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Massive Bust Predicted for Australian Housing Market

End of increased homebuyer grants by AU government to pop bubble

July 27, 2009

By JILL FRASER
Australian Correspondent for MortgageDaily.com


First-time homebuyer programs have helped prop up Australia's housing market. But an Australian economist -- who more than a decade ago predicted that the residential securitization model would flop for investors and insurers -- sees home prices tanking over the next decade. And his outlook for the United States is no better.

An online poll conducted by leading Australian mortgage firm Loan Market Group found that two-thirds of respondents believed the recently boosted 'First Home Owners Grant' Down Under has increased the price of residential housing.

The Australian Federal Government expanded the 'First Home Owners Grant' as part of a (AU)$10.4 billion stimulus package unveiled in October 2008. The grant was lifted from (AU)$7,000 to (AU)$14,000 for existing dwellings and from (AU)$14,000 to (AU)$21,000 for new homes.

The boost to the scheme will start to be phased out on Sept. 30 and end on Dec. 31. From Jan. 1, 2010, the first homeowners' scheme will revert to its original (AU)$7,000.

The move has been hailed by the Australian real estate industry and most economists -- who believe it has provided a solid foundation for the property market during the economic downturn.

Loan Market Executive Director John Kolenda said the combined effects of softer property prices, low interest rates and the boosted grant had created an environment in which many more Australians have been able to afford a home.

Data shows first-time homebuyers accounted for 27 percent of all home loans approved in March.

But one economist, Dr Steve Keen, Associate Professor Economics and Finance at the University of Western Sydney, has slammed the doubling of the grant -- arguing that it is "merely delaying the day of reckoning."

For years Keen has warned that the world's reliance on massive debt to drive growth would be its downfall.

"The ratio of private debt to GDP is now 1.7 times what it was at the start of the Great Depression in the USA, and 2.2 times what it was in Australia," he said -- adding that the de-leveraging of this debt will swamp anything the government tries to do in stimulus.

Keen has recently been heralded in a survey of economic models by Professor of Economics at the University of Groningen in the Netherlands, Dirk Bezemer, as one of only twelve economists internationally -- and the only Australian -- "who saw the financial crisis coming."

Pointing to excessive debt as the root cause of the global financial slump, Keen said increased borrowing off the back of the enhanced First Home Owners Grant in Australia is creating an even bigger bubble -- which will ultimately lead to a "massive final bust."

Dubbing it the "First Home Vendors Grant," he said that "it's asking first home buyers to take out leveraged positions to boost the economy at a time when it's very likely the economy is going to go cactus and so are house prices."

He describes all stimulus packages as fodder for junkie economies and says in the end they're just postponing the inevitable.

"
They're dangerous artificial fixes," Keen said -- equating the attempts of governments to restart private borrowing by injecting billions of dollars into the economy to a drug overdose.

"
Our 'neoclassical' economic doctors are trying to bring the patient back to health by administering more of the same drug," he declared. "It's a bit like giving a junkie, who has just taken an overdose, more heroin."

Critical of securitization, Keen said in 1996 he warned the Wallis Committee, which conducted the last inquiry into the Australian financial system that securitizing loans would skew the system.

In a 1996 letter to Committee Chairman Stan Wallis warning about the potential crisis to come, he wrote the following.

... The impact of securitisation:

The securitisation of debt documents such as residential mortgages does not alter the key issue, which is the ability of borrowers to commit themselves to debt on the basis of "euphoric" expectations during an asset price boom. The ability of such borrowers to repay their debt is dependent upon the maintenance of the boom, and as the share market reactions to yesterday's comments by Alan Greenspan reminded us, such conditions cannot be maintained indefinitely.

Should a substantial proportion of eligible assets (e.g., residential houses during a real estate boom like that of 87-89) be financed by securitised instruments, the inability of borrowers to pay their debts on a large scale will not, of course, directly affect liquidity in the same fashion that a failure of bank debtors does. Instead, the impact will be felt by those who purchased the securities, or by insurance firms who underwrote the repayment.

  • Where this is a government, the impact on liquidity will again be slight, since public debt will replace private.

  • Where this is a financial institution, such as a bank, it will be in a very similar situation to the State Bank of Victoria (and many others) after the last real estate crash, with similar consequences.

  • Where this is an insurance company, it could be driven into bankruptcy, with an impact on liquidity via its shareholders and its own creditors. However this would not be as serious as the second instance above.

  • Where the securities are trade-able, there would obviously be a collapse in the trade-able price, and, potentially, the bankrupting of many of the investors -- depending again on their own financing arrangements.

Overall I would agree that direct regulation of securitisers is not warranted. What is needed instead is prudential overview of the extent to which banks, insurance firms and superannuation institutions invest in securitisers and their products. However, I would object strongly to the proposal from Aussie Home Loans that securitisers should be able to call themselves banks ...

"The main reason Australia has lost the tight links between our central bank the Reserve Bank of Australia rates and mortgage rates is due to securitisation of loans and the fact that banks are sourcing a lot of their lending from wholesale borrowing and wholesale market is unaffected by short-term rates," Keen told Mortgage Daily.com. "As a consequence of securitisation, the influence the RBA has on bank rates has been weakened and when you have volatility in the wholesale market -- and we're going to see more soon -- that is enough to drive up the cost of funds for banks and they've got a legitimate reason to put their rates up."

Keen forecasts double-digit unemployment and a 40 percent decline in Australian home prices during the next decade.

His forecast for America was equally bleak.

Once the debt financed U.S. spending has ended, Keen said the huge hit to aggregate demand will be so enormous that even the scale of President Barack Obama's borrowing and spending won't be able to counteract the degree of de-leveraging.

"As things get worse, the only feasible thing for Obama to do will be throw out the conventional advisers and listen to contrarian arguments," said Keen.

His solution? Debt abolition: writing debt off systematically.


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Australian journalist Jill Fraser reports on the country's mortgage industry for LendingCentral.com. Jill is also a book author. She has been in the media business for 26 years. Reach Jill at [email protected].

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