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.