How the RBA made Australia a real estate price servant in a $ 9 trillion market

Size, it seems, really matters.

Ten years ago when Main Street was forced to bail out Wall Street and taxpayers around the world amassed trillions of dollars to save commercial banks and the entire capitalist system, that was the whole rationale that was required.

The banks, they said, were Too Big To Fail. Once again he became the Sentence of the day.

A few weeks ago, it was China Evergrande.

The hopelessly indebted Chinese real estate developer who is dragging his competitors and the Middle Empire real estate market into a quagmire is becoming an unsolved problem. Most believe that Beijing will be forced to rescue in one form or another, because a total collapse could be catastrophic.

Here’s another to add to the list: our own residential real estate market.

Of course, we are not alone. Almost all developed economies and many developing economies have seen house and land prices skyrocket over the past two years from already high levels.

The reason is quite obvious: interest rates are at their lowest for 5,000 years and households borrowed as if there was no tomorrow, just to gain a foothold in the market.

Inflation is a concern for economists in Australia and abroad.(ABC News: Alistair K Crossed)

But tomorrow came early. With rising inflation here and around the world, the money markets have gone crazy.

They have pushed interest rates, especially short and medium term rates, much higher. It is in anticipation that central banks, especially ours, will be forced to hike rates much earlier than expected to fight the rapidly rising cost of living.

But office jockeys forget a very important thing. Central banks may no longer have the capacity to raise interest rates to levels close to the levels required to slow an inflationary surge. This could send a large number of households, many of whom are eyeball leverage, with less than 2% loans, to the wall. And that would collapse the economy.

Having created the largest real estate bubble in history, our own reserve bank now has its hands tied.

The property is now too big to fail.

The problem at a glance

Just to set the scene, here are some jaw-dropping statistics.

Australians now own $ 9 trillion in real estate. And the nation has tumbled an additional trillion in the past five months.

We owe about $ 2,000 billion to our banks. And our banks are extremely real estate oriented, with about 60% of their total loans in residential real estate.

When it comes to household debt, we are world champions, regularly vying for first place. As you have probably guessed, most of this debt is related to housing. And as this graph from the Reserve Bank shows, soaring house prices are the cause.

It’s a nice little merry-go-round. Or, as others may say, feedback loop.

House price and household debt graph Verrender Column

Nationally, the average home loan jumped to $ 565,000, three times more than in 2002.

At first glance, a $ 2 trillion debt on a valuation of over $ 9 trillion seems pretty safe. But the debt is skewed towards new real estate entrants, young Australians who are essential to sustaining the economy.

They are the ones who are in debt. And the speed and level of borrowing over the past 18 months has been something to see.

Check it out.

Home loan commitments Verrender 2 column chart

The inflation bogey comes back to bite

Most people mistakenly believe that the Reserve Bank sets interest rates. This is not the case. Rates are set in a trading market where money changes hands at a price.

The RBA is by far the largest individual player in the market and its decisions are quickly reflected in prices.

This is when things work normally. At the moment, they are not.

Last Friday, after a surge in higher than expected inflation in the September quarter, money markets went to war with the RBA, stepping up efforts to keep interest rates above zero.

In retaliation, the Reserve Bank made…. nothing.

An ibis perches next to the headquarters of the Reserve Bank of Australia in central Sydney, Australia, Feb.6, 2018.
The RBA is under increasing pressure to raise interest rates.(Reuters: Daniel Munoz)

This has sparked discussions that the RBA will raise the white flag when it sits down at Martin Place in Sydney tomorrow for its November meeting; that it will abandon its post-pandemic efforts to force short-term interest rates to the floor.

RBA Governor Phillip Lowe has been adamant that official rates will stay at 0.1% until 2024 at the earliest and the bank has been in the market to buy government debt on the open market to keep a cover on market rates.

After last week’s inflation figures, which surged on the impact of soaring fuel prices, market traders convinced themselves that the RBA simply couldn’t wait another three years to act. and pushed short-term debt rates to 0.75%, almost 8 times higher. than the official rate.

These markets are where our banks borrow money. If left unchecked, it will quickly trickle down to new mortgage pricing and could see the end of super-cheap variable home loan rates. Super cheap fixed rate deals are now scarce.

Owners 1, Affordable housing 0

Real estate is the most important asset for a large part of Australian households. When prices go up we feel richer and spend more. When they are in decline, reverse psychology kicks in. People spend less and construction slows down, putting a huge hand brake on the economy.

When real estate crashes, that’s when the problems get really acute.

As the main source of income for our banking system, real estate is also its Achilles heel. A major downturn lifts bad debt, immediately burns profits, and undermines the value of most of its debt portfolio.

An aerial view of houses and vacant blocks.
It is in Australia’s best interests to maintain a strong housing market.(ABC News: Armin Azad)

This scenario poses a significant risk to our financial system.

For this reason, central banks and governments must keep housing markets buoyant. One need only look back at the GFC ten years ago to see the appalling impact created by the bursting of a real estate bubble.

After sitting on the sidelines while homes went to the moon, now no one can afford to let them come back to earth as the system relies on constant price increases.

If inflation really takes over, instead of the transient rebound effect of last year’s recession, the RBA and many of its counterparts will find themselves on the edge of a cliff. Little room for maneuver with the prospect of disaster at the slightest misstep.

If they cannot raise rates to slow inflation, it will be up to the government to cut spending. It is never popular with voters. The drop in house prices either. And given that there are far more voters who own a home than there are those who dream of owning one, guess which side governments are likely to favor?

That is why when our leaders talk about affordable housing, they are talking from behind.

About Virginia Ahn

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