Will Australia follow the UK?
Westpac recently provided a useful comparison of the Australian and UK housing markets, which have historically shared some commonalities. Even though the UK market had housing shortages similar to those in Australia, house prices have still fallen by 13.3 per cent over the last 12 months, according to the leading FT/Academetrics house price index (as we’ve noted before, the FT index includes a much larger sample of sales than the more widely quoted Halifax or Nationwide benchmarks – note to the RBA, stop using the Halifax proxy!).
ELMAT: Note that Australia can kick out an immigrant deal and hordes of Asians will invade them ending this house collapse.
Westpac concludes, as we have done, that the chief difference between the Australian and UK markets is access to credit. Indeed, they argue, as we have, that a banking crisis precipitated the UK housing crisis, and not the other way around (think of this as “endogenous risk” causing asset price falls).
One of the drivers of the banking crisis (in addition to poor capitalisation levels, comparatively very poor lending practices, and higher relative exposures to US sub-prime assets) was in turn the collapse of the mortgage securitisation markets in the UK – not because of fundamental issues with the integrity of those mortgages, but primarily as a result of the huge increase in universal risk-aversion and investor antipathy towards any mortgage-backed securities (ie. extreme illiquidity).
Exactly the same thing occurred here in Australia with the collapse of the local primary mortgage-backed securities market, which has now been shut for economically viable funding since November 2007. You don’t need to be a rocket scientist to work out why we argued so forcefully – and ultimately successfully – that the government needed to supply short-term liquidity support to Australia’s mortgage-backed securities market, which was an unwitting casualty of the global financial crisis. While the RBA disagreed with this position at the time, they acknowledge that current pricing in the Australian RMBS is difficult to rationalise with reference to fundamentals:
“Securitisation markets remain dislocated, with the bulk of residential mortgage-backed securities (RMBS) issued since the last Statement purchased by the Australian Office of Financial Management (AOFM)… The high spreads on RMBS do not appear to reflect investor concerns about the quality of collateral…losses on RMBS…remain low as a share of securities outstanding… Investors in rated tranches of prime Australian RMBS have never borne a loss, with losses mostly covered by lenders’ mortgage insurance.”
Following the collapse and nationalisation of Northern Rock in the UK, which accounted for around 10 per cent of all housing finance, the major UK lenders started severely rationing credit by reducing LVRs (amongst other things) with the predictable consequence that house prices started to fall. Much of the UK banking system has now been nationalised as a result. These myopic actions by lenders can trigger “negative feedback loops”, as seen in the UK, with the end-game that the banking system in effect cannibalises itself. This is precisely why the Australian government should intervene immediately if they see any signs of serious credit rationing in the domestic mortgage market. Westpac comment (see also figures below, which show firstly relative housing finance approvals in Australia and the UK and secondly, UK arrears and repossession statistics):
“The presence of substantial pent-up demand for housing – long seen as the ‘saving grace’ for the Australian property market – has not prevented a sharp downturn from unfolding in the UK.
Banking system problems and an associated tightening in credit conditions have been the driving force of housing weakness in the UK. The absence of these problems in Australia has been just as critical as supply shortages to the relative outperformance of local housing markets.
On the surface, housing markets in Australia and the UK share a lot in common – something of serious concern for Australians given the sharp downturn and house price falls currently underway in the UK. A closer look though reveals a more complex story and gives some hope that local markets may continue to hold up comparatively well…
The most disconcerting similarity between the two markets is that they are both fundamentally undersupplied…
In Australia, five years of subdued building have coincided with record population inflows. These inflows and well established demographic shifts would normally have led to 870k new households being formed over the last five years. Instead, only 690k new dwellings have been built. The resulting shortfall – of 140k, set to rise to 190k by end 2009 – is not directly observable but is apparent in average household sizes and rental markets, where vacancy rates remain at record lows with rents escalating at double digit rates…
Most – including RBA governor Glenn Stevens – cite this ‘pent up’ or latent demand for housing as a critical factor behind the resilience of local markets, firstly in the face of stretched affordability and high interest rates through late 2007/early 2008 and more recently in the face of the substantial external shock of the global credit crisis…
Why then has the UK housing market been so much weaker? In contrast to Australia, where prices are down a comparatively mild 4 per cent from their early 2008 peak and dwelling approvals are off 30 per cent, UK house prices are in free-fall – off 18 per cent from their peak already with new housing starts plunging to their lowest level since WWII, mirroring in nearly every way the savage declines in the US…
There are factors at work in the UK that are largely absent in Australia. In particular, the UK banking system has experienced far greater problems than Australia’s. Much of this is due to the weak UK housing market of course, but the core problems emerged well before housing markets turned down. British banks had more significant exposures to the ‘toxic’ assets at the core of the sub-prime housing crisis. Moreover, several key players were also heavily reliant on securitisation markets for funding…
The story of the UK housing downturn really starts with the closure of credit markets that precipitated the collapse of Northern Rock in late 2007/early 2008. Indeed, it is very much more a story of a banking crisis that precipitated a housing crisis rather than a housing crisis that precipitated a banking crisis as per the US. The collapse of Northern Rock was a particularly important event in the UK. It removed a major provider of housing finance – Northern Rock is estimated to have had a 10 per cent share of the mortgage market when it collapsed and had been growing faster than any other bank as it sought aggressively to gain market share (110-120 per cent loan to house value mortgages were the norm). Up to 70 per cent of Northern Rock’s mortgage book was funded on wholesale markets (i.e. as opposed to retail deposits). When those markets closed, Northern Rock failed with weeks. Although it is an extreme example, the UK banks more generally were considerably more reliant on wholesale funding than their Australian counterparts…
Northern Rock’s collapse coincided with a sharp tightening in credit criteria by UK lenders. Maximum loan-to-valuation ratios were cut sharply and the availability of finance to higher-risk borrowers basically stopped…
Notably, there was also a steep rise in the number of house repossessions from late 2007, rising 54 per cent to 40k in 2008 (and forecast to climb to 75k in 2009). The bulk of the rise has also preceded any significant rise in home loan arrears. Normally the two move in tandem, as per the early 1990s experience. This suggests the credit crunch itself may have led directly to a significant rise in foreclosures rather than the more normal process in which high interest rates and/or deteriorating labour market conditions lead to a gradual rise in delinquencies and defaults. The sudden withdrawal of available finance probably compounded the situation for many stretched owners, limiting options for refinancing onto better terms…
Either way, this wave of repossessions would have weighed heavily on prices as distressed sales combined with a sudden withdrawal in demand – the latter due to both a fear on the part of buyers and the reduced availability of finance. Outright price declines – which began in mid-2006 in the US – only began in 2007 Q4 in the UK according to most measures…
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The upshot of all of this is that mortgage lending has all but collapsed in the UK. The number of new mortgages issued by all lenders has fallen by around 75 per cent from the late 2007 peak in the UK. In Australia, the equivalent fall has been 28 per cent, with the most recent figures showing a tentative upturn gaining traction.”
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businessspectator.com.au |
