Most analysts were tipping a rate cut of 25 basis points when Federal Reserve chairman Ben Bernanke recently addressed the financial markets. But the cut of 50 basis points, which took the funds rate to 4.75% and provided a huge fillip for equity markets worldwide, confirmed just how seriously the Fed is taking the US housing crisis.
With hindsight, a monetary stimulus of this proportion for the US economy wasn’t surprising. To speak of a housing market crisis in the world’s biggest economy is not to exaggerate.
Consider these numbers: foreclosures rose 36% to 243,947 in August from July. Compared with a year ago they’re up 115%, with states such as Florida and California leading the charge. For the seventh successive month, the Housing Market Index fell in August, matching its previous record low set in January 1991. And the latest figures on home building permits reveal a 5.9% drop to an annual rate of 1.3 million – a 12-year low.
Jason Anderson, senior manager at the research house BIS Shrapnel, has no doubts the housing fallout will spread in the US. “When you get dwelling starts falling by the degree that they have in the US, you will have wider economic effects.” But Anderson is sanguine about the prospects for the Australian property market, finding the differences far more significant than any perceived similarities between the two markets.
He says: “In the US, housing starts were down 10% in 2006 and they’ll be down another 25% this year to about 1.3 million starts – that’s probably the key difference. In Australia, it’s been a pretty mild downturn in terms of new constructions, coming off from 175,000 in 2004-05 to about 150,000. Remember, too, that in past downturns housing starts could fall as low as 120,000. Prices, too, have come off but only after a period of very strong price growth – much stronger than the US.
Rod Cornish, Head of Property Research at Macquarie Bank, concurs. “What happens in Australia is that the construction cycle oscillates between a low and high level; it doesn’t get beyond those levels. But in the last US boom construction went beyond anything they’ve seen before. Despite solid migration, there was certainly too much activity – and now there’s the fallout.”
Anderson advances two reasons for Australia’s mild downturn. “First, the level of underlying demand driven by population growth and overseas migration is supporting dwelling construction in Australia at a much higher level. Second is affordability. Although it’s an issue, it does differ across cities. It’s obviously far worse in Sydney than in Melbourne or Brisbane where people still seem able to get into the market.”
Anderson also highlights the different financing arrangements to underpin his argument that Australia won’t experience a fallout – USA style. “In the US boom, people were entering into financial arrangements where they were getting fixed rate loans for short periods. But once that period finished, you shifted back to the standard mortgage rate.
“These arrangements became popular in 2002-03 because you had rising rates as the Fed was tightening. So I think there were people buying a new house who really extended their finances, and when the honeymoon period of the loan began to roll over then you saw a significant increase in the number of defaults.”
“The difference with Australia is stark. To begin with, financial institutions here are a lot more cautious – and transparent – than they were in the US. Secondly, what tends to happen here is that people with poor debt histories typically pay more for their debt. But in the US in the boom people who were a higher risk were getting debt at a lower cost – but only for a short period. It seems no one thought what would happen when the music stopped and a higher rate kicked in.”
He adds that the only city to experience anything like what’s happening in the US is Sydney. “We’ve seen some declines in property prices in parts of Sydney and there has been an increase in the number of defaults. But it’s nowhere near the rate of defaults that people are factoring into their US numbers.”
Cornish says the US construction slump started well before the issues with the subprime debt market came to light. “The extreme issues with subprime have only occurred this calendar year and then it’s really only the variable subprime loans that have had the problems; the interest rates rose so far.
“The cash rate went from 1% to 5.24% and it’s now back at 4.75% but you can imagine what it did to people who had to reset at a higher rate. Now we are starting to see an easing in interest rates – a move to try and alleviate, to some degree, some of these problems.
“But there will be more re-sets coming on over the course of the next 12 months. In my opinion we’re likely to see defaults remain fairly high” – thankfully a far cry from where the Australian market is right now.