House prices in our two major cities are falling at an increasing pace, hence, what will the spill-on effect have in-stall for Australia in 2019?
The term ‘credit crunch’ is definitely a term that is open to interpretation. For me, my interpretation of a credit crunch is where a systemically important bank, or banking system is unable to receive the necessary cashflow from its assets to cover its outgoings on the liabilities side of their balance sheets scaring the markets from recycling their funding (particularly short term funding) back into the particular lender or banking system. Therefore, if a bank or banking system is unable to find short term wholesale funders to keep pumping money back into the system, the outgoings will significantly exceed the revenue generated. Thus banks liquidity buffers shrink whilst retail/corporate credit markets cease up.
I am personally with the view that in 2018 Australia witnessed a ‘credit-tightening’ event, which is nowhere near to the scale of a credit crunch. But a credit crunch is possible as 2019 progresses.
In-the-field research we have conducted over the year tells us that credit to home buyers ‘is’ available. However, the size of the loans banks are able to offer homebuyers are ‘smaller’ than what homebuyers were able to secure in say early 2017. This is clearly reflected in the house price falls we have witnessed over the last 16 months in Sydney and more recently in Melbourne.
If we continue to see this price fall acceleration in Sydney that the preliminary December data is suggesting, Australia has a serious problem on its hands. With society overleveraged to the hilt and the cost of money on the rise globally, the Australian economy is at risk of a full-blown credit crunch. Why?
From our perspective, the reasoning is simple. You first have to identify who holds the riskiest loans that banks have issued over the years. Hence you need to first take a look at the quality of loans packaged up in Australia’s RMBS market.
Using Westpac as an example, until recently, roughly 50% of all new loans issued were interest-only. Hence, one would think that if Westpac over the years issued RMBS’s, that roughly 50% of the securities packaged up in these RMBS would be interest-only loans. However, using a 2015 RMBS issuance as an example, (Series 2015-1 WST Trust) of the $1.932Billion in loans on that RMBS book, only 25% of the loans packaged are interest only.
Major banks issuing RMBS that are significantly underweight interest-only loans relative to the proportion of interest-only loans on their mortgage books has been a common trend throughout the years by major banks. Combined with the notion that the securitisation market in Australia is relatively small versus the size of the Australian mortgage market, that tells us that major Aussie banks are holding onto the riskier loans versus selling them. Which tells us that if we do see further instability in the property market that the stress from delinquencies will be more visible on their own books versus witnessing the banks securities inside these RMBS’s struggle.
This is broadly the opposite to what happened in the US during the lead up to the GFC. Thus as prices continue to fall, and borrowers struggle to repay their debts, expect the RBA to begin to acquire through the Committed Liquidity Facility major tranches of AAA rated junk that lay in these banks mortgage books to help banks repay their short term creditors and keep banks afloat.
Second, you need to take a look at how Australian banks over the years have used unrealised capital gains from one property as collateral against the purchase of another property. It is this issue in itself, that always made buying property (irrespective of the price) easily accessible to first homebuyers (using equity in their parents house) and property investors (using equity in their own home or properties in their existing property portfolio). If there is little or no unrealised capital gains to collateralize against the broader property market like there once was, the feedback loop accelerates house price declines due to restricted lending capabilities.
Third, the spill-on effect from this impact into the broader economy is clear. If there is no money to be made in buying and selling or developing new properties, we can expect major job losses to begin in the household construction sector alongside the wealth of service providers related to the residential construction industry. And as any Sydneysider or Melbournian knows, by global standards, we have an unusually large sum of utes and trucks on the road that are going to or from a residential construction site. Unfortunately the scale of the Sydney and Melbourne residential construction industries are so large that it’s enough to send a snowball throughout the broader economy as job losses in this sector commence and eventually mount.
Furthermore, with many in the construction industry well paid and in high demand over the years, many were able to secure large loans to buy and/or build their own dream homes, or create their own property construction businesses. I fear for many industry participants, they will be the first to feel the pinch in 2019.
Hence, if we start to see the residential construction sector break down alongside the accelerating trend in house price falls, Australia may see its first recession since the early 1990’s by this time next year as the RBA attempt to stem the bleeding through QE and acquiring banks junk to cover their short term liabilities.
I must say over the years, I have found it simply remarkable the scale of government protectionism towards the banking and real estate sectors. With government taken for a ride by the vested interests, it is safe to conclude that this in itself has created a significant unjustified premium on the value of Australian real estate.
With this unjustified premium now evaporating by the minute, lets hope that we get a positive long term outcome that reflects the next generation of young Australians ability to afford the opportunity to not only just save for a house, but at the same time maybe save enough to start a new business and give the Aussie economy much needed diversification.
I wish you all a very happy holidays and look forward to 2019.
