13 August 2008
By
Tim Hewson
There's no doubt the US economy is in serious trouble. The obvious question is how much longer will they refuse to accept they are already in recession to prevent further financial chaos?
The
Federal Open Market Committee (FOMC) Chairman Dr Ben Bernanke in August last year loosely described the then eminent US sub-prime crisis as a containable bubble likely to result in losses of only US$100 billion.
He has since swallowed humble pie and admitted he is wrong! And the 2.5 million US homeowners with mortgages that will be forced into foreclosure over 2008 will serve as a bitter reminder.
Can it get any worse?
The US household debt to income ratio currently stands at 136% and the US consumer has increased their household debt levels in the last six years as much as they did during the previous forty.
You often hear horror stories of one in three homes in California being sold due to foreclosure, of banks owning entire streets and of property auctions offering bargain hunters to buy-one-get-one-free so banks can clear their inventory.
In his recent semi-annual Monetary Policy testimony to Congress, Bernanke stated that the US economy had "confronted some significant challenges thus far in 2008" and cited the credit crisis, weak housing market and slower consumer spending as the root of the US economy's problems (aka recession).
Outlining the impending threats of increasing unemployment and "
stagflation", Bernanke also admitted that fixing the housing crisis is now "the central issue".
In the minutes of the June FOMC meeting, the Committee admitted they are increasingly nervous about inflation and now face the dual challenge to contain inflation and promote growth in order to prevent a deep recession.
Many economists believe that the FOMC must cut interest rates further in order to do so, but the Fed Funds Rate is already at 2.00% and the Discount Rate is at 2.25% down from 5.25% and 6.25% a year ago respectively.
Is it already too late?
With the massive surge in foreclosures likely to spill into 2009, the National Association of Builders has indicated that confidence is dropping further and faster than anticipated.
This was further exacerbated by shake-up of the Government Sponsored Enterprises (GSEs)
Fannie Mae and Freddie Mac. Together, these two lending organisations account for roughly 50% of the US$12 trillion US mortgage lending market. This led to the US Treasury stepping in to introduce a radical rescue plan to alleviate the pressure of the most severe US housing slump since the Great Depression.
The strength of these measures is likely to be further tested as 1.5 million mortgages are about to be reset this year resulting in a 3-4% increase in rates and an increase of up to 30-40% in mortgage repayments.
There's no doubt that there has been a significant deterioration in the US mortgage market and losses by financial institutions will be significant as the credit environment continues to decline. Compounded by inflation, increasing energy and commodity prices, the FOMC has already "eased policy considerably" to "mitigate downside risks to economic activity".
Still, the housing sector worsens. New home sales are down, housing starts continue to drop, home prices are falling and foreclosures are rising.
In response, the US Government recently introduced new rules for mortgage lenders to establish "lending standards aimed at curbing abuses while preserving responsible sub prime lending and sustainable homeownership", including the requirement for lenders to now verify the income and assets of applicants as part of their credit approval.
I'm no Einstein, but shouldn't the more pertinent point be how and why the US let this sector get to a point where the basic fundamentals of credit evaluation and industry regulation were not entrenched in the first place?
More importantly, the impact this disaster is now having an effect on the Australian market.
Can we still call Australia home?
Still suffering from a long-term credit spending hangover, Australia's housing market represents a delicately stacked house of cards dangerously close to taking a tumble.
In a February
blog post I estimated that roughly one in ten Australians was already suffering mortgage stress - where monthly mortgage repayments account for more than 30% of net income. Well, more recent figures show that I was spot on.
A recent survey by Fujitsu Consulting concluded that 748,000 of Australia's 8 million households are already suffering mortgage stress. With increasing food, fuel and finance costs, the June 2008 annual inflation rate jumped to 4.5%. As a result, survey figures suggested an increase over 11% to 923,000 in mortgage stress by September this year.
The May 2008 Housing Finance figures from the Australian Bureau of Statistics (ABS) concluded the value of dwelling commitments dropped by 6.1%.
As a result, the number of new mortgages approved for the same period was down more than 34% and represented that largest fall in 18 years.
Attributed to this is the 12 successive interest rate rises by the Reserve Bank of Australia (RBA) taking the
Official Cash Rate (OCR) to its highest level in over 12 years.
According to a survey conducted by Retail Financial Intelligence, it was badly needed. This indicated that a massive 25% of people use more than 50% of their net income to make their mortgage repayments - more than doubled since 2007.
Importantly, the proportion of people anticipating problems in paying their mortgage had risen to 27% up from 15% last year.
The RBA further support this by suggesting that 13.9% of household disposable income is spent on paying off mortgage interest alone, the highest level since the RBA began collecting data.
According to
Infochoice, the average standard variable mortgage interest rate ranges from 8.55% to 10.17% and three year fixed rates range from 8.84% up to 10.60% - so now is
not the time to be locking into a fixed rate loan.
Affordability of the 'Great Australian Dream' is rapidly deteriorating
New South Wales State Government figures show there were 1077 court-ordered home repossessions in first quarter of 2008. While recent figures from BIS Shrapnel indicate that Sydney housing prices will increase by as much as 18% over the next 3 years, the Housing Industry Association (HIA) Economics Group indicate that housing starts for 2007 were off 13% at their lowest level in 6 years.
The
HIA CBA First Home Buyer Affordability Index has also fallen 3.5%and is down 10% for the past 12 months.
The HIA have suggested that more than 1 million new homes are required in the next 5 years to meet demand and we are also facing a rental crisis with the average cost of renting a home at $420 a week and units only marginally lower at $400 a week.
In the D.R. Address to HIA in May earlier this year, K.Rudd stated that "accessible, high quality housing is central to our vision for Australia's future" and that "our ambition is for Australia to be a home-owning society".
Unlikely mate!
In the last 12 years, the median cost of the family home has increased 200% and inflation has also increased by 35%.
In 1996, the average home only cost four times the average annual wage. Now this has nearly doubled to seven times the average salary.
Over the same period, the size of the average mortgage for a first home buyer has increased from $107,000 to $228,000 and now requires a six figure salary to finance the average home loan.
The average loan repayments in 1996 represented only 17.9% of the average household income. They now account for more than 32% of net household income.
So now the newly elected Housing Minister,
Tanya Plibersek, has the task of cleaning up Australia's housing industry and providing K.Rudd's "working families" somewhere to live.
And the banks aren't making it any easier
With all the banks now increasing their home loan rates independently of the RBA, the non-bank lenders also feel the impact of the tightening credit environment and costs of finance extended by the banks.
The major banks are also cutting commissions paid to mortgage brokers, further increasing pressure on non-bank lenders.
So unfortunately, discounted home loans from non-bank lenders are now a thing of the past as the credit crisis has also claimed their primary funding mechanism - securitisation.
As a result, the banks now hold more than 90% of all owner occupied finance for the first time since 1994.
If anything, this should provide the Government with a clear incentive to rapidly implement its home loan portability legislation.
So where to from here?
The Australian economy is slowing, employment is decreasing, inflation is rising, wage pressures are on the rise, home owners are forced to meet increasing repayments and consumer sentiment is at levels similar to the Great Depression.
The International Monetary Fund (IMF) recently issued the RBA with a warning that a "firm monetary policy stance is essential for keeping medium-term inflations expectations well anchored".
But there is light at the end of the tunnel. In a recent speech, by
RBA Governor Glenn Stevens, he provided a very clear indication that the RBA has finished its monetary policy tightening stance stating that:
While many economists do not foresee monetary policy easing until second quarter 2009, the living arrangements of one in ten Australians remains delicately stacked like a house of cards in a hurricane.
The more important question is whether the RBA has done enough to prevent Australia from being dragged into a national housing crisis as a result of the US instigated sub-prime credit crisis, or whether the banks will push the housing market over the edge?
Only time will tell!