Australia’s bubble banks [+ update 3]

Estimates suggest the Australian housing market has nearly $3 trillion of bubble value waiting to burst, while the capital base of Australasia’s banks is well under $200 billion. 

This excessive leverage is not a healthy sign – especially when those Australian banks are also our banks …

ONE of the top global regulators during the global financial crisis has lent support to David Murray’s suggestion of tougher capital requirements for Australia’s big four banks, arguing they are excessively leveraged and their preferred ‘risk-weighted’ capitalisation measures are misleading.
    Sheila Bair, appointed by President George Bush to chair the US Federal Deposit Insurance Corporation between 2006 and 2011, said permitting Australia’s big four banks to be leveraged more than 20 times was unwise…
    “Capital levels around 5 per cent of liabilities [equivalent to leverage of around 20 times] certainly doesn’t leave a huge cushion of equity if asset prices decline,” she told The Australian, wryly observing the “very healthy amount of debt” of Australia’s big four banks…
    With $3.164 trillion in assets and $147 billion in ‘tier 1’ equity the majors together are leveraged more than 20 times.

As Ludwig Von Mises pointed out over a hundred years ago, this of course is part of the inherent fragility of modern fractional reserve banking, in which debt is organised into currency and the banks who issue that debt are inherently bankrupt, backstopped only by the power of central banks to print new money. and taxpayers to bail them out.

For the naive mind [said Von Mises] there is something miraculous in the issuance of fiat money. A magic word spoken by the government creates out of nothing a thing which can be exchanged against any merchandise a man would like to get. How pale is the art of sorcerers, witches, and conjurors when compared with that of the government's Treasury Department!

In the end, all that backs this excessive leverage is that naivety, and the power to tax and bail out.

The big four banks are united in opposition to a suggestion in the July interim report of the Financial System Inquiry, chaired by Daivd Murray, that they might need higher capital levels to curb the prospect of taxpayer funded bailouts, proffering PwC analysis showing the majors were “at or above the 75th percentile of bank capital” compared to relevant global peers.
    Commonwealth Bank, ANZ, National Australia Bank and Westpac combined have a ‘risk-weighted’ capital ratio of 8.6 per cent, according to June APRA data, above APRA’s minimum of 8 per cent to apply from 2016.
    But Macquarie Group analyst Michael Wiblin said ANZ, NAB, CBA and Westpac were, among the 175 banks the brokerage tracks, in the top third ranked by leverage — a simple measure comparing bank debt to equity. “Their risk-weighted capital ratios look good because they have large home loan portfolios, which have a lower risk weighting,” he said.

That “lower risk weighting” is one reason banks like lending on housing – it allows them to create more debt than they otherwise would. It’s also another reason housing sits in a bubble.

Indeed, as Hugh Pavletich points out,

the Australian housing market is grossly over-inflated, house prices being in excess of 5.5 times household incomes for its metropolitan areas (the major markets are much worse), while for normal markets it should not exceed 3.0 times … refer this year’s Demographia International Housing Affordability Survey.
    As a check measure, the Total Housing Stock Value to Gross Domestic  / State / Metropolitan Product should not ideally exceed about 1.2 times … tops 1.5 times … as I explained within a Fairfax Australia article early 2011:  REPORT: HOUSING AFFORDABILITY OUT OF SYNC WITH INCOMES.
    The mid 2013 figures (from James Gruber / Forbes)  show the ratios were the United States 1.15 times; Canada 1.78; United Kingdom 2.82; New Zealand 3.18 and Australia a frightening 3.26 times.
    The Australian situation has worsened since mid-2013, leaving New Zealand’s bubble economy severely vulnerable. 
    Just recently,Paul Marin of Melbourne’s Age newspaper argued (Australian) house prices are inflated and a fall seems certain - the only question is when. And Eryk Bagshaw of the Sydney Morning Herald spotted more evidence of the same bubble, with home buyers lining up for three days to buy property.

Australia now has a housing market in excess of $A5.0 trillion, which therefore has at least $A2.5 trillion of bubble value incorporating about $A625 billion of bubble mortgages.

As reported in The Australian above, the major Bank’s capital base  is just $A147 billion.

This does not even consider risks within the mining sector, with their dramatic fall in commodity prices, nor the many risks within the agricultural sector.
     When the Irish housing bubble burst in 2007 –8, its metro Median Multiples were 4.7 (refer 2008 Demographia Survey) and by 2013 had fallen to 2.8 Median Multiples.*
     About a quarter trillion euros of bubble value was wiped out of the Irish housing market when its bubble burst.
     The housing Median Multiple Stretch is currently far more extended in Australia and New Zealand at about 5.5 times.
    What was the capital ratio of the Irish Banks at the time of the housing bubble crash ?
    Why hasn’t the train of events of the Irish housing bubble collapse not been discussed in the public and political arenas in Australia and New Zealand ?
    In using the Irish housing bubble as a guide, how would the Australian banks cope if $A2.5 trillion of bubble value was wiped out of the Australian housing market ?

These are the sort of questions good journalists should be asking.

These are the sort of risks that should further encourage good politicians to realise fixing the housing market is a matter of the utmost urgency.

And these are the sort of facts that should cause good economists to question their addiction to the inherent risks of fractional reserve banking.

---

* The Schedule of the 10 Annual Demographia International Housing Affordability Surveys is accessible via PERFORMANCE URBAN PLANNING: http://www.performanceurbanplanning.org/.
    Within an article I wrote back in early 2009, HOUSING BUBBLES & MARKET SENSE, an extract from an article written by Michael Lewis for Portfolio.com is incorporated, dealing with the significance of the Median Multiple measure for housing …

UPDATE 1: Sheila Blair’s warning is being discussed at Macrobusiness.Com.Au…

UPDATE 2:  Familiar with housing busts and bubbles themselves, Australia’s not ‘the lucky country’ anymore say Irish commentators.

Two months ago, I warned that Australia’s status as 'the Lucky Country' was doomed and that an economic crash was imminent.
    Then, many Australians derided the prognosis, but now the penny has finally dropped as optimistic press splashes are replaced by mounting fear.
    'Clear and present danger' screams the Sydney Morning Herald while the Australian warns 'Economy faces a difficult ride' and the Australian Financial Review doesn’t hold back either, with 'Economy enters danger zone'. Bloomberg is even more pessimistic: 'Australia gives up on Australia as investment dwindles.'
    The headlines indicate that something has changed Down Under this antipodean spring, as smart locals have realized what serious analysts have known for a long time and was predicted here – Australia is poised for a Greece-style financial meltdown.
    The cause is a dramatic freeze in Chinese construction, which feeds on Australian iron ore …
    Screeching halts are a wonderful thing for runaway trains but tend to cause havoc in frothy markets and, as previously outlined, the sudsy Australian housing casino is as precarious as a plane where the passenger is trying to switch off the engines…
    “All the official evidence is that Australia’s economy and banking system could handle a property crash – the banks and regulators say they have stress tested the impacts of a severe downturn and the banks are big and strong enough to weather a sharp correction,” [says Jonathan Shapiro, a journalist at the Australian Financial Review]. “I have my doubts.”
    The balance sheets of two of Australia's four pillar-banks have cash-to-asset ratios that are lower than what Lehman Brothers held in the US 15 months before its collapse. Worse again, the asset sheets of each of the 'big four' financial institutions represent close to half of Australia's total GDP – Lehman's was just 5 percent of the American total. That seems to question whether the regulators are living in the real world and Shapiro’s doubts are well-founded.

UPDATE 3: “Australia’s major banks could be hit with a ratings downgrade and find it more expensive to borrow money in overseas markets if their bond-holders are forced to incur losses in the event of bank failures, according to Fabienne Michaux, head of Standard & Poor’s Ratings Services Australia and New Zealand.”