Aussie Boombustology

A friend recently introduced me to Vikram Mansharaman, the author of Boombustology: Spotting Financial Bubbles Before They Bust.  The book is based on a seminar – Financial Booms & Busts – taught by Vikram at Yale.  I found the framework which Vikram presents quite familiar as we typically examine economics, psychology and many of the “lenses” in the Boombustology toolbox in our own work.  There are a number of critical points in his review of prior bubbles, which can be read in a day, but perhaps my favorite quote from the book is the relationship below:

“Because increased collateral values inspire more credit, reflexive dynamics can often be identified by the concomitant growth of credit and collateral values. If credit is rising rapidly along with asset prices, there is a high probability that reflexive dynamics are under way.”

With this in mind, I revisited the chart below from Steve Keen, illustrating Australian home prices and the change in credit growth in the economy.

Looks like the growth rate in Australian Housing credit is plumbing the lowest levels ever.  I’m not a quant guy, but I’m pretty sure that “ever” is a long time.

Given that Australia’s Private Sector Debt has rapidly exceeded that of even  the most prolific American spenders, I wonder what happens when the private sector begins deleveraging from the extremes shown below.

I also think it is interesting that most folks have the impression that Australia has very little debt.  If we learned anything from the recent crisis, it’s that private sector liabilities can quickly become the public sector’s responsibility.  So it’s important to look at the total debt in the system.  In this light, Aussies are actually in line with the US due to heaps of household and financial sector debt obligations.

 A good friend of mine, and one of the most successful investors I know, has been lecturing me on the importance of catalysts when sizing positions.  I am beginning to come around to the idea, particularly as we have been writing about the Australian Property Bubble for over a year now, and I am looking forward to moving on to something new.  Some may say we’ve been early, but I’d remind them that we’ve been warning of European defaults for over two years!  Call it what you want but our thesis continues to develop and we continue to see increasing evidence of falling prices and deteriorating economic conditions down under.  What follows is a collage of evidence I’ve accumulated over the past several weeks (maybe longer), that when put together, paints a very clear story in our opinion.  So Kyle, GET FIRED UP!!  Here is your evidence:

Properties are languishing on the market in a number of suburbs.  This article in Perth Now explains that, “Almost 311,286 properties are for sale across Australia, the highest in more than five years and almost 30 per cent more than the same time last year. In Melbourne, there are 50 per cent more properties for sale, 30 per cent in Sydney, 14 per cent in Brisbane and almost 40 per cent in Adelaide. Meanwhile, auction clearance rates have remained below 50 per cent for 20 consecutive weeks in Australia’s largest housing markets.”

CourierMail explains, that “Sellers who manage to snare a buyer in Brisbane’s soft property market are seeing their deals fall over as a new trend emerges of valuations coming in below contract prices, making it difficult to obtain finance. Owner’s estimates of their property’s actual value are often wildly optimistic.”

Prosper Australia has ignited a small but growing push calling for a “buyers’ strike” to protest against the high cost of housing.  “There are 1.3 million Australians with negatively geared rental properties. They are diverting all rents and some personal income to meeting interest payment in the hope of capital gains. When only capital losses are expected, investors will flood the market and overwhelm demand. Buyers will step back, making it virtually impossible to sell at any price.”

It seems that the Australian Bankers Association is waking up to reality, taking the unprecedented step of launching a website – www.doingittough.info – for financially stressed homeowners to negotiate hardship packages, according to the Daily Telegraph.  “The Big Four banks are on high alert for a rocky 2012 with a sharp rise in defaults.”  This is the first time the banks had set up a site to deal with customer hardship on mortgages and other financial products like credit cards and personal loans.  Recent reports have pointed to a higher ratio of “non-performing loans” and people falling behind on mortgage repayments in recent months.

One in ten Australian households are in housing stress, according to Australian’s for Affordable Housing.  A startling 460,000 households spend more than half of their income on housing costs.  It’s no wonder Australian’s are shouting out for help.  The cost of housing is the single biggest cost of living issue in Australia today.  Spend a few minutes perusing this site to get a feel for their frustrations.  We have seen how this story ends.

In a recent report, Moody’s warned that there are “meaningful uncertainties” for Australian housing and mortgage delinquency rates are likely to increase over the next decade. We doubt it will take that long.  “Capital city house prices have more than quadrupled and household debt has tripled since 1990. Simple metrics indicate that the current price levels are not sustainable.”

According to Australian Real Estate and Property, “If a second global financial crisis (GFC) occurs credit markets will tighten up.  Australian banks already have up to 40% exposure to European debt and the big four Australian banks ratings were downgraded by Moody’s Investor service due to this wholesale funding exposure. Unfortunately in 2011 Australian borrower home loan arrears hit a 15 years high with Australian banks and borrowers in a binge-buying hangover.  The time period 2008 and 2009 combined make up 40 per cent of the mortgage loan books of the major Australian lenders. The Australian borrowers who purchased property during the height of the Australian Government economic stimulus in 2009 and hence the peak property prices, are now most at risk to falling property prices.” 

It’s no wonder that, “The Australian Prudential Regulation Authority has told banks to model what would happen if the European meltdown spread to Australia through a series of stress tests designed to ensure the strength of the local banking system,” according to The Australian Financial Review.  “The stress test has been prompted by an escalation of the European sovereign debt crisis that could lead to a global recession and a hard landing in China. It comes in the same week that the Reserve Bank of Australia’s deputy governor, Ric Battellino, warned that Australia’s indirect exposure to Europe through the effect on some of our important trading partners, could be significant.  The short notice and time frame allowed by APRA, particularly in light of negative comments from the RBA, indicates the regulator is preparing for a difficult 2012.”

The banks problems are likely to be compounded as most of the Australian economy is already in recession.  So it shouldn’t come as a surprise that, “The number of companies entering some form of insolvency administration in calendar year 2011 continues to set new records, per Dissolve.  A recent report stated that, “The months of March, April, June and now July 2011 have been the highest ever for each of those months. The calendar year to July 2011 is also the highest ever.”

“Thirty-six companies in the residential construction sector have entered voluntary administration in the past two weeks,” often the precursor to liquidation, according to The Age.  ”There has been a marked increase in the insolvency of builders and building-related businesses over the last few weeks and this is likely to increase after Christmas when contractors have to fund the long slow-down or shut-down period, with little cash flow coming in. With banks being reluctant to increase facilities for building companies, this will only exacerbate the situation.”  The author concludes with a very important point:

“A big part of the problem is the delay of payments to these businesses, which puts their cash flows under undue pressure. According to the country’s biggest receivables management and credit report company, Dun & Bradstreet, the trade payment terms for the construction sector are at the highest level since the fourth quarter of 2009, which was at the height of the global financial crisis. Over the past 12 months, payment terms in the construction sector deteriorated by nearly two days from 52.8 to 54.4 days, which is almost double the conventional standard of 30 days. In 2003 the average was 45 days.

“Payment trends are known to be an accurate leading indicator of an economic correction. Indeed, the last economic decline was preceded by a blowout in trade payments. The concern is that as the global credit market crunches, and credit availability starts to tighten again, the impact of late payments on cash flow will be devastating in a sector that is already hurting.

“Residential housing and construction are a key component of the economy and when things go south they have a huge knock-on effect. Things are likely to get worse before they get better.”

A year ago, some of my Australian friends claimed that housing prices would not fall because the economy was so strong and without a rise in unemployment, prices would maintain their elevated levels.  I disagreed with the comment then but it is still worth noting that Australia’s job market is weakening today as businesses look to cut costs to cope with a deteriorating economy.  Per News.com.au, “The economy outside mining has been quite weak so companies have had to start laying people off to get their costs under control . . . That suggest for 2012 there will be weaker consumer spending, greater downside risk for businesses and this is of course even before the full impact of the European debt crisis.”  Perhaps this explains why consumer sentiment collapsed in Australia by the most since the start of the financial crisis three years ago.  At least for most consumers.  Apparently, some of them, like this 25-year-old high school dropout from Western Australia making $200,000 a year running drills in underground mines, is the exception, according the WSJ.  We’d suggest it is more likely just another indication of the unsustainable credit boom and forthcoming bust in China, as our friend Vikram eloquently outlined in his book.  Don’t worry, we’ll have more on this shortly as well.