In Tuesday’s Port Phillip Insider we made the point that although Aussie governments have helped inflate house prices for 30 years, there’s no guarantee they will continue to do so.
The government has helped boost house prices because it’s in their interest.
If something happens which causes high house prices to no longer be in the government’s interest, the bubble will pop — or at the least, deflate gradually.
For the moment at least, that may not be likely. The inseparable link between house prices and the banking system is the single biggest reason why governments encourage housing bubbles.
If house prices collapse, the loans against those houses go sour. Folks are in negative equity. They can’t sell in order to pay off the loan. If they don’t have the income to cover the mortgage, due to an economic downturn, the banks won’t make back the money they’ve loaned.
If that happens on large enough a scale, it would be bad news for the banks. You would be looking at US, UK, and European-style banking bailouts.
And if you think it couldn’t happen in Australia, remember that if it wasn’t for the Commonwealth Bank of Australia’s [ASX:CBA] takeover of BankWest in 2008, Australia would likely have experienced a domestic banking collapse.
Back to our point, governments have only propped up the Australian housing sector because it has been in their interest to do so.
But what happens when it’s no longer in their interest?
Our bet is that that time may soon arrive. And if we’re right, it will coincide with the wave of Baby Boomer retirees, as they shift from oversized three and four bedroom homes, to more manageable one and two bedroom homes.
As we pointed out, many Baby Boomers want to downsize so they can access the monetary value of their homes. Many who have minimal savings believe that their home is their ‘retirement fund’.
Trouble is, downsizing doesn’t provide the cash injection that most think it will. To stay in the same area, a one or two bedroom home may only be 10–20% cheaper than the large family home they’re selling.
Deduct the costs of buying and selling, and the cash injection they expected may turn out to be hardly worth the effort.
Our guess is that when enough Baby Boomers start grumbling about this fact, added with the number of younger folks who complain they can’t afford to buy an entry-level house, a future Australian government will have no qualms about taking a populist approach.
That is, they’ll introduce price controls on housing. Or rather, on specific types of housing. Sound unlikely? Don’t be so sure about that.
We were intrigued today by an interview in the Australian Financial Review with economist Steve Keen.
Keen believes Aussie house prices are in an extraordinary bubble. He believes that, sooner or later, there will be a house price crash.
However, Keen also believes there needs to be a complete reform of the banking and debt system, which will help make housing bubbles a thing of the past.
See what we said about the link between banks and housing.
To excerpt from the article:
‘So how do modern, monetary economies escape the spiral of ever higher debt? Keen believes there needs to be a reset of private debt levels via a “people’s quantitative easing” — effectively, a government bailout of households — to something more in the order of 50–100 per cent of GDP, from around 120 per cent now.
‘Under the plan, the banks would be instructed to use the government cash injections to pay down the account holders’ existing debt. If a person had no debt, then they would simply receive the cash.
‘He says the initial instalment should be larger than, say, the $1000 Rudd stimulus package, but not by much. “In anything like this, which hasn’t been tried before, I would want to do it in small doses,” Keen says.
‘What is then needed involves radical but simple regulatory reform of the banking sector.
‘“What I want to do is bring in a range of bank rules which would limit the amount of lending you can give against an asset to some multiple of the income-earning capacity of the asset.”
‘Keen gives the example of a property with an estimated or actual annual rental income of $50,000, in which case the loan limit could be $500,000. Now the bidder for a house ready and nominally capable to take on the most debt wins.
‘Under Keen’s prescription, both are limited to how much they can borrow, which means the bidder with the most savings is the one who wins.’
We’re not sure the conclusion on that is true. The winner will be the bidder who is prepared to pay the most. It’s entirely possible that someone with greater borrowing capacity would choose not to use it.
In which case, the bidder with most savings withdraws, allowing the bidder with less savings to buy up to their maximum limit.
The point here is that this won’t be the first or last time that you’ll see commentary in the press about capping borrowing. And by natural extension, if the proposal is to cap borrowing, it must also cap house prices.
Whichever way you look at it, it will be an attempt at price controls. If that happens, the ‘golden age’ of Aussie house price rises will be over.
The debt binge will come to an end. The current banking system as you know it will come to an end.
The only matter is when. When will this all happen?
Ah, if only we knew.
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Defining ‘affordable’ for Australian Housing
A wonderful bit of doublespeak from yesterday’s Australian:
‘Households have made use of lower rates to bid up house prices; though housing is now more affordable than at any time in the last 13 years, despite soaring house prices.’
Got to get our head around this. Aussie house prices are, simultaneously, the most expensive they’ve ever been, while at the same time, the most affordable.
It sure is a head scratcher.
Of course, the culprit here is the word ‘affordable’. It means different things in different mouths.
It’s rather like the Commonwealth Bank of Australia’s famous ‘Equity mate’ ads, which tell you how you can ‘withdraw equity’ from your home.
It’s a genius piece of marketing. Because as anyone knows, the withdrawal of ‘equity’ from a home, is actually the taking out of debt against that home.
Equity is an asset. When you have an asset, you hope to earn something from that asset. But when you withdraw equity, the bank charges you interest on it. That’s because the ‘equity’ is actually debt.
In this case, ‘affordable’ refers to low interest rates. In that respect, we suppose low interest rates have made it more ‘affordable’ to buy a house.
The only problem is that while the rates may be lower, the loan required to buy the home is higher.
According to the article, house prices have risen 40% over the past five year. Mortgage interest rates, have fallen. Five years ago, you could have gotten a mortgage with an interest rate around 7.5%.
Today, the Commonwealth Bank will deal you a home loan for around 4.5–5%. That’s good. A $500,000 mortgage five years ago would rack up interest charges of $37,500.
Today, it may only cost $22,500 in interest.
However, the borrower today, would need to borrow 40% more to buy a comparable home. So their mortgage is actually $700,000. And their mortgage repayments, even at the lower interest rate, are $31,500.
That’s less. But what happens if and when interest rates rise again? Even if they only go to 6%, the mortgage interest is $42,000. And should interest rates rise to 7.5%, suddenly the interest charges rise to $52,500.
How affordable is that we wonder? Especially for the buyer who had to borrow 40% more than they would have five years ago, but may soon have to pay interest costs that are significantly more than they are today?
On a final note, the Australian article also points out:
‘The Reserve Bank’s quarterly report on household finances shows that household debt has soared 32 per cent, or $550 billion, over the past five years to a record $2.3 trillion.’
What else can we say?
Publisher, Money Morning
Editor’s note: The above article was originally published in Port Phillip Insider.
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