Last week I suggested that recently a ‘fog’ had engulfed Australia’s residential property market. Extending that analogy, I feel the question now is how thick and wide spread that fog might be?

Further and perhaps the bigger question is, how long before there are signs of the fog lifting and what’s the role of housing finance?

As a starting point access to finance will be the single biggest factor in the market in 2019. This central issue alone will push aside all other debate about topics like affordability and supply and side-issues like infrastructure.

There’s no stepping over the reality that we face a combination of greatly reduced confidence in the market alongside a credit-crunch or to some degree a credit-strike by the major banks. Then we have the related topic of taxation policy, all of which have combined to create the fog.

As long as buyers feel they do not have a clear vision of their financial prospects, and even more so how lenders do, then market conditions will remain confused and fragile.

The Credit Crunch We Had to Have

This time last year, the biggest threat hanging over markets was the prospect of the Reserve Bank increasing official interest rates. During this year, we saw rate rises happen in New Zealand, Canada and the USA and for us the big problem was that many home-buyers were buying at record prices and many with interest only loans.

Interest only loans became popular as price increases ran to record levels. Take Sydney for example, where prices have risen 80% over the past five years. As a result, since late 2017, the local housing market had started to appear jumpy.

However, the accepted wisdom was that a possible downturn would only be triggered by significantly higher interest rates or a big jump in unemployment levels.

Neither happened however, the arrival of the banking royal commission in February and the scurrilous behaviour it soon uncovered, coupled with tighter lending standards, at first just for investors, but then for all borrowers has now had even greater impact.

Interest rate increases were relegated to the back stalls and the breath and energy of the market was soon knocked for six, and as 2018 heads into the holiday season, to use a sporting term, many of the big financial players have left the field (heads bowed). Leaving us all as spectators wondering if we should also pack-up and go home!

Rate Rise or Credit Crunch

Tougher lending rules and a banking sector clearly caught out breaking the rules has changed the finance landscape for the residential market slowing the rate of demand for new and existing homes. Making it harder for all buyers and that includes for first time buyers and for anyone looking to trade either up or down.

The impact will also slow new developments and may well limit future supply. Slowing development will also impact many other areas of the economy there will be less demand for raw materials and labour and less household goods sold.

How the Federal Government responds to the commission in February 2019 will be a test for the entire sector and a much bigger task than for instance a potential review of negative gearing. The policy settings will impact the financial markets and that includes housing finance with repercussions for some time.

An interest rate rise would have impacted and will eventually impact millions of already existing borrowers and would have slowed demand, but perhaps not as abruptly as the current credit restrictions.

Some Headline Figures

History will record that the banking royal commission was resisted until the need became irresistible. Tighter regulatory rules were never going to be enough, but in combination the market has been well and truly up-ended.

There are some key figures that demonstrate why all this has been necessary, and I suggest that what’s currently happening will in the long-run, leave the market stronger. There’s a silver lining.

By having the current credit-crunch we may have avoided some more nasty shocks that the market could have delivered outside of the controlled, if admittedly, alarming breadth and findings of the royal commission.

The major banks and the housing market are very much aligned. The banks hold about 60-65% of their assets as home loans, loans that increased in value by 30% over the last 5-years.

Of these loans valued at around $650 billion, about 40% are or were interest only, that is until APRA restrictions set a limit of 30%. Borrowers were facing $120 billion in loans maturing in 2021 and that could see potential re-payments increase by 30-50% and eroded the banks securities.

In addition to restricting interest-only loans APRA also instructed the banks to be more selective in their lending to investors and some developers of high-rise apartment projects. However, it must be noted that the banks have been subject to stress-testing and all past as sound and all were well within tight regulatory tolerances.

Where to Now

These figures look daunting and it remains to be seen to what extent the steps the regulator and Federal Government will take in the light of the royal commission.

Any policy will have in mind the security of the bank’s, and the general health of the economy. There will be a need to limit the scale of any possible losses incurred by banks in the improbable outcome of a severe property market downturn.

The dilemma that is facing the RBA and the government is that by tightening lending standards too far, we run the risk of causing property prices to fall further, magnifying the challenges facing the banks and the wider economy.

Financial markets are complex and key factors also include interest rates, the level of unemployment, the role of secondary lenders, policies like lending to investors and encouraging first time buyers.

There are related impacts outside of the banking system such as tax policy, the impacts on established trade up and down buyers, loans from family and from superannuation, it’s a complex mix and unfortunately, what we are now seeing is borrowers taking much of the burden and it’s starting to show.

According to figures from the ABS, home lending activity is at its lowest level since 2013 and in the September quarter figures had fallen 13.5% lower than the level a year ago.

The number of loans to owner occupiers purchasing established homes (excluding refinancing) was steady in September but was down by 2.5% in the quarter and was 11.7% lower than a year ago.

First home buyer activity has retreated following the improvements of 2017. Lending to first home buyers was down by 2.0% in the quarter and is down by 3.7% year on year.

The value of lending to investors continued to slide down by 5.0% in the quarter and is 18.2% below 12 months ago.

APRA’s restrictions were designed to curb high risk lending practices but we are now seeing ordinary home buyers experience delays and constraints in accessing finance and disrupting lending for new residential building. When banks apparently start making loan-application judgements based partly on how much fast-food you might buy, then the pendulum has swung too far.

A more complete view of the effect on actual building activity will not be clear until the second quarter of 2019 and reversing activity will not be a quick task.

With the prospect that the release of the banking royal commission findings may see further upheaval in the banking system, there will be a pressing need to re-build and maintain the flow of housing finance.

In New Zealand, we have already seen some minor easing of restrictive policies, and there is room to suggest the same here.

Banks may have lost their customer focus, but a credit crunch will ‘punish’ homebuyers unreasonably.

Back to the BBQ

Last week I noted that chatting around the Aussie BBQ had turned negative as far as housing was concerned. This week I was at a Christmas BBQ held for residents and their families at a new housing estate.

Those who attended this function on a hot Sunday early afternoon, struck me as a stable, well-dressed orderly and an intelligent group of people. They appeared to be a wide ethnic mix including several second and third generation immigrant families all the kids were well-dressed and attentive to their parents.

The crowd was happily eating a Rotary sausage sizzle, drinking no-sugar Coke, iced coffees and soft-serve ice cream. These are not high-risk customers of the type APRA is so cautious.

The housing estate and its new residents were positive and clearly aspirational, the bedrock of Australian society, and I kept think how is this wrong, and how can we allow poor financial regulation and bad corporate culture to take too heavy of a toll on the positive impact the housing market exerts on individuals and their families, on our economy and wider society.

Next week I’ll move to how development needs to respond to the loss of confidence discussed last week, and the credit crunch to how product and markets might adjust in 2019.