Bank Bubble Denial Spreads

Poor old Paul Bloxham, chief economist at HSBC Australia.

In the space of a few days he’s gone from being premium foie gras to plain old chopped liver.

From being the toast of the town to just vegemite on toast.

Last month you could barely turn the pages of the business press or avoid an interview with him on business television shows as the mainstream press went gaga over Bloxham’s call that the Reserve Bank of Australia (RBA) wouldn’t lift interest rates.

This was a call against the consensus opinion among analysts that the RBA would lift rates.

As it happens, the RBA didn’t increase rates and the mainstream press had a new superstar interest rate predictor on their hands.

He even went out on a limb to say that the RBA would increase rates at the November meeting – which it did. The only trouble is that a couple of weeks ago Bloxham changed his mind.

He decided that the RBA would wait until December before raising rates.

And perhaps the market took notice of their new guru. According to yesterday’s Australian Financial Review (AFR) before the RBA announcement:

“Swaps traders are betting there is only a 23 per cent chance that the RBA will increase its overnight cash rate target to 4.75 per cent, compared with as much as 60 per cent before September-quarter inflation data was published last week…”

But then the RBA made the announcement that dashed the dreams of the mainstream press:

“At its meeting today, the Board decided to raise the cash rate by 25 basis points to 4.75 per cent.”

Drats! Despite being an ex-RBA drone, and who the mainstream thought would have a hotline to the RBA Board, it turns out that Bloxham has as much idea about interest rate movements as anyone else – ie. none.

Bloxham’s fifteen minutes of economic fame is over. Now he’ll be consigned back to the pack with the other analysts and commentators who singularly fail to wow the crowd with their interest rate predicting mumbo-jumbo.

But really, the monthly interest rate circus is just a farce. And it always will be when you’ve got a handful of bureaucrats and so-called business leaders deciding what the price of money should be.

Although one thing’s for sure. The RBA and the major banks are helping out with making our housing price crash prediction come true.

Borrowers that are geared up to the eyeballs, and who were suckered in by the Fairy Ruddfather’s bribes have seen their mortgage repayments increase by over $500 per month since the RBA started jacking up rates again.

Perhaps you don’t think that sounds like much.

But think of it this way. In annual terms it equals an extra $6,000.

And more importantly, for an average income earner with an average mortgage it means that an extra $8,571 of before tax income needs to be re-allocated from saving or spending into paying off the mortgage.

For the average income earner who earns around $65,000 who lives with a second income earner who earns around $48,000 that’s an extra 7.5% of their gross income they need to free up.

That would take their total annual repayments on a $350,000 mortgage (the average) to $30,264, or the equivalent of before tax income of $43,234.

In other words, nearly 40% of gross income.

But that’s if they’re lucky and didn’t take the advice of the property spruikers who told them property prices always go up and that interest rates would stay low.

Because according to the Commonwealth Bank home loan calculators, borrowers with the income levels I’ve mentioned above could now borrow up to $568,000 or an annual repayment of $49,116… or $70,000 of before tax income… or 62% of gross income.

In net income terms, it would work out around 76% of income!

Even more crucial than that is the obvious abject failure of Australia’s banks to convince overseas investors that the domestic banking sector and housing market are safe.

I mean, hasn’t the Commonwealth Bank just completed a global tour spruiking the Aussie housing market, claiming that the income to house price ratios are nowhere near as bad as many claim?

Seeing as the whole point of the tour was to get investors to buy the bank’s debt for as low an interest rate as possible, it must surely mean the bank has failed to convince those investors about the security of the Aussie housing market.

Higher interest rates means higher risk. International investors clearly view Australian banks and the Australian housing market as being a higher risk than the banks and the RBA would have you believe.

The fact that Commonwealth Bank has had to increase mortgage interests rates by more than the RBA cash rate is proof the bank is being forced to pay out more than it would like on the debt it issues.

Of course it’s not just CBA that’s in trouble on that score. If the report released by Westpac titled, “Australian housing: the bubble myth” is anything to go by, then Westpac is equally scared about what will happen when the supposedly mythical bubble pops.

The bubble denying is spreading from bank to bank. First CBA, now Westpac… we’ll wait for ANZ and NAB to take their turn…

Anyway, we took the opportunity of the Melbourne long weekend to read through Westpac’s report in full.

Several readers picked up on something we wrote in Friday’s Money Morning. We quoted from the report:

“There is little evidence of excessive speculative activity by investors in recent years and we see little risk of disruption from investors selling properties – residential property has outperformed other assets and continues to offer a stable, secure source of income.”

Our comment was that the bank’s economists must be mad if they think property offers a secure source of income. That hadn’t the bank realised that 70% of property investors were losing money on investment properties.

Some readers have claimed that the bank was commenting about the reliability of the income to the bank, not to investors. Not so. It’s clear Westpac is referring to the income earned by investors.

If you’re in any doubt you can read the full report by clicking here.

The point I’m making here by bringing this up is that you should be under no illusion about how desperate the Aussie banks are to spruik and cheerlead for the property market.

It’s not their own income that the bank is keen to talk up, if anything the banks are trying to talk it down, instead the banks need to keep the myth alive that housing is not gripped by a speculative bubble.

But aside from the usual bluff and bluster from the banks, there were a number of things that stood out from the report.

First, compare and contrast these two statements from the report:

“The notion that aggressive rate cuts and first home buyer incentives could have ‘rescued’ a falling market just as the bubble was bursting is not compelling. Speculative bubbles are famously resistant to policy moves both on the way up and on the way down.”

Now read this paragraph:

“Importantly policy is also well-placed to deal with any shock if it were to emerge. Low public debt levels mean there is ample scope for fiscal stimulus if required. In addition, with interest rates near historical averages there is plenty of capacity for the Reserve Bank of Australia to apply aggressive monetary stimulus if a threat emerges.”

Er, so even though bubbles are “famously resistant to policy moves”, don’t worry because “policy is… well-placed to deal with any shock if it were to emerge.”

So, what’s the difference between a “shock” and a bursting “bubble” then?

Nothing apparently. They are the same. As the report again points out later on:

“As such it is worth asking if there is a shock that could indirectly trigger a house price collapse?

“Domestic policy shocks are unlikely to trigger a housing collapse. The 2008 episode showed us that it is possible for the authorities to reverse policy mistakes rapidly. Rates can be cut and fiscal stimulus can be applied.”

Of course, Westpac insists Australia doesn’t have a speculative bubble, just high prices. Which the chart I’ll show you in a moment will disprove.

Every man and his dog knows that the banks and the housing market were bailed out in 2008 and 2009. And no amount of denial by Westpac can ignore the fact that Australian housing is in a speculative bubble… as evidenced by a chart Westpac uses in its own report:

Apparently the US and UK housing markets were in a bubble, but Aussie house prices (the dark line) aren’t. Even though Aussie house prices have continued to soar while US and UK prices have sunk.

But the best proof of the speculative nature of owner-occupiers and investors and their attitude towards price growth is the following amazing chart:

According to this chart, as of this year around 40% of loan applications for owner-occupiers are interest only, low doc or non-conforming. Low doc and non-conforming speak for themselves, but interest only provides more proof of the speculative nature of housing.

There’s no reason to take out an interest only loan unless the borrower either can’t afford the extra repayment for a principal and interest loan, or they’re banking on the value of the house increasing and either selling before the interest only period ends, or getting a re-valuation on the house and withdrawing equity (increasing debt).

But look at the right hand side of the chart… almost 50% of investor loans are interest only, and when you add in low doc and non-conforming you’re looking at 60%.

Again, why would you take out an interest only loan unless there was the belief that the value of the property would rise?

Whichever way you stack these numbers, and whatever spruikers claim, the simple fact is that Australia is mesmerised by the belief that property prices only ever go up. So much so that they’re prepared to pay thousands of dollars each year in interest on the punt that the house price will rise.

For an owner occupier taking out the average sized mortgage that means an interest bill over $27,000.

However things may not be looking so good for the ‘house prices always go up’ theory. According to our pals at RPData, “Affordability improves as Australian capital city dwelling values flat-line.”

We’ll try to remember to use that line the next time one of our share tips goes down, “Don’t worry about it, the affordability has improved!”

But in terms of trying to pull the wool over your eyes Westpac has come up trumps with the charts it has presented on page twenty-one of its report.

The bank goes to some lengths to claim that first home buyers are actually doing quite well out of their property purchases and that they’ve built up a nice bit of equity in their homes – equity that can only be released by selling the house or by borrowing it from the bank.

The chart we liked the most was this one:

The aim of this chart is to prove that thanks to rising house prices, FHBs that borrowed 90% of the house value now only have around an 81% debt compared to the higher valued home.

Talk about massaging the numbers. For a start, given the chances that FHBs are more likely to be the ones that take out an interest only loan, any “equity” they’ve supposedly built up will have been gorged by the interest repayments… interest payments to banks like Westpac.

But secondly, using an inflated house price to argue that LVRs are now lower because house prices have risen does nothing to counter the argument against a house price bubble. If anything it confirms the unsustainable growth of house prices, especially when you compared Aussie house prices to US and UK prices as shown on the previous chart.

Sure LVRs may be lower, but for most that’s only a paper profit – one they’ll never have the chance to cash-in on.

Once the FHBs start getting into trouble thanks to increased interest rates, that equity will soon prove to be worth nothing, and FHBs will find their first home buying experience to be the worst decision they’ve ever made.

Thanks to the RBA and CBA, the pin and the housing bubble have edged just a little bit closer.

Cheers.

Kris Sayce
For Money Morning Australia

Tagged as: australia, bank, dollar, HSBC, interest, mortgage, rba