In today’s Money Morning…mounting pressure in the housing market…how the RBA has washed its hands of the problem…the limited influence of APRA…why the big banks now have control…and more…

Talking about the property market is as Australian as complaining about how cold the meat pies are at the MCG. We just can’t help it.

A couple of weeks ago, fresh property data from the Australian Bureau of Statistics (ABS) landed in my inbox. Like a dog with a bone, I couldn’t let this batch of numbers go to waste.

Some of the numbers in the report were so big that I had to read them twice.

The ‘Residential Property Price Indexes: Eight Capital Cities, December 2016’ report tells us that Australian property prices rose 4.1% in the December 2016 quarter across all Australian capital cities. The year-on-year increase for all eight cities came in at 7.7%.

Of course, it goes without saying that Melbourne and Sydney saw the biggest gains, rising 10.8% and 10.3% respectively.

Then I stumbled on this bit…

‘The total value of residential dwellings in Australia was $6,438,537.3m at the end of the December quarter 2016, rising $274,160.0m over the quarter.

‘The mean price of residential dwellings rose $25,400 to $656,800 and the number of residential dwellings rose by 39,600 to 9,802,700 in the December quarter 2016.’

Did you catch that? The total value of the Australian housing market is an insane $6.4 trillion.

Compare that to the $1.56 trillion of outstanding mortgage debt as at December 2016. Meaning the total value of Aussie housing is roughly four times the amount of money owed.

On their own, those figures help the property market look relatively robust.

However, when you break it down, you can see the problems.

Let’s start by adding that Australia’s household-debt-to-GDP ratio is 123%. Given that this is predominantly tied up in mortgages, you start to wonder how concentrated the mortgage debt is.

You then have the number of people seeking financial help on the rise as well.

The National Debt Helpline says over 14,000 calls weren’t answered in January this year, jumping from 11,000 in January 2016. It added: ‘…around 30 per cent of Australian households were in some sort of financial distress…About 20 per cent of the population…have got no cash in the bank if something goes wrong.’

And it was only at the start of the year that Digital Finance Analytics claimed that one fifth of Aussies are at risk of losing their homes if interest rates rise by 0.5%.

In May 2015, Moody’s research showed the proportion of residential mortgages more than 30 days in arrears was 1.34%. A year later, in 2016, that figure increased to 1.5%.

There’s clearly pressure in the housing market.

Early data tells us financial strain is being felt somewhere. The thing is, the problem isn’t visible. Not yet, anyway.

Finally, as I mentioned in Tuesday’s Money Morning, the RBA is turning over the housing problem to the Australian Prudential Regulation Authority (APRA).

Basically, they believe it is APRA’s job now to control the number of investors in the market, so that Aussie housing remains affordable.

It would be funny if people’s financial futures didn’t depend on the value of their house.

The RBA has come in, pumped up the market, and is now wiping its hands clean of the problem.

Some in the media are calling for APRA to limit investor loans to 7% — or even 5% — instead of the current 10%. I don’t think there’s much APRA can do now.

What if the Aussie banks are slowly trying to contain the problem?

Make no mistake; I’m no fan of the big banks. Banks — having issued highly geared loans on the basis of wage growth and constantly rising capital values — have been a large contributor to the problem.

In saying that, the banks know more about the mortgage debt problem than we do.

They have the internal data.

Having worked inside a lending company before, I know they watch the number of delinquent loans carefully. After all, if people don’t pay back their debt, banks can’t hand back cash on deposit.

The point is, if people are going to fall behind on their mortgages, they will know first. Before you, before the regulators, and before the rest of the market.

Banks will do everything in their power to keep this knowledge internal…shareholders don’t like this sort of news. And if people get nervous about a bank’s ability to pay out cash, it results in bank runs, in which large numbers of people attempt to withdraw cash at the same time.

And that brings me to one of my favourite charts at the moment.

Have a look at this:

Source: AMP Capital, RBA

Click to open new window

The red line is the official RBA cash rate. The blue line is the standard mortgage variable rate. And the green line is the gap between the RBA’s cash rate and the mortgage rates banks offer.

For almost two decades, banks had a 2% buffer between the RBA’s cash rate and the rates they offered to home-loan borrowers. For preferred clients — in other words, people with a large deposit — that buffer could drop down to 1.5%.

That all changed in the aftermath of the 2007–08 financial crisis. Since then, rates have slowly increased from 1.5–2% to almost 3% in 2012. Initially, the banks were able to blame the cost of international funding.

Since the start of 2015, the banks have started to grow the buffer again. Today, the gap between the cash rate and the standard variable mortgage rate is 4%.

It first started with major banks not passing on the full rate cut to lenders. Remember how the mainstream press labelled them mongrels, and politicians called them thieves (that’s the pot calling the kettle black) for not passing on the full rate cut?

The next step for banks has been to raise rates outside of RBA decisions. A couple of times, they’ve blamed the cost of offshore wholesale funding. The reason the banks have to dip into international markets for money is because the demand for credit and loans exceeds the deposits in the bank.

I find it hard to believe this is the case anymore.

As I said, banks know their risks. They know where the damage is.

Every time a bank raises rates outside the RBA cycle, it is taking steps to control its own risk. It could be that the banks are taking steps to protect themselves from the fallout of mortgage debt.

Chances are it will be too little, too late.

Pay close attention to how the banks raise rates outside the RBA cycle. That will give us more clues as to how bad the mortgage debt really is.

Regards,

Shae Russell,

Editor, Money Morning