Tuesday, 7 April 2009

Notes on the housing market

Rent versus buy (click chart to embiggen)

A quick edit to add here - the above chart shows the price of rent V repayments in a range of 4 to 7%, the last time I "owned" a house the interest rate shot up to 18% - Consider yourself warned.

Some interesting thoughts from Dan Denning at The Daily Reckoning

..."Now, about the property market. There is a new claim that rising unemployment is a big threat not just to home owners, but also renters. "If unemployment rises to nine per cent next year, as many economists predict, the number of tenants facing eviction rises to 216,000 nationally," reports the Sunday Telegraph, citing a report by Fujitsu Consulting.

We have no idea who these guys at Fujitsu are. But they are definitely flying their housing crash/rental crisis flag on a regular basis. In this case, the logic of the argument seems sound. Rental vacancies are low. Landlords have to pay mortgages on properties and know there are plenty of other tenants around. The squeeze begins.

Over the weekend, the Federal government stepped in to try and relieve the squeeze, but only for mortgage owners. It amounts to the construction of a mortgage prison for the unemployed, if you ask us. And it's not exactly new. The Prime Minister has taken credit for a move announced by Commonwealth Bank chief Ralph Norris three weeks earlier. That move allows mortgage holders who've lost their job to defer payments on the mortgage for up to twelve months.

So what's the story? Well, the short story is that his move keeps Australian house prices high and more Australians in mortgage debt for longer.

Don't get us wrong. What the bank and its customers choose to agree to is between them. That's the spirit of capitalism! Voluntary exchange, enforceable contract, no compulsion or coercion. You signs your mortgage and you pays your money. But have you ever known a bank to do something out of the kindness of its heart?

Banks don't want to foreclose on a homeowner. It's expensive. And the bank doesn't want to own the home outright anyway. That's complicated. It has to then carry it on the balance sheet and value it while it tries to resell it.

The bank would rather keep you in the home, where you think you own it. And most importantly it wants to keep you paying on the mortgage. The longer you're in debt, slaving away at the mortgage, the more regular bank earnings will be (which isn't so bad if you're a shareholder collecting dividends.)

In its current form, the various banks' plans allow mortgage owners to either capitalise interest or choose an interest-only option. Capitalising the interest means the value of the monthly interest payment is added to the principal. The loan grows larger over time. This threatens to put the mortgage owner in negative equity.

The interest only option is more likely. Hmm. Interest-only mortgages. Sound familiar? The mortgage owner doesn't pay down the principal at all for up to twelve months. Blah blah blah. We could go on with the details. But you see the basic problem.

This is a move designed to keep people in their homes because it "feels" bad when people lose their homes. We're certainly not making light of it. It does feel bad. And once you get beyond how you feel about it, it IS bad. But policy made to make people feel better doesn't do anyone a real financial favour.

The problem is that there are already too many people in Australia who shouldn't, financially speaking, have mortgages at all. They have not prepared for rising interest rates or the possibility of a job loss, both of which can throw the worst-laid housing plans into complete disarray. Rates may be cut tomorrow by the RBA. But joblessness is definitely on the rise.

This is also the banks trying to prop up property prices to support their own loan books. By keeping marginal buyers in their homes during a recession, it prevents a flood of new inventory which might depress prices (especially since demand for housing finance should be expected to fall in a recession, although we'll know more about this later in the week when the numbers from the ABS come out).

The bottom line is that any effort by the bank or the government to keep the marginal buyer in a house he can't afford just keeps housing more expensive for everyone else. Property prices are already too high. Keeping people in homes with huge mortgages just keeps them in debt for longer.

What Australia needs is a good property price correction to correct the inflationary excess of the credit boom that pumped up prices so much in the first place. The two-decade credit boom and investment in residential property hasn't made the country wealthier if it's put hundreds of thousands of people into debt they can't repay. It's made the country poorer.

And don't forget the unintended consequences. So far, the mortgage moratorium applies only to the Big Four and their customers. Smaller banks, building societies, and credit unions aren't part of the plan yet. Will this cause an exodus of borrowers from these smaller firms? Will they refinance with the Big Four in order to have access to the leniency terms?

Who knows? But it certainly can't hurt business for the Big Four. They manage to grow their loan book at the expense of smaller non-traditional firms. This might not work out exactly the way they plan, though.

Many of these smaller firms are the ones extending credit to marginal first home buyers. So perhaps the banks will end up bringing on to their balance sheet the single riskiest mortgage assets in the Aussie market. Keep the subprime plague at bay from the front door, and open up the back door for a house warming party. Good plan!"

Dan Denning
for The Daily Reckoning Australia

Steve Keen has a whole lot more to say on this in Lies, Damn lies and Housing Statistics

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