Why Aussie banks are weakening

Australian banks are breaking primary support levels. There are two major reasons for this. One is the precarious level of household debt as a result of the housing bubble. The first graph below shows how housing prices have more than doubled compared to disposable incomes (after tax but before interest payments) over the past 30 years. And how household debt has risen, not as a result of, but as the underlying cause of, the housing bubble. Without rising debt there would be no bubble.

Australian House Prices and Household Debt to Disposable Income

Growth in Australian housing prices is now slowing, prompting fears of a correction.

Australian House Price Growth

The second reason is falling returns on equity. Banking regulators have increased pressure on major banks to improve lending standards and increase capital backing for their lending exposure. For decades banks were given free rein to increase lending without commensurate increases in capital, to the extent that the majors hold only $4 to $5 of common equity for every $100 of lending exposure. Low interest rates, increases in capital and slowing credit growth have all contributed to the decline in bank equity returns to the low teens.

Australian Banks Return on Equity

Australia: Housing bubbles and declining business investment

The Australian housing bubble is alive and kicking, with house prices growing at close to 10% per year.

House Prices

Loan approvals are climbing, especially for owner-occupiers. Fueled by record low interest rates.

Loan Approvals

Causing household debt to soar relative to disposable income.

Loan Approvals

Business Investment

Nominal GDP growth of 6.34% for the 2017 FY is a rough measure of the average return on capital investment.

Australia Nominal GDP

With a mean of close to 5% over the last two decades, it is little wonder that business investment is falling. Not only in mining-related engineering but in machinery and equipment.

Australia Business Investment

Capital Misallocation

More capital is being allocated to housing than to business investment.

Australia Credit Growth

Returns on housing are largely speculative, premised on further house price growth, and do little to boost GDP growth and productivity.

The result of soaring house prices and household debt is therefore lower business investment and lower GDP and wages growth.

Australia Wages Growth

You don’t have to be the sharpest tool in the shed to recognize that soaring household debt and shrinking wage growth is likely to end badly.

Australia: Housing, Incomes & Growth

A quick snapshot of the Australian economy from the latest RBA chart pack.

Disposable income growth has declined to almost zero and consumption is likely to follow. Else Savings will be depleted.

Disposable Income & Consumption

Residential building approvals are slowing, most noticeably in apartments, reflecting an oversupply.

Residential Building Approvals

Housing loan approvals for owner-occupiers are rising, fueled no doubt by State first home-buyer incentives. States do not want the party, especially the flow from stamp duties, to end. But loan approvals for investors are topping after an APRA crackdown on investor mortgages, especially interest-only loans.

Housing loan approvals

The ratio of household debt to disposable income is precarious, and growing worse with each passing year.

Household debt to disposable income

House price growth continues at close to 10% a year, fueled by rising debt. When we refer to the “housing bubble” it is really a debt bubble driving housing prices. If debt growth slows so will housing prices.

House price growth

Declining business investment, as a percentage of GDP, warns of slowing economic growth in the years ahead. It is difficult, if not impossible, to achieve productivity growth without continuous new investment and technology improvement.

Business investment

Yet declining corporate bond spreads show no sign of increased lending risk.

Corporate bond spreads

Declining disposable income and consumption growth mean that voters are unlikely to be happy come next election. With each party trying to ride the populist wave, responsible economic management has taken a back seat. Throw in a housing bubble and declining business investment and the glass looks more than half-empty.

Every great cause begins as a movement, becomes a business, and eventually degenerates into a racket.

~ Eric Hoffer

China holds its head above water

A quick snapshot from the latest RBA chart pack.

Manufacturing is holding its head above water (50 on the PMI chart) and industrial production shows a small upturn but investment growth is falling, as in many global economies including the US and Australia. Retail sales growth has declined but remains healthy at 10% a year.


Electricity generation continues to climb but steel, cement and plate glass production all warn that real estate and infrastructure development are slowing.


Interest rates remain accommodative.


Real estate price growth is slowing but remains an unhealthy 10% a year. Real estate development investment rallied in response to lower interest rates but is clearly in a long-term decline.


There are no signs of an economy in immediate trouble but there are indications that the real estate and infrastructure boom may be ending. Through a combination of fiscal stimulus and accommodative monetary policy the Chinese have managed to stave off a capitalism-style correction. But failure to clear some of the excesses of the past decade will mean that the inevitable correction, when it does come, is likely to display familiar Asian severity (Japan 1992, Asian Crisis 1997).

Australia: RBA hands tied

Falling wage rate growth suggests that we are headed for a period of low growth in employment and personal consumption.

Australia Wage Index

The impact is already evident in the Retail sector.

ASX 300 Retail

The RBA would normally intervene to stimulate investment and employment but its hands are tied. Lowering interest rates would aggravate the housing bubble. Household debt is already precariously high in relation to disposable income.

Australia: Household Debt to Disposable Income

Like Mister Micawber in David Copperfield, we are waiting in the hope that something turns up to rescue us from our predicament. It’s not a good situation to be in. If something bad turns up and the RBA is low on ammunition.

Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. The blossom is blighted, the leaf is withered, the god of day goes down upon the dreary scene, and — and in short you are for ever floored….

~ Mr. Micawber in Charles Dickens’ David Copperfield

Is the Coalition prepared to die defending the housing bubble?

I don’t always agree with David Llewellyn-Smith but love his pithy style. Here he takes the Turnbull government to task over their housing and immigration policies.

Cross-posted with kind permission from Macrobusiness:

….Because that’s what it looks like.

We all know that the Coalition hearts the housing bubble. Everything it does spells undying infatuation:

  • protecting property tax rorts;
  • focusing only on supply-side reform and even then doing pretty much nothing;
  • shelving any and all policy reform that might disrupt its smooth and burgeoning progeny, plus
  • running a staggeringly huge immigration program despite widespread economic damage.

It’s the last point that I want to focus on today because that’s the one where Coalition bubble-love rubber hits the road for its electoral prospects.

Since the WA election, Coalition polling has been devastated. A little bounce in Newspoll has been wiped out by landslides against the government in Ipsos and Essential polls. Moreover, the carnage has been just as apparent in the Coalition’s primary vote which has hemorrhaged voters to One Nation. The latter has been unaffected by the WA election despite doing less well than expected.

The major change in politics since the state result has been a commitment by One Nation to never ally with the Coalition again. The fringe party has realised that such pragmatism is lethal to its prospects.

This simple truth seems yet to have filtered through to the federal Coalition. As One Nation takes a material portion of its vote, and that vote refuses point blank to ally with it, there is ZERO chance of the Coalition winning a federal election ever again, and probably not at the state level either. While One Nation exists in this form, the Coalition has effectively ceased to exist as a political force.

One might have thought that the prospect of NEVER WINNING ANOTHER ELECTION might be enough to trigger some soul-searching in the party. And it has done a little. Do-nothing Malcolm has switched from toying with random ideas to deploying random ideas but it’s still all at the margins and is meaningless:

  • 18c reform won’t move the needle;
  • contradictory coal and hydro investment won’t move the needle;
  • a retrograde company tax cut won’t move the needle;
  • a supply-side housing affordability Budget won’t move the needle.

All together they might nudge it a little but it won’t be enough. Nothing like it.

Indeed, I’ll go so far as to say that the Coalition could do the following immensely popular policies and it would still get clubbed from office:

  • abolish negative gearing;
  • install gas reservation;
  • offer tax cuts.

The problem is that these are all cyclical fixes for what is a structural shift to One Nation driven by one very simple truth: Australians are done with high immigration.

That’s Pauline Hanson’s primary appeal. She makes little sense on other issues and is bat shit crazy on many. But her one great power, the one that vibrates deep in the bowels of every Australian that is marginalised by house prices, falling wages, can’t get a job, is fearful of Islam or just a bigot, or is just plain pissed off at the direction of the country, is the deep and legitimate truth that running a mass immigration program during a period of high unemployment is treasonous economics.

Thus there is only one policy shift that can change the Coalition’s fate and it is as plain as the nose on Pauline Hanson’s face: cut immigration and cut it hard.

Cutting immigration back to 70k per year or less would completely shift every electoral parameter as the Coalition:

  • finally had a housing affordability policy to put up against Labor’s negative gearing reforms;
  • finally had an environmental policy to put up against the immigration-hypocritical Greens;
  • could gut One Nation overnight and go to work on wiping it out by exposing the loons as weakening polls divide them.

This one policy shift would put the Coalition instantly in the running for the next election even if it were Do-nothing Malcolm that did it.

So, why does the Coalition suffer from such suicidal bubble-love that it can’t or won’t grab this lifeline?

  • many Coalition MPs are personally leveraged to the bubble so they’ve their own financial interests in mind;
  • as yesterday’s revelations about the MPs that prevented negative gearing reform showed, they are political hacks with terrible policy judgement;
  • they are bereft of the intellectual depth and corporate memory to contemplate alternative economic models. Cutting immigration to 70k would take pressure off eastern capital house prices enabling further rate cuts and a lower currency;
  • the Howard and Costello myths make this even worse,
  • and, the Coalition is closely wedded to the business interests in banking, retail and construction that benefit from high immigration even as the net result is negative for the wider economy.

I’ll add one more factor which appears increasingly important. Career politicians don’t care for their own political party or its nominal values as they used to. The dominant ideology of unglued self-interest comes with the wonderful fringe benefit of not having to take responsibility for anything. Contemporary Coalition MPs see party membership as a gravy train to private sector riches in board positions, lobbying roles and other forms of ‘control fraud’ in the very sectors that thrive on the bubble. So, for them, arbitraging the fate of the party for personal gain is all just a part of being a good liberal.

Backing self-interest used to work in political forecasting but does this rabble even have that in them?

Australia is on a different path

Motor vehicle sales are strong, according to the Federal Chamber of Automotive Industries:

Motor vehicle sales across Australia got off to a solid start in January, with the month’s sales nudging ahead of the same period last year and showing a rise in activity among private purchasers.

Total sales for January, including passenger cars, SUVs, light and heavy commercial vehicles totalled 84,910 for the month, 0.6 percent up on the same month in 2016.

Within the segments, light commercials fell 3.9 per cent, passenger car sales declined slightly (down 0.8 per cent), while SUVs continued their consistent growth pattern with a gain of 3.2 per cent….

But retail sales growth is slowing.

Australia Retail

While housing is slowing after a surge in high-density units over the last five years.

Australia Housing

Resources exports have been performing well but a slow-down in Chinese housing sales could act as a hand-brake on future growth.

US: Why the enthusiasm?

Retail sales are surging, with Retail & Food (ex-Motor Vehicles) growing above 5% a year for the first time since 2012.

Retail & Food Sales

Light vehicles sales are back at their 2000-2006 norm of 17.5 million units a year, reflecting consumer confidence.

Light Vehicle Sales

Housing remains soft but growth in new starts and building permits continues.


Durable goods orders are also soft but unlikely to remain so if retail sales growth continues.

Durable Goods Orders

Inflationary pressures are likely to rise. Which is why the Fed expects to increase the pace of interest rate hikes in 2017.

Chinese real estate bubble “slows”

Elliot Clarke at Westpac reports that home price growth in tier-1 cities “slowed materially” in January 2017:

From 29%yr in September 2016, tier-1 new home price growth has slowed to 23%yr. Similarly for the tier-1 secondary market, price momentum has slowed from 33%yr to 26%yr since September.

Tier-2 and tier-3 cities have far lower annual growth rates: 12% and 9% respectively for new homes and 9% and 6% for existing dwellings.

When we compare tier-1 price growth to Sydney and Melbourne, the Chinese bubble is in a different league. From CoreLogic: “Sydney home prices surged 15.5 per cent and Melbourne’s 13.7 per cent over the year [2016]”.

It is hard to imagine a soft landing when property prices have been growing at 30% a year.

Even 15%….

Pickering: Australian housing “severely overvalued”

Interesting view from Leith van Onselen:

ScreenHunter_3304 Jul. 15 10.21

Business Spectator’s Callam Pickering has produced an interesting assessment of the RBA’s new research paper, which attempts to determine whether Australian homes are overvalued versus renting.

Like my analysis posted earlier, Pickering also concludes that Australian housing is significantly overvalued given the likely prospects for incomes and capital growth; although how he arrives at his conclusion is a little different:

My general view is that Australians are frequently ripped off when purchasing a home. A combination of poor housing policy… combined with housing supply restrictions… have resulted in arguably the most expensive housing stock in the world…

[The RBA] find that the decision to buy or rent is highly sensitive to one’s expectations regarding capital appreciation. Their base scenario assumes that house prices will continue to grow at their post-1955 average, during which time real house prices rose by 2.4 per cent annually. Under this scenario, housing is perfectly priced compared with rents.

But as I’ve argued frequently it is unreasonable to assume that future house price growth will match past gains…

The sensitivity of their analysis to various price growth assumptions is contained in the graph below.

ScreenHunter_3305 Jul. 15 10.31

Structural shifts in the Australian economy resulting from an ageing population and a declining terms of trade, combined with the Chinese economy slowing, will weigh on income and price growth, while high levels of indebtedness should place a speed limit on potential growth.

The most interesting scenario considered by Fox and Tulip is the scenario where real house prices grow at the rate of household income growth (denoted in the graph by “HHDY”). This scenario is perhaps a little optimistic (the risks to income growth are on the downside) but it approximates our current reality… Under this scenario, housing is overvalued by around 20 per cent…

[The RBA research] using plausible assumptions for price growth, suggests that housing is severely overvalued in Australia and many Australians are getting ripped off.

Spot on and well argued.

Reproduced with kind permission from Macrobusiness

Saul Eslake: 50 years of housing policy failure | | MacroBusiness

Leith van Onselen quotes Saul Eslake:

Research by Judy Yates of the University of NSW shows that home ownership rates among younger age groups declined dramatically between the 1991 and 2011 Censuses – from 56% to 47% among 25-34 year olds; from 75% to 64% among 35-44 year olds; from 81% to 73% among 45-54 year olds; and 84% to 79% among those over 55…

Eslake also nails one of my pet hates: federal/state intervention in the housing market to boost demand, driving up prices and fueling the housing bubble:

Eslake puts the recent failure of housing supply to keep up with demand down to two main factors, namely:

  • The decline in the provision of social housing; and
  • Restrictive state and local government planning schemes and upfront charging for development and infrastructure.

Eslake is particularly scathing of policies that boost demand, such as FHB Grants and negative gearing.

Read more at Saul Eslake: 50 years of housing policy failure | | MacroBusiness.

Australia & NZ: Housing wealth to disposable income

Leith van Onselen posts this chart comparing housing wealth to disposable income. Australia and New Zealand are the worst offenders, with ratios close to 5:1, while the US never reached 3:1 even at its sub-prime peak.

Housing wealth to disposable income

What’s wrong with inequality?

Robert Douglas summarizes the argument against inequality presented by Andrew Leigh, economist and (Labour) parliamentarian, in his book Battlers and Billionaires:

Leigh sees inequality as a socially corrosive force undermining the egalitarian spirit that has been one of the positive defining characteristics of Australian society. He argues that unequal wealth demands attention from our political system and that there are a variety of ways in which it can be addressed.

There has been much hand-wringing from the left about rising inequality, but I believe this is an attempt to frame the political debate along class lines — the rich against the rest — as Barack Obama succeeded in doing, with the able assistance of Mitt Romney, in 2012. Framing the debate in relative terms is shrewd politics. An attempt to distract voters from the real issues:

  • Is poverty rising or falling?
  • Is general health, as reflected by life expectancy, improving or deteriorating?

Poverty is a subjective concept, as Thomas Sowell points out:

Most Americans with incomes below the official poverty level have air-conditioning, television, own a motor vehicle and, far from being hungry, are more likely than other Americans to be overweight.

Life expectancy, however, is difficult to fudge.

Inequality, as I said earlier, is relative: we can have declining poverty and rising life expectancy while inequality is growing. In fact when the economy is booming and employment rising, inequality is also likely to be growing. Do we really want to kill the goose that lays the golden eggs? Raising taxes to discourage new entrepreneurs? That is what targeting inequality can succeed in doing: harming the welfare of all rather than improving the welfare of the poor at the expense of the rich.

Instead we should focus on job creation and health improvements. And if that means creating incentives to encourage entrepreneurs, so be it, provided we all benefit.

The fact that inequality rose after the GFC is an anomaly that is unlikely to persist in the long term. The wealth of the masses are predominantly represented by real estate, while the rich hold a far higher percentage of their wealth in financial assets: stocks and bonds. Housing was hardest hit by the GFC and has taken longest to recover, causing a surge in inequality readings. That is not the fault of the rich — apart from a few investment bankers — and in fact we should learn from their experience. Real estate investment may have served us well in the past, but that is likely to change with the end of the credit super-cycle. We will need to concentrate a far higher percentage of our investment in stocks and bonds.

Read more at Inequality, health and well-being: time for a national debate.

SCHIFF: The Great Reflation | Business Insider

Peter Schiff writes:

The truth is that most buyers cannot afford today’s prices without the combination of government guarantees and artificially low mortgage rates. The Federal Reserve has been conducting an unprecedented experiment in economic manipulation. By holding interest rates near zero and by actively buying more than $40 billion monthly of mortgage-backed securities and $45 billion of Treasury bonds, the Fed has engineered the lowest mortgage rates in generations.

Read more atSCHIFF: The Great Reflation – Business Insider.

Australia: Property risk highest in a long time

Posted by Houses and Holes in Australian Property, May 20th 2013:

MB contributor, Rumpletstatskin, wrote an interesting post on the Australia property cycle this morning. In it he mused that:

The crucial lesson in all this is that Australian nominal asset prices have been supported by fiscal policy during the financial crisis, ongoing monetary policy adjustments, and foreign investment (including in mining infrastructure), which all supported employment and incomes.

This support allowed a slow melt adjustment since the financial crisis. Home prices have fallen, mortgage rates are down, and rents have increased. This means that buying a home is more affordable compared to renting than it has been for 15 years.

My message, if it wasn’t clear, is that if you have been holding off purchasing a home because of the risk of capital losses, then these risks are probably lower now than at any time in the past decade. Maybe prices will be a couple of percent lower at the end of next year, but I have a hard time wrapping my mind around downward price movement more severe than a couple more years of the slow melt, or around 3% in nominal terms. The chances of price gains is also now much higher.

Unfortunately this coming 2 year period is also likely to be economically unstable, with low wage growth and a fragile labour market. That is the catch with trying to time the residential property cycle – it is a game for players with lots of capital.

Cameron argues his post well but I vigorously disagree with these conclusions.

Australian property prices are not affordable on any spectrum that looks beyond the current cycle. Indeed, they remain at nose-bleed levels on any historical comparison.

Yet, prices have held at these high levels for over a decade and there is no saying that they won’t continue to do so. Throughout the GFC and afterwards I argued that the time of reckoning for the Australian housing bubble was not yet at hand. This was based largely upon the assumption that the nation had lots of firepower left in monetary and fiscal policy that would protect the downside. And so it turned out to be.

But each successive challenge has sapped these supports and insurance policies. Monetary policy is at 2.75% and probably has, at best, 1% of cuts left before it is exhausted. Fiscal policy too has limits now that the Budget guarantees bank borrowings. Not to mention the political paralysis preventing spending. We will never see another post-GFC stimulus program.

Most importantly, these limitations are apparent as the Australian economy enters a very serious challenge in the form of declining mining investment. In its editorial this morning the AFR wrote:

If Professor Garnaut is right, Chinese steel use per capita – the great driver of Australia’s resources boom – may not grow much further. He believes Australian resource investment will slide from 8 per cent of gross domestic product to just 2 per cent, effectively taking out about two years’ worth of national economic growth. This is already showing up in a string of profit warnings from mining services companies and an emerging slump in profitability in coal.

Think about that a moment. 6% of Australian GDP disappearing over the next three years before we even start to grow. This is the same forecast currently projected by ANZ and Goldman Sachs. It must be taken very seriously.

If this comes to pass, then it will be very difficult for Australia to avoid a recession and property bust of some kind. There will be very big falls in the dollar and they will protect Australian property prices to an extent. The fall will trap Asian investors already in the market but it will also deter future investors as currency risk becomes the new reality.

But the fall in the dollar is also going to hit consumers, much more quickly than it is going to benefit tradable sectors. Consumers will see purchasing power eroded as high inflation in oil and all imported goods overwhelms income growth. This will keep confidence under the cosh.

More to the point, a 6% draw down in business investment will hit the labour market hard and potentially trigger forced selling in property markets. Perth and Darwin especially are going to be at risk of property busts as the many project labourers on our major mining projects flood back into town with nothing to do. Not to mention the trouble we’ll see in the many sundry industries that have benefited from the mining boom. Brisbane is at risk of this dynamic too but has already corrected sharply so has less downside.

These factors, along with a generalised stalling in income growth, have the potential to feed bad loans back into the banking system. The majors can absorb serious losses. But how serious? And how much credit rationing would it take to pop the grossly oversupplied Melbourne and Canberra property markets, the latter afflicted with big job losses from a new government as well? Sydney is strong but only so long as credit keeps flowing.

There are of course arguments about high immigration, underlying demand, under supply and rising rents to support the market. And they will play some part. But none of these will matter in the circumstances I’m describing. If there are not enough jobs then people will move in together. Shortage will turn to surplus.

Cameron’s argument that the property cycle could be approaching a turning point will hold if these turn out to be normal times. A moderate retrenchment in mining investment will allow time to rebalance the economy so long as the dollar falls. Even so, things will seem abnormal. Inflation be high and property prices may rise in nominal terms but not so much in real.

But that is far from certain, indeed, may not even be the base case.

I am not saying any of this will happen. But if the mining investment cliff turns out to be precipitous in the next two years then the risk of a property shakeout is higher than at any time I can remember.

Reproduced with kind permission from Macrobusiness Australia.

7-23 – The Housing “Supply” I See | Hanson Advisers

Bottom line: In order to permanently de-lever this housing market something must be done to address the 20 to 30 million homeowners in a negative or “effective” (lacking the equity to pay a Realtor 6% and put 20% down on a new house) negative equity position; with 2nd liens; and without the credit needed to qualify for a new vintage loan. That’s because repeat buyers are the “durable” demand cohort; not first-timer buyers and “investors” who come and go with the stimulus wind like we saw in 2010 and will again in the second half of this year.

via 7-23 – The Housing “Supply” I See | Hanson Advisers.

Hat tip to Barry Ritholz

China Pins Hopes on Public Housing – WSJ.com

One of the biggest public-housing projects in history will help determine whether China can remake its real-estate sector fast enough to prevent its economy from flaming out.

China is in the midst of a crash program to build 36 million subsidized apartments by the end of 2015—enough units to house the entire population of Germany. The goal is twofold: to head off social unrest by ensuring decent places to live for low-wage workers, but also to cushion an expected fall in high-end construction—the result of policies to tame property speculation—by ramping up construction at the low end: so-called social housing.

via China Pins Hopes on Public Housing – WSJ.com.

Comment: ~ This is good news for iron ore and (coking) coal miners in Australia and Brazil: steel prices should recover.

Auditor Says F.H.A. Could Need Bailout – NYTimes.com

WASHINGTON — The Federal Housing Administration has a “close to 50” percent chance of requiring a bailout if the housing market deteriorates next year, the agency’s independent auditor said in a report released Tuesday.

The F.H.A., which offers private lenders guarantees against homeowner default, has just $2.6 billion in cash reserves, the report found, down from $4.7 billion last year.

The agency’s woes stem from the national foreclosure crisis. In the last three years, the F.H.A. has paid $37 billion in insurance claims against defaulting homeowners, shrinking its cash cushion.

via Auditor Says F.H.A. Could Need Bailout – NYTimes.com.