Australia’s Economy is a House of Cards: Part 3 of 4
So why are governments so keen to inflate housing prices?
The government loves Australians buying up houses, particularly new apartments, because in the short term it stimulates growth – in fact it’s the only thing really stimulating GDP growth.
Australia has around $2 trillion in unconsolidated household debt relative to $1.6 trillion in GDP, making this country in recent quarters the most indebted on this ratio in the world. According to Treasurer Scott Morrison 80% of all household debt is residential mortgage debt. This is up from 47% in 1990.
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Australia Household Debt to GDP. Source: Bank for International Settlements, Macro Business
Australia’s household debt servicing ratio (DSR) ties with Norway as the second worst in the world. Despite record low interest rates, Australians are forking out more of their income to pay off interest than when we had record mortgage rates back in 1989-90 which are over double what they are now.
Everyone’s too busy watching Netflix and cash strapped paying off their mortgage to have much in the way of any discretionary spending. No wonder retail is collapsing in Australia.
Governments fan the flame of this rising unsustainable debt fuelled growth as both a source of tax revenue and as false proof to voters of their policies resulting in economic success. Rather than modernising the economy, they have us on a debt fuelled housing binge, a binge we can’t afford.
We are well past overtime, we are into injury time. We’re about to have our Minksy moment: “a sudden major collapse of asset values which is part of the credit cycle.”
Such moments occur because long periods of prosperity and rising valuations of investments lead to increasing speculation using borrowed money. The spiraling debt incurred in financing speculative investments leads to cash flow problems for investors. The cash generated by their assets is no longer sufficient to pay off the debt they took on to acquire them. Losses on such speculative assets prompt lenders to call in their loans. This is likely to lead to a collapse of asset values. Meanwhile, the over-indebted investors are forced to sell even their less-speculative positions to make good on their loans. However, at this point no counterparty can be found to bid at the high asking prices previously quoted. This starts a major sell-off, leading to a sudden and precipitous collapse in market-clearing asset prices, a sharp drop in market liquidity, and a severe demand for cash.
The Minsky Cycle. Source: Economic Sociology and Political Economy
The Governor of the People’s Bank of China recently warned that extreme credit creation, asset speculation and property bubbles could pose a ‘systemic financial risk’ in China. Zhou Xiaochuan said “If there is too much pro-cyclical stimulus in an economy, fluctuations will be hugely amplified. Too much exuberance when things are going well causes tensions to build up. That could lead to a sharp correction, and eventually lead to a so-called Minsky Moment. That’s what we must really guard against”. A Minsky moment in China would be an extreme event for the parasite on the vein of Chinese credit stimulus- the Australian economy.
Today 42% of all mortgages in Australia are interest only, because since the average person can’t afford to actually pay for the average house- they only pay off the interest. They’re hoping that value of their house will continue to rise and the only way they can profit is if they find some other mug to buy it at a higher price. In the case of Westpac, 50% of their entire residential mortgage book is interest only loans.
Percentage of interest only loans by bank. Source: JCP Investment Partners, AFR
And a staggering 64% of all investor loans are interest only.
Share of new loan approvals for Australian banks. Source: APRA, RBA, UBS
This is rapidly approaching ponzi financing.
This is the final stage of an asset bubble before it pops.
Today residential property as an asset class is four times larger than the sharemarket. It’s illiquid, and the $1.5 trillion of leverage is roughly equivalent in size to the entire market capitalisation of the ASX 200. Any time there is illiquidity and leverage, there is a recipe for disaster- when prices move south, equity is rapidly wiped out precipitating panic selling into a freefall market with no bids to hit.
The risks of illiquidity and leverage in the residential property market flow through the entire financial system because they are directly linked; today in Australia the Big Four banks plus Macquarie are roughly 30% of the ASX200 index weighting. Every month, 9.5% of the entire Australian wage bill goes into superannuation, where 14% directly goes into property and 23% into Australian equities- of which 30% of the main equity benchmark is the banks.
ASX200 by market capitalisation, Big 4 banks top and Macquarie on the left (arrows). Source: IRESS
You don’t read objective reporting on property in the Australian media, which Llewelyn-Smith from Macro Business calls “a duopoly between a conservative Murdoch press and liberal Fairfax press. But both are loss-making old media empires whose only major growth profit centres are the nation’s two largest real estate portals, realestate.com.au and Domain. Neither report real estate with any objective other than the further inflation of prices. In the event that the Australian bubble were to pop then Australians will certainly be the last to know and the propaganda is so thick that they may never find out until they actually try to sell.”
Take, for example, this recent headline from the Fairfax owned Sydney Morning Herald on March 1st 2017, “Meet Daniel Walsh, the 26-year-old train driver with $3 million worth of property”. It appeared in the property section, which for Fairfax today sits on the homepage of their masthead publications, such as the Sydney Morning Herald, immediately below the top headlines for the day and above State News, Global Politics, Business, Entertainment, Technology and the Arts. The article holds up 26 year old Daniel, who services five million dollars worth of property with a train driver’s salary and $2,000 a week of positive cash flow.
This is what the Australian press more commonly holds up as a role model to young people. Not a young engineer who has developed a revolutionary new product or breakthrough, but an over leveraged train driver with a property portfolio on mostly borrowed money where a 1% move in interest rates will wipe out the entirety of this cash flow.
Yet this young train driver isn’t an isolated case, there are literally hoards of these young folk parlaying one property debt onto another in the mistaken belief that property prices only ever go up. Jennifer Duke, an “audience-driven reporter, with a background in real estate and finance” from Domain, also promotes Robert, a 20 year old, who had managed to accumulate three properties in two years using an initial $60,000 gift from his mum. Jeremy, a 24 year old accountant, has 8 properties with a loan to value ratio of 70%, Edward, a 24 year old customer service representative, has 6 properties despite a debt level of 69% and a salary under $50,000, and Taku, the Uber driver, has 8 properties, with plans for 10 covered by a net equity position of only $1 million by November 2017.
How a train driver can service five million dollars of property on $2,000 a week of positive cash flow comes through the magic of cross-collateralised residential mortgages, where Australian banks allow the unrealised capital gain of one property to secure financing to purchase another property. This unrealised capital gain substitutes for what normally would be a cash deposit. This house of cards is described by LF Economics as a “classic mortgage ponzi finance model”. When the housing market moves south, this unrealised capital gain will rapidly become a loss, and the whole portfolio will become undone. The similarities to underestimation of the probability of default correlation in Collateralised Debt Obligations (CDOs), which led to the Global Financial Crisis, are striking.
Fairfax’s pre-IPO real estate website Domain runs these stories every week across the capital city main mastheads enticing young people into property flipping as a get rich quick scheme. All of them are young, with low incomes, leveraging one property purchase on to another.
At Fairfax – whose latest half year 2017 financial results had Domain Group EBITDA at $57.3 million and the entire Australian Metro Media which includes Australia’s premier mastheads Australian Financial Review, Sydney Morning Herald, the Age, Digital Ventures, Life and Events EBITDA at $27.7 million – property is clearly the most important section of all.
In between holding up this 26 year old train driving property tycoon as something to aspire to, Jennifer has penned other noteworthy articles, such as “No surprise the young support lock-out laws” which parroted incredulous propaganda claiming that young people supported laws designed to shut down places where young people go – Sydney’s major entertainment districts.
As if the Australian economy needed further headwinds, the developer-enamoured evangelical right have crucified NSW’s night time economy. Reactionary puritans and opportunists alike seized on some unfortunate incidents involving violence to simply close the economy at night. NSW State Government, City of Sydney, Casinos, NSW Police, public health nannies, evangelicals, property-crazy media and, of course, property developers had the collective interest to manufacture and blow up a fake health & safety issue to create lockout laws – and then instituted broad night time economic terraforming policies designed to herd patrons to large casinos so they could become permanent monopoly owners of the night time economy in Sydney and Brisbane, while conveniently damaging the balance sheets of small businesses located in competing entertainment areas, so the property could be demolished and turned into apartment blocks.
Property watching at Fairfax has become a fetish. Almost on a daily basis Lucy Macken, Domain’s Prestige Property Reporter, publishes a gossip column of who bought what house, complete with the full address and photos of the exterior and interior and any financial information she can glean about them. I know of one person whose house was robbed – completely cleaned out – shortly after Macken published their full address. Perhaps that was a coincidence, but I am utterly amazed that Fairfax senior management allows this column to exist given the risks it poses to the people whose houses and private details are splashed across its pages.
Fairfax, to be fair, is not without its fair share of great journalists, albeit a species rapidly becoming extinct, who are very well aware of what is really going on. Elizabeth Farrelly writes, “Just when you thought the government couldn’t get any madder or badder in its overarching Mission Destroy Sydney – when it seemed to have flogged every floggable asset, breached every democratic principle, whittled every beloved park, disempowered every significant municipality and betrayed every promise of decency, implicit or explicit – it now wants to remove council planning powers. The excuse, naturally, is ‘probity’. Somehow we’re meant to believe that locally elected people are inherently more corrupt than those elected at state level, and that this puts local decision-making into the greedy mitts of Big Developers”.
However, despite the picture Domain would like to paint, young people with jobs aren’t responsible for driving house prices up, in fact their ownership is at an all time low.
In 2015-16 there were 40,149 residential real estate applications from foreigners valued at over $72 billion in the latest data by FIRB. This is up 244% by count and 320% by value from just three years before.
To put this 40,149 in comparison, in the latest 12 months to the end of April 2017, according to the Australian Bureau of Statistics, a total of 57,446 new residential dwellings were approved in Greater Sydney, and 56,576 in Greater Melbourne.
Even more shocking, in the month of January 2017, the number of first home buyers in the whole of New South Wales was 1,029 – the lowest level since mortgage rates peaked in the 1990s. Half of those first home buyers rely upon their parents for equity.
The 114,022 new residential dwellings in Sydney and Melbourne in 2015-16 should also be put in comparison to a net annual gain of 182,165 overseas immigrants to Australia of which around 75% go to New South Wales or Victoria.
This brings me onto Australia’s third largest export which is $22 billion in “education-related travel services”. Ask the average person in the street, and they would have no idea what that is and, at least in some part, it is an $18.8 billion dollar immigration industry dressed up as “education”. You now know what all these tinpot “english”, “IT” and “business colleges” that have popped up downtown are about. They’re not about providing quality education, they are about gaming the immigration system.
In 2014, 163,542 international students commenced English language programmes in Australia, almost doubling in the last 10 years. This is through the booming ELICOS (English Language Intensive Courses for Overseas Students) sector, the first step for further education and permanent residency.
This whole process doesn’t seem too hard when you take a look at what is on offer. While the federal government recently removed around 200 occupations from the Skilled Occupations List, including such gems as Amusement Centre Manager (149111), Betting Agency Manager (142113), Goat Farmer (121315), Dog or Horse Racing Official (452318), Pottery or Ceramic Artist (211412) and Parole Officer (411714) – you can still immigrate to Australia as a Naturopath (252213), Baker (351111), Cook (351411), Librarian (224611) or Dietician (251111).
Believe it or not, up until recently we were also importing Migration Agents (224913). You can’t make this up. I simply do not understand why we are importing people to work in relatively unskilled jobs such as kitchen hands in pubs or cooks in suburban curry houses.
At its peak in October 2016, before the summer holidays, there were 486,780 student visa holders in the country, or 1 in 50 people in the country held a student visa. The grant rate in 4Q16 for such student visa applications was 92.3%. The number one country for student visa applications by far was, you guessed it, China.
Number of Student Visa Applications by Country 2015-16. Source: Department of Immigration and Border Protection
While some of these students are studying technical degrees that are vitally needed to power the future of the economy, a cynic would say that the majority of this program is designed as a crutch to prop up housing prices and government revenue from taxation in a flagging economy. After all, it doesn’t look that hard to borrow 90% of a property’s value from Australian lenders on a 457 visa. Quoting directly from one mortgage lender, “you’re likely to be approved if you have at least a year on your visa, most of your savings already in Australia and you have a stable job in sought after profession” – presumably as sought after as an Amusement Centre Manager. How much the banks will be left to carry when the market turns and these students flee the burden of negative equity is anyone’s guess.
In a submission to a senate economics committee by Lindsay David from LF Economics, ‘We found 21 Australian lending institutions where there is evidence of people’s loan application forms being fudged”.
The ultimate cost to the Australian taxpayer is yet to be known. However the situation got so bad that the RBA had to tell the Big Four banks to cease and desist from all foreign mortgage lending without identified Australian sources of income.
Ken Sayer, Chief Executive of non-bank Mortgage House said “It is much bigger than everyone is making it out to be. The numbers could be astronomical”.
So we are building all these dwellings, but they are not for new Australian home owners. The Westpac-Melbourne Institute has overall consumer sentiment for housing at a 40 year low of 10.5%.
Instead we are building these dwellings to be the new Swiss Bank account for foreign investors.
Share of consumers saying ‘wisest place for saving’ is real estate. Source: ABS, RBA, Westpac, Melbourne Institute, UBS
Foreign investment can be great as long as it flows into the right sectors. Around $32 billion invested in real estate was from Chinese investors in 2015-16, making it the largest investment in an industry sector by a country by far. By comparison in the same year, China invested only $1.6 billion in our mining industry. Last year, twenty times more more money flowed into real estate from China than into our entire mineral exploration and development industry. Almost none of it flows into our technology sector.
Approvals by country of investor by industry sector in 2015-6. Source: FIRB
The total number of FIRB approvals from China was 30,611. By comparison. The United States had 481 approvals.
Foreign investment across all countries into real estate as a whole was the largest sector for foreign investment approval at $112 billion, accounting for around 50% of all FIRB approvals by value and 97% by count across all sectors – agriculture, forestry, manufacturing, tourism – you name it in 2015-16.
In fact it doesn’t seem that hard to get FIRB approval in Australia, for really anything at all. Of the 41,450 applications by foreigners to buy something in 2015-16, five were rejected. In the year before, out of 37,953 applications zero were rejected. Out of the 116,234 applications from 2012 to 2016, a total of eight were rejected.
Applications for FIRB consideration, approved versus rejected 2012-13 to 2015-6. Source: FIRB
According to Credit Suisse, foreigners are acquiring 25 percent of newly completed housing supply in NSW, worth a total of $39 billion.
Demand for Property from Foreign Buyers in NSW (% of total, unstacked). Source: NAB, SBS
In some circumstances, the numbers however could be much higher. Lend Lease, the Australian construction goliath with over $15 billion in revenue in 2016, stated in that year’s annual report that over 40% of Lend Lease’s apartment sales were to foreigners.
I wouldn’t have a problem with this if it weren’t for the fact that this is all a byproduct of central bank madness, not true supply and demand, and people vital for running the economy can’t afford to live here any more.
What is also remarkable about all of this is that technically, the Chinese are not allowed to send large sums of money overseas. Citizens of China can normally only convert US$50,000 a year in foreign currency and have long been barred from buying property overseas, but those rules have not been enforced. They’ve only started cracking down on this now.
Despite this, up until now, Australian property developers and the Australian Government have been more than happy to accommodate Chinese money laundering.
After the crackdown in capital controls, Lend Lease says there has been a big upswing with between 30 to 40% of foreign purchases now being cash settled. Other developers are reporting that some Chinese buyers are paying 100% cash. The laundering of Chinese cash into property isn’t unique to Australia, it’s just that Transparency International names Australia, in their March 2017 report as the worst money laundering property market in the world.
Australia is not alone, Chinese “hot money” is blowing gigantic property bubbles in many other safe havens around the world.
But combined with our lack of future proof industries and exports, our economy is complete stuffed. And it’s only going to get worse unless we make a major transformation of the Australian economy.
We can’t rely on property to provide for our future. In 1880, Melbourne was the richest city in the world, until it had a property crash in 1891 where house prices halved causing Australia’s real GDP to crash by 10 per cent in 1892 and 7 per cent the year after. The depression of the 1890s caused by this crash was substantially deeper and more prolonged than the great depression of the 1930s. Macro Business points out that if you bought a house at the top of the market in 1890s, it took seventy years for you to break even again.
Australia CQ Real Housing Price Index 1890 – 2016. Source: LF Economics, Macro Business
Instead of relying on a property bubble as pretense that our economy is strong, we need serious structural change to the composition of GDP that’s substantially more sophisticated in terms of the industries that contribute to it.
Australia’s GDP of $1.6 trillion is 69% services. Our “economic miracle” of GDP growth comes from digging rocks out of the ground, shipping the by-products of dead fossils, and stuff we grow. Mining, which used to be 19%, is now 7% and falling. Combined, the three industries now contribute just 12% of GDP thanks to the global collapse in commodities prices.
If you look at businesses as a whole, Company tax hasn’t moved from $68 billion in the last three years – our companies are not making more profits. This country is sick.
Indeed if you look at the budget, about the only thing going up in terms of revenue for the federal government are taxes on you having a good time- taxes on beer, wine, spirits, luxury cars, cigarettes and the like. It would probably shock the average person on the street to discover that the government collects more tax from cigarettes ($9.8 billion) than it collects from tax on superannuation ($6.8 billion), over double what it collects from Fringe Benefits Tax ($4.4 billion) and over thirteen times more tax than it does from our oil fields ($741 million).
Turnbull is increasing the tax on cigarettes by 12.5% a year for the next four years. In the latest federal budget, the government forecasts that by 2020 that it will collect $15.2 billion from taxes on tobacco per annum. This is four times the amount that the government collects from the entire coal industry per annum.
Just compare these numbers: $15 billion is over double what the government projects it will collect from petrol excise in that year ($7.15b), 21 times what it will collect from luxury car tax ($720m), 27 times what it will collect from taxes on imported cars ($560m) and 89 times what it will collect from customs duty on textile and footwear imports ($170m).
As a sign of how addicted to taxing you the government has become, look at the myriad of taxes on cars – high import duties, stamp duty and a luxury car tax – these were designed to protect a car manufacturing industry which doesn’t exist anymore. Yet the government is still increasing them. We closed the last factory this year. These taxes are not only blatant cash grabs but serve to stifle the deployment of electric cars, which have hit a dead end in Australia. Likewise, the taxes on textile and footwear imports were originally designed to protect our textiles, an industry that has now collapsed and that lost 30% of its manufacturing workers this year.
If you look through federal budget forecasts, taxes on cigarettes is the only thing practically floating the federal government’s finances other than wishful thinking in forward projections. Which is, of course, some other future administration’s problem.
How they think they can raise $15 billion in taxes per year on cigarettes – a product that costs a cent per stick to make and will retail for almost $2 a stick in 2020 – without creating a thriving black market, another Pablo Escobar and throwing hundreds, perhaps thousands of people in jail, who will decide unwisely to participate in that black market, astounds me. But that’s how the government decides to plug the hole in its accounts instead of cutting spending.
Of course like so many things this all gets sold to you, the general population, under the banner of ‘health and safety’- and it’s easy to sell because all you need to do is parade out a few patronising doctors. The truth is that it’s really just for the health and safety of the government budget, because the economy is really, really sick.
If the government wants to fix the budget, I would have thought the most practical way to do it would be to find ways to grow the economy. You’ll never wean the government off wasteful spending no matter who is in power. The politicians, after all, need to keep that up in order to buy votes through profligate policies such as welfare for the middle class.
But instead of thinking of intelligent ways to grow the economy, the focus is purely on finding more ways to tax you. Just think of all the times over the last couple of years, all the random thought bubbles, that various politicians have proposed raising taxes on superannuation, high earners, banks, property, tripling fines for cyclists, tripling fines for companies, the GST to 15% or 20%, the GST on low value imports, the GST on digital goods, stamp duty, alcohol, sugar, red meat, it’s endless.
They are even proposing banning the $100 note, so that when the RBA drives interest rates negative, you won’t be able to withdraw your hard earned funds in cash so easily. You’ll either have to spend it or have the rude shock of the bank taking money out of your account each month rather than earning interest.
Here’s a crazy idea: the dominant government revenue line is income tax. Income tax is generated from wages. Education has always been the lubricant of upward mobility, so perhaps if we find ways to encourage our citizens to study in the right areas – for example science & engineering – then maybe they might get better jobs or create better jobs and ultimately earn higher wages and pay more tax.
Instead the government proposed the biggest cuts to university funding in 20 years with a new ‘efficiency dividend’ cutting funding by $1.2 billion, increasing student fees by 7.5 percent and slashing the HECS repayment threshold from $55,874 to $42,000. These changes would make one year of postgraduate study in Electrical Engineering at the University of New South Wales cost about $34,000.
We should be encouraging more people into engineering, not discouraging them by making their degrees ridiculously expensive. In my books, the expected net present value of future income tax receipts alone from that person pursuing a career in technology would far outweigh the short sighted sugar hit from making such a degree more costly – let alone the expected net present value of wealth creation if that person decides to start a company. The technology industry is inherently entrepreneurial, because technology companies create new products and services.
Speaking of companies, how about as a country we start having a good think about what sorts of industries we want to have a meaningful contribution to GDP in the coming decades?
For a start, we need to elaborately transform the commodities we produce into higher end, higher margin products. Manufacturing contributes 5% to GDP. In the last ten years, we have lost 100,000 jobs in manufacturing. Part of the problem is that the manufacturing we do has largely become commoditised while our labour force remains one of the most expensive in the world. This cost is further exacerbated by our trade unions – in the case of the car industry, the government had to subsidise the cost of union work practices, which ultimately failed to keep the industry alive. So if our people are going to cost a lot, we better be manufacturing high end products or using advanced manufacturing techniques otherwise other countries will do it cheaper and naturally it’s all going to leave.
Last year, for example, 30.3% of all manufacturing jobs in the textile, leather, clothing & footwear industries were lost in this country. Yes, a third. People still need clothes, but you don’t need expensive Australians to make them, you can make them anywhere.
That’s why we need to seriously talk about technology, because technology is the great wealth and productivity multiplier.
However the thinking at the top of government is all wrong.
I recently heard a speech by the Chief Scientist of Australia where he held up a smashed avocado on toast as a prime example of Australian innovation. Yes, smashed avocado on toast. I am not sure which Australian company has the patent on smashed avocados on toast – it’s too surreal to even think about.