Is there a forthcoming "Housing Slump" in Australia ???

Can we say Australia is a single market ???

"NO" resoundingly and the following depends upon it.
Monday 8th November, 2010 – Melbourne, Australia

By Kris Sayce

EDITORS COMMENT:

Kris is a harsh property investment critic.

So far none of his doom and gloom “the bubble is about to BURST” predictions have come true. BUT, in the interests of broad spectrum analysis, it is worth reading his comments.

Jack Henderson

(click on the links to view the pics, graphs and charts)
"Auction clearances dive on interest rate rises", reports today's Australian Financial Review (AFR). It states:

"In Melbourne, the clearance rate dropped sharply to 61 per cent, the lowest turnover since mid-December 2008…"

Ouch! It certainly isn't a sellers' market.

And our friends at RP Data agree with us. Money Morning reader Duncan pointed us towards a comment by RP Data on its own Facebook page:

Source: Facebook

As Duncan says, it's not really all that puzzling why there's an increase in the number of properties for sale "when conditions are not particularly strong for sellers."

But it looks as though RP Data have already received some helpful feedback from Dale Morris who posted the following response:

Source: Facebook

We agree with Dale's last comment. Just as the mainstream economists failed to see the credit crunch arriving in 2007 and 2008 because they were blinded by bogus economic growth, so the property bulls have failed to see the coming housing collapse because they've been blinded by their own bogus spin.

I tell you what, with the housing market hanging over the edge of a cliff by a single thread I wouldn't want to be on the wrong side of a $100 million bet on the next move in house prices.

But, are we again jumping too soon with the housing crash forecast?

According to Dow Jones Newswires last week, "Australian Government Examining Plans to Back RMBS Issuance – Sources".

If you're not familiar with the jargon, RMBS stands for Residential Mortgage Backed Securities.

As a quick primer, it simply means that a financial institution bundles up a bunch of mortgages it has written to home buyers and then flogs these off to investors who buy them in return for receiving the interest payments from the homebuyers.

Prior to the meltdown of global markets two years ago, the big issuers of RMBS were the non-bank lenders. Because they don't have customer deposits to use as capital to fund loans, they've got to go out and borrow the money in order to lend it to home buyers.

But when markets collapsed in 2008 and the appetite for risk followed suit, investors were less keen on lending money to the housing market. Especially considering what was happening to house prices overseas.

Of course, the government came to the rescue and helped its buddies in the banks to not only stay afloat but to help them increase their market share too.

The two following charts from the Reserve Bank of Australia's Statement on Monetary Policy provide a clear picture to this. The first shows the collapse in RMBS issuance from late 2007 onwards:

Source: Reserve Bank of Australia

You can see that RMBS issues dropped from an average of around $12 billion during the previous two years to an average of around $4 billion since then.

But as I say, that's when the government stepped in, putting your money on the line to underwrite Australia's major banks. The same banks the government is now involved in a verbal stoush with.

Source: Reserve Bank of Australia

It's no coincidence that at the same time as RMBS issues slumped that the issuance of bonds by Australia's banks increased… by roughly the same amount.

But it was a double booster for the banks as they also saw a massive increase in deposits as savers took advantage of the other taxpayer bailout, the deposit guarantee:

Source: Reserve Bank of Australia

On that point, for the first time we heard some sense from a politician last night when we caught a few snippets of shadow Treasurer Joe Hockey's interview on Sky last night.

To paraphrase, Hockey said it was a fairly rum deal for bank CEOs to complain about government interference when it was taxpayer money that saved the banks from going broke. He made the comment that wage earners on $50,000 a year were underwriting the banks to make sure the CEOs kept their jobs earning $50,000 a day.

As I've said before, I've got little time for Hockey or any other pollie, but once in a while they do come up with something that makes sense… what he doesn't admit though is that if he had been Treasurer at the time, he would have done exactly the same thing as Wayne Swan – bail out the banks.

The problem for the banks and the housing market is two-fold. Not only have they succeeded in bringing forward a whole bunch of buyers into the market who may otherwise have provided housing demand over the next three to four years, but they've also encouraged them to do so with jumbo-sized loans.

Of all the fancy charts and tables in the RBA's Statement on Monetary Policy the most shocking was this one:

Source: Reserve Bank of Australia

Perhaps you've seen the desperate attempts from the bankers and spruikers to argue that house prices have gone up not due to a speculative bubble, but rather because interest rates are now "structurally" lower (whatever that means) than they were twenty years ago.

They claim mortgage sizes are bigger because interest rates are lower and therefore borrowers can borrow more. Therefore there isn't a bubble.

Personally, we don't buy that argument. It's a speculative bubble regardless of what the bankers and spruikers claim. And furthermore, who says interest rates are "structurally" lower?

Mainstream economists? The same mainstream economists who couldn't even predict the RBA's interest rate increase last week, but who suddenly have the power to predict what the overall "structural" interest rate is for an entire economy.

Give me a break!

But evidence of their nonsense is in the chart above. If it really was the case that borrowers had adjusted their borrowing higher thanks to lower interest rates then you could reasonably expect the proportion of household interest payments as a per cent of disposable income to remain steady.

As you can clearly see, this isn't the case. As a percentage of disposable income, the amount allocated towards the payment of interest has doubled since 2000 – from around 6% to 12%.

Simply put, it's evidence of a speculative bubble. Buyers are prepared to pay over the odds for an asset, and are prepared to pay a higher debt servicing cost based on the belief that the asset will increase in value by more than the cost of servicing the debt.

Source: Reserve Bank of Australia

So far many buyers have been lucky. Those that were already in the market prior to 2008 got a nice boost as the suckers bought in.

But for those that were suckered in by the bribes, and for any over-leveraged borrower, time would seem to be running out.

Since 2008 according to the chart above, house prices have risen by around 16% - give or take a point here or there.

While that doesn't sound too bad, take out all the costs of buying, the interest payments already made… plus the costs of selling the house, they'd be lucky to break even… and then there's the cost of buying something cheaper (if they can) and the risks of buying in before the bubble bursts.

What you're left with now are buyers committing more of their wages towards interest repayments than ever before. And that has come at a time when interest rates were at record lows.

You can see again by looking at the chart above the impact a small move in interest rates has on borrowers.

Think about it. Back in 2001 the RBA had the cash rate around 5%. And it was at roughly that same level from 1997 – 5%. At that time interest payments as a percentage of household income was just 6%.

Today, with the RBA cash even lower, at just 4.75%, interest payments as a percentage of household income is now 12%, and with more interest rate rises on the cards, it's likely to get worse for borrowers.

Now, there's also something else to consider. And that's the impact of income tax cuts which coincided with the increase in the ratio of interest payments.

So that while disposable incomes have increased, this has potentially filtered through to an increase in household debt. In other words, more money in the pocket and a bigger loan with the bank.

But that shouldn't be used as an argument or an excuse for thinking that there isn't a speculative bubble. Because don't forget that what the government gives with one hand it takes with the other.

The Australian Federal burden has been largely unchanged over that period, around 30-35 cents of every dollar goes to the government. In fact you could argue that it has increased when you factor in GST and compulsory purchases such as private health insurance.

And of course don't forget State taxes as well.

The way we see it is that cuts in income tax rates – while welcome – have had the effect of making the consumer and borrower feel richer while at the same time slugging them for increased indirect taxes.

So the net benefit of income tax cuts to the individual is virtually zero.

However, it has led to a false impression of a wealth effect which has lulled many – mostly first home buyers – into taking out bigger and bigger mortgages and creating the environment for a house bubble that's on the verge of bursting.

That's evidenced by the increase in interest payments as a percentage of disposable income. If borrowers hadn't leveraged up further then you would have seen the percentage drop as disposable income increased.

But it hasn't its increased. And that tells you that borrowers are borrowing more and banks are lending more.

Yet, when it comes down to it, the ability of borrowers to service this debt is no better today than it was twenty years ago. In fact, thanks to the speculative housing price bubble, and further interest rate increases, the ability of borrowers to service this debt is worse and will get much worse from here.

Cheers.
Kris Sayce
For Money Morning Australia