The Week Ahead: Three Warning Signs Of A Bear Market

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Updated October 13, 2017 16:11:23

A house auction in Norwood>> Photo: There are signs our frothy housing market, combined with rising interest rates, could get ugly. (ABC News: Michael Coggan)

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>Map: Australia

I'm not normally a fan of Parliament hauling private sector executives before them and asking thorny questions.

But when the Australian House of Representatives did so this week with the big banks, it was both useful and instructive.

And, to be perfectly frank, terrifying.

Let's start with Westpac chief executive officer Brian Hartzer.

First, he confirmed the little-known but startling fact that half of his $400 billion home loan book consists of interest-only mortgages.

Yep, half. Of $400 billion. At one bank. Oh, and ANZ, CBA and NAB are all nearly at 40 per cent interest-only.

Mr Hartzer went on to make the banal statement: "We don't lend to people who can't pay it back. It doesn't make sense for us to do so."

So did it make sense for all those American mortgage lenders to lend to people on adjustable rates, teaser rates, low-doc loans, no-doc loans etc. before the global financial crisis?

Of course not. The point is that banks are not some benevolent, unitary actor taking care of their own money.

There are top managers like Mr Harzter acting on behalf of shareholders.

Mortgage stress hotspots map

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New data shows that even a small rise in interest rates could tip one million Australian households into financial stress.

Those top managers delegate authority to lower-level managers, who are given incentives to write lots of mortgages.

And, as we know, the incentives of those who make the loans are not necessarily aligned with those of the shareholders.

Those folks may well want to make loans to people who can't pay them back as long as they get a big payday in the short term.

ANZ chief executive officer Shayne Elliot repeated Mr Hartzer's mantra, saying: "It's not in our interest to lend money to people who can't afford to repay."

Recall, this is the man who on ABC's Four Corners said that home loans weren't risky because they were all uncorrelated risks (the chances that one loan defaults does not affect the chances of others defaulting).

That is a comment that is either staggeringly stupid or completely disingenuous.

Messers Harzter and Elliot must take us all for suckers.

They have made a huge amount of interest-only loans, at historically low interest rates, to buyers in a frothy housing market, who spend a large chunk of their income on interest payments. This certainly looks troubling. It may not be US sub-prime, but it could be ugly. Very ugly.

To put it in context, there appears to be in the neighbourhood of $1 trillion of interest-only loans on the books of Australian banks.

I say "appears to be", because reporting requirements are so lax it's hard to know for sure, except when CEOs cough up the ball, like this week.

>We asked if you thought the housing market, combined with rising interest rates, could get ugly.

Uncorrelated? Really?

The big lesson of the US mortgage meltdown is that the risks on these mortgages are all correlated.

If a few people aren't paying back an interest-only loan, that is a fair predictor that others won't pay back their loans either. Yet it seems Australian banks are a decade behind the learning curve.

The Reserve Bank cautions that one-third of borrowers don't have a month's repayment buffer. And where are interest rates going to go from here? Up. It is just a question of when.

And when that does happen — or when the interest-only period on loans (typically five years) rolls off and principal payments start having to be made — watch out.

We should all remember that the proximate cause of the US mortgage meltdown was borrowers with five-year adjustable-rate mortgages (ARMs) that had huge step-ups in repayments and needed to be refinanced to be serviceable.

Four Corners: Betting on the House

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Kirthi Demeijer is one of the thousands of Australians having trouble making her home loan repayments. Four Corners uncovers the problems with the housing market.

When the market couldn't bear that refinancing, defaults went up. Then the collapse of US investment bank Bear Stearns, then Lehman, then Armageddon.

Australia's large proportion of five-year interest-only loans — turbocharged by an out-of-control negative-gearing regime — looks spookily similar.

It's one thing for borrowers to do silly things. When it becomes dangerous is when lenders not only facilitate that stupidity, but encourage it.

That seems to be what has happened in Australia.

And APRA's "crackdown" and the Reserve Bank's warning may be far too little, way too late.

We might stumble through this. I hope we do. But if so, it will be because of dumb luck, not good institutional and regulatory design. And definitely not because of good corporate governance.

Whatever happens, we should learn those lessons.

Richard Holden is Professor of Economics at the UNSW Australia Business School.

Originally published in The Conversation

Topics: housing, government-and-politics, business-economics-and-finance, banking, australia

First posted October 13, 2017 10:51:53

Source : http://www.abc.net.au/news/2017-10-13/property-market-spooky-signs-of-risk-banks-are-ignoring/9046362

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