IAN VERRENDER. Distribution of debt poses new trigger to the property, housing market

Apr 14, 2017

The trigger has been cocked. Our attitude to property has changed. No longer is it merely a castle, a family retreat and a place in which to find shelter. It’s now a highly geared investment vehicle.  It will take enormous skill and a huge degree of luck for our regulators to reset the safety catch.  

Ask almost any economist from a major financial institution and they’ll tell you Australian housing is safe; for now.

The reason, they’ll explain, is that for a significant fall or even a correction to take place, there needs to be a trigger — some cataclysmic event that would cause a spike in unemployment and a big uptick in forced sales.

Australians, we’ve learnt, will do almost anything to avoid losing the family home. At least, that’s certainly been the case for most of the past century.

Unfortunately, it’s an argument that no longer holds true. For a new and potentially dangerous dynamic has taken hold that could easily overwhelm that homing instinct.

Most of the recent concern about the east coast housing bubble has been based on the extreme level of household debt that has gripped Australia in the past 30 years.

No matter how you measure it, against income or the size of the Australian economy, we are at the highest levels in our history and among the worst in the world.

But it is not merely the quantum that is the concern. It is the make-up, or rather the distribution, of the debt that has changed. It’s a change that threatens to turn our long-held belief about the behaviour of home owners on its head.

How we learned to love property and imperil the economy

For the past five years, ever since the Reserve Bank decided to ramp up east coast housing to take up the slack from the mining downturn by slashing interest rates, investors increasingly have forced first home buyers out of the market.

Nationally, investors account for about 40 per cent of all new loans for housing. But in NSW, the most populous state and the place where price rises have been the greatest, investors account for about half of all new loans.

First-home buyers, in the meantime, have been all but forced out.

The end result is that there is an increasing proportion of households with investment properties. And that completely changes the dynamics of home ownership.

While those owners will do almost anything to maintain ownership of the family home, they won’t think twice about selling an investment property if they think they will lose money on the deal.

As many of them attest, it has been the primary source of saving for their retirement. And according to the Reserve Bank, there has been a marked increase in self-managed superannuation funds that have taken on debt to purchase investment properties.

So the attachment, the personal hold that our regulators and banks are relying upon has greatly diminished in the past 20 years.

Right now, our banks have more than $1.5 trillion in outstanding home loans on their books. More than one third of that total, $543 billion, has been lent to investors.

Nine years ago, when the Australian Prudential Regulation Authority first began gathering such data, total lending for mortgages was just $683 billion.

Property no longer safe as houses

As our regulators only now seem to be discovering, the lending standards on investment loans have been remarkably lax. Many are interest only loans while a large number of borrowers have used equity in the family home to help gear up for an investment property.

Should a downturn occur, even what once would have been considered a modest correction, investors are more likely to dump extra properties to protect their hold over the family home.

That now makes real estate as risky a lending proposition for our banks as shares.

Cast your minds back about 15 years. In the run-up to the financial crisis, our banks went on the rampage, offering loans to almost anyone with a bank account to borrow money so they could invest on the stock market.

They were called margin loans. You don’t hear too much about them these days. But they worked beautifully when stocks were booming. You used the loan to buy shares. The bank would even help you assemble your portfolio.

If the dividends didn’t cover the interest on your loans, you wrote off the losses via the magic of negative gearing. And when you sold your stocks — at an enormous profit because of the soaring market — you repaid the cash. Sound familiar?

In December 2007, when the cracks appeared in the global financial system, stocks began to tank. And the banks began to call on investors to stump up the margins.

If you couldn’t cover the paper losses on your portfolio, and many couldn’t because they didn’t have the collateral in the first place, your stocks were sold.

What that did was compound the selling pressure and global share markets went into free fall.

It should have been a salient lesson for financial institutions about declining lending standards and the dangers of boosting asset prices with vast amounts of debt. But memories are short in the business world, especially when bonuses are at stake.

The property threat to banking, and the economy

Last week Wayne Byres, the banking regulator, took his turn to bludgeon our financial institutions. Banks would have to put aside more capital, just in case the housing market takes a turn for the worse, he told them.

For years, our banks have been campaigning behind the scenes to thwart such a move.

They’ve already been saddled with tighter global regulations in the wake of the GFC and, as memories fade of the dire situation in which they found themselves, they’ve complained long and hard that they are safe enough and that tighter regulations will stifle the economy.

Mr Byres last week invoked David Murray’s call in the most recent Financial System Inquiry, that our banks should be “unquestionably strong”.

The fact is, they are anything but. Banking is the riskiest business on earth.

While they are in the business of borrowing and lending, the debt attached to our banks is around 40 times the size of equity in the businesses.

Just to compare, the average debt to equity ratio for non-financial Australian businesses is around 0.8.

They also are horribly exposed to Australian real estate. About 60 per cent of their total loans are for housing. Byres is relatively new to the job. But he has been saddled with a huge problem.

A little over a decade ago, the organisation he now runs decided it was a good idea to allow the big four banks to decide for themselves exactly how much cash they should stash way as a buffer for a housing market downturn. All in the spirit of deregulation.

It shouldn’t come as a surprise to learn that each of them decided housing, being such a reliable asset for which to lend, no longer needed all that cash sitting in reserve down in the vaults.

They slashed what is known in the game as the “risk weighted asset ratio”; from 50 per cent in 2007 to just 16 per cent by 2014.

That allowed them to really ramp up the lending. While the policy has since been reversed, we now are living with the consequences.

Investors seem little perturbed by the mounting risks in the system. Banks dominate the Australian Securities Exchange. Real estate dominates the banks.

The banking regulator has been slowly ramping up the heat on the banks, in an effort to slow investor lending and to raise lending standards. Just a fortnight ago, it ordered a clamp down on interest only loans.

Is it too little, too late? Let’s hope not. For property corrections have a habit of causing extreme economic pain. Just look at the US, Ireland and Spain in the past 10 years.

In each of those countries, it was property market speculators that sent prices through the roof and later created havoc within the banking system once the inevitable collapse occurred.

The trigger has been cocked. Our attitude to property has changed. No longer is it merely a castle, a family retreat and a place in which to find shelter. It’s now a highly geared investment vehicle.

It will take enormous skill and a huge degree of luck for our regulators to reset the safety catch.

Ian Verrender is Business Editor of the ABC. This article was first published on 10 April 2017.

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