They’ve only gone and done it. It’s been threatened for some time now, but eventually US Federal Reserve chairman Ben Bernanke has confirmed the Fed will pursue a policy of “printing” money.
So, why should we care? Surely that will be positive news for Australia.
It could be the beginning of a global inflationary disaster. And it’ll be on a scale never seen before.
But I’ll have to cover that off tomorrow, because today I want to follow up on our notes from Tuesday about the impending housing bubble in Australia. But if you are after a dose of the Fed today I’m sure Dan Denning, upstairs at the Daily Reckoning will have plenty to say on the subject.
After dishing out millions and billions of dollars in new home-lending thanks to the government’s First Home Buyers Grant, Commonwealth Bank of Australia boss Ralph Norris now thinks “there could be some concerns if it became a permanent fixture in the home loan system.”
If we remove our cynical and contrarian hat for a few moments we have to ask why Mr. Norris would say such a thing. Isn’t the Australian banking system robust, safe and conservative?
Aren’t Australian banks’ lending practices far more responsible than their US and UK counterparts? How could such a fabulous scheme such as the FHBG, which gives buyers the opportunity to buy a house for free (monthly repayments required) possibly be bad?
It couldn’t could it? Could it? Hello…
Well, let’s take a look. One of the main problems – perhaps the problem – with the FHBG is that it has created a distortion between supply and demand. And the longer it continues the greater the problem will become.
Take a look at the chart below from Steve Keen’s Debt Deflation website…
Since the late 1980s, Australian house prices have risen six-fold. A rise that has come virtually without a correction. In fact, most of the price appreciation has come during the last ten years.
In contrast, following a similar rise in the US market, their house prices have fallen by around 30-40%. We acknowledge there are some circumstances in the US such as non-recourse loans that create a different dynamic to here in Australia, but regardless, the rapid price rise still represents a bubble waiting to be popped.
The problem that governments now have is any measure they take will lead to one of two conclusions. Withdrawing subsidies to home buyers will cause the market to crash, yet if the subsidies are continued it will cause the bubble to get even larger.
So given this, why would Mr. Norris pipe up about it now, after reaping the benefit for years?
Clearly the reason is he recognizes the potential scale of the problem. And he knows the only way to get the banks and overleveraged borrowers out of the impending hole is if the government stays involved.
But he’s treading a fine line. Effectively, the banks want to have their cake and eat it at the same time. They want to continue the steady supply of new home loans whilst making sure their existing customers are able to pay. This is only possible if the economy continues to grow and people don’t lose their jobs.
Of course he also understands that if the house prices continue to rise then it is increasing the risk exposure on the bank’s balance sheet. They know the property valuations aren’t real, but it is too late to do anything about it.
The only way the banks can be saved from annihilation once the housing bubble pops is for the government to step in and guarantee home loans. That step simply takes the risk away from the banks, puts it onto the taxpayer and encourages the banks to continue lending.
But who would pay for the scheme? The evil savers of course. Although in reality it wouldn’t just be the savers it would be anyone depositing cash into a bank account. You would see the return of a deposits tax… and probably a withdrawals tax as well, just to make sure there’s no escape.
Of course it’s all just speculation. We’re sure the brains-trusts in Canberra can come up with their own terrific ideas. But whatever they do, you can be almost assured they will do everything they possibly can to make sure the property market doesn’t crash on “their watch.”
The conventional wisdom is always put forward that house prices are different to any other type of asset. Different because the home is a tangible asset, you live in it; even if you get into financial strife it will be the last sacrifice you make.
In other words, things have to get really bad before you’ll sell it, therefore the chances of an oversupply of houses leading to falling prices is unlikely. Guess what, things could be about to get “really bad.”
Conventional wisdom is often proven to be incorrect. The main reason people assume house prices always go up is because they always have done in the past. But that doesn’t mean to say it will always be the case. As the managed funds disclosures tell us, “past performance shouldn’t be used as a guide for future performance.”
At some stage a tipping point will come where the balance between supply and demand shifts significantly in favour of the buyer. Once that happens you will start to see house price deflation, where buyers will prefer to rent rather than buy as house prices continue to fall.
This would necessarily mean that home owners who are struggling to keep up with repayments will need to sell before they move into – or further into – negative equity. Making the housing market even more favourable for buyers.
Eventually, as always happens with supply and demand, the excess selling will dry up and buyers will start to push prices up again.
Unfortunately, unlike the supply and demand price action for everyday consumer goods, it is a scenario that is likely to play out over many years rather than just a few days.
The longer it is delayed, the worse the consequences will be.
Other Stuff on the Markets
As I mentioned above, the US Federal Reserve is cranking up the printing press – or more correctly, it has pressed the button to buy treasury bonds and mortgage backed securities in the market.
Why is that printing money? Well, because the government doesn’t actually have any money. It is trillions of dollars in debt. Therefore it has to ‘create’ some (USD$1 trillion) so it can buy the bonds in the market and flood investors with cash.
We’ll have more on this tomorrow.