House prices down! Property market correcting! FHBs Revolt! It’s all happening folks and to many the inevitable asset price correction will gather full speed from here. But be warned and not deluded, the vest powers in every quarter will fight tooth and nail to try and prevent it happening. I had planned to write this post anyway but Swan’s announcement on Friday of increased and unnecessary government support for the RMBS market through the AOFM has signaled another continuous step in the propping up of an unsustainable market and the march to systemic failure.
As I and other bloggers on this site have continually stated, over expansion of credit is at the heart of over heated house prices. Keeping credit available to over indebted borrowers is the coalface where the fight will continue. Make no mistake it is a fight against those that will grab whatever loot they can, while they can, and then leave us all with the debt and the mess to clean up. Until recently the burglars have been sure they’ve had the upper hand, but other challenges are emerging for the banks and the government to deal with which is starting to make them desperate.
Twice in previous posts I have referred to the problem of an increased FX rate and offshore debt. To put it simply, referenced from the rest of the world, as the A$ strengthens Australia’s offshore borrowings, the majority of which are on the bank’s balance sheets, are increasing substantially even if Australia’s banks do not actually increase its $A borrowings.
The banks’ offshore borrowings are mostly but not totally hedged, unless we either use the hedge proceeds to reduce debt or, take advantage of the high A$ on unhedged debt maturing to repay debt, then we need to borrow more offshore currency (e.g. US$) to maintain the same level of $A debt. As we are not repaying debt but rolling it over, and with a continuing A$/US$ FX rate of 1.05 plus continued strength in Euro and Sterling, our offshore borrowings relative to the rest of the world are growing significantly. A reasonable assumption of the average A$/US$ FX rate of the bank’s borrowings is around 80 cents then our $US borrowings will increase by over 25% just to maintain the same level of A$ debt. As the gross offshore borrowings are around A$700bn then that’s a very worrying prospect.
The strength of the $A is slamming many of our industries but also our indebtedness to the rest of the world. The price to pay for solely relying on houses and holes is very high indeed.
The banks, Swan and the regulators are getting very anxious about this situation and the need to actually significantly increase offshore borrowings to keep the property market dancing. Or at least, let’s dance until it’s someone else’s problem. Consequently we get the unusually timed announcement of increased government support for the RMBS markets of $4Bn. There was no need to actually do this or to do it now. The AOFM has about $3.25bn of previous allocation yet to spend. Was it simply an announcement they wanted to keep out of budget day or a dog whistle to the offshore markets?
The Australian government will do all that it takes at the moment to prop up the bank’s ability to raise offshore funds. This keeps the credit flowing into the hands of anyone willing to take on the weight of debt on the promise of riches for all. A gratuitous $4bn is not actually much for the amounts of debt required but it speaks volumes to offshore investors into our banks of the support which the government will give to keep the dance going. Keep squarely in mind that it’s $4bn of borrowed money. So the government is signaling that borrowing to prop up the market is not a problem.
My view is that the fight back to maintain increasing credit levels will occur on many fronts in 2011 before the weight of debt gets far too much through 2012. Property market corrections therefore will be sparodic at best for a while to come. Perhaps the fight of a thousand cuts.
Covered bond legislation will be finalized in the second half of the year. The importance of covered bonds will be that the major banks will be able to weaken their balance sheets but still maintain the same ratings with implied government support and so will be able to further leverage up those under capitalised balance sheets. This is stated in the explanatory note to the covered bond legislation [REF] where it says that depositors do not have to worry if a bank fails as the government explicitly guarantees deposits of $1m or less (of course all deposits have an implied guarantee).
But the real rub is that if the government guarantee was ever called upon then a retrospective levy is imposed on the other banks to pay for the shortfall. So actually the banks do not pay for the guarantee unless it blows up. A certain recipe for overt risk taking spelled out in conjunction with a mechanism i.e. covered bonds, for increasing leverage.
So what are the other things that’ll be brought out of the burglar’s bag of tricks to keep Swan in power and the bankers with their snouts in the ever-increasing trough of our indebtedness?
The major banks will continue to falsely represent the strength of their balance sheets through dubious and opaque methodologies for calculating risk-weighted assets on residential mortgages and false comparisons of their balance sheets with offshore banks. Legitinmacy will be given to all this by inaction or even support from both APRA and the RBA. Everything OK here, global investor just dive in!
I’ve also pointed out the reporting that the banks outline for deposits. That is there are significant loans defined as deposits which are not deposits including over $170bn of offshore loans as at 30 Sept 2010 (updated figures in a few weeks).
I was in discussions with a large bond fund manager last week who informed me that his best performing asset was his many hundreds of millions in retail bank deposits. As APRA loves to make the point that deposits are the lowest risk liability of banks. I ask, “What drugs are you on?”.
Don’t be surprised if deposits suddenly qualify for some form of tax break but with no reform of negative gearing of course. More money into houses at the expense of wealth creating sustainable businesses is of no consequence to the powers that wish to abrogate any responsibility for a massively over leveraged housing market.
Will there be a return of FHOG? Although mindlessly stupid and against any sensible non conflicted advice, I do not count it out. Again, it would need to be funded by debt which only compounds the problems.