When it comes to bubbles, Australian property ticks pretty much all the boxes. If there is a sharp correction in the eastern states it will have a devastating impact on our banks and economy, writes Ian Verrender.

"There is no cause to worry. The high tide of prosperity will continue." Andrew W. Mellon, US Secretary of the Treasury. September 1929.

"These consultations confirm our view that the underlying economy remains sound." White House statement, Black Monday, October 19, 1987.

"Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications." US Federal Reserve chief Alan Greenspan, June 9, 2005

Bubbles.

They build slowly, generally last longer than anyone imagines, and are often accompanied by regulatory complacency and political inertia.

It's a different story when market bubbles burst; quickly and in spectacular fashion, as a crushing stampede for rapid exits results in enormous casualties.

Despite what many economists continue to proclaim, financial market crashes have far reaching and long lasting impacts on the real economy.

As we learned nine years ago, asset market meltdowns can be even more devastating. The property market collapses that swept the US, then the UK and Europe rippled through credit markets and ultimately brought global banking and the world economy to its knees.

When it comes to bubbles, Australian property ticks pretty much all the boxes. Valuations that stretch into far reaching galaxies, fuelled by a debt binge that long ago unshackled itself from any kind of relationship with household incomes, all encouraged by monetary authorities and an accommodating tax regime.

Could it all blow up in our faces? Absolutely. It's happened elsewhere in the western world in recent years, and it's happening right now in Australian mining towns that saw real estate values skyrocket during the boom.

Is it certain to blow? Nothing ever is certain. But the odds are increasing as the economy faces serious headwinds, not the least of which are slowing global growth, a protracted collapse in commodity prices and a rapidly cooling Chinese economy.

Should sharp corrections in Sydney and Melbourne real estate values occur, it would have a devastating impact on our banking system, given its extraordinary exposure to residential property. And that would shake the economy to its core.

A week ago, the Australian Prudential Regulatory Authority, released its latest statistics on home lending. The numbers were nothing short of alarming.

As of December, mortgage debt over property issued by Australian banks and other authorised institutions has grown to just shy of an eye-watering $1.4 trillion.

In 2008, when APRA first began compiling the statistics, it stood at just $638 billion. In the intervening years, not only has the number of mortgages ballooned, but the average size has grown as the property market has kicked into overdrive.

That doubling in Australian housing debt is remarkable and concerning, not just because of the short time frame and the fact it partly has occurred during a period of the lowest wages growth in history, but because a great slab of it has been struck at record low interest rates.

Think about this: those mortgages are variable rate loans, issued over 25- and 30-year terms. At some stage during the next two decades, either interest rates will rise or a recession will occur. Under either scenario, you can only imagine the impact of rising defaults on our banking system.

Even my old chum Maurice Newman agrees. Last week, in spirited defence of his former boss's economic credentials, he had this to say:

With Australia's total debt to GDP ratio third only to Japan and the EU, it would seem a ratings downgrade is on the cards.

While he's absolutely correct, the fundamental difference between sovereign and private debt appears to have eluded him. Where Japan and the European Union have stratospheric levels of government debt, Australia's problem is private debt. And that debt is all about mortgages.

According to Parliamentary research, and a point rammed home by Tony Abbott towards the end of his time as prime minister, Australian government debt pales into insignificance when compared to Japan and Europe.

Net Australian government debt, according to the latest MYEFO statements, stands at just $278.76 billion, or about 17 per cent of GDP. Compare that to our $1.4 trillion in outstanding mortgages and the sobering reality that our private debt now stands at about 130 per cent of GDP.

What is most concerning, is that a large and growing chunk of those mortgages is funded through offshore credit markets. If credit markets tank as they did in 2008, our banks once again will be forced to run to Canberra for a taxpayer bail-out, which certainly will impact on our credit rating.

For almost a decade, a chorus of international and local bears have predicted a calamitous drop in Australian residential property prices. That it hasn't occurred has given ammunition for those who believe it never will. But that's a false argument that merely breeds complacency.

In 2010 and 2011, your diarist was ridiculed by the bears for arguing that a medium term crash was unlikely, and the more credible scenario was a gradual unwinding in property values.

During that period, there was a sustained easing in real estate prices across most capital cities as the eastern states laboured under the weight of a surging currency, courtesy of the resources boom.

A year later, and everything changed. The Reserve Bank, mindful that resource project investment was about to collapse - as the construction phase of the boom came to an end - began cutting interest rates.

It was a deliberate attempt to fuel an eastern states construction boom, to help take up the employment slack from the looming collapse in mining construction.

As Sydney and Melbourne property values once again began to soar from already ridiculous levels, the central bank stood by and watched, clinging to the mantra that its mandate simply was to maintain full employment and contain inflation.

Throughout 2014, governor Glenn Stevens repeatedly brushed aside calls to impose controls to curb housing prices. But last year, in a sudden about face, he described Sydney housing as "crazy" and within months, the banks were forced to restrict investment housing loans.

The result? Investors, who accounted for 39 per cent of all new mortgages in June last year, now make up 36 per cent.

That measure was combined with a crackdown on the rorts surrounding foreign property purchases, where a flood of money out of China appeared to be pouring into established Australian housing. Foreign investment rules were not enforced, nor was any real data collected.

So suddenly, the heat is ebbing from Sydney and Melbourne property prices.

At the root of the problem, however, is our tax system. Given the family home is exempt from any form of tax, Australians naturally have flocked to real estate as a means of transferring wealth to their children.

But the introduction of negative gearing and the discount on capital gains tax, now the subject of intense and angry debate within the Government, has added an almighty accelerant to Australian real estate and created a powerful lobby of vested interests determined to maintain the status quo.

Unwinding those tax incentives is vital. Such a move would direct investment into more productive uses and help curb business costs, including wages.

Doing nothing, ignoring the warnings and pretending that it will all somehow work its way out, is a recipe for impending disaster.

Ian Verrender is the ABC's business editor and writes a weekly column for The Drum.