Possibly not. On the face of it, house prices are extremely high, 30 per cent above the 80 year average. Australian house prices are among the most expensive in the world. According to the consultancy Demographia, they are in the “severely unaffordable” range, when compared with median household incomes: about a fifth more expensive than houses in the United Kingdom and almost double American prices (on the relative measure). Viewed purely as a financial asset, a severe correction seems almost certain.
Yet there are a number of countervailing forces. One is a shortage of housing supply, exacerbated by high levels of immigration into Australia’s capital cities. Another is that housing loans in Australia are not non-recourse loans as they are in America. This means that in America lenders can hand back the keys to a house and all they have is a bad credit rating. In Australia, defaulters still owe any money that is not recouped by the sale of the house. Accordingly, they stay as long as they can in the house. Better to be indebted and in a home than indebted and homeless.
The effect of Australia’s unusually generous negative gearing laws also favours property as a financial asset, reducing the likelihood of a sharp fall. But with more than a million households predicted to experience some kind of mortgage stress, according to Fujitsu Consulting, the possibility for a sharp sell-off certainly exists.Enjoying this article? Click here to subscribe for full access. Just $5 a month.
If there is a sharp downturn in housing, it could set off a negative spiral by forcing banks to reduce lending to accommodate weaker asset prices, which in turn would contribute to weaker asset prices. The possibility exists of something akin to a credit squeeze. In the short term, the four main banks have been lending aggressively to soak up the market share vacated by the non-bank lenders and regional banks. They now dominate most of the new lending.
But this process is almost over, and the banks are now moving into a deleveraging phase to reduce their exposure. At the moment, the leverage ratio of Australian banks is 18 times equity, the highest level since the Asian financial crisis and “entirely inconsistent with a slowing economy”, according to a report by Goldman Sachs JBWere.
The report estimates that if the value of assets on balance sheets for all financial intermediaries were to fall by 0.5 per cent, or bad debts rose by 0.5 per cent, then the leverage ratio of banks would rise. This could mean that the cycle of easy money leading to a bubble in the property market could turn into its opposite: restricted or expensive money that ends up pricking the property bubble.
If property assets on banks’ balance sheets were to fall sharply – be it houses or commercial property – the leverage ratios would rise even higher. That would encourage banks to reduce lending, something they are already intent on doing (despite their leverage ratios being much more healthy than their American or British counterparts).
Goldman Sachs estimates that just reducing banks’ current leverage from 18 back to a more acceptable 16 times would require credit to slow by $180 billion. If the value of their assets were to fall sharply because of a sharp property price fall, or because their bad debts continue to spiral – both the Australian and New Zealand Banking Group (ANZ) and the National Australia Bank (NAB) recently reported billion dollar write downs – then the credit taps could be turned off even more aggressively.
Australia’s stock of wealth is skewed more towards property than in the United States. The so-called “wealth effect”, where rising house prices give owners the impression that they are rich, encouraging them to consume more aggressively, is more applicable to Australia than America. Accordingly, a sharp fall in house prices would probably have a more depressing effect on consumer sentiment and the overall economy.
The total value of shares on the Australian Securities Exchange is about $1.5 trillion. The total value of Australia’s 8.3 million dwellings is $3.7 trillion. In the United States the value of houses and shares is more in balance. The stock market is worth $US15 trillion, while the housing market is worth about $US20 trillion. In the United Kingdom, the stock market is only about a third of the value of housing, which is over $9 trillion, and so a “negative wealth effect” would be felt more keenly.
Look closer and more than a third of the capitalisation of the Australian stock market is accounted for by the financial sector (including property trusts). These companies derive a substantial portion of their business from property lending. The conclusion? Australia is not so much riding on the sheep’s back as on the roof of stellar house prices.