Thank God It’s the “Lucky Country”, and Good Thing it’s not a Bubble …

We have previously written about the many extant housing bubbles in the world, which are a result of the incessant monetary pumping by central banks (see: “A Tale of Two Bubbles” for details). Recently Australia’s big banks published a study in which they strenuously deny that one of the biggest housing bubbles the world has ever seen is actually a bubble. This is no surprise, because when – not if – this bubble implodes, Australia’s financial system will be in major trouble and the “big four” Australian banks are going to have a front-row seat. As “The Australian” reports, the “banks are dispelling housing bubble fears”. Not surprisingly, their arguments sound eerily similar to those of the NRA in the US shortly before the demise of the significantly less enormous US housing bubble.

 

“Amid fears that record low rates are laying the ground for problems, the Australian Bankers’ Association will today release a ­report arguing there is “insufficient evidence” of a speculative bubble, adding that the banks have not added to the price surge by relaxing lending standards.

After assessing the past 25 years, the paper, “Key truths on housing in Australia”, finds that the biggest driver of prices is mortgage rates falling below 5 per cent, and plays down the impact of foreign buyers. It also backs a Reserve Bank study this week that shows the highest debt loads are held by wealthy, less risky borrowers.

But the ABA does concede that houses are expensive relative to rents and “current rates of return may be economically viable only if expectations of further price gains are fulfilled”.

Also, prices have become more expensive relative to purchasing capacity and buyers should view “with a critical eye” claims that the structural housing shortage is massively driving the market. The major banks have repeatedly dismissed a bubble in their most lucrative asset class, and the ABA says it is important to “get the facts on the table” and not just focus on the recent bull market, particularly in Sydney.

“House prices in Australia are currently in a period of strong growth. (But) there is insufficient evidence to conclude that house prices are unsustainably overvalued or that Australia is currently experiencing a speculative ‘bubble’,” the report says.

[…]

Since the market stirred to life in mid-2012, Sydney is up 35 per cent — far outpacing the 23 per cent increase in the patchy broader market, including capital cities like Perth that have begun going backwards, according to CoreLogic RP Data.”

 

 

sidney shack
Anecdotal proof that there is “insufficient evidence of a bubble” in Australia’s housing market: this shack on Edith Street in Sidney sold for $980,000 in May of 2014. The cottage has been uninhabited for 20 years. The walls that have not disintegrated are covered in graffiti and the house is littered with rubbish. The backyard features the remnants of an outdoor toilet, with rubbish strewn about amid patches of weed, which are the only vegetation. Size of the property: 278 sqm. (~2,992 sqft.)

Photo credit: Attila Szivasi

 

Let’s take a look at some of that “insufficient bubble evidence”, shall we? We will start with a piece of anecdotal evidence. Below is a picture of a shack that was sold in Sidney for $980,000 in May of 2014 – when prices were actually not yet quite as elevated as they are today:

We have a picture of the inside of this magnificent palace as well:

 

inside the palaceIt’s amazing what a million dollars gets you in Sidney …

 Photo credit: Attila Szivasi

 

Here is a chart showing the development of median house prices in Sidney and Melbourne since 1996:

 

1-Oz - house prices Sidney and Melbourne house price data (via a recent CLSA report) – click to enlarge.

 

Of course, house prices as such are not really telling us much. For instance, in hyper-inflationary economies like those of Argentina and Iran, property prices are rising at a much faster pace. However, Australia’s CPI inflation rate has oscillated between 1.2% and 5% over the past decade, so the increase in house prices has far exceeded the official decline in the purchasing power of the RBA’s fiat confetti. In fact, between 2001 and 2011, Sydney land prices rose 512 per cent faster than inflation while the city’s population grew only by 16 percent. Moreover, wage growth in Australia is in a steep downtrend, making the growing lack of affordability stand out like a sore thumb:

 

2-house prices to incomeAustralian house prices relative to income – the national ratio of approx. 7 has risen deeply into bubble territory  – click to enlarge.

 

3-australia-wage-growthAustralian wage growth: disappearing act – click to enlarge.

 

Australia’s banking regulator seems a tad more worried about the explosion in house prices than the banks – even though this lone voice of official caution still fails to call a spade a spade, because, you know, they don’t know what a bubble is and how to spot one (as we all know, it is really difficult for government bureaucrats to identify bubbles. Apparently nefarious unseen forces are somehow keeping them from looking at charts):

 

“The head of the banking regulator doesn’t know if the housing market is in a bubble, but says it certainly looks risky. With house prices rising much more quickly than incomes, and household debt still high, the property market could pose a risk to the economy, Australian Prudential Regulatory Authority chairman Wayne Byres said.

“If you look at the conditions we are in at present, where we have very low interest rates, very high household debt, subdued income growth, rising unemployment, very high house prices, a very competitive financial market in terms of house lending … there’s a lot of potential for risk,” he told a federal parliament economics committee.

“Risk is probably higher than it might otherwise be and that is why all of the agencies are paying particular attention to it at the moment.”

But Mr Byres stopped short of saying Australia was in a housing bubble. “I don’t know what a bubble is and I don’t quite know you spot it … If these things were easy to spot and define, almost by definition regulators could deal with them,” he said.

 

(emphasis added)

We want to make two points about this: firstly, the fact that “all the agencies are paying particular attention to it at the moment” is completely irrelevant. It will achieve precisely nothing. The RBA is cutting interest rates to the bone, Australia’s credit and money supply continues to soar, and so more and more gasoline is poured on the fire. The bubble will keep growing, regardless of how much bureaucratic “attention” it receives. It will keep growing until either the trend in rates reverses, or it becomes so massively overextended that it simply can no longer be sustained regardless of the height of interest rates. It is already far too late for anyone to do anything about it.

Secondly, the idea that “regulators could deal with bubbles” if only they could learn how to read and interpret a chart is equally ludicrous. In a fractionally reserved banking system backstopped by a central bank, booms and busts of increasing frequency and amplitude are absolutely certain to occur. The only way to stop this from happening would be to return to a sound money system. There is not even the slightest chance that anyone in power will advocate a return to sound money in the framework of today’s welfare/warfare statism.

As we noted above, it is a good thing that Australia is the “lucky country”, because it sure looks like a lot of luck will eventually be required.

 

4-australia-interest-rateThe central bank’s administered interest rate – the main cause of the massive rise in house prices – click to enlarge.

 

Crazy Political Ideas and Reckless Monetary Policy

The growing problem of housing affordability – which as we have previously pointed out practically forces young people into life-long debt slavery – obviously cries out for insane political “solutions”. Instead of thinking about how to rein in the bubble (which has become practically impossible, because it would fatally impair the banking system), politicians are looking for ways to light an even bigger fire under it. Thus Australia’s treasurer John Hockey has come up with the brilliant idea to make it easier for Australians dip into their superannuation retirement funds to scrape the money for overprices houses together:

 

“Treasurer Joe Hockey has suggested allowing Australians to repeatedly dip into their super over the course of their lives to pay for things such as job retraining or buying their first homes.

But the radical idea – which represents a significant rethink of the role and nature of the superannuation system – threatens to inflame tensions with the super industry, and has been quickly slammed by Labor and some economists.

[…]

“We are prepared to look at a diverse range of proposals to help young Australians buy their first home,” Mr Hockey said on Saturday.

[…]

John Daley from the Grattan Institute said allowing first-home buyers to access super to pay for their first homes would only help to push up house prices – making it even harder for first-home buyers to afford a home.

Saul Eslake, the chief economist of Bank of America Merrill Lynch, said the best way to help young first home buyers was to increase housing supply because that would drive prices down.”

 

(emphasis added)

The housing supply is actually going to increase markedly over the next several years. The next chart shows residential house and unit (apartment) construction approvals. The latter have increased quite a bit:

 

5-units vs approvals-ceHouse and residential unit construction approvals in Australia – click to enlarge.

 

This market reaction to soaring prices is quite normal, and to be welcomed from the point of view of first-time home buyers. It is however dangerous for the many people who have been and are buying houses on credit for investment purposes, and with that it is dangerous for the banks as well. As the chart below shows, credit-financed speculation in Australia’s housing market is raging:

 

6-Oz - Investor share of mortgage assetsShare of Australian mortgage loans extended to investors/speculators – click to enlarge.

 

The central bank is undoubtedly aware of the risks, which explains why it has instituted an A$ 350 billion emergency lending facility for the banks, the so-called “committed liquidity facility”. Australian banks get a lot of wholesale funding from overseas, and got into quite a bit of trouble when those funding sources dried up in the 2008 crisis. Guess what the banks are turning into “liquid and marketable assets” to “give to the RBA” in case of an emergency? That’s right, mortgages!

The problem with such a backstop is that it introduces an added element of moral hazard (the entire monetary system is one big case of moral hazard of course, but this is making it even worse). The RBA insists of course that it will get all Walter-Bagehoty should the banks actually need to avail themselves of this backstop – they may be “illiquid”, but must still be “solvent” and assets they offer to pawn with the central bank must be of “high quality”. Readers may recall what happened to the ECB’s asset eligibility criteria in the course of the euro area’s debt crisis. They went out of the window real fast. Commercial bankers know of course that the central bank will relent under crisis conditions. We don’t think that the managers of Australia’s big banks are spending much time and effort on hoping that their assets will be “good enough” for the RBA once push comes to shove. They know full well they are “too big to fail”.

Meanwhile, the easy money policy practiced all over the world has had similar effects in Australia as elsewhere. Below we show a chart of the narrow money supply measure M1 (currency and demand deposits), which mirrors the debt growth in the economy. It is certainly not too big a surprise that there is such a huge housing bubble:

 

7-australia-money-supply-m1Since 2000, Australia’s narrow money supply has nearly tripled – click to enlarge.

 

At the same time consumer credit has gone through the roof:

 8-australia-consumer-creditConsumer credit has been on an uninterrupted steep upward trajectory as well – click to enlarge.

 

Due to the demise of the boom in commodity prices, the central bank has decided to continue to cut interest rates – even though it is aware that this will increase the risk the housing bubble poses for Australia’s economy. As one market observer remarked in early March:

 

“Governor Glenn Stevens’s effort to revive business investment with cheap finance is adding fuel to the country’s biggest property market. Home sellers may get a further boost, with 18 of 29 economists forecasting a 25-basis-point cash rate reduction on Tuesday.”

 

Elsewhere we read that given the expired commodities boom, “the RBA’s hands are tied as property prices go through the roof”, followed by this astonishing (to us, anyway) statement below the headline:

 

“The Reserve Bank is struggling to manage the two-speed economy while the government fails to lift productivity and cut unemployment.”

 

This reflects the widespread belief that central banks and governments should “manage the economy”. In fact, both should simply leave the economy alone. It is precisely because of their repeated failed attempts to “manage” the economy that the economy is in trouble in the first place. If government management of the economy were such a great idea, the Soviet Union would have thrived; after all, the government managed and planned every aspect of the economy there, with the sole exception of 2% of the arable land that farmers were allowed to use for themselves.

 

Recent Developments – Blow-Off Frenzy Underway

There are anecdotal signs that the allegedly non-existing housing bubble in Australia is actually entering its final, frenzied blow-off stage – which usually takes place shortly before a downturn begins. The following was reported from a recent auction where developers were bidding for various properties:

 

“1 Stansell Street, Gladesville, is described by the agents as “a rare find”. The four bedroom, single story brick home sits on 714.5m2 in a mixed use zone between an unit block and service station, which in real estate speak made it “only moments from all major shops and roads”. It currently rents for $800 per week.

The Professionals Ermington described it as a “highly sought after opportunity” and were proved correct Saturday when it sold for $2.85 million – a staggering $1.1 million above the reserve. Agent Paul Tassone told Domain.com.au that around 300 watched in disbelief as 28 registered bidders chased the property.

“The buyer was a developer who plans to rent it out before eventually redeveloping the site,” he said. Domain reports a clearance rate of 84% among the 628 auctions in Sydney on Saturday. Among the other properties that suggest the market is a long way from cooling were:

A duplex in Moore Street, Coogee, went for $1.43 million – $530,000 above the reserve.

A 4-br house on Belmont Road, Mosman, which will be rebuilt as two homes, sold for $2.235 million – $685,000 above reserve.

A 1-br worker’s cottage in Little Bloomfield Street, Surry Hills, bought by a first home buyer for $840,000 – $90,000 above reserve.”

 

(emphasis added)

Here is what the $2.85 million “rare find” looks like:

 

stansell-St1For $2.85 million you get something that is basically one step above “shack” in Sidney these days.

Screenshot via Nwes Corp Australia

 

As a developer attending the auction in which this house was sold remarked:

 

“I have never seen anything like it – it was like the Easter Show, and more unusual.”

 

Low, or rather non-existent, interest rates have fired up housing bubbles in various European countries as well, but in Germany or Austria one could probably buy between 5 to 10 similar houses for the same amount of money – in spite of the price increases that have occurred in these countries in recent years.

 

Conclusion

As always, it is impossible to say when exactly the boom will actually stumble. Even though numerous warning signs are noticeable, the continued provision of easy money by the central bank and political intervention could well serve to drive the bubble to even crazier levels. The day will come though when everybody involved will come to rue the heady days of easy credit and every increasing prices.

Tic-toc.

 

ron matasinHere we see Mr. Ron Matasin in the quasi-ruin of the living room of his house, which he wisely sold for a staggering A$ 1.9 million in May of 2014. A list of other, even more uninhabitable shacks that were selling for similar prices at the time can be found here.

Photo credit: David Swift

 

Charts by: Tradingeconomics, CSLA, David Scutt

 

 

 

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3 Responses to “Australia’s Bubble Trouble”

  • phil coleman:

    Pater,

    I forgot to add another tidbit: Australian banks are highly exposed to residential housing mortgage debt with about 60% of their total loans in residential real estate. Compare this to US banks which have residential real estate mortgage loans of around 38% of their total loans. The Australian banking system has the highest real estate loan ratio in the world and this puts Australian banks in a precarious position. This is one further reason why interest rate hikes here will be resisted strongly by the authorities, and of course by the banks. And it’s one more reason to be fearful…

  • phil coleman:

    Pater,

    You might find the following data relevant to your post on Australia’s housing bubble:

    There are four major banks in Australia (the “Big Four”: NAB, Westpac, Commonwealth and ANZ) and many smaller ones. In the Australian stock market the Big Four banks represent about 29% of the total stock market capitalization. I believe that this is unique in the entire world. Namely that just four companies comprise such a large proportion of the total market and they are all banks. In the US there are many more banks and the total market capitalization of all US banks large and small totals only about 16% of the whole market. As an aside it is also worth noting that if you add the two large Australian mining companies (BHP & Rio Tinto) these six companies have a total market capitalization of over 40% of the entire Australian stock market.

    So us lucky Australians have over 40% of our stock market supported by just six companies; four of them banks deep in bubble territory and two of them mining companies largely reliant on export, mainly coal and iron ore, almost entirely to China and Japan. Saints preserve us!

    Despite this absurd and dangerous concentration of entities in the structure of the economy the Australian dollar has surged in the past few days from around 72 cents per $1US to over 78 cents per $1US, or over 8%. This followed Janet Yellen’s statement last week that caused the $US to slump somewhat.

    I am flummoxed by the grotesque and alarming current situation here and bemused by the naivety of economists, investors and central bankers who appear to be blissfully unaware of the dangers we are facing in Australia.

    Surely the $AUD must be a rip-snorting shorting opportunity?

  • TheLege:

    While this wouldn’t dent the housing bubble thesis, I would just point out that using a few high-priced shacks as examples of excess doesn’t necessarily prove the thesis (the rest of the data more than suffices).

    These shacks are being bought (mainly by developers) because the land on which they’re built has invariably become valuable as a result of re-zoning exercises in the major metropolitan areas which has led to previously undesirable properties suddenly turning into winning lottery tickets for their owners. Where once only a single story property was allowed to stand, suddenly 5-story apartment blocks are just fine with the local council etc etc.

    I would also imagine that a portion of the increase in purchases of investment properties has been driven by changes in rules around Self-Managed Superannuation Funds (pension funds). Property can now be included in these SMSFs, which has led to very many people rushing out to do just that – a sure ticket to riches in retirement! (as opposed to financial evisceration).

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