Foreign Investors Shun Australian Bank Debt

The Australian banks’ excessive borrowing from foreigners, which has been used to fund the Great Australian Housing Bubble, is something that I have warned about since starting this blog. This issue first entered my consciousness in 2009 when reading fellow blogger, David Llewellyn-Smith’s brilliant book, The Great Crash of 2008.

Amazingly, this issue has received little attention from mainstream Australian commentators and economists who have continually espoused Australia’s ‘strong’, ‘conservative’ and ‘well-regulated’ banking system, despite these very same banks requiring considerable taxpayer support during the Global FinancialCrisis.

So it had been left largely to a hand full of bloggers, including Houses and Holes, Delusional Economics, Money Morning, and me to sound the alarm…That was, until now. On Christmas Day, the Herald-Sun and Perth Now published identical articles warning that the foreign investors whom funded the Great Australian Housing Bubble are growing cautious:

AUSSIE banks, once held up as the envy of the world, are now at the mercy of foreign lenders.

Despite the Federal Government’s measures to boost competition in the banking market, little has been done to address the huge reliance on overseas lenders to fund our mortgage market.

Official figures show our banks now owe overseas investors a record $352.7 billion, equivalent to 27 per cent of the country’s entire economic output.

The extraordinary figure, contained in data from the Australian Bureau of Statistics, is fuelling concerns Australia’s financial system is becoming over-stretched…

Global fund managers are already getting nervous about Australia’s overheating property market – a fact that could lead them to charge a higher interest rate for money they lend to our banks – or withdraw funding all together.

“If the global economy recovers strongly that could push interest rates up a lot, and that’s a real risk for Australia’s because rates are already high and house prices are becoming an issue,” said Trevor Greetham, asset allocation director at Fidelity Investments in the UK, which has $3.4 trillion under management.

Analysts said if Mr Greetham and others like him withdraw funding, then our banking system will be plunged into a catastrophic credit crunch. Mortgages will be rationed, minimum deposit sizes will be forced up and property prices are likely to collapse…

“Everybody is looking for the first signs that overseas investors have had enough,” one banking analyst said.

Gerard Fitzpatrick, global fixed income portfolio manager for Russell Investments, said he was increasingly cautious about lending to Australian banks.

Speaking from London last week, he cited the recent catastrophe in Ireland, where the house price bubble effectively broke the banks.

“I’m not saying Australia is the same as Ireland, but there are definitely similarities,” Mr Fitzpatrick said.

“You’ve had a booming housing sector and rapidly increased lending by banks.

“The two situations have enough in common for bond investors to consider the consequences for the Australian housing market – and the banks that are supporting it.”

Wow. It’s no big deal when a handful of contrarian bloggers sound the alarm over our banks’ heavy offshore borrowings and the risks of a sudden liquidity crisis. But when two of the nation’s main tabloid newspapers warn of a possible credit crunch and property market crash, then its time to take this issue seriously.

Even if foreign investors continue to provide funding to Australia’s banks, the cost is likely to rise significantly. A recent article published in New Zealand’s Business Day explained this situation:

Banks posted record profits in 2010 but earnings growth in the coming year may be difficult as the big four Australian banks behind New Zealand’s trading banks prepare to compete for funds with heavily indebted foreign governments…

On top of the competition from foreign governments in the coming years, the banks are having to refinance their debt at higher post-GFC rates and will pay a premium for longer-term debt as they seek to lock in funding.

“There’s going to be a lot of demand for longer duration bank debt than what we’ve seen in the past,” CLSA Asia Pacific analyst Brian Johnson said.

Credit Suisse’s Jarrod Martin and James Ellis warned local banks could be crowded out.

This is at a time when the local banks have a huge funding requirement, with CBA and Westpac the fourth and fifth biggest borrowers in global debt markets, UBS analyst Jonathan Mott said.

The past decade saw banks lend more money to home buyers and businesses in Australia without matching the lending with savings. The funding gap was filled by a growing reliance on offshore debt markets…

Now a greater challenge lies ahead: having to compete harder in offshore credit markets against global banks and heavily indebted northern hemisphere governments expected to issue debt aggressively from 2012.

“Banks could find their access to flows of wholesale funding diminishes below critical minimum requirements (their annual re-financing tasks) which cannot easily be replaced by other funding sources,” Messrs Martin and Ellis said.

“Ultimately that cost would be passed through to borrowers…

So it looks like one of the key pillars supporting the Great Australian Housing Bubble – easy credit – is showing signs that it might collapse. No wonder then that the Australian Government recently announced that it will permit Australia’s banks to issue covered bonds to open up a new source of relatively low cost funding, even though they could put depositor and taxpayer funds at risk.

But even if covered bonds can successfully increase the flow of credit to the Australian economy, you have got to wonder whether tapped-out households will accept the offer of more debt. The fact is, the hubris and exceptionalism previously displayed by the Australian populace regarding Australia’s banking system and housing market appears to be evaporating and confidence waning. And as with all assets fuelled by debt, confidence is everything. Once the masses stop believing that borrowing heavily to buy housing is a sure bet, then the Australian housing ponzi will collapse on itself. Home buyers will delay purchasing just as sellers rush for the exits. I described the psychology of the housing market in an earlier post:

Property market observers should also be careful to not get too carried away in applying conventional demand-supply dynamics to the housing market.

Ongoing price increases within the housing market often stimulate demand as opposed to the conventional assumption that price increases suppress demand. This is because as prices rise the ‘got to get in now’ mentality intensifies. So as prices rise, more and more people are attracted to purchasing (investing in) houses, pushing prices up further and attracting even more people into the market.

Eventually, however, excessive leverage sees the hysteria unravel. People start selling and as the number of properties on the market begins to increase and prices begin to fall, the ‘got to get out now’ mentality begins to develop. Eventually, the number of people exiting the market develops into a stampede despite prices falling (which ‘should’ stimulate demand), and the bubble pops. Only time will tell whether this dynamic has been the real driver of house price growth over the last decade.

With credit in Australia likely to contract, cracks appearing in the China growth story, and poor demographics, it looks like the Australian housing market and economy might be in serious trouble.

Cheers Leith

Leith van Onselen

Leith van Onselen is Chief Economist at the MB Fund and MB Super. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.


  1. Of course those who still have an interest in propping up the market will point to the fact that 'people still need somewhere to live' and the alleged 'housing shortage' in Australia. Now, where I live in Sydney it is easier to spot the permanently vacant houses at night than the people forced to live on the street or in the park, so I have never quite understood the housing shortage argument. In fact, if we count rooms rather than dwellings, the reality is even further from the picture of a 'shortage'. Indeed, there may be a surprising elasticity of supply for a 'bricks and mortar' commodity. Unoccupied rooms are harder to spot from the street on an evening stroll, but I know that through the last couple of years a large number of my home and unit owning friends were lucky enough to live in a dwelling with 1 or 2 bedrooms unoccupied. Since the last interest rate rise hit hard, most (about 3 in every 4) of them have taken in a tenant to balance the budget. Admittedly these are all couples or singles with no children (except in one case, where the tenant is a long term family friend) and this doesn't work so well if there are children. Still, if there's any pattern to this beyond my circle, an awfully large number of people are going to use this elasticity of supply to find accommodation and they are the ones who would otherwise be competing for a lease in their own name or looking to purchase a first home as a way out of the 'rental crisis'. Next year will be very interesting across the entire spectrum of real estate.

  2. I guess that in this game of musical chairs it will be the last to have their bubble collapse who may be the winners. If for example our bubble collapses before the Chinese one does then the Chinese investors will pile in and pick up as much real estate as they can.

    when their bubble crashes just who will be left owning the title of property of the defaulted loans will be interesting to see.

  3. Hi Anonymous.

    ABS figures, census figures etc, all point to about 800,000 empty houses in Australia. That taken on top of your empty rooms, 2.3 people per 4 bedroom macmansion point makes for a massive oversupply.

    We may all fiddle with ourselves and pretend otherwise, but the overseas investors actually look at the figures and our weird-arsed belief systems, and wonder how long they can ride this gravy train before it crashes.

    Looks to me like they are wondering who will be the last fool in!

  4. Great post Leith as always.

    I knew when I first found and read your blog that your objective and insightful writing would win the day with you arguments that are rational whilst most of the housing debate is not, and this is of course supported by research which also shows that all humans are illogical when it comes to making financial decisions.

    I have been holding off buying now for over 6 years and have watched my saving grow risk free. I have not played the negative gearing game and still remember the negative gearing issues from the 80's as a tweenager.

    I am happy to be debt free and take a regular safe return on savings. Which I think for the last year at least has actually beaten the stock market.

    Of course I look at housing and prices and I just can not believe the disconnect between prices paid and the average wage in Australia. It is plain mad.

    Still 2011 may well see some correction to the house price myopia of "the only way is up!" if the Australian Government does not play another boosting card that is.

    Still, I do not regret renting, actually it has been stress and debt free… (we save 60%+ of our earnings each month).

    I am more concerned about bank stability when it all goes pop?!

    I know I should not ask this as no one really knows for sure but I think the NAB have the least risk compared to the others and their business/consumer debt ratio (Let's not talk about Westpac and their rental mortgage scheme if any go under Westpac will be forever known as Southpac as they hit permafrost and poocicles!).

    Hmmm… I have kinda ranted a bit sorry.


    Please keep the great work coming and loving the debate and insight.

    Thank you!

  5. Leith – many thanks for such a well reasoned article.

    As most are aware, housing should not exceed 3 times household income or about 1.5 times GDP.

    Australia's 23 major metros are currently sitting at about 7 times household incomes – NZ's 9 major metros about 5.5 times.

    Australia with a GDP of about $A1.2 trillion according to the RBA has in excess of $A4 trillion of residential stock. By my rough calcs there is about $A2.2 trillion of bubble value and well in excess of $A400 billion of bubble mortgage debt. In the case of NZ near $NZ300 billion of bubble value and some $NZ60 plus of bubble mortgage debt.

    Texas – where housing is about 2.5 times household incomes, with its $US1.2 trillion GSP has about $US1.8 trillion of residential stock – about 1.5 times.

    Better still the hugely economically powerful Greater City of Houston with 5.8 million people, has a Gross Metropolitan Product acording to the BEA of the Dept of Com of $US405 billion and a residential stock of $US430 billion – about 1.1 times. Check out the prices at the Houston Association of Realtors and weep.

    The property ponzi party is over.

    Hugh Pavletich
    Co author – Annual Demographia International Housing Affordability Survey
    New Zealand

  6. POP! Puss everywhere.

    Like a big zit.

    That's what's going to happen to Aussie's housing market.

    Australia will be a good investment if prices fall 50%.

  7. Is the security system you are talking about a wirless system? And I hear the celular based monitoring services are a lot safer as there are no telephone lines that can be cut. Awesome website, good content.