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I have been holding myself from making this post, but what the heck!

Some of my friends are continuing to buy into the housing market craze. While a few tout the double digit returns they have already scored in just a year- ignoring their loan has yet to been paid off & liquidity concerns, just in case they choose to cash out in the foreseeable future. Others are being whipped (as I see it) into the housing craze by their partners with the view- If things go bad, at least they’ll have a roof over their head.

Now seeing a very interesting scenario develop in the Aussie housing market.About a week or two ago some of the major banks decided to increase their fixed loan interest rates. This is sure to be followed by other banks in the future. Speaking for myself, I reckon the main stream media did a horrible job of showcasing this event…or perhaps I wasn’t observant enough with my minimalist approach to watching television.

When banks take such a stance, the relationship (inverse to near equilibrium) between credit availability and cash rates is disrupted. To elaborate further, I am using the USA as a benchmark (mainly due to availability of data).

The graph below is a plot of US Fed rates and 30 year mortgage rates.

United States MBA 30-Yr Mortgage Rate and Fed Funds Rate

United States MBA 30-Yr Mortgage Rate and Fed Funds Rate

Notice the year beginning 2008 where the relationship between mortgage rates and Fed fund rates is disrupted with mortgage interest rates increasing as Fed fund rates dropped. This was followed by a steep drop in the Housing Price Index as depicted below.

US Housing Price Index

US Housing Price Index

A similar tone at home was in action during 2008; mid July onwards the RBA begun a spree of cuts in interest rates while the banks increased their mortgage rates throughout the year. The follow through…a dead drop in the housing price index.

However, the concern this time is the velocity with which credit levels have increased since the start of 2010 (sounds similar to the US). And with interest rates already at historic lows, leaves the RBA in no man’s land if it has escalating housing price concerns and maintaining a lower Australian Dollar to improve our competitiveness on an international scale.

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Australian Consumer Credit

Coming back to the recent increase in mortgage rates by Banks in a low cash rate environment- Theoretically, an increase in interest rates from Banks or the RBA for that matter is meant to curtail or discourage credit availability in the market. So the expectation is that an increase in the cost of credit achieved through the banking sector will slow down rocketing housing costs & a drop in cash rate by the RBA will keep the Aussie Dollar lower; thus keeping things in check. Not that I am implying the RBA and Banking sector are in talks to maintain an equilibrium by “division of labor” (but in reality that’s how things often work). Alternatively, we might subscribe to the main stream view of APRA (Australian Prudential Regulation Authority) requiring the Banks to hold more capital reserves to protect against mortgage defaults as the underlying reason for the rate rise by banks. Either ways it’s a two edged sword. Perhaps, a restriction on Loan to Value Ratio’s (LVR) would have been a more apt solution.

The fault here is, an increase in mortgage rates with a view of discouraging consumers to obtain credit is in conflict with increasing Building Permits; at all time highs.

Building Approvals

Building Approvals

So the question I am asking myself is what happens when mortgage rates increase in an inflated consumer credit environment; adding in a touch of falling household savings (see graph below) and oversupply of housing.

Saving Ratio

Saving Ratio

And the thoughts to my question is inclined towards the unintentional creation of more debt & this debt is unlike the debt we are seeing today (couldn’t source housing foreclosure data for Australia…should give ABS a call to check availability) where the average person is managing their mortgage payments. The sorrowful debt looming is “debt due to consumer mortgage defaults”.

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