March 3, 2016 by Dymphna 18 Comments

Out of town economists gone mad!


Let me dubunk some foreigners read on the Australian market… again.

A few people have sent me this clip from 60 Minutes (might need to login to view), and asked me for my thoughts.

Here, there’s another economist saying that house prices in Australia are “crazy”, and the bubble is about to burst. He reckons house prices are about to collapse 50-80%!

As Jon Giaan uncovered, turns out this report was part of an elaborate sting on the banks. It was a classic case of media manipulation in a “hedge-fund drive-by”.

But as I’m listening to this guy, there were two things that tipped me off to the fact that I was listening to someone who didn’t really get the Australian housing market.

First is the instance of Interest Only Loans. Second is the debt to income ratios.

Let me humbly set chicken-little straight.

On the first point, he says, “40% of new loans are interest only. That means that people are betting that prices will rise. That’s a ponzi-scheme.”

A ponzi shceme, like a pyramid scheme, works by getting the new suckers to pay out the old suckers, until you run out of suckers. And the Australian public are suckers.

With all due respect, get stuffed.

This proposition is built on the idea that most property buyers are stupid and don’t know what they’re doing. That they’re just buying property regardless of the price and the repayment schedule because they believe that prices always rise.

I literally don’t know anyone who thinks like this. Maybe it was true at some point, but I don’t think it is now.

Most property investors I know spend a lot of time thinking about property. In my view, the market as a whole, is sophisticated enough now to know that prices can go both up and down. And this is in the mind of most people.

It also totally misses the attractiveness of interest only loans to most people.

We’re covering old ground here. In August last year ASIC published a review of interest-only loans. Like our economist mate here, they worried that it was just institutionalised gambling.

But in the end they found out that it was nothing like that. The key findings were:

  • The majority of interest-only home loans were extended to investors;
  • Overall, there was a smaller proportion of interest-only home loans in higher LVR categories when compared to principal-and-interest home loans
  • A diverse group of consumers tended to take out interest-only home loans. In general, interest-only home loans were more popular with consumers who earned more money, though a substantial proportion (29%) of owner-occupiers with interest-only home loans earned less than $100,000
  • Consumers with interest-only home loans were, on average, further ahead in reducing the balance of their loan when including funds held in offset accounts related to the home loan, than those with principal-and-interest home loans.

The take home is that I.O loans tend to be held by higher-income earners, with lower LVRs, many of whom hold considerable amounts in off-set accounts, and who are also further ahead in their repayments than other borrowers.

What were you saying about Ponzi scheme?

Interest Only loans, when combined with an offset account, are about flexibility. It’s about giving yourself options. It’s not about taking a ‘punt’ on the market.

Maybe they’re not so prevalent in other countries, but our mate here seems to have no idea how they work.

If ASIC’s not worried, I’m not worried.

The second point is about our debt to income levels. The argument here, and you hear this one a lot, is that because our mortgage debt relative to income is so much higher than it used to be, house prices are over-valued, ergo bubble, ergo end of the world.

Again, this totally misses the point. It’s like he’s got no idea how the mortgage market works.

Income is part of the equation, but only part of it. But to connect income with house prices we need to factor it up by our leverage. Almost no one buys a house out of income. Everyone uses leverage.

And so to understand whether prices are unreasonable, we need to look at both income and leverage together.

There hasn’t been a lot of work on this. But Bank of America Merrill Lynch crunched some numbers, and what they found was that if you index the median Australian house price in 1985 by the growth in disposable incomes and the change in borrowing capacity flowing from declining mortgage rates (holding loan-to-value ratios constant), current house prices look slightly cheap.

Not ‘crazy’ expensive. Slightly cheap.

This bloke’s ‘analysis’ conveniently ignores the steady decline in interest rates and the continual opening of new credit channels that we’ve seen over the past few decades.

If you ignore all that, of course prices look expensive. But you can’t ignore it. It’s a fact of the market.

It’s not hard to tell a story that Australian house prices are expensive. A lot of the ratios that work well in other countries will tell that story.

But the reality is they don’t work here because they don’t reflect the way the mortgage market here actually works.

But hey, don’t let the facts get in the way of a good story.

Anyone else getting tired of these doomsday scenarios?

What’s your view of where the market is right now… and where it’s going to be in 24 months?