leading up to the global financial crisis, Australian households had consumed more than they earned and accumulated debt at alarming rates. The collapse of Lehman Brothers five years ago – last week, signalled a new age in Australia where prudent households used falling interest rates to pay down their debts at a faster pace.

Data from the RBA last week suggests between 50 and 90 per cent of the 2.25 percentage point savings on interest rates have been used to make prepayments on mortgages around the country and goes some way in explaining why retail spending remains in the doldrums. But not everyone has mortgages. The falling cash rate has also had a significant impact to savers with money in the bank, especially retirees who now have less income and have been forced to cut back on spending putting more pressure on a deteriorating domestic economy.

Investors’ lead Mortgage Credit Growth

In recent months there has been an up-tick in credit growth for residential mortgages. According to AFG, Australia’s largest mortgage broker, investors comprise of 36.7 per cent of new home loans in August. In contrast, first time buyers now make up only 11.3 per cent of the market.

In NSW last month, investor loans made up a unprecedented 49.5 per cent of mortgages processed – the highest level of investor activity ever recorded for any state according to AFG.

AFG’s General Manager of Sales and Operations, Mark Hewitt says “With property prices starting to rise, and rates set to remain low for a while yet, a lot of investors are anticipating the next property cycle.”

Wealth Disaster

For some investors, the tiny returns on cash have ‘forced’ them to seek greater yields in the property market. It is believed a reasonable portion of the investor activity is the Self-Managed Superannuation Fund (SMSF) sector. In September 2007, legislation came into effect allowing SMSF the ability to leverage up to purchase property in the fund.

Led by endless number of “super” spruikers (‘The stampede into property by self managed super funds is a risky business’), Mum & Dad SMSF investors are being coaxed into investment structures they don’t understand and this has led many experts including the regulators to worry about this growing trend. For those that know what they are doing, they have worked out there is only one thing more tax effective than negative gearing, and that’s investing in property through their SMSFs.

Loans in SMSF must be non-recourse, but depending upon the diversification of the fund, some super funds could lose substantial wealth if Australia’s property bubble were to correct. This no doubt would anger younger generations who are not only locked out of housing, but will be paying increased taxes to fund the pensions of those who will have recklessly lost their superannuation.

Currency Wars: USA 1, AUST 0

Capital inflows from the mining boom and the perception Australia has a miracle economy has seen the Australia dollar surge in recent years. The persistently high Australian dollar along with high energy and labour costs have made Australia uncompetitive on a global stage and have been slowly hollowing out the Australian economy. According to the ABS, jobs in the manufacturing sector are now at its lowest level since records started in 1984. The story is not much better in retail and tourism. Rising unemployment could be a real challenge for a housing bubble built upon perceived perpetual growth.

A decision by the US Fed this week not to scale back their 85 billion a month stimulus program sent the Australian dollar back over 95 cents. The RBA has a target to bring the Australia dollar down to 85 US cents and this may force the hand of the RBA to further slash interest rates in the coming months to bring the Australian cash rate closer in-line with world interest rates, and prevent a greater inflow of capital into Australia, causing rise of the Aussie.

“It’s a disaster”

If the residential property market is “hot” now, can you imagine what another rate cut or two will do to it?

Robert Mead, Pimco’s head of portfolio management in Australia calls it a disaster. He told the AFR, “If the only impact from stimulatory policy elsewhere in the world is to inflate our residential prices, it’s a disaster,”

And how far will the RBA go to hit their target of 85 cents?

Tony Adams, Colonial First State’s head of global fixed interest rates and credit told the AFR, “The RBA is after 85c but I don’t think they are going to get there.”

Macroprudent Controls

So, it was quite timely for the International Monetary Fund (IMF) on Monday to release its report titled “Key Aspects of Macroprudential Policy.”

In announcing the report, José Viñals remarked “Policymakers learned the hard way that systemic risks could not be addressed through the traditional mix of macroeconomic policies”

“A new approach was needed to fill the policy gap and ensure financial stability in both advanced economies and emerging markets.”

Following the move by New Zealand’s central bank in August to clamp down on risky lending (‘RBNZ takes action to limit damage from housing bubble’), there has been some discussion if the same policies should be applied here. The Australian Prudential Regulation Authority (APRA) has written to banks warning about relaxing lending standards (‘With record low rates and pent up demand fuelling prices, APRA’s putting lenders on notice’), while it works out how to best proceed.

The banking lobby has naturally fired back, suggesting any tightening of lending will push first home buyers out of the market, not that there are many left! Applying Loan-Value-Ratio (LVR) limits on mortgages may also have little effect with SMSFs who are only able to borrow up to 80 per cent. Maybe the correct course of action is to reverse legislation allowing super funds to leverage into the property bubble? But if negative gearing is a sacred cow, one wonders if allowing super funds to leverage into asset bubbles will also be untouchable?

Who is going to act first? Time is ticking.

» The stampede into property by self managed super funds is a risky business – The Business (ABC), 17th June 2013.
» Mortgage Index September 2013 – AFG, 2nd September 2013.
» With record low rates and pent up demand fuelling prices, APRA’s putting lenders on notice – The Business (ABC), 11th September 2013.
» IMF takes aim at housing bubbles – Australian Financial Review, 17th September 2013.
» RBA watchful as cheap money heats housing market – The Australian, 18th September 2013.
» Regulators should target loan serviceability to head off trouble – The Australian, 19th September 2013.
» Australian dollar climbs to three-month high and shares jump after US Fed maintains stimulus – The ABC, 19th September 2013.
» Home owners use interest rate cuts to pay down mortgages – The Age, 20th September 2013.

» IMF Executive Board Discusses Key Aspects of Macroprudential Policy – International Monetary Fund, 16th September 2013.
» Making Macroprudential Policy Work – International Monetary Fund, 16th September 2013.




14 Comments

  1. People’s eyes are indeed bigger than their stomachs, wallets, salaries, and bank accounts (if applicable). Help me from this foresaken world if their eyes are bigger than their credit cards too.

    I can’t fathom this, all of this. With lower interest rates, you’d think people would exclaim, beauty! I’m going to pay down as much debt as I can before an increase, or just for my own peace of mind”. No! they get into more debt, and if possible, use their retirement savings for an investment property! That was someone’s brilliant idea.

    If the RBA, banks,… are serious about debt being repaid, then increase interest rates. Guess it doesn’t matter now, what ever the age group, many will be shackled by their own decisions. So many of them, it does effect everyone else too.

    I must be living of the planet Stupider.

  2. Quoted from MB comments:

    “Can’t blame the average punter. They were all in shares when the GFC happened, then all in cash as rates fell, now they’ll all be in property when the bubble finally bursts. Herd mentality and lack of financial literacy. Also, they’re all lazy and won’t invest in anything that requires work or thought on their part.”

  3. With Hockey and Edey both coming out to emphatically deny that a bubble exists both the govt and RBA have committed themselves to driving it even bigger it would seem. (They will be the patsies I assume not the PM or Governor)

    If they both sit on their hands for too long this economy and country will be toast and retirees will have blown their SMSF and will not be able to comprehend their futures.

    I mean Jeez! Even Christopher Joye knows that 6 months ago it was manageable declines possible, now even he is getting extremely concerned.

  4. Australians are as dumb as dogshit when it comes to Real Estate.

    You cannot rationalise with your average Aussie punter as our obsession with everything RE has now become a religion – the masses are ignorant and blinded by greed.

    Period.

    The only way for this to end is to let the bubble inflate to such an extreme that collapse becomes inevitable. We are already well on the way, no turning back now.

    And once we get our inevitable collapse lessons will be painfully learnt.

    There is NO OTHER WAY for this debt fuelled party to end.

  5. @ Big Bubbles
    “The only way for this to end is to let the bubble inflate to such an extreme that collapse becomes inevitable. We are already well on the way, no turning back now.”

    Could not agree more, hopefully the dollar stays resilient and the RBA keeps dropping and the bubble expands at a faster rate, all this while Darth Stevens and Wing Nut keep their heads in the sand. (or maybe they know this is the only option left they have, going all in on the bubble)

  6. @Big Bubbles

    Couldnt agree more with you. I thought the US was bad but that is nothing compared to Australia. Its a ticking time bomb…… the sad thing is bankruptcy in Australia is lot different then the US bankruptcy laws…… From my understanding in Australia you still have to pay the debt off…. is that correct

  7. @LBS

    You have to pay off your debts in the USA also… in 46 of the 50 states. That little nugget of disinformation has made the rounds in Australia and seems to have taken on a life of its own…

  8. I agree with the above comments, and with Big Bubbles, but remember, we are different here in Australia. I’m not being facetious. Our government will do ANYTHING to maintain the bubble. I don’t know whether governments in other countries put as much a priority of keeping the bubble inflated as our government and RBA does. Hence we have the massive immigration, the unrestricted foreign investment, negative gearing, use of super to buy, the low interest rates (which other countries have too) and the constant spruiking wherever we turn. In the past few years, when the bubble has shown the smallest signs of deflation, the government has become adept at propping it right back up again, even higher than before. And it doesn’t matter who’s in power – both sides are absolutely committed to the bubble.

  9. The big test will be to keep all the balls in the air as mining jobs go and the supporting jobs with it.

    China cannot keep braking and accelerating on the credit pedal, soon it will be out of petrol and the best they can muster is keeping it running at low tank levels.

    The govt and RBA were lucky after the GFC, this time around is going to be much harder, if we head into recession it could be a big one with the 22 years without one and the excesses accumulated.

    Over here in the west we have nothing left from the Massive Boom already!

  10. @ Minsky

    Yes! Yes! Yes! If I had a hot dinner for every time I’ve been howled down about that I would be bigger than Clive Palmer!

    And yes, the debt does follow. Bankruptcy does NOT mean your debts are simply wiped. Sure somethings can be worked out, but the consequences are not worth it.

    My ability to borrow is precious….and will get used when the time is right.

    Fearful when others are greedy and greedy when others are fearful……

    Aussie’s are like lambs to the slaughter…Sorry, slaves to their masters…..When this all falls apart, minimum wage will be damn attractive to a large percentage of the population.

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