Madness has gripped Sydney's and parts of Melbourne's property market; a malaise that, if allowed to continue, could have dire consequences for the nation, writes Ian Verrender.

It's finally happened. Parody has become reality.

A parking space in the Sydney Harbourside suburb of Kirribilli was put up for auction on Saturday. We're talking tarmac here. With a couple of painted lines on the ground.

There were hopes the 12 square metre fingernail of land would fetch $50,000, which not that long ago would have elicited guffaws from incredulous residents. By the time bidding stopped, however, the former lucky owner had collected a cool $120,000.

That's not the record either. A couple of weeks back, a Potts Point car space fetched $260,000.

Meanwhile in Sydney's outer western suburb of Mount Druitt, which recently attracted national attention courtesy of the SBS series Struggle Street, a detached house last week sold for $1 million.

Madness has gripped Sydney's and parts of Melbourne's property market; a malaise that, if allowed to continue, could have dire consequences for the nation.

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So far, much of the debate around the rampant real estate market has revolved around affordability and the worrying concern that we are in the process of creating a class system based upon land ownership as wealth is transferred from a generation entering the workforce to those about to exit it.

But a far greater and more immediate danger lurks in the shadows. The prospect of a reversal - of a sudden decline in property values in the two major capitals - would be enough to tip the nation into a severe economic crisis.

It's not as though it hasn't happened elsewhere. The collapse in American property markets in 2007 sparked the worst global recession in generations. The UK endured its own crisis borne from overly exuberant real estate speculation. The same thing happened across Europe.

The east coast capital city property bubble is being driven by investors who borrowed $11.5 billion in April, a 23.5 per cent rise from a year earlier. They sidelined owner occupiers, who borrowed $9.8 billion.

None of this is being fuelled by wages growth. Beneath this month's GDP figures - which superficially showed an encouraging 0.9 per cent lift for the March quarter - lay the real story. Nominal GDP - a much better proxy for earnings and wages - grew just 0.4 per cent for the quarter and an anaemic 1.2 per cent for the year.

In the past fortnight, the Prime Minister and the Treasurer have been assailed by the nation's three most powerful economic mandarins, each of whom has directly contradicted the Government mantra on rising property prices.

Treasury head John Fraser, Reserve Bank chief Glenn Stevens and financial system inquiry author David Murray have all expressed alarm at recent developments in the eastern states capital city housing markets.

They have yet to detail the mechanism by which their unfolding fears could play out if the Sydney and Melbourne housing bubble is not deflated. But here is a likely scenario over how an unfettered boom could wreck the economy.

Financial market meltdowns can wreak havoc on the real economy as the sudden loss of wealth obliterates spending both from consumers and business. The stock market crash of 1987 was a forerunner to our last major recession.

As debilitating as equity market implosions can be, property market collapses have the capacity to be far more toxic. That's primarily because of the far greater amount of debt that's involved. Debt, the great accelerant in a rising market, can unleash a firestorm on the way down.

Banking is vital to the health of an economy. It's also the riskiest business there is, operating on huge leverage and skinny margins. When the value of the assets the banking system has lent against suddenly declines, it doesn't take much to send shockwaves through an economy.

If you believe it couldn't happen here, think State Banks of NSW, Victoria and South Australia. That's just for starters. Twenty years ago, Westpac and ANZ also were on the brink.

It has long been argued that Australia's housing market was unique with inbuilt flexibility that would mitigate against shocks through the banking system. Unlike much of America, variable mortgage rates allow institutions to better manage their funding commitments and given Australian mortgages are full recourse loans, the onus is on borrowers if they no longer can repay.

Maybe, but that didn't help our banks in 2008. The laughable myth in the aftermath of the financial crisis was that Australian banks sailed through the storm in tip top shape. Nothing could be further from the truth.

When the crunch came, they couldn't refinance their huge offshore debts. And it was the Rudd government that rode to the rescue, extending the nation's AAA credit rating that allowed them to limp through.

In all, they borrowed $120 billion, courtesy of the taxpayer subsidy. Whenever that uncomfortable fact is raised, they indignantly respond that they had to pay a nominal fee for the service as though the idea of fees is a foreign concept. Without that cash, it would not have just been RAMS that collapsed.

Ever since the stock market collapse in 1987, when the entrepreneurs all hit the wall, Australian banks have deliberately targeted real estate. It may have been dull. But it was hugely profitable. And unlike corporations, homeowners would do just about anything to avoid default.

They embarked on a massive spree, raking in offshore cash as wholesale debt markets developed, and pumped it into mortgages.

That was aided and abetted by negative gearing, a discount on capital gains tax and more recently self-managed super funds that now can gear up to buy property. Overwhelmingly, investors seek out existing properties rather than develop new ones, forcing owner occupiers to borrow more.

The more money the banks pumped in, the higher real estate prices rose. The higher the prices, the more that was needed in loans; a business model of rare beauty that some call a Ponzi scheme.

Australian households now are among the among the world's most indebted. In 1990, household debt accounted for about 60 per cent of income. By 2013, it had risen to 180 per cent. The reason? Mortgages.

Between them, the big four banks hold about 80 per cent of all Australian mortgages. All up, Australians owe about $1.4 trillion on their houses, which is rising at a rapid clip each month. It is their most important business.

That concentration - both geographically and in one asset class - leaves the banks hugely exposed in the event of a real estate slump.

And while the Housing Industry Association and the Commonwealth Bank regularly attempt to massage the statistics in a vain attempt to prove that Australian housing is as affordable as it has ever been, most of their calculations are based upon the simple premise that interest rates are at record lows.

That's true. But it is also the biggest danger. Home loans run for 25 to 30 years. Anyone who thinks rates will stay at record lows for that length of time is deluding themselves.

Our major banks face serious challenges within the next 12 to 18 months. Having bumped up their reported earnings in the past three year by cutting their provisions for bad and doubtful debts to the bare minimum, any hit to the broader economy will immediately flow through to their bottom lines.

Given mining revenues have been swamped by declining commodity prices, resource investment is collapsing from a once in a century boom, and large sections of the manufacturing sector are preparing to depart the country, a banking crisis resulting from a property bust would deal a crushing blow to our economic future.

Despite the Treasurer Joe Hockey's unfortunate recent outburst that anyone predicting a recession was a "clown", there is a very real prospect of just such an event within the next few years, which would depress property values and ripple through the financial system.

That expensive car park may be off the street. But it will provide little shelter and certainly no protection.

Ian Verrender is the ABC's business editor.