Financial System Inquiry: Housing has become a significant source of systemic risk

The Financial System Inquiry’s Interim Report released yesterday confirms what we already know – Australia’s tax system is broken as it encourages risky leveraged and speculative investment that will one day come back to bite Australia hard and “compromise the speed of a subsequent recovery in economic activity”.

The report takes aim at negative gearing and the fifty percent capital gains discount that when combined has seen Australian households take on significant unsustainable leverage since 1999.

“Certain tax and regulatory settings distort households’ saving decisions towards housing, for both owner-occupiers and investors. Tax incentives also encourage investors to use more leverage than otherwise might be the case. Since the Wallis Inquiry, the increase in housing debt and banks’ more concentrated exposure to mortgages mean that housing has become a significant source of systemic risk”

The report indicates that increased finance to the unproductive housing sector may crowd out funding for other more productive sectors such as business at the detriment of the Australian economy.

It also goes some way to model and explain the possible consequences:

Housing is also a potential source of systemic risk for the financial system and the economy. Since the Wallis Inquiry, the increase in households’ mortgage indebtedness has been accompanied by banks allocating a greater proportion of their loan book to mortgages; the share of loans for housing has increased from 47 per cent in 1997 to its current share of 66 per cent. A large enough disruption to the housing market could have significant implications for household balance sheets, financial stability, economic growth, and the speed of recovery in household spending and broader economic activity following a shock.

As discussed in the Stability chapter, the FSI Secretariat conducted an analysis of a number of scenarios (Box 5.3). One of the scenarios considered the effect of a shock that resulted in a sharp and prolonged fall in house prices. In this scenario, household wealth would contract and there would be broader and, potentially, long-lasting effects on the economy and financial system. A sharp fall in house prices could push some households into negative equity and would amplify financial distress associated with any broader economic downturn. Deleveraging, combined with lower consumer confidence, would weigh on household consumption and broader economic growth. The extent of the damage to households’ balance sheets would determine, to a large degree, the speed of recovery of household consumption.

An extreme shock of this nature would also affect the quality of banks’ balance sheets and their capacity to extend new credit. This would include business lending, particularly for small businesses — which tend to use housing as collateral. Offshore wholesale funding would be likely to become more expensive and some banks might find it more difficult to raise funds, which would exacerbate pressures on the cost and availability of bank credit. Overall, the deterioration in bank balance sheets would compromise the speed of a subsequent recovery in economic activity.

» Financial System Inquiry Interim Report – Commonwealth of Australia, 15th July 2014.
» Call to ban borrowing by super funds – The Business (ABC), 15th July 2014.


  1. Mortgages might represent 66% of banks loan books but I bet the other 34% is lent to businesses that build houses.
    When this whole thing blows sky high we can forget about debating balance sheet repair, negative equity and funding pressures because the real debate will be about unemployment north of 20%, systemic poverty, mass evictions, bank failures and the decimation of super funds.

  2. @Michael +1

    Except for mass evictions. Someone will restart the Unemployed Workers Movement from Australias 1930’s depression. Members of the Unemployed Workers Movement all rallied together to prevent the sheriff from seizing homes or evicting tenants.

    The government hasn’t yet considered the civil unrest that will result from its flawed policies.

  3. This commentary puts into context the idiocy of this government and to be fair all previous governments. A house of cards has been created that will soon come crashing down.

    Well over 50% of economic activity in Australia is related to financial services. GDP growth has been a con as financial transactions are included – Australia has been an economy whose growth has been based on an expansion of debt as a ‘positive contribution’ to GDP.

    I don’t know about ‘may’ but it seems to me that as over 60% of national assets are non productive ones – housing (UK is around 20% and US 15%) we have already had that ‘crowding out’. This has been in combination with the effects of the high dollar.

    The idiot neo liberal economic types warned of the so called dangers of public debt crowding out private debt as public debt is so irrational and private debt is rational as individuals always make such rational and well informed decisions. As consequence we have clapped out and inadequate public infrastructure and a private debt mountain that feeds through as higher wage demands, higher rents and increases the cost of living. The whole scam of privatisation and reduced public infrastructure is also becoming clear.

    The mis-allocation of investment and the debt problem is now so big politicians are ill equipped to deal with it. All seem capable of doing is kicking the can down the road and creating an imaginary public debt crisis so they can bully and impoverish the weak in our society.

  4. It is not a surprise to the read the contents of the report. However, it is a bad sign that such report comes too late when OZ is deeply doomed to the imminent crisis, a stumble that may never allow the lucky country to get up again…

  5. Most of the leveraging has been by investors who have already paid off their homes. If they lose a few investment properties as a result of a property crash it doesn’t matter as they will have the equity to pay off the banks. They will all be okay. It is the families that have taken on debt without a choice that will be the worst hurt. The buildings keep going up in Brisbane and they keep selling, so either it’s the property investors or foreign buyers as no first home buyer or young entrant family can afford property. I hope the govt has a good pension and medical budget stored for the boomers when their housing market goes pop

  6. @Pete

    Government have their options

    Some big business have spent some time prepping

    Haven’t you seen the razor wire going up around airports electric sub stations watre..

    Only place it use to be in oz was around prison


  7. @FHBdreamer,

    Can’t see during a property crash how investors would be ok if they lose a few properties. On mass everything they are servicing would be worth far less. And that’s assuming they can off load their investments. Would you buy at the top of a crash? Who would buy?

    Nor would I assume that investors have “already” paid off their homes. Bet ya that’s where the magic puddings are produced. Booming credit figures underline that.

    As for the banks, I might just find myself going all the way to the bank, and laughing AT it! Those greedy bastards are holding one very large basket of eggs.

  8. The company I work for in WA regularly does shutdown work in Kwinana. Whilst working on one recently one of the tradesmen asked me if I had taken a pay cut to work on this project to which I replied that I am full time and my rate doesn’t fluctuate.
    It turns out what used to be $50 an hour was now $43 and he was pissed, I did not have the heart to tell him this is only the beginning.

    As stated recently on this site-
    The findings are consistent with OECD data released last year showing Australia’s relative unit labour costs have surged 54.1 per cent since 2000, while for comparison, unit labour costs fell in Germany, UK, US and Japan by 14.6, 20.4, 25.9 and 46.2 per cent respectively.

  9. That tradesman should be happy he still has a job! $43 a hour will be heaven in a couple of years after he loses his job, defaults on the mortgage and then the bank and LMI provider go after him for their loses…

  10. Admin,
    We may also need a special topic over SMSFs and property investment.
    I doubt that SMSFs are ruining people’s retirement eggs, imposing deeper social implications.
    Only a suggestion. Thanks

  11. @Millimouse – it’s probably worthy of special topic, but it is very much on topic with the FSI warning about leveraged property investment in SMSFs. I note Duncan Hughes has an article in the weekend AFR, Ill-advised DIY super funds lose on borrowing to buy property. The article is pay walled, but you can read it here.

    According to the article some SMSFs have lost 75 per cent over the last two years leveraging up into property, despite booming markets. (I would hate to see what happens when the market turns.) Investors who have between $100k and $150k are persuaded to sink it all into a leveraged $500k property.

    “Instead they have suffered massive negative equity – which happens when the value of a property falls below its purchase price – that combined with the high cost [of setting up the fund] has consumed their super savings.”

    This is consistent with comments in the FSI. ASIC reviewed the files of one hundred SMSF investors and found much of the poor advice was related to setting up leveraged SMSFs to buy property. All these investors had less than $150k and it was common to find them borrowing and investment in a single asset class.

  12. People really are ignorant arn’t they. The SMSF leveraged investing in property reminds me of a comment that was made by a home buyer during the sub-prime bubble in the US. Apparently his mortgage broker had told him that he would be paying the 2% rate for the life of the loan. He was quite oblivous to what the term “negatively amortising” meant. I’m sure we’ll hear similar stories about SMSF property investing in the coming months.

  13. @ Admin

    Nice clean article. 1% of advice classed as good…Ouch.

    We have had several of these mobs phone us at home continually pushing to get their hands on our super.

    The superannuation bubble is perhaps going to be even more spectacular than the general economy. There are many ‘reputable’ experts out there trying to get access to super. Even my bank wanted my super to be rolled into my current business.

    As much as housing policy has failed Australian’s, I personally think it is nothing compared to the farce that superannuation has become. Honest workers are having money that could be theirs, put into a super fund that many don’t know or care about, and the fund managers are having field day (not to mention all the small businesses that are NOT paying super to staff and then folding). Then there are the type that are educated enough to want to set up a SMSF, but get taken for a ride by the new breed of advisers who are seeing this as a cash cow.

    As per usual, the rich are doing great with SMSF’s. Many pumped them full under Howard, and now have massive tax free income. It’s awesome. Yet, we are warned of future pension cuts.

    Super will be abandoned at some stage in the future. But the fall out required before this becomes socially palatable will be massive.

  14. Thanks Admin for the message.

    Early this year the bulls cited that only around 3% of super money had flowed into the property market, indicating that super funds are constant cash inflows to blow up the property market further. Apparently these bulls suddenly disappeared as most cheaters after getting what they wanted…

    The FSI does not confirm 3% or not. My concern is that probably much more or even most super funds are geared in the housing market but not revealed…

  15. I am not sure if this more propaganda from the real estate/property industry, but the other day on Sydney radio station 2GB, there was some economist saying property in Sydney is going to go up by 15% this financial year ie.2014/15.

    When will this madness all end?, the economy is tanking badly, massive job losses, no job security (unless you are a politician or CEO), and dropping wages.

    How can you generate a string economy, when most people’s purchasing power is directed to paying off the massive mortgages, leaving less money for discretionary spending?

  16. @Matty

    Great post 1+, but what I can’t understand is that, isn’t Superannuation meant to be used solely as your pension fund once you retire? And that the idea of Super, particularly compulsory Employer sponsored super was so that it saved the Federal Government billions of dollars, so instead of them paying you a pension, you live off your Super (assuming you have enough to retire on).

    Well if some people stand to lose their Super money in property (if both the economy and property market tank), then what do they have to retire on?

    Former Labor prime minister Paul Keating was right all those years ago, Australia has become “the banana republic”, a once great economy based on actually making things (ie.manufacturing), is now reliant on massive debt and a massive Ponzi scheme called property.

  17. I wish I could be as confident of the bubble popping as some of you are, especially when the government has opened Australia for business to a virtually unlimited number of wealthy foreigners.

    With over 100 real estate agencies in China alone selling Australian real estate and with the amount of Chinese money invested in Australian property set to double, priced-out Australians are increasingly irrelevant.

    So while mining is slowing down, factories are closing and jobs are being lost and offshored, the only industry that our government is hell-bent on supporting is real estate, and they are prepared to sell off the country to the detriment of our own citizens in order to prop up the housing bubble.

  18. Talking about systemic risks consider Deutsche Bank with a derivatives exposure of 5 times the GDP of Europe.($75 Trillion)
    If it goes down our whole financial system won’t be far behind. Collapsing SMSFs will be the least of our problems.

  19. What are you guys on about…

    Every year or so the government brings out a new law saying ‘OK now since no one’s buying homes and there’s no foreign anymore and there’s no first home buyers or super buyers we have to tap into existing buyers to drive up prices. Major barrier for existing buyers is the stamp duty and capital gain tax. Let’s remove those two entirely. Bam. 10 more years of growth in housing. While tripLing the baby bonus to make sure there’s a new poor generation to keep the housing demand high.

    Watch it happen without fail.

    They are the biggest business in Australia and they will do anything since 90% of their stakeholders will demand it. That’s how government works.

    I talked to a work mate last night. He brought up the ‘cheaper to rent’ report and slammed it for being nonsense RBA garbage this and that. Lies I need to buy a house how stupid is it cheaper to rent.

    I sat down opened excel. Put in the cost of the average house, the loan repayment and then maintenance costs. Dr aged it down to show him 30 years at our growth rate which 1%

    Then I showed him what happens if you put it in a savings account. 20% more after 30 years…

    He didn’t believe it said it’s wrong said I’didn’t still be paying rent forever. Blah blah blah. NOTHING I said would convince him otherwise. He owns 5 properties now and it’s his retirement fun and he refuses to admit he’s wrong. Then he brought up the ‘my first loan in 1970 seemed like a lot. I was getting 10k a year and it cost me 30k for a house and I had to pay triple the interest…

    So I showed him what 10% on 30k with a 10k income is against a now 600k 5% with a 50k income. He just flat out denied it. Which is why I know that’s how the government sees it that way. They are in it for themselves not the people.

  20. Looks like the bubble is deflating in China, as expected. This house of cards is coming down.

  21. @Paul

    I love how the finger is pointed at the government: The government wanted to take some heat out of the market, but it may have worked too well.

    While partly true, the fact is, the person who signed the mortgage is at fault. While, the guy in this story has a relatively high income, the fact that housing is crazy expensive doesn’t ring any alarm bells…..”I just have to have property”.

    It’s a world wide belief: A friend of mine had a girl (single mum, all of 20 years old) over for dinner…..they weren’t five minutes into the night and she asks “Whose name is the house in?”….Seriously?
    A: It’s ok to demand to know someones residential status?
    B: This is a KPI when starting a relationship?

    Ironically, he’s now renting that place out while he “upgraded” into another, bigger place with some land……and can barely put food on the table……….(Just another example of sacrificing EVERYTHING to say they own property, when they only really own the debt……These guys give up everything, hobbies, lifestyle, holidays, future savings, low blood pressure (lol), even the right to eat a healthy diet)

    I honestly believe the generation of young kids and those yet to be born, will live like our grandparents (I’m gen Y) and be fearful of debt, striving to have their own savings, and only buying what they conservatively can afford.

  22. @Matty

    Yup. Just like our grandparents. That’s what I tell people we are headed for. I take a reverse observation though, if the current generations “have” everything before they earned it, why didn’t our astute grandparents do the same?

  23. @ Paul

    I’m an Adelaide-ian: Where are you?

    @ Patrick

    Spot on. Only today my grand parents were saying they wished they had interest so low when they were younger and in business: I said “But the trouble is everyone is loaded to the hilt with debt though” and the response “well, yes. I spose they wont be able to pay it WHEN interest rises.

    I personally believe for Australia to go through the pain the USA did in 07/08/09 we will need to see interest rates rise to 5% or so, then the defaults will rapidly rise, unemployment explode, massive service sector recession. Asset price collapse: BUT!

    There is no way that the RBA will raise rates, inflation is non existent in the real economy (government charges and big business charges are rising rapidly) but mum and dad businesses can’t raise prices, the economy is so weak already.

    What is going to cause interest rates to rise? I don’t know, but I highly suspect it wont be “internal” to Australia. Sooner or later, a developed country WILL default, and that will be catastrophic to the world financial system. The financial system assumes that there is practically ZERO risk with government bonds. When in fact, as we can clearly see, governments balance sheets are far worse than some companies? I once heard Apple has something like 10X the amount of cash that the USA government does!

    Governments as safe borrowers? Take the SA government for example: A debt of some $2billion and rising exponentially. Yet, there is no real improvement in the economy, no improved productivity, companies closing every day, defence contracts failing….

    And then someone like Jaime Packer. Some say during the GFC he was on his last million, yet move forward a few years and he’s worth some $6 billion dollars……

    Who would you lend your retirement to?….mmmm…ahh…interesting.

    The government to save you? Not on your nelly.

  24. The way I see it, if property price does come down in Australia, it would have to be via higher interest rates, rising mortgage defaults, mortgagee / firesales – all leading to a downward spiral. And because it’s across the whole market, I doubt any politician or central banker can do anything to stop the rout, unless one legislates to prohibit foreclosures.

    Property price rises in Australia have been driven by a combination of a few factors. I am not sure which have been most dominant as a cause for the property rise – (a) restrictive land zoning laws in turn curbing supply (b) pro-investor property policies – negative gearing, allowing super funds for property investments etc (c) lax lending practices by banks making property loans now a major part of their loan books (d) low interest rates overall making many borrowers take on more debt than they would otherwise be comfortable servicing (e) lax foreign investment rules for residential property making Australia a desirable destination for hot money, especially from the PRC in recent years.

    I do not think (a) will change in my lifetime. State governments are addicted to stamp duty from property transfers and no state government of either persuasion would do anything which would lead to a hit on such a revenue source. Local governments would also want to be able to keep raising rates from ever rising property prices in their suburbs.

    Neither will the federal government (of either persuasion) do anything to make less favourable the environment for property. No party wants to see a sustained property price drop while on their watch. So any talk from any politician about making property ownership affordable one hears from time to time is just that- talk. Also, I would be surprised if many politicians (and/or their spouses, their children, their staff, their rellies ) do not own investment properties themselves, so there is an element of self-interest in making sure the bubble isn’t pricked. And for most, self-interest prevails over everything else.

    The RBA has publicly stated they see no bubble so I do not see them raising rates to such a point where it would hurt the property market.

    All around the world, inflation outlook is said by central bankers to be benign. Even if not in fact, the definition for inflation can always be tweaked such that it gives central bankers reason to keep interest rates low, for as long as possible.

    The only way I see interest rates rising is not by way of inflation expectations rising, but by credit risk expectations rising. I am not sure if it would be via sovereign debt, where their higher interest rates would filter up to the less creditworthy borrowers, or if it’s the junk borrowers who would start defaulting first, which would lead to higher funding costs for all non-sovereign borrowers, including for our big four eventually, with the sovereigns largely insulated.

    I am not sure if this story on zerohedge about higher yield credit crashing a few days ago will lead to something more widespread across the entire debt market further out in time, but I wouldn’t be unhappy if that happens.

  25. @43 This is insane! When is this madness going to end? It’s all actually incredibly disgusting, and reading that piece in the SMH has left a bad taste in my mouth and a sick and empty feeling in my stomach. It’s all so WRONG!!!

  26. The systemic risk to the banks is not increased by the Chinese buyers as they mostly pay cash. The problem created is one of asset bubbles as China tries to export its inflation by making it easy to send funds overseas to protect its currency. No wonder our government is looking the other way as increasing real estate values soothe the savage voter into thinking all is well.

  27. Joe,
    Thanks for the insightful analysis. Behind the plain facts there are much more we do not know.

  28. @Joe
    Unfortunately coming to the conclusion that the only factor driving property is the supply of credit. Until the credit tap is turned off prices will continue to rise.

    @Average bloke
    You have to wonder how a student can afford a $4.3m investment property and why he would buy one with a yield of 2.3% you’d be better off leaving the money in a term deposit. Only reason I can guess is hot money being laundered out of China.

  29. Lol. Peoples stupidity never fails to amaze:

    The couple are say if their income was the same as the rate their house rose in ‘value’ then they would be living in a much nicer house. That’s the idea you clowns: House values are supposed to be based upon the income they can generate, which is peoples income!

    OMG, when this show stops it’s gonna be amazing. We will see entire family estates wiped out.

  30. This property bubble we are having here in Australia (especially here in Sydney), just seems to keep going and going.

    I am from Sydney, and just recently a duplex house (across the road from where I live), sold for $820,000 and I live in south west Sydney, hardly what you call a wealthy part of Sydney. Just of curiosity when I looked up the prices paid for property in my suburb, the prices have gone absolutely ballistic eg. even modest homes are being sold for well over $1 million.

    On radio station 2UE the other day, one of the announcers mentioned that more than 170 suburbs in Sydney have a median price of $1 million.

    Once again, how can people afford these crazy prices?, wages are not keeping up, there is no job security, people are losing jobs all over the place, and small business is getting smashed (have a look at all the empty shops in your local shopping centre).

    Unless there is a massive correction in house prices (it won’t happen as the Government of both persuasions will keep the bubble alive), the next generation of Australians will be renting for the most part.

  31. The one big factor now preventing the bubble from bursting is the unrestricted buying of Australian real estate by foreign purchasers. As demonstrated by the Chinese student in the example above, money is no object, and it would be safe to say that a lot of money coming here is corrupt money.

    When nobody else can afford to buy, foreign investors will be the last ones standing. There is absolutely no policing of the laws that are in place. Nobody is ever prosecuted. The FIRB are there in name only, and their job is to rubber stamp every application, that is, if they bother to apply. If they don’t apply, it doesn’t matter – they are never stopped from purchasing as many properties as they want.

  32. @Master Yoda – it’s much worst than just the next generation renting for their life. They will also be a generation of jobless as the housing bubble consumes any last bit of the productive economy we have left. That is why the government is so keen to claw back unemployment benefits for those under 30 with youth unemployment at levels not seen in two decades.

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