Beware Australian Housing - the debt bubble will burst

(*Note: this post is a rough draft and will be edited/added to in the coming weeks. More new posts will come around mid March)

Australian Housing Bubble?

Almost no other economic topic right now, is as hot and contentious as the direction of Australian housing.

I have come to the conclusion that Australian housing prices must fall, indeed all property prices (commercial, industrial, rural). Demographics, low interest rates, "a housing shortage", historically low interest rates, first home owner grants - cannot stop the direction of the market forces. Both debt and lending are now imploding.

Housing prices, just like the sharemarket go through cycles between boom and bust. However, in Australia I believe we have become very complacent. We think property is a sure fire way to wealth. We believe its normal for prices to increase 5 percent or 10 percent per annum (just like we believe we are recession proof because we haven't had one since 1991). Throughout history house prices have always busted after times of major credit (debt) expansion. A crash will come to Australia soon - its just a matter of timing. Timing is everything.

As Warren Buffett once said,

"You only find out who is swimming naked when the tide goes out."

The tide is well on its way out. Full employment is the key for most individuals on whether they can weather the storm. For others the size of total debts will prove the Achilles heal.


Unaffordable Housing

Australia right now has amongst the most expensive and unaffordable housing in the developed world. The reason it's so unaffordable is that four letter word, D-E-B-T. As we have had economic good times since the early 1990s, individuals and banks have felt more and more comfortable to take on my risk and more debt. With such a long period of job security (for most), we foresee our future to be bigger and better than the past.

As an example I once used, during the mining boom, Perth had a stella rise in housing prices. Miners were flying in and out of Perth and getting paid over $100,000 p.a. to drive a truck. With more and more people on higher incomes, inevitably the housing prices in Perth rose strongly against all the other major cities. To secure their dream home close to the city, buyers out bid each other and took on larger mortgages. Now that the mining boom has come crashing down, where is a mine truck driver going to find a $100K job to meet their mortgage repayments?

Right across Australia, how can the retrenched workers keep their mortgages?
Banks whom are tightening who they lend to... would they now give a mortgage to a low-wage metals factory worker in Western Sydney?
All of a sudden in the last 6 months, Australian individuals and banks have changed their outlook from that of increasing wealth to a complete reversal. Alarm bells are ringing. Some are asking questions about the future. Too many think things won't get bad here. Just like the patriotism we see on US news networks, many Australians think "everything will be different for this time, the Australian economy is strong and resilient!"...

As chart 1 shows below. Real house prices have vastly outrun real wages for the last 25 years. Even more startling is rental yields have just been so low. Negative gearing is one of the big reasons why rents have remained much lower than where they should be (but I will save rent discussion for another time).

Chart 1: Australian Real house prices, wages, construction costs and rents.

Australian housing vs the world

Australia has the most unaffordable housing – study confirms

A group called Demographia released a 'Performance Urban Planning' report ranking property affordability across various countries. The report concluded that Australia has the most unaffordable housing of all the nations surveyed. The report simply used a ratio of Median House Price to Median Household income. A house is "Affordable" if the ratio is 3.0 or less. It's "Moderately unaffordable" if the ratio is 3.1 to 4.0. It's "Seriously Unaffordable" if the ratio is 4.1 to 5.0. And it's "Severely Unaffordable" if the ratio is 5.1 or more.

Results: Australia sports a ratio of 6.3, which is both "Severely Unaffordable" and "Seriously Daloob." New Zealand comes in next t 5.7, followed by Ireland at 5.4 and the U.K. at 5.3. Owing to its large number of metropolitan areas in which there is a wide variety of median prices and incomes, the U.S. nationwide ratio is just 3.2.

On a city basis: The Sunshine Coast in Queensland is the least affordable. The Gold Coast came third, behind Honolulu, and Sydney was fifth, behind Vancouver. Melbourne and Adelaide were equal 12th and were still less affordable than New York (14th), London (16th) and Dublin (32nd).

(More on this survey, including a table of least affordable cities can be seen at Daily Reckoning)


Graphs of concern:

To put more of a perspective on Australia's housing bubble the following graphs compare Australia to some of the other developed countries, which have seen large declines in recent years.

Chart 2: Compared to the United States, Australian households are much more weighed down by household debt.

Chart 3: House Index - Aus, US, UK

Chart 4: Like Japan?


And the big daddy of all graphs (also seen on Chris Martenson's economic crash coarse series)

Chart 5: The history of US housing (in inlfatoin-adjusted terms) since 1890.
The picture speaks for itself. The recent housing boom and crash in the US has been like no other before it. Notice the 1970s and 1980s bubbles came back to pre-bubble levels when it burst. The US is in completely uncharted waters. A graph of Australian housing would look worse than this chart.
Chart 6: This is what WhoCrashedtheEconomy worked out
Australian household debt

If we think subprime was a mess in the US, things could potentially get much worse in Australia when housing prices come down. Indeed, a recession (an ultimately a depression) in Australia is tied to Australian housing (more than anything else). We just have too much debt tied to housing (inflated mortgages)!

Household debt as a percentage of disposable income

Household debt in Australia is alarmingly bad as Alan Kohler pointed out late last year.

In Australia the total debt to GDP ratio is at 160 percent, compared to 100 percent in 2000 and 50 percent in 1980. Household debt to disposable income is over 150 percent, compare to 50 percent in 1990.

Chart 7: Australian vs US household debt
The US reached a height of around 130. Australia has gone over 160. It doesn't matter if we don't have a high level of sub-prime loans in Australia - we are up to our ears in debt.

Once Australia's unemployment rate reverses from around 4% (if you believe that number) and heads towards 6 or 10 percent, housing prices will come down. Australian's are over leveraged to their houses, by taking out huge mortgages to pursue the Australian dream. Few people have taken into consideration that they may loose their job along the way. With no sound income, many Australian's will have no choice but to foreclose on their mortgage. Banks won’t want to hold empty houses, so an avalanche effect can take place when the banks flood the market with discounted homes.

Housing market tends to crash after the sharemarket.........

Sell the holiday house first?

Last year just before Xmas, I was holidaying on the southern coast of New South Wales. The town was, Tuross Heads, a small beach house/fishing town near Bateman's Bay with a population of about 2,000 people. I have never seen so many houses for sale in one spot. In some streets it was nearly every second or third home with a "For Sale" sign on the front lawn. If people expect house prices to come down, is it plausible that people will sell their beach house/investment property first? Is this a sign of the top of the bubble? With one in every 2 or 3 houses for sale in the street, the first couple of sales would impact the selling price for all the other houses in that street. Perhaps this is one reason why property prices (like shares) can fall so quickly if sellers are massing at the front gate. It's better to get out early, then to get out after everyone else.

Since this trip, 'For Sale' signs have become common place around many towns and suburbs. When I went home for Xmas, I noticed nearly 1 in 3 homes/BnB's/holiday houses along a river stretch was for sale. This is a visual sign that things are shifting...

But Australia has record demand for housing!

Some argue that Australian household prices will continue to hold its ground or gain in value in the coming years because we have record immigration levels and demand for housing.

Chart 8: Alan Kohler ABC News 28 November 2008

For a while I felt this argument had some traction. I've come to realise that this will probably not be. If anything, strong housing demand will mean much higher rent prices in Australia. Strong demand does not mean higher prices. For instance, world silver prices are falling right now, but there is now a 10 to 16 week wait to take delivery of silver from a bullion dealer. Silver demand has never been stronger. Prices can disguise real value. There are always market manipulators at play trying to influence under-educated investors, and one of the worst in the housing market is the Australian Government.

2007: The falls have started

Despite record high immigration levels and strong support from first home buyers, Australian housing prices fell in all states except South Australia and the NT.

Chart 9: House Prices 2008
Chart 10: Doesn't matter how you measured it - Australian housing prices will continue to fall.

Australian Government encouraging first home buyers

The Australian Government continues to encourage (through handouts and stimulus packages) Australians to jump into the property market. Buying a property is big investment decision, and unfortunately many buyers do very little due diligence.

I believe the first home buyers grant is extremely irresponsible. (Will add more on this soon)


Housing Deflation - The key ingredient is bank lending (more to come on this section)

There must be liquidity of buyers in the market who can absorb selling pressures. If buyers dry up and widen their spread, price deflation will take hold. Once buyers expect prices to come down $100,000 or so, they will sit back and not participate. In effect you get price deflation (prices fall quickly because you only need a few sellers in the market
without liquidity - home financing + willing buyers (who can absorb selling pressures) - the market falls

In a housing bull market, buyers compromise to the seller. For example is a home is advertised as $500,000, but the nearest buyer is at $490,000 (the spread is $10,000), the buyer is more likely going to raise their offer to $500,000 to get in before someone else.

However in a housing bear market, sellers start to outnumber buyers. Price spreads widen because buyers are no longer willing to take on increased amounts of debt because of uncertainty in the job market and wider economic conditions (ie. what we have today). But the key is expectations. If buyers and sellers start to expect prices to go down (such as selling lots of for sale signs and data which shows this), sellers start compromising and sell to the nearest buyer. eg. if the seller wanted to sell for $500,000, but the nearest buyer is $450,000 ($50,000 spread), they they are likely to do so, particularly if they are forced to because they have no job and the bank repossesses the house. In effect we end up with price deflation (asset destruction) - buyer liquidity dries up and prices fall rapidly (like in the US housing market today).

Price deflation has already hit the Australian sharemarket, with many small stocks registering very few trades now, because buyers feel safer to stay on the sideline. Those holding stock also want to exit the market and will sell at almost any cost to get out and switch to an alternate investment. In the housing market, more pressure will come onto the rental market. Rents will continue to inflate, while the underlying asset value of the house will fall. In effect rental yields will become more attractive over time (as they have been historically low).

Chart 11: Interbank Lending



The value of Australian housing prices in Gold and Silver

A few blog posts back I measured the All Ordinaries in terms of Gold and silver which showed that the Australian sharemarket actually peaked in 1999. It has only been going up in fiat currency terms (until the last year). The same applies to Australian housing. Australian housing has peaked and made plateau (stage 3 consolidation) between 2001 and 2005.

Chart 12: Just like the sharemarket, gold gave early warning signs a few years ago.


The data I have (till 2006) shows that Australian housing has fallen by 38 percent in terms of gold.

In 1986 you needed 208 ounces of gold to buy an average Australian home. At the peak of
the cycle, in 2004 you needed 923 ounces of gold to buy an average Australian home.

(silver chart to come shortly)


Conclusions:

- Debt, debt, debt. Australian's have way to much and its tied to our home prices. The world will continue to witness destruction (deflation) of debt ridden assets. We have seen it in the sharemarket. I will ultimately come to property.
- The ability of banks to lend (debt) is paramount.
- On the buyers side – liquidity (amount) of buyers must be outnumber sellers for prices to hold (and continue to go up). If buyers expect prices to fall, they will widen their spreads and price deflation will set in.
- On the sell side – Unemployment levels are the key, however the type of employment in the economy is critical. If people go from full-time to part-time or casual, or no employment whatsoever, they will be most vulnerable to defaulting on their mortgage. These sellers will sell to the nearest buyer regardless of price offered.
- Holiday houses and the most expensive houses in the cities will be most vulnerable.
- Many regional communities that rely heavily on commodities could face dramatic price declines if the commodity prices and shipping movements do not rebound very soon.
- Perth is the capital city most at risk. Canberra is probably the least at risk. In the long run, all areas in Australia are not immune.
- Above all, do not rely totally on what the Government says, the media, or myself. Everyone must do their own due diligence and come to their on conclusions and act accordingly. The free market is emotionless and does not care if you make money or loose money. Take responsibility into your own hands.

Cheers
Scott


[The 4 Corners program had a look at how the financial crisis has hit Australia so far on Monday night. Worth a look]

Bubbles Burst

Bubbles

Today I examine market/financial bubbles.

Wikipedia's definition of an financial bubble:

"An economic bubble (sometimes referred to as a speculative bubble, a market bubble, a price bubble, a financial bubble, or a speculative mania) is “trade in high volumes at prices that are considerably at variance with intrinsic values”

Bubbles vary in length and magnitude.

Market psychology on the way up:

- Excitement
- High expectations
- Hype
- Speculation
- Market sentiment (mood) often bullish.
- Sector sentiment often very bullish.

Mark psychology on the way down:

- Reality sets in
- Actions (of managers) speak louder then words
- Deadlines not met
- Cost overruns
- Market sentiment may be bearish.
- Sector sentiment may be very bearish.

My interpretation of bubbles:

i) A lot of bubbles start with a strong breakout of resistance, which then sets into a long up (bull) trend.
ii) The peak is usually brief - with little consolidation.
iii) Support is broken at the top and a strong down (bear) trend sets in which gains momentum.
iv) The bubble more often then not goes back to the pre-bubble resistance line (now support line).

Technical Analysis of sharemarket bubbles

The following is another perspective on the Australian All Ordinaries chart applying my interpretation of a bubble.

Chart 1: The All Ords bubble has burst back to the pre-boom levels.
The bull market lasted around 44 months, while its taken only around 13 months to deflate. This illustrates that as soon as the All Ords hit a technical bear market in January 2008, the sellers flooded the market and sold out of holdings at almost any price.

Shares which Bubble:

There are countless examples on the Australian stockmarket (and indeed any financial market) of bubbles which have burst back to pre-bubble levels. Each bubble is unique in magnitude and length.

To show this, lets have a look at Compass Resources (CMR.ax) and Minemakers (MAK.ax).

Some bubbles have an equal inflation and deflation, such as Compass Resources.

Last week Compass fell into administration. The company had potential to be a significant lead/zinc producer with operations in the Northern Territory. The company was one of the best performing stocks in 2006, its now in the worst performing stocks for 2009, having essentially reached zero shareholder value.

Chart 2: Compass Resources. Its bubble had a more equilateral rise and fall.

Other bubbles have rocket-like momentum on the way up, with a longer decline when the bubble pops.

Chart 3: Minemakers - phosphate bubble
Minemakers had an extremely volatile 2008. It went up an astonishing 700% in only three and a half months, then took 7 months to fall back to the 45 cent region. A big bubble inside the space of one year.


Commodities Bubbles:

The following charts show bubbles which have burst in some of the main commodities (both metals and food). Each chart is measured in $USD and is over a 25 year period. (these charts are sourced from IndexMundi

Chart 4: Copper

Chart 5: Zinc

Chart 6: Wheat

Is it a bubble? Depends on your measuring stick:

All the above charts, have been measured in terms of fiat currencies, that is, the Australian Dollar or the US Dollar.

Could it be that the extreme volatility in sharemarkets, property, commodities etc in recent years has been largely attributed to the world monetary system?

If you measure a tangible good vs another tangible good (say gold vs crude oil), price will always go sideways over time (from oversold to undersold and back again). In other words you have one finite resource vs another finite resource. Supply and demand determine price.

However measuring price with fiat currencies we have a situation where the money supply is expanding at an exponential rate (see my article on money supply >here<). We need more and more money to buy the same amount of gold or barrels of oil. This is inflation and the devaluation of currency. Since 1971, when President Nixon closed the Dollar link to gold, the US money supply (based on M3) has increased by over 1300 percent. A 13 fold increase in 37 years. This is the main cause of the big bubbles in recent years, and the subsequent deflationary pressures causing most to burst to pre-bubble levels. (The Australian Dollar has lost around the same amount of purchasing power since 1971).

To demonstrate the difference between fiat-based bubbles and measuring a tangible vs. tangible, lets look at Crude oil, first against the US Dollar, then crude oil vs gold.

Chart 7: Crude Oil in $USD terms - Nothing has fallen harder then oil in the last year.

Chart 8: Crude Oil in Gold terms (both using USD as Index). Also known as the gold-oil ratio.

Chart 9: Was there a bubble and crash in oil? Not when measured against gold.
If you compare this chart to the USD measured crude oil chart, the spike when oil went to $147 is shown by a small movt against gold. Indeed oil was outside the trend and expensive against gold. You only needed around 6 barrels of oil to buy 1 ounce of gold. Conversely, as oil crashed below $40 USD in late 2008 (and Gold recovered slightly in USD), oil in terms of gold moved back up its trading range, making gold look more expensive and now requires around 20 barrels of oil to buy one ounce of gold.

So where is the bubble and the crash?

* There is much less extreme volatility if you measure tangible goods vs other tangible goods *

Conclusions:

- Since 1999 there was a major change in the tide. We moved from a financial (debt) cycle to a commodities cycle (we are halfway through an average commodities cycle).
- This has caused extreme volatility and uncertainty in pricing of financial assets (sharemarket, property).
- Financial assets are now facing deflation. In other words, debts are being revalued and re-risked.
- Meanwhile tangibles (when priced against one another) continue to move between overvalued and undervalued. Very few bubbles are formed. Value will always go sideways over time under this measuring stick.
- Bubbles have been dramatic only in terms of fiat based currencies.
- Future financial bubbles will be even more volatilie and even more inflationary on the way up.
- Be weary of charts which go rise too quickly. A vertical movement must find a new level of support at the top.
- The peak point is the key. If it cannot hold the peak levels, expect a strong downward movement from the top.
- The Australian sharemarket bubble has broken, but this will not stop it from going lower.
- The next big financial bubble to burst is Australian housing.
- Government's and central banks will do whatever they can to keep "prices" artificially high rather then let financial debts burst.
- They will do this at the cost of the fiat based monetary system. (Hyperinflation bubbles should be seen by 2020).

Cheers
Scott

Automatic Teller Man

Stimulus Package Attempt #2

Yesterday the Australian Government released details of a second stimulus package to the tune of A$42 billion dollars.

Summary:
• $14.7b for schools - $200,000 each
• $6.6b for 20,000 new homes
• $3.9b to insulate 2.7m homes
• $890m for road repairs and infrastructure
• $2.7b small business tax break
• $12.7b for cash bonuses of up to $950

Kevin Rudd – the human ATM
First there was FuelWatch, then FoodWatch - now introducing... ATM-Watch!

Kevin's criteria to stimulate the economy:

Criteria #1: You must be an Australian Citizen
* REWARD: $950 per person (cause you should feel good about being an Aussie!)
Cost: A$12.7 billion

Criteria #2: All Australian citizens must stay warm
* REWARD: here's some pink batts to put in your ceiling (just what I intended to get for Xmas!)
Cost: A$3.9 billion

Criteria #3: All schools must spend $200,000 on maintenance
* OPTIONS: repair holes in Detention Room doors and walls; remove graffiti; service vending machines.
Cost: A$1.9 billion

Wow, I never knew spending money could be this hard! Really is there any skill required to announce a $42 billion spending spree in one day? An ATM could have handed out the money in a more thoughtful way to passes by. If the ATM runs out of money, just fill it up with more printed cash (from the Government's blank check book...).


$42 billion to support 90,000 jobs

The package is supposed to support jobs - 90,000 of them. Lets see, 42bn divided by 90K = $466,666.67. Nearly half a million dollars per job to "support" insulation installers, builders, and of course Armaguard security officers (need more people to keep those ATMs full).

A lot of money to sort out the winners from the losers (losers of cause being the working taxpayer).

I was hoping there would be a few billion handed out to "support" the Australian wine industry. It's just been through its worst export year in 15 years (by value and volume). If only every working taxpayer was given a dozen of bottles of shiraz in the mail. Maybe it will come out in the budget :). Maybe he will introduce a "wine-o tax" (alla "alco-pop" tax) for the industry instead.


Temporary Deficit

Despite the Prime Minister, Kevin Rudd, saying it would be a "temporary deficit'', today's mini-budget reveals the nation's finances will be in the red for at least the next four years with the accumulated deficit of $118 billion (almost identical to the $115 billion that has been wiped from expected tax collections from companies, individuals and the GST).

The Australian Government will now be deep in the red for at least the next four years with an accumulated deficit of $118 billion.

The Prime Minister and Treasurer claim the deficit will be temporary. It’s all rhetoric. Circumstances will get worse. The stimulus packages are short-sighted and will only provide short-term economic “activity”.

There is no plan for long-term job creation.

There is no exit strategy to get out of deficit (there are no large assets left to sell (like Telstra) to repay debts).

Expect a third attempt to stimulate the economy come the budget on 5 May 2009. Least there might be some money which will be thrown at productive assets (bail out State obligations to upgrade ports, railway hubs etc)

Chart 1: From a $20 bn surplus to a $20 bn deficit in two year.
source: ABC news 2/2/09

Chart 2: Put it on the credit card please
source: ABC news 3/2/09

The deficit projections will blow out more as the year progresses. Even more worrying, how much will the Government devalue the purchasing power of the Australian Dollar by the end of 2009?

The Opposition

The opposition isn't much better than the Government. To date, I would give the Rudd Government ½ star out of 10, and the opposition 1 star. They are reading the same book but on a different page. They are both viewing the world from the book of Keynesian economics.

Opposition comments on the $42 billion package:

Malcolm Turnbull:

So far, the Opposition Leader, Malcolm Turnbull appears to be more interested in wedge politics.

He responded this morning and explained why the Coalition will block the $42 billion economic stimulus package. Turnbull proclaimed that the package was so big "it looked like panic".

Turnbull still, however, supports the need for a type of stimulus. He wants tax cuts, rather than targeted one off hand outs. In my opinion, tax cuts will not fix the structural problems of Australia and the world monetary system.

Turnbull quotes from today:

"Someone has to stand up for fiscal discipline."

The Federal Government's plan would mean borrowing $70 billion over the next four years, an act that would increase national debt to $200 billion.

"That is a $9500 debt for every Australian, a debt our children will have to pay off years into the future"

"It is an insult to taxpayers"

Peter Costello:
(Tuesday 3/2/09 on Lateline)

"It's poor quality spending"

"Spending should create long term production, create long term new jobs"

"The budget has gone from a $20 bn surplus to a deficit. Not because revenues have fallen. This deficit is driven by policy decisions. $28 billion of policy decisions."

One former politician has actually given this some thought...

Paul Keating:

On Monday night, just before the Prime Minister released the $42 billion stimulus package, former ALP Prime Minister, Paul Keating gave a frank interview on ABC's Lateline program >here<.

Keating appears to be the only political figure in Australia which has actually put some thought into the problems we face from the financial crisis. He cites some major strucutural reforms must be persued, and that the United States no longer has any economic bargaining power to bring to the table.

Here is some of what Keating discussed:

"Expansion of credit running for 60 years. This is the first time 2008, 2009 where we've had a contraction of credit.

What we need is a completely new global political and economic settlement.

Be rid of the old IMF.

Be rid of the old G7.

Bring the surplus countries into the political framework. G7 is made up of all debtor nations. There are no surplus countries.

We need a totally new Bretton Woods Agreement.

The United States cannot reflate the world. .. but they will try to reflate their way out.

You will start to see in the price of gold, if this goes on for a couple more years, the serious question of an American default. A default by the United States treasury.

Until we get a true settlement, where the great states like India and China, and their big economies and the surplus countries like Russia, the oil countries in the middle east, get a greater say…Until we get to a representative world structural of power. That is global political and global financial power, then that’s the only way confidence will really return to the system. This can't be done by the Americans.

On Kev's 7000 word "social capitalism" essay:

We should not get too ideological about it. In the end rational policy is always good.

On Kev's attack on Neo-Liberals:

When Keating was pressed if he identified himself as a neo-liberal, his answer was

"Absolutely".

Future for both major parties

The days for soaring popularity for both major political parties are numbered. We will hit recession. Unemployment will rise. Housing prices will fall. All debts must be accounted for. Inflation will start hitting food and rents more. M0 money supply will increase sharply, while M3 money supply will contract (as property prices fall in Australia).

The political party which wakes up first and stops reading from the book of Keynesian economics and realises that a new monetary framework is required, will do better in the long-run. Perhaps a new political force will come before either party reinvents themselves.

Invest your $950

The best thing you can do (in my opinion only), is either use the handout to repay high interest bearing debts (credit cards, car loans) or save it.

Through the saving option – avoid saving cash. The Australian dollar will continue to diminish in purchasing power (vs tangible items). ie. $950 in Australian dollars might have $850 purchasing power by years end.

On the flip side if $950 were saved for real money, that is, gold and silver, your savings will increase in purchasing power going forward. I will be investing in the shadow monetary system. Think long term. The more citizens with gold and silver, the less capacity government will have in the future to try and print its way out of the black whole. Governments cannot print a nation into great wealth, just ask Zimbabwe.

Cheers
Scott