Welcome to Eureka Street

back to site

Australia's delayed GFC


House sitting on blocks

The winter surge in Australia's residential property market has many independent observers – as opposed to real estate spruikers and the banks – increasingly worried. Australia is at risk of experiencing a delayed global financial crisis (GFC) effect, which would result in great stresses being put on the financial system.

The property market is growing at an annualised rate of 15 per cent, which, in an environment in which interest rates in developed countries are running at close to zero, is a suspiciously high return.  Sydney is especially hot, with prices 40 per cent above their pre-GFC peak and 20 per cent above their November 2010 peak.

The main trigger is low interest rates. They are at once a symptom of what is wrong in the global financial system and a catalyst for what will soon be wrong. After the GFC, the only way for the United States and Europe to stave off complete catastrophe was to flood the system with money, effectively reducing the cost of capital in the economy to near zero. Interest rates around the developed world fell.

Australia's experience was different, however. Unlike most developed economies, especially the US, property prices did not fall sharply. As a result, there was not the same kind of pressure on local banks, which for the most part sailed through unscathed. There were many reasons for this. Former Treasurer Peter Costello's ability to run prudent federal budgets, which left Australia with exceptionally low government debt, was one. The China-driven investment boom in resources was another. The Rudd government's cash splash in 2008 was a skilful piece of timing, staving off recession. And the property market was greatly assisted by negative gearing and Australians' love of property.

Interest rates are only now falling in Australia in what can be described as a 'delayed GFC effect'. The cash rate is at a record low of 2.5 per cent and investors are starting to take riskier bets in property, desperate to get better returns than are offered by term deposits.

Many are sounding warnings. David Murray, former head of the Commonwealth Bank and head of the Financial System Inquiry, has said the banks should be shoring up their capital base to be ready for a correction in asset prices 'inflated by unprecedented global monetary stimulus.'

The Australian Prudential Lending Authority (APRA) has released data showing an increase in risky loans, including interest only loans. Investment loans are now 37.9 per cent of the total as investors seek alternatives. Credit agency Moody's has warned about growing risk, noting that the banks' credit growth has greatly outpaced the systems' growth. Jeremy Lawson, chief global economist at Standard Life, reckons the Australian housing market is 30 per cent over valued. Australia has the third-most overvalued housing market on a price-to-income basis, after Belgium and Canada, according to the International Monetary Fund.

Foreign investors, also keen to find better returns, are exacerbating the situation. Foreign buyers are reported to be purchasing about two-fifths of all newly developed homes in Melbourne and Sydney. There are anecdotal reports of intense activity from Chinese investors, some of whom are bypassing the foreign ownership rules.

Self-managed super funds, which control $560 billion, may also be having an effect. SMSFs can leverage their funds up to five times, and if they start concentrating heavily on the property market that will only increase the competition. At the moment, the amounts are comparatively small, although it is growing fast.

The generational cost of soaring property prices has been widely discussed. Most young, first home buyers are priced out of the market. Even the Reserve Bank is advising that renting makes as much sense as buying.

Yet what is only now starting to come into focus is the extent to which the whole economy is in hock to house prices. It is not just households that are groaning under the weight of such high mortgage debt.

As Murray – who should know, having run one of the Big Four Banks – implies, a sharp fall in the housing market will put intense pressure on our major lending institutions. This would have a deeply depressing effect on all parts of the economy. Australia's 'delayed GFC effect' may not be just the current low level of interest rates. We may also experience property falls and, in consequence, banking problems.

Certainly the potential is there for a sharp sell-off with such a high proportion of property owners being investors rather than occupiers. If investors think they have made a bad choice, they are much more likely to sell than occupiers, who tend to have an attachment to the dwelling.

The regulators, as ever, are taking a hands-off approach; in other words, not regulating at all in the area that matters. Some intervention now could prove extremely prudent, such as the policy of the Reserve Bank of New Zealand, which has changed banks' maturity profiles to provide greater protection against liquidity risk in the medium-to longer term. Or the government could do the politically unthinkable and make the negative gearing tax break less attractive. But the probability is that there will be no action, and Australia's economy will sail into perilous waters.


David JamesDavid James is a business journalist with a PhD in English literature. He edits Personal Super Investor.

Image via Shutterstock.

Topic tags: David James, property market, GFC, Australia, house prices, banks



submit a comment

Existing comments

Thank you, David. You are, once again, a sane and balanced voice in the wilderness. The corrective is coming: we need to prepare. Pity Hockey & Corman are not Costello or Keating.

Edward Fido | 05 September 2014  

The war on savers and its subsequent destruction of yields on low risk investments has resulted in ever more mums and dads owning shares and buying properties. This is a good thing if you use it to buy time to re balance an economy. In the case of Australia, re balancing our economy basically means moving away from our reliance on mining by undertaking serious productivity reforms. We are not doing this, however, all we seem to be doing is flooding our economy with cheap money so productivity reforms can be avoided. One assumes that in the end productivity reforms will be implemented as part of a recession we will have to have to convince the electorate that such reforms are in fact the only policy solution that actually works.

Robert Lopez CPA | 06 September 2014  

I echo Mr Fido's comments. However it seems to me that the gambling instinct in Australian society is very strong. Despite the economic sense that David James writes many Australians punt on property. I'm reminded of the blind spot of the problem gambler. His wife was thrilled when after after much cajoling by her he went along to Gamblers Anonymous. Her joy was short-lived when he returned from his first meeting and said: "I'm not going back there. GA's full of losers." Until they actually crash themselves - hit rock bottom - most problem gamblers think they can get away with their gambling. It's a pity that a similar situation exists with regard to property. Until "the recession we will have to have" comes along the government is unlikely to implement productivity reforms that wean speculators away from property. Who is going to have the political courage to tell them they will have to go "cold turkey"?

Uncle Pat | 08 September 2014  

Thanks, but very scary! It emphasises how bad governments have been since the later stages of Howard`s mob, but the worst is probably with now been a highly destructive opposition first. Given that is it impossible for the banks to sensibly regulate themselves? They must see the huge danger to themselves (and us ) that they are building up , but presumably short term profits come first, and the security of knowing that the government is going to bail them out anyway when the inevitable happens. Amazingly irresponsible; God help us!

Eugene | 08 September 2014  

I know it is probably not right to draw conclusions from the number of comments made by readers of ES on a particular subject. But I must say I am very disappointed by the small number of readers who have commented on David James article. Is this a sign only a few readers are interested in the topic? Or most readers agree with James' proposition "the whole economy is in hock to house prices." and there is little we can do about it? Or most readers are themselves players in the property gambling game? If the latter I can see why any government would be slow to move on the negative gearing tax break.

Uncle Pat | 10 September 2014  

I'm looking at purchasing my first property and looking at this situation hopefully. Can't wait for house prices to crash! Then I can enter the market on the ground floor. Any idea when this correction might take place? Or is this just more empty doomsaying?

Kent Kingston | 12 September 2014  

The property business sector is developing at an annualized rate of 15 for every penny, which, in a domain in which intrigue rates in created nations are running at near zero, is a suspiciously exceptional yield.

Aiden ordell | 09 September 2015