In today’s Money Morning: An error corrected… The year’s worst housing bubble story… Marvellous water views… and cars and lithium…
Why it Won’t Take a Shock to Knock House Prices for Six
Yesterday we made a most terrible error. We left out a ’t. When advising you to look after your bars of gold, we should have written:
“Just make sure you’ve got a safe place to keep it where the government can’t get hold of it should the Governor-General ever activate Part IV of the Banking Act.”
Hopefully that clears things up.
We thought housing articles couldn’t get any worse after reading the effort from HSBC’s Paul Bloxham last week.
But oh boy. We were wrong.
The Sydney Morning Herald’s Jessica Irvine has knocked out what is, in our opinion, the year’s worst housing bubble article – that’s a big claim when it’s still only March!
But it’s hardly surprising, seeing as much of the material appears to have been drawn from Mr. Bloxham’s half-baked effort last week. After all, if you take a badly baked cake and mix it up, what are you left with? That’s right, an even worse cake.
There’s no point taking apart the entire article, because as I say, it’s largely a rehash of Mr. Bloxham’s effort.
But I will go over a couple of points. I know, maybe it gets a little boring covering old ground. But as long as the mainstream press and banking insiders keep printing the same old drivel, I’ll keep printing rebuttals.
So if you’ve had enough of housing bubbles, give this section a miss and scroll down to see what Aaron Tyrrell has to say about cars and lithium.
Marvellous water views
If you’re still with me, let’s take a look at some of the schoolgirl errors made by Ms. Irvine:
Ms. Irvine backs Mr. Bloxham’s claim that Aussie houses are better quality than those overseas. Not surprisingly, no proof is given. Where is the data to prove this?
Then Ms Irvine claims Aussies houses have “marvellous water views”! And that’s why high prices are justified. What on earth does that have to do with anything? If “marvellous water views” are a house price crash preventer, then surely a lack of “marvellous water views” is a house price bubble preventer.
Yet the lack of “marvellous water views” didn’t stop house prices in Arizona forming a bubble.
Yes, people may desire a water view, but it doesn’t mean houses with water views can never be overpriced. The same dynamic of excessive credit and the belief that prices can never fall has played out in houses with and without views.
In fact, based on some of the discounting that’s happened among prime Sydney apartments on the Harbour, we’d say those properties with a “marvellous water view” are likely to be hit the hardest.
But those are just trivial things. Things she may now regret writing. Of more interest is the following comment:
“You see, house prices only fall when people are forced to sell their homes. Otherwise, households choose to simply remain in their home and wait things out. Property investors are loath to realise their capital loss.
“A true collapse in house prices would indeed require some large external shock – a doubling of unemployment or interest rates – to trigger the wave of forced home sales that it would take to provoke house price falls.”
Not true. People buy and sell houses all the time. People upsize and downsize. If someone wants to sell, they’ll sell… not just when they’re forced to.
All that’s required for house prices to fall is for people to think that house prices will fall. Just in the same way that share prices can fall when they reach a peak. Sellers look to get out first before everyone else gets the same idea.
But because it can take so long to sell a house, the stock of housing on the market can build up quickly. And before sellers know it, they’re no longer the only house on the street for sale… they’ve got competition. And as you know, in all areas of an economy, competition tends to drive down prices.
And let me tell you something, there’s a whole bunch of competition on the market right now.
Competition among sellers
This week SQM Research sent out its latest analysis of housing stock on the market. As you’ll see in the table below, there’s been a huge increase in the number of houses up for sale:
In fact nationally there has been a 46% increase in the supply of housing for sale, compared to the same time last year… 46%!
Talk about a housing glut…forget the housing shortage lies. Australia has a huge excess of housing. Incidentally, we did hear our old pal Peter Switzer banging on about the housing shortage last night on Sky Business Channel… it seems you can’t keep a good excuse down.
But what will the glut do to prices? That’s right, push them down thanks to increased competition. I can picture buyers now, “Why should I pay $500k for your house when there’s one down the road for $480k…”
Forget “large external shocks”, or a “doubling of unemployment or interest rates”, all it needs is increased competition… and we’ve got it.
But Ms. Irvine also ignores the fact that different sellers are in different circumstances. Someone who bought a house for $100k, may be happy to accept $300k, whereas someone who bought for $350k may not be so happy.
But that won’t stop the first house from selling. And it won’t stop house prices from falling just because someone chooses to hold out for a higher price – which may never arrive if buyers can get something similar for cheaper.
You see, the idea that something major has to happen in order for prices to fall is nonsense. There doesn’t need to be a big bang catalyst to spark a house price rout.
All that’s needed is for the fundamentals of supply, demand, price and quantity to play out. And that’s happening right now.
Interest rates are up 20%
But what about the idea that interest rates need to double? Not true. When interest rates are kept artificially low, it sucks in a whole bunch of borrowers. Those that wouldn’t otherwise have borrowed are drawn into the market.
As with anything, artificially low interest rates create malinvestments.
And as Ms. Irvine correctly points out, it encourages lower lending standards too.
Because so many borrowers have been sucked in on low interest rates, it distorts the market. But at some point the demand for borrowing will begin to dry up, and investors who would otherwise have put savings in the bank will look elsewhere for higher returns.
That creates a problem for a Ponzi banking system. Banks need to keep filling the hopper. They need more deposits and more borrowing to keep the Ponzi finance flowing.
When that slows down – as it has – the banks need to raise interest rates. Simply so they can encourage savers to deposit money, or to encourage investors to buy their bonds.
Remember all the crazy offers the banks were making to attract deposits last year? Yeah, of course you do. That’s Ponzi finance in action. It was an indicator of the market starting to tip over.
But here’s the thing. If the bank has lowered its lending standards and kept interest rates low for too long, interest rates only have to rise marginally in order for it to have a big impact on borrowers.
It’s just like leveraged investing. It works great when things are going your way… and… not so great when things are going against you.
For instance, the ANZ Bank reckons the median house price is $559,000. Let’s say someone has taken out an 80% mortgage, borrowing $447,200. An interest rate of 5% would mean repayments of $2,401 per month.
But should the interest rate increase to 7%, repayments increase to $2,976 per month.
That’s an extra $575 per month of after-tax money.
And if interest rates go to 8%, then you’re looking at monthly repayments of $3,282… an extra $881 per month.
“Oh, that won’t happen,” the spruikers say. Really? Too late, we’re almost there. Mortgage interest rates got down to about 5% in 2008. Today they’re above 7%. And that’s why prices are on the way down. That’s about a 20% increase from the low point.
“Oh, but people are ahead on their mortgages, the RBA says so.” Don’t trust those figures too much. Sure, plenty of people would have gotten ahead on their mortgages. Especially as interest rates dropped in 2008 and 2009. But trust me, it won’t take long for that benefit to be wiped out.
Not when repayments are an extra $700 or $800 per month.
And don’t forget, those that are ahead are those that had mortgages prior to 2008… before interest rates were cut. Those that were suckered in by the first-home buyer’s bribe won’t have any buffer, because they were conned into borrowing as much as they could afford, just at the point when interest rates were at the low.
Any interest rate increase will hurt them harder. Each 0.25% rise in interest rates is an increase of 5% increase for someone who took out a mortgage when rates were at 5%.
Whereas it’s only a 3.5% increase for someone who took out a mortgage with rates at 7%. Believe me, it may not seem like much, but it makes a whole lot of difference when you’ve overextended yourself with a giant mortgage.
Unemployment may be higher than you think
But what about the unemployment rate. Again, don’t get too excited. Sure, the unemployment rate is 5%. But remember who counts as employed… anyone doing more than one hour of work per work… yeah, those people are gonna help prop up house prices!
For a start, consider that today about 28% of all employed people work part-time.
In 1978, it was only about 14%.
What does that tell you? It tells you there has been a relative increase in people working part-time. That much is obvious.
What else does it tell you? Well, we’re not a labour force analyst so we can’t say for certain. But we can take a stab at a guess or two…
Granted, more flexible working arrangements have played a part. But we’ll guess it also means that people are now counted as part of the permanent labour force when previously they weren’t… therefore distorting Australia’s unemployment rate.
You can see that distortion in the number of unemployed people and the number of people not in the labour force. Both these numbers have only increased by about 50% over the past thirty-three years.
In normal circumstances you’d expect those numbers to increase as the population increases.
But while there has been an increase it has been nowhere near as much as the increase in the number of people in the workforce. Those employed full-time has more than doubled. But importantly, the number of people working part-time has increased more than three-fold.
In other words, fiddling of the employment statistics is giving a distorted impression of the strength of the Australian economy.
Both of these facts tell you it won’t take a major shock to interest rates or unemployment to knock house prices down. All it will take is a marginal move in either – thanks to the increased leverage from low interest rates.
Nothing I’ve written will stop the spruikers from carping on about the invincibility of the Australian housing market. House prices are falling around their ears, yet still they make the same old tired excuses.
But really, the spruikers must learn to do better. And if they insist on egging on the mainstream press to write anti-bubble stories, they should give them better and more convincing material than rubbish about “marvellous water views”.
For Money Morning Australia