Housing Bubble

&nbsp;Australia&rsquo;s housing market is experiencing a peak growth rate, but experts say the current boom won&rsquo;t last forever.&nbsp;

In this month&rsquo;s Finder RBA Cash Rate Survey&trade;, 40 experts and economists weighed in on future cash rate moves and other issues relating to the state of the economy.&nbsp;

While all experts surveyed predict the cash rate to hold, nearly half of those who weighed in on property prices (47%, 16/34) believe Australia&rsquo;s current house price growth is unsustainable.

Property market growth surged at its fastest rate in 33 years in March, with national dwelling values also increasing by 6.2% over the past year according to CoreLogic.&nbsp;

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Graham Cooke, head of consumer research at Finder, said that some experts are concerned a housing bubble is emerging.

&ldquo;Rock-bottom rates, government stimulus and a fear of missing out have really lit a fire under the belly of the market.&quot;

&ldquo;Listing numbers are unable to meet high buyer demand, keeping inventory levels low overall and adding to the sense of urgency among buyers. &quot;

&ldquo;We&rsquo;ve seen more borrowed for housing over the last six months than during any similar period in history &ndash; and economists have tipped us to borrow more over the next six.&quot;

&ldquo;It&rsquo;s unlikely we&#39;ll see any regulatory intervention from policymakers yet, but this might be a possibility down the track,&rdquo; Cooke said.&nbsp;

According to Mala Raghavan of the University of Tasmania, buyers may put themselves at risk by acting too hastily.&nbsp;

&ldquo;The recent uptick in buying behaviour largely appears to be due to the fear of missing out, and many buyers are rushing into the market without clear foresight of the impending risks.&quot;

&ldquo;When mortgage rates start rising, many households will risk being unable to service their loans, and could be vulnerable to foreclosures,&rdquo; she said.&nbsp;

Graham Cooke, head of consumer research at Finder, said that some experts are concerned a housing bubble is emerging

jordan_55689

1 in 2 experts say recent house price growth is “unsustainable”: Finder

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Australian residential prices remained “40% overvalued” and the bubble is yet to burst, the international doomsday commentator Harry Dent has claimed.
Australia was going to lead the next global bust, he said.
Dent forecast “Australian prices would fall 50%” in the next downturn and he ranks Australia as the third most overpriced market in the world, coming in behind Hong Kong and China.
“Don’t take the ‘oh, we had a little crash and it’s over, time to buy again because we don’t want to miss out’,” Dent said.
“Real estate, mark my words, will in five, 10 or 15 years time never be better than this. The best cities, Sydney and Melbourne, are going to go down more than say Adelaide. Rich people will lose the most money,” he tipped.
Dent again claimed that Australians’ exposure to a weakening Chinese economy would be the primary trigger of the downturn.
“It’s going to be more pervasive,” he said ahead of his seminar tour to Sydney next month.
He said while Australia escaped the worst of the global financial crisis, it would not avoid the next global downturn, which would be worse than the 1929 depression.
Dent says the recent Reserve Bank of Australia rate cuts would only exacerbate the looming correction.
“Maybe we’re over-forecasting this, that’s possible, but there’s not much upside in real estate anywhere in the world left after a bubble this size,” Dent added.
“Your great Australian real estate bubble is going to burst … maybe I am wrong, maybe it’s 30 or 40%.
“But there’s no way real estate is going to go up much further … and there will be no soft landing,” he said.
When Dent was on his 2016 tour he forecast a 50% fall. However, Sydney prices rose by 75% after that forecast, followed by a 15% decline over the past two years. Dent gave his latest forecast to Martin North at Digital Finance Analytics, who noted that debt is higher than it’s ever been.
“Yet the Reserve Bank here is basically encouraging people to get into the market now to try and support the economy,” North said.
Dent’s latest doomsday claims have been slammed by mainstream property analysts.
“He has never been correct on the Australian housing market,” the boss of SQM Research Louis Christopher said yesterday.
“I am concerned for people who get hoodwinked into his seminars,” Christopher added.
Property economist Dr Andrew Wilson said Dent was a “discredited doomsayer”.
Wilson said that the bubble collapse claims were “click-bait”.
“And, as usual, outrageous predictions of steep and sustained house price declines will prove to be so much nonsense — as has clearly again been the case this year,” he said.
“With the prospect now of a lengthy period of relative certainty and predictability ahead, buyers and sellers will increasingly ignore the snake-oil salesmen and take advantage of the ongoing benefits of home ownership and investment,” Wilson said.
This article first appeared in The Sunday Telegraph. 
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j.ballantyne1990-6AQqhLzZaK

Harry Dent is back predicting property prices will "fall 50%"

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GUEST OBSERVER
It’s reporting season, and over the past few weeks some of Australia’s biggest companies have been releasing information on how they’re travelling. 
These reports reflect key themes of how things are going in key sectors of the economy. 
Today we look at the banking sector.
The Australian banking industry is a classic economic ‘oligopoly’ with the so-called ‘Four Pillars’ or ‘Big Four’ (National Australia Bank (NAB), Commonwealth Bank of Australia (CBA), ANZ and Westpac) dominating not only the banking sector but the whole financial sector and arguably the economy.
The big four banks account for over 25 percent of the market capitalisation of the ASX 200, and are valued at over $360 billion. In total, the four banks reported assets in 2015 of some $3.5 trillion or about 10 times the size of BHP and RIO combined, and profits for their latest financial year of over $30 billion between them.
<a href="https://62e528761d0685343e1c-f3d1b99a743ffa4142d9d7f1978d9686.ssl.cf2.rackcdn.com/files/114178/width668/image-20160308-15110-odx4a3.png" target="_blank"> Click to enlarge</a>
<img src="https://62e528761d0685343e1c-f3d1b99a743ffa4142d9d7f1978d9686.ssl.cf2.rackcdn.com/files/114178/width668/image-20160308-15110-odx4a3.png" alt=""><a class="license" href="https://creativecommons.org/licenses/by-nd/4.0/">CC BY-ND</a>
 
 
<h2>The risks in Australia’s banking system</h2>
In an oligopoly, the dominant players operate a very similar business model. This is true of the Big Four, which operate within a structure known as ‘universal banking’. Not only do each of these behemoths run a traditional retail and business bank, they also have wealth management (mainly retail superannuation fund management) and insurance subsidiaries. To complete the picture, each of the four runs a wholly owned bank in New Zealand, again dominating the banking system in that country. The banks operate throughout Australasia, often with competing branches (and valuable jobs) in each small town - Australia is ‘over banked’.
The risks of having one of the most concentrated banking systems in the world were outlined in 2012 by the International Monetary Fund (IMF), it warned that Australia’s banks had: “broadly similar business models and reliance on offshore funding leave them exposed to common shocks and disruptions to funding markets. Against a still worrying global environment, these risks will need to be closely monitored, particularly if the domestic economy slows sharply.”
Among the four banks, there is constant jockeying for prominence and any one time one bank climbs to the top of the pile. At the moment, the clear winner is CBA, largest by capitalisation, latest annual profits and staff employed with the lowest Cost to Income Ratio (CIR). Another winner is Westpac, the smallest by assets and employees but with an enviable CIR and Net Interest Margin (NIM) leading to excellent profit results. Meanwhile, NAB trails the others by profitability and with a low NIM and high CIR, will be likely do so for some time. Nonetheless, NAB is by any standards a very profitable company, if a bit overshadowed by the other banks this year.
It should be noted that not all banks report their financial results at the same time in a completely consistent fashion. However each quarter the banks are required to report their risk numbers to the Australian Prudential Regulation Authority (APRA), the banking regulator. These so-called APS 330 reports give a picture (albeit slightly murky) of where banks are taking risks and the size of those risks.
These numbers show that the banks hold roughly similar amounts of assets, so-called Risk Weighted Assets (RWA) and associated capital. Although Westpac, being slightly smaller, has about 10 percent less of each. This data shows Big Four banks are still predominantly lending institutions with about 86 percent of their Risk Weighted Assets (RWAs) related to credit.
While ANZ has a higher proportion of corporate and business lending than the others, about 23 percent of its credit (RWAs) relates to retail, mainly residential mortgage, lending. With a few notable exceptions, such as CBAs exposure to interest rate risks and NAB’s operational risks, the risk numbers are similar across the banks.
From an analysis of prior APS 330 reports (not shown), it appears that, although the RWAs for residential mortgages have increased slightly for all banks (mainly because lending has increased), the banking sector has not factored in much additional capital to cover the potential for the busting of a housing bubble.
The large Australian banks will in the next year face headwinds from a number of directions. First, any busting or even deflation of Australia’s real or imagined housing bubble will undoubtedly give the banks serious headaches.
Likewise, the end of the mining boom is already beginning to take its toll on mining companies, even the largest. If the gloom spreads, loans to the sector might be under pressure. Last, but far from least, banking scandals will definitely come to the fore this year especially market manipulation and product misselling.
<h2>Disruption from technology</h2>
Following the retreats of both NAB and ANZ from their respective overseas forays, it looks like the four banks are going to resemble each other even more as they are all embarking on strategies that target the same Australasian retail, mortgage and business markets. But there is at least one significant point of difference between the banks that might give a clue to potential shifts in future.
In banking, as in other industries, technology is critical. After an outsourcing deal that went sour, in 2008 the CBA board was forced (some say was brave enough) to embark on a complete refresh of its ageing IT systems, often called a Core Systems Replacement (CSR).
After some significant project blowouts, CBA eventually got the CSR to work and their annual profit numbers are beginning to reflect that success. Meanwhile, NAB is in the middle of its almost decade long CSR project (called Nextgen) and is constantly changing its management, which does not bode well for its completion in the near future. On the other hand, the new Chief Information Officer (CIO) of Westpac has denied that the firm needs a CSR, and has embarked on a much needed face-lift to the bank’s ageing systems.
After a number of attempts to change its core systems, the new management of ANZ have just announced that they are hiring an ex-Google executive to become its head of ‘digital banking’ - but to do what is still not certain.
Given the oft repeated fact that some 70 percent of IT projects fail, it looks like one or more of the banks are in for some big headaches over the next decade.
For this snapshot, the information is collected from the latest annual reports (2014-2015), except for CBA which reported its semi-annual numbers in February 2016. The risk figures are taken from the 2016 December quarter APS 330 reports of the banks to APRA, which are available at the banks’ websites.
Pat McConnell is honorary fellow, Macquarie University Applied Finance Centre, Macquarie University and author for The Conversation. He can be contacted <a href="https://theconversation.com/profiles/pat-mcconnell-13137" target="_blank">here</a>.
 
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jchancellor-FAypfDUnLy

Property 101: The housing bubble risk to the big four banks

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GUEST OBSERVER
Strong house price growth in Sydney and Melbourne in recent years largely reflects fundamentals.
Interest rates have been low, population growth and foreign demand have been strong and supply has been insufficient in these cities.
Tightened prudential settings and higher mortgage are expected to cool the Sydney and Melbourne housing markets in 2018.
Prices have risen most where housing supply is inadequate.
Australia has had a housing construction and price boom in recent years.
<a href="https://www.propertyobserver.com.au/images/2017/09/01/Screen%20Shot%202017-09-01%20at%2010.41.44%20AM.png">Click to enlarge</a>
<img src="https://www.urban.com.au/images/2017/09/01/Screen%20Shot%202017-09-01%20at%2010.41.44%20AM.png" alt="">
Much of the boom reflects the central bank's use of its cash rate setting to manage the mining boom.
A high cash rate in the earlier period (4.75% in 2011), held back housing to make way for the mining boom.
Subsequent cash rate cuts (to 1.50%) drove a housing construction and price boom.
This has been mostly a good story.
The housing construction boom has helped to fill the growth gap left by falling mining investment and has reduced an accumulated housing undersupply.
Not many houses were built during the mining boom.
<a href="https://www.propertyobserver.com.au/images/2017/09/01/Screen%20Shot%202017-09-01%20at%2010.42.38%20AM.png" target="_blank">Click to enlarge</a>
<img src="https://www.urban.com.au/images/2017/09/01/Screen%20Shot%202017-09-01%20at%2010.42.38%20AM.png" alt="">
The challenge has been that national housing prices have risen by 50% since mid-2012 and much of the rise has been driven by rising household debt.
This has reduced housing affordability and raised questions about whether Australia has a housing bubble. 
However, just because prices and housing debt have risen does not necessarily mean that there is a bubble.
The key question is whether the rise is in line with fundamentals? In our view, to a large degree, it has been.
Housing prices have risen very little in regions where housing demand has been weak, or supply has been boosted.
In contrast, where supply has not kept up with demand, house price growth has been strong.
For example, housing prices have only risen by 6% in Perth, 11% in Adelaide and 21% in Brisbane since 2012, where the mining retreat has had its biggest effects (Chars 25 &amp; 26). By contrast, Melbourne and Sydney prices have risen by 60% and 80%, respectively. In addition to low interest rates, demand for housing has been supported by migration (both international and domestic) and foreign investment: factors which have been strongest in Sydney and Melbourne.
Although supply has increased in the Sydney and Melbourne markets, it has still been insufficient to meet demand (Chart 27).
These fundamental factors largely explain the price boom and, as a result, we do not judge it to be a bubble.
It’s the distribution of debt that matters the most
Another element that could indicate a housing bubble would be misallocated lending.
If the lending that has driven the housing boom has been to households that may be unable to service it when interest rates rise, then this could cause a sharper fall in housing prices than otherwise, much as the sub-prime crisis did in the US last decade.
It is therefore the distribution of debt that matters most, rather than the aggregate level.
Although Australia has high household debt levels, in our view, they are high for fundamental reasons.
There is also strong evidence that the distribution of debt is fairly favourable and the institutional features of the mortgage market should help to ensure financial stability.
First, all of Australia's mortgages are full recourse loans. Second, Australia does not have sub- prime or low documentation loans.
Third, most of the household debt is held by higher income households (Chart 28). Fourth, although household debt is high when compared with other countries, this partly reflects differences in the tax system. In Australia, households are able to deduct the expenses related to investment properties from their broader income tax liabilities.
As a result, around one-quarter of household debt is investors that own rental properties. In many other countries, these rental properties are owned by the corporate sector.
Fifth, given the lack of tax deductibility of expenses on a first, owner-occupied, mortgage, households have an incentive to pay down their owner-occupied mortgages ahead of schedule.
As a result, the average mortgage in Australia is over 2.5 years pre-paid, which offers a significant buffer in the face of a negative income shock.
Finally, prudential settings have been tightened in Australia since late 2014, given concerns that authorities have had about the booming Sydney and Melbourne housing markets.
Tightened prudential settings make it unlikely that there has been a large enough mis-allocation of housing lending to be a systemic risk.
Overall, we expect housing price growth to slow in Sydney and Melbourne over the next couple of years, as new supply ramps up, the foreign bid pulls back (partly due to new state taxes on foreigners) and interest rates rise. 
<a href="https://www.about.hsbc.com.au/hsbc-in-australia/management-team" target="_blank">PAUL BLOXHAM</a> IS CHIEF ECONOMIST (AUSTRALIA AND NEW ZEALAND) FOR HSBC. 
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Housing boom not bubble: Paul Bloxham

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<img src="https://counter.theconversation.edu.au/content/75050/count.gif?distributor=republish-lightbox-advanced" alt="The Conversation" width="1" height="1">
GUEST OBSERVER
I didn’t think it was possible for there to be more focus on the Australian housing market than in 2016, but the last couple of weeks have proved me wrong.
ABS figures revealed that in the December quarter, across the eight major Australian cities, house prices rose 8.9 percent and apartment prices rose 4 percent. Those are stunning figures, particularly on the back of the huge rises of recent years.
This prompted renewed discussion about whether prices constituted a bubble. Many players weighed in, but former Liberal Party leader John Hewson put it most succinctly, saying on ABC’s Lateline:
“I think it’s a crisis, it is a bubble. I know people are hesitant in saying that, it is a bubble.”
In one sense it doesn’t really matter whether there is a housing bubble or not. Once buyers start believing there is and think it will burst, they have every incentive to wait to purchase. That dries up liquidity in the property market and sellers who need to sell are forced to take a steep discount. That justifies the buyers’ belief that prices are going to fall. And that, simply put, is how a bubble bursts.
Are we at that point yet? It’s hard to say, but given that a former Liberal Party leader, the ASIC chairperson, and the Secretary to the Treasury(among others) have said so recently, there is reason to think we might get there.
The most recent board minutes revealed the RBA was somewhat focused on housing as well. The minutes stated:
“Over recent months, conditions appeared to have strengthened in Sydney and had remained strong in Melbourne; these cities had continued to record brisk growth in housing prices, and auction clearance rates had remained high. Housing loan approvals and credit growth had picked up for investors, primarily in New South Wales and Victoria” and that this “continued to suggest that there had been a build-up of risks associated with the housing market.”
The minutes also noted a number of positive developments, from the terms of trade to the strength of our trading partners to business sentiment. The notable exception was the labour market which continued to confound understanding. The RBA noted that the key implication was that:
“Domestic wage pressures remained subdued and household income growth had been low, which, if it were to persist, would have implications for consumption growth and the risks posed by the level of household debt.”
It is difficult to assess the future path of the cash rate. The economy looks like it might be strengthening, and if business investment were finally to rebound, there would be a case for a rate rise. But with a weak labour market, a rise in rates would put the squeeze on those heavily indebted households. This could, in turn, detonate the property market. The nightmare scenario is that it has a big enough effect on bank balance sheets that they contract lending significantly, further hurting the property market.
This is the delicate tightrope the RBA is trying to walk.
The run-up in prices has put further focus on housing affordability. The Coalition have suggested they will announce a series of measures to address it in the budget. They are rumoured to be considering schemes like allowing first home buyers to access their superannuation – which is a very bad idea. It is another policy that fuels the demand side without addressing supply. I have said numerous times – including in my McKell Institute plan – that demand-side excesses such as negative gearing need to be curbed and the supply side needs to be encouraged.
The housing package might be the most interesting thing to look out for in the federal budget on May 9.
Richard Holden is professor of Economics and PLuS Alliance Fellow, UNSW and author for The Conversation.
He can be contacted <a href="https://theconversation.com/profiles/richard-holden-118107" target="_blank">here</a>.
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If it looks like a bubble and sounds like a bubble…

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There is little doubt the Sydney auction market has started out a lot better in February, than it finished off last December.
At this stage, four weeks in, the positivity has been more evident from the auction clearance rate being on the rise, than prices making any advances.
February typically suffers none of the inbuilt end of year fatigue. Saturday's preliminary clearance sat at over 70 percent.
You never know, but prices could spurt again, especially if our fresh stock levels stay low after the upcoming early Easter break, and the banks begin to ease up on their lending.
It would not be a second wind for prices, because we've already seen that many times, just when the market seemed destined to head backwards.
Sydney is highly resilient when it comes to property price momentum, often catching forecasters out of step.
I was thinking of the contributing mix, intrinsic and not so, when I popped a few questions to Harry Dent, one of the world’s most controversial economic futurists.
He is currently touring Australia. Last time he toured in 2014, Dent's worst case scenario was for a post-China bubble burst impacting on Sydney with property prices possibly set to collapse by as much as 60 percent.
His controversial forecasts were labelled as scaremongering by many commentators including Chris Joye.
Dent's earlier 2011 crash forecast also saw the founder of wealth manager Yellow Brick Road Mark Bouris counter the claims. 
In 2011 on David Koch’s Sunrise program, Dent urged viewers to sell their homes before the 50 percent crash in prices arrived at their doorsteps after a China crash hits our shores.
He will be pursuing the same message this time around.
I told Dent that dwelling prices in Sydney now sit at around a $895,000 median, up from $610,000 in early 2014.
The median represents a significant 46 percent rise since Dent's last warning, and an 80 percent rise since his 2011 warning.
Pressed by me, Dent admits he was wrong through he sticks to the yet-to-occur outcome, merely adjusting the timing of his dire forecast.
"I was wrong, how about that," he said.
"I'm early."
Australia will burst whenever the China bubble bursts, he says.
Dent warns many won't see it coming, and adds that real estate, unlike the stockmarket, won't have any easy escape route, and its recovery will take much longer.
"This is not a normal bubble," he suggests noting the global real estate bubble had extended well beyond typical lengths.
He argues the global bubble has been caused by central banks printing money, not just low interest rates.
Dent says suggests central banks can't keep printing money for ever.
"What's not different is by every measure, is these are bubbles.
"Chinese real estate is a bubble.
"The Sydney real estate is a bubble." 
"Better to get out a little early," he will be telling his 2018 audiences.
This article was first published in the Saturday Daily Telegraph
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Harry Dent says he was early with his dire Sydney price collapse forecast

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Sydney home owners can feel confident that their property values will hold up amid the gradual wind-down of the price boom.
There are two reasons. One is that economists are predicting values will fall. Given their track record of getting it wrong on real estate, we can be fairly sure values won’t decline.
The other reason is the historic precedent. Sydney has had big price booms before and when the bull run ended, there was no decline in values. Prices simply stopped growing.
I fully agree with the growing list of pundits calling the end to Sydney’s boom. I’ve been writing about it for the past 5-6 months.
On 21 May I wrote in this column: “It was inevitable that Sydney would run out of puff eventually and the most likely time for it to happen was in the third year of price growth – which means some time this year. It’s rare for major markets to sustain a boom for any longer than that. 
“I’ve just finished the research for the latest edition of The Price Predictor Index, examining market activity in suburbs and towns across the nation, and it indicates Sydney has begun a gradual fade.”
That view was subsequently confirmed by sales figures for the June Quarter, which continued the pattern seen in the March Quarter figures. It’s clear now that, in terms of sales activity, Sydney peaked in the December Quarter last year and has been on a gradual fade ever since.
But does this mean prices will collapse? Not if 2004 is any guide.
The preceding 2-3 years represent the last time Australia had a genuine national property boom. In 2002, six of the eight capital cities recorded double-digit growth in median house prices, including three (Sydney, Brisbane and Adelaide) where prices grew more than 20%. The national average rise was 18%, double the average rise in the past 12 months.
The following year was even more prolific. In 2003, all eight capital cities recorded growth of at least 13%. Five of capital cities grew more than 20% and the city average that year was a 19% rise.
The past 12 months, in comparison to those stellar years, have been rather tame, with only Sydney recording double-digit growth (although some research sources have Melbourne nudging above 10%). Media hysteria suggesting we have been in the midst of an unprecedented national boom lately is quite ludicrous when we consider the 2002-2003 scenario.
 The bottom line, however, is this: by 2004 the boom had run out of steam. Economists, journalists and other pontificators were routinely predicting a collapse in prices. But it didn’t happen. The growth subsided but there was no price decline.
Earlier this year I conducted a research exercise for a client, examining media coverage of real estate since the beginning of the 21st Century and comparing it to actual outcomes.
This revealed that reports of bubbles, unsustainably high property values and inevitable price collapse have occurred constantly in Australian media over the past 15 years.
Every economist complaining that property prices should fall because they don’t comply with their theory about where prices should be has been given airplay.
Every overseas spruiker seeking to drum up attention for a book launch or a seminar tour has gained massive publicity by forecasting that our property values were about to decline 40%, 50% or 60%. One was silly enough to predict a 90% drop in land values and media was silly enough to publish it.
None of them was right. Despite that relentless production line of doomsday headlines stretching across 15 years, there has been no Armageddon in Australian real estate.
So, now the chattering economists are at it again. No matter how many times they get it wrong on real estate, they will continue to step up for another bout of false profiteering. 
The boffins at Macquarie Bank have rolled out some very specific forecasts about something they call “Australian property prices”. They’re going to start falling in March next year. And the decline won’t be 5% or 6% or somewhere in the band from 5-10%, it will be exactly and precisely 7.5%.
Will they be proven accurate? Not a chance.
Terry Ryder is the founder of <a href="https://www.hotspotting.com.au/" target="_blank">hotspotting.com.au</a>. You can <a href="https://mailto:ryder@hotspotting.com.au" target="_blank">email him</a> or follow him on <a href="https://twitter.com/hotspotting" target="_blank">Twitter.</a>
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terryryder-YECXbqmri2

The end is nigh for Sydney's property boom: Terry Ryder

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EXPERT OBSERVER
There are two things that can happen to an asset price bubble. It can burst dramatically, or deflate slowly.
Which brings us to the Australian housing market.
Prices in Sydney and Melbourne continue to decline at a modest rate. The <a href="https://www.corelogic.com.au/research/monthly-indices" target="_blank">CoreLogic index</a> has Sydney prices down 6.1% for the last 12 months, and Melbourne down 3.4%.
This barely dents the huge increases in previous years and is consistent with “deflate slowly” scenario.
What could cause a pop?
<h2>Interest-only loans could do it</h2>
As I have <a href="https://theconversation.com/vital-signs-if-it-looks-like-a-bubble-and-sounds-like-a-bubble-75050" target="_blank">said here before</a>, one of the worries is interest-only loans.
Around A$360 billion of these loans are due to be rolled over over the next three years. If they are not, they will convert to principal-and-interest loans, which are much more expensive to maintain.
Given that only about 15% of loans currently issued are interest-only, down from 40% in recent times, that means a lot of people are starting to pay the more expensive principal and interest. For some, the jump in repayments will be as high as 40%.
That’s scary enough. But <a href="https://www.rba.gov.au/monetary-policy/rba-board-minutes/2018/2018-10-02" target="_blank">this week’s minutes of the October Reserve Bank board</a> meeting point to another concerning possibility – an old-fashioned credit crunch.
The bank put it this way:
Members discussed the release of the interim report of the Royal Commission into Misconduct in the Banking, Superannuation and Financial Services Industry… Members observed that while the regulators had already overseen a tightening of lending standards, and a degree of tightening of lending standards had been implemented by banks in anticipation of the Commission’s findings, it was possible that banks could tighten lending conditions further given the issues raised in the report. Members noted that it would be important to monitor the future supply of credit to ensure that economic activity continued to be appropriately supported.
Translation: the banks have stopped lending as much, and might lend even less; this could be bad for the economy.
Could it blow up the housing market?
Well, possibly. Here’s how.
<h2>Here’s how it would happen</h2>
If the amount of housing credit available is significantly reduced, it is hard for people to buy properties.
That means it becomes hard for people to sell – or even move from one property to another. A market with fewer buyers and sellers in it (what economists call a “thin market”) means more volatile prices.
This turns the price someone gets from selling a property into more of a lottery. There’s a decent chance the seller gets much less than she thought.
Worse still, most people are highly leveraged in residential property – often putting down a deposit of just 10% to 20%.
<h2>Owners would get hit rather than their banks</h2>
All the drop in the selling price hits the owner, because the bank gets paid back no matter what.
So a 10% drop in price can wipe out all the seller’s equity in the property.
Even if the owner has paid down, say, half the loan, that’s a big hit.
It’s the prospect of this that causes people not to want to sell. If an owner can hold on, they will.
So which properties end up on the market? Precisely those of the people who really need to sell.
<h2>They would sell because they had to</h2>
Knowing this, and without much competition, buyers turn the screws, pushing down prices still further and exacerbating the problem.
Of course, for that to happen people need to sell.
Why might that be? There are are number of reasons. Their repayments could rise because of rates rising. Even without an official rise in the cash rate by the RBA, banks can, and recently have, raised rates because of their funding costs in money markets.
A borrower might need to change cities because of their job, or might lose their job and be unable to meet repayments. Or a borrower might have an unexpected expense, perhaps relating to health care. The list goes on.
<h2>We can’t be sure it won’t happen</h2>
It is hard to predict whether any of those things will happen to people in sufficient numbers to cause a meltdown.
But that’s the whole point – it is hard to be confident that it won’t happen.
And if it does occur then the consequences could be huge.
<h2>Game theory suggests it might</h2>
It might seem perverse that the big four banks could voluntarily cut back on lending and cause a collapse in prices that craters their own loan books. Yet that’s exactly the lesson from the work of <a href="https://www.nobelprize.org/prizes/economic-sciences/1994/press-release/">John Nash</a>, who won the 1994 Nobel Prize in economics for his work on game theory. In a strategic setting, what is best for the individual might not be best for the group.
If individual banks don’t cut back their lending but others do, they will get stuck with the worst loans.
Avoiding that fate might mean creating market conditions that hurt all existing loans.
It’s the paradox at the heart of game theory.
<h2>But I’m hoping for the best</h2>
I’m still betting on the residential property market deflating slowly, rather than popping.
But unfortunately you don’t need to get too creative to imagine scenarios that involve a very loud pop – for property owners, the banks and the economy more generally.<img src="https://counter.theconversation.com/content/105137/count.gif?distributor=republish-lightbox-basic" alt="The Conversation" width="1" height="1" style="border: none !important; box-shadow: none !important; margin: 0 !important; max-height: 1px !important; max-width: 1px !important; min-height: 1px !important; min-width: 1px !important; opacity: 0 !important; outline: none !important; padding: 0 !important; text-shadow: none !important;">
<a href="https://theconversation.com/profiles/richard-holden-118107" target="_blank">Richard Holden</a>, Professor of Economics and PLuS Alliance Fellow, <a href="http://theconversation.com/institutions/unsw-1414" target="_blank">UNSW</a>
This article is republished from <a href="http://theconversation.com" target="_blank">The Conversation</a> under a Creative Commons license. Read the <a href="https://theconversation.com/vital-signs-the-housing-market-might-deflate-but-it-might-pop-heres-how-105137" target="_blank">original article</a>.
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