Australia’s Housing Bubble- Past the Point of No Return

Canada and Australia- the Tale of Two Similar Bubbles

From Short of the year 2010:

So the big next crisis will be outside the U.S, with the key being inflation and dollar liquidity. With all the world depending on helicopter's Ben dollars falling around on all who is too big to fail, a short squeeze in the dollar(like what is maybe happening now with the potential collapse of the Euro) will bring all the "emerging world" to its knees. Another thing that could happen, with or without a dollar rally is a pickup in inflation which will force those central banks to tighten. In India, China and Australia it seems like it is happening and in Israel it is happening for sure.

Since the article was published in December 2009 a lot of things have happened. The dollar rallied and the euro fell sharply (as we predicted in the Euro Crisis section), Q.E ended (for the time being, causing a tightening in liquidity worldwide and China is showing signs that its inevitable collapse is approaching.

So what do Australia and Canada have in common in this vulnerable global environment? Both of them have giant housing bubbles of their own that have reached their limits, they both have artificially strong currencies due to the dollar carry trade that developed during the period of Q.E 1.0(March 2009-March 2010), and both them are vulnerable to a depression in China due to their commodity orientated economies.

 This is what we wrote in How to Profit from the Coming Collapse of China:

3. Short Australia's ETF(EWA)- Australia has a giant housing bubble of it’s own. The index is 50% financial and the rest is commodity producers. When China falls the commodity producers will suffer, as will the Australian economy. Combine that with the collapse of its own housing bubble and the index could lose a lot. Plus, remember that in such case the Australian dollar will fall sharply, so if you short the ETF you will make a profit out of currency appreciation,

6. Short Canadian banks- Like Australia, Canada too has a housing bubble. With a slump in oil they will make a great short(And so will the currency)

And in China's Coming Depression and The Peak Of Deflation

The major driver behind increasing minerals and energy commodity prices since early 2009 has been demand in China, where consumption has grown and offset falling demand in major developed economies such as the United States, the European Union and Japan. Demand for commodities within China has been underpinned by the government’s economic stimulus package, which is targeted to infrastructure developments such as roads, railways and electricity networks. The stimulus package has also buoyed consumer sentiment which has supported demand for consumer durables such as automobiles and electrical goods. For many commodities, stock building has provided additional support for imports.

The increase in China’s minerals and energy demand since early 2009 has been accompanied by significant increases in imports of some commodities such as iron ore, thermal and metallurgical coal and copper. This rise in imports has in turn provided support for production in exporting countries such as Australia and Brazil.

So obviously, a crisis in China means a fall in commodity prices and a move towards very low inflation rates worldwide or even outright deflation. That will probably mark the peak of the deflationary pressures confronting the globe.

Housing prices have reached the sky

According to the Australian Bureau of Statistics house prices soared 20 per cent in the 12 months between March 2009 and March 2010, the "fastest ever recorded" in Australian history.

Australian housing prices are inflated in levels that are beyond belief. A simple comparison of the prices to the long-term historical average, rental yields, and average income leads to only one conclusion . Australia has a giant housing bubble an when it will burst the country will suffer just like the United States and Europe are suffering today.

From Wikipedia

Australian real estate prices, like in the rest of the world have been rising along with average income this the end of world war II. Up until 1997 the price to rental yield ratio and the price to income ratio have held steadily. However, since 1997, prices have been going through the roof. The policy response by the Australian central bank to cut interest rates sharply has trigged an acieration in price in appreciation just like similar responses affected housing prices in China, Brazil, Canada, India, and Israel. What do all of these economies have in common? It is simple. All of these countries didn’t have interest rates at zero back in 2002 when the U.S housing bubble was inflated, so their economies still reacted to monetary stimulus. In places where interest rates didn’t have room to go down (since they were close to zero back in 2002) the interest rate cut magic wand didn’t work.

In July 2010, The Economist  published its ’House-price indicators’ that aims at determing if housing prices in different places are overpriced and by how much. From a list of 20 countries, Australia was noted as being 61.1% overvalued on a long term average of price-to-rents ratios. It was also noted that:

More concerning, however, is our analysis of “fair value” in housing, which is based on comparing the current ratio of house prices to rents with its long-term average. By this measure Australian property is the most overvalued of any of the 20 countries we track.

A household in Australia today that wants to buy an house will face twice the debt of previous generations. This was noted in 2008, in a report issued by the Senate Select Committee on Housing Affordability in Australia reported:

"The average house price in the capital cities is now equivalent to over seven years of average earnings; up from three in the 1950s to the early 1980s….

Even the RBA Governor, Glenn Stevens, is more than hinting at the fact that Australia is suffering from a housing bubble:

"How is it that in a country this big in area and this small in numbers of people we can't manage to make the marginal price of a dwelling lower than it is? It seems to me quite high."

More from Mr. Stevens:


“potential vulnerabilities need to be addressed in good times. . . Australia does not have a problem with public debt . Nor a problem with corporate debt” (we disagree with this part)

... “ the big rise in debt in the past couple of decades has been in the household sector.”...
...”it wouldn’t be wise for that build-up in household leverage to continue unabated over the years ahead” ... “further big increases in indebtedness could increase vulnerability to shocks”. ..


Despite the reluctances on behalf of RBA to admit that there is a giant bubble (they are not in a position to say what others have been warning about. Just like Bernanke was not in a position to do so in 2005). There are plenty of investors and economists in Australia who are warning about the ultimate outcome:


Any doubt that borrowed money is what has driven house prices into the stratosphere in Australia is dispelled by the data: despite all the hooey about Australian lenders being more responsible than those in the USA, mortgage debt in Australia rose three times faster since 1990. Having started with a mortgage debt to GDP ratio that was just 40 per cent of America's, we now have a higher ratio than the USA — and ours is still increasing while theirs is clearly falling.

From The Economist

Edward Chancellor, one of the few who have predicted the global credit bust has said:

"Australia is in the midst of an unsustainable housing bubble that could burst at any time ... house prices are more than 50 per cent above their fair value -- a once in 40-year event... luck rather than skill had allowed the Australian economy to fare better in the global financial crisis than other developed economies."

And According to The Australian business section, hedge funds are selling their stakes in major Australian banks because:


'...sentiment towards the Australian banks had soured because of doubts that the strength in the national property market would be sustained.'

The policy response in 2008 only made the bubble bigger

Housing prices in Australia actually started to fall in early 2009 but then the government intervened with incentives for first time home buyers  at the order of $21,000 for new houses and $14,000 for existing homes which was combined with a sharp drop in interest rates.

Intelligent investors and economists in Australia (yes, there are a few of those left in the world) questioned the  “wisdom of encouraging marginal buyers to enter the market at this stage of the cycle, just ahead of a sharp rise in unemployment and with interest rates so low" Australia has created its own sub-prime market.

Like in many other places in world, Easy credit and a “welfare for the rich” tax system encouraged investors and regular households to take on crazy loans, including the very popular interest-only loans. (It should be noted that such loan were also very popular in the United States during the years 2002-2007)

These kind of loans are made for a limited period, usually between 5 and 10 years, and are designed to cover only the interest on the loan, while at the end of the period, the borrower still owes the full amount borrowed. The borrowers hope (and usually “know for sure”), that a substantial capital gain will enable them to sell the house before they need to pay off the loan. As was the case in the United States, the borrowers are mostly speculators who want “a piece of the action”.

A good example for the mania is a new interest-only loan product that was launched at May 2010. It was of course marketed as a solution for those seeking entry to the RE market. It reduces repayments on a $300,000 mortgage by $5000 a year:

“Homebuyers are to be offered never-ending mortgages in a bid to overcome Australia's affordability crisis.” where one lender, “is preparing to sell loans that have no fixed term and no requirement to repay any capital along the way. . . . Repayments would be kept to a minimum, allowing borrowers to benefit from capital growth in their property.”

From Wikipeida

Australia’s economy is extremely vulnerable

From 1994 to 2009 Australian private debt to GDP ratio grew from about 80% to 160%. Private debt has been growing on an average of 15% per annum in the years 1998–2009, growth in GDP was less than 3% when stripping out the growth that derived solely from an increase in debt As can be seen by the charts, total household debt as a percentage of disposable income grew from 45% in 1990 to 155% in 2009, while housing debt to disposable income increased at a staggering rate from 35% to 140%.

Consider the following from Business Spectator:

"Between 1976 and 2008 net foreign debt increased from $3 billion to $600 billion and during that time from 4 per cent of GDP to 53 per cent of GDP. Even if the shark doesn’t bite today, ultimately keeping our foreign debt growing at 18 per cent per annum is unsustainable. Currently we are like a flock of turkeys, who every day go to the foreign debt markets to get fed the foreign debt we need to keep alive and every day we get what we need. Every day the strength of the argument for foreign debt being a great diet increases, another day goes on in 'party Australia' without a problem. Every day we get fatter and happier. Until ‘CHOP’ it’s the day before Christmas and the foreigners who have fed us for so long take our fat and happy head off. "

Even Greece is in better shape;

"ALL this Greek stuff isn't exactly good for the old fear factor but let's keep it in perspective. If you look at the problem on a debt-to-GDP basis, Greece has a debt that equates to 125 per cent of GDP. . . This is like an Australian family earning $100,000 a year having a mortgage of $125,000. On that equivalent, the Greek government is cruising because the average adult wage in Australia is $64,906 and the average mortgage is $354,000. So the average mortgaged adult in Australia has a debt-to-GDP ratio of 545 per cent. One economist who was asked at what point does debt as a percentage of GDP become a problem? replied: When people think it's a problem."

From Wikipedia

The total amount of credit in Australia is $1.9 trillion, and one trillion of that is in the sector housing. Please remember that we are talking about a country with a population of 22 million, which means that that every man, woman and child in Australia carries a debt burden of 110,500 dollars. The US, by the way,  with a population of 309 million has “only” $53,500 of debt per citizen.

Massive misallocation of capital

As every Austrian economist knows, the most devastating thing about bubbles is that they cause an unimaginable waste of capital and resources. As Hayek beautifully explained, the artificial planning of interest rates by the central banks distorts the coordination of time and interest. The head of business banking at the NAB summed it up perfectly:

""Housing confers minimal economic benefits yet it allocated a massive amount of capital... a banking system which allocated capital away from the most productive areas of the economy — business — is ultimately bad for growth, bad for competition, bad for jobs, bad for business and in the end, bad for Australia."


Initial signs of weakness


The slow rise in interest rates and the end of government stimulus have started to affect the prices in Australia. Housing prices stopped rising in April 2010, and in some areas started to decline. In fact, in the capital cities there was no growth in prices 2010. While in some places such as Brisbane, Perth, and Darwin prices fell between 0.3% and 1.2.


According to Bloomberg  those signs have accelerated recently:

"RBA’s Stevens said on June 9 that there are signs Australian households have “sensed” the risk of increasing levels of leverage and are showing “a certain caution.” Home-loan approvals fell in April for a seventh straight month, and auction clearance rates dropped in the week to June 27, according RP Data, the fifth consecutive week of declines. "


Investment implications

In 2008 the Australian dollar joined company with the Polish zloty, and the Mexican peso as a currency that lost more than 30 percent in value against the U.S dollar. A housing crisis there, combined with a slowdown in China may cause a much sharper slump. Australia’s main stock index is represented in the NYSE through an ETF, EWA. Almost 50% of the index is financial and housing related stocks, which means that in crash scenario such as the one that is approaching a large portion of those companies may perform like the banks in United States performed during 2008. The other half is commodity related companies that will suffer from a recession in China and tighter lending standers of the Australian banks due to capital losses that they will surely face once housing turns south.