Australia’s first home buyer debt binge threatens banks and property market: Gottliebsen

Australia prides itself on the fact that we have four banks with AA credit ratings. Yet Citi analysts say we are in danger of losing those ratings because our banks, led by the Commonwealth, have over-expanded lending, particularly in housing.

We have all been around long enough to know that these analysts’ reports require elaboration and qualifications, but overnight it suddenly hit me that Australia was in danger of losing this treasured bank status because of our own version of sub-prime.

To understand this you have to go back to the American origins of sub-prime and then examine the parallels with what is happening today in Australia.

The origins of both the US sub-prime crisis and the over-lending in Australia is related to well meaning interference by governments in the financing process.

Back around 1977, then president Jimmy Carter signed into law an act that required banks to meet the credit needs of lower income people in districts where they were big depositors. It was a piece of total nonsense, because at the time everyone in banking knew that if banks loaned to people who could not pay there would be huge bad debts.

Surprisingly, the act lay dormant for over two decades until president Clinton told the big US banks in the late 1990s that if they wanted to expand their operations into more US states, consolidate branches or merge, they would need to lend to low income people in compliance with the Carter act.

The banks got the message and sub-prime was born. Of course, I must emphasise that although the politicians started sub-prime, they can’t be blamed for what happened next.

Here in Australia our version of the Carter low-income lending act was the expanded first home buyer grant. But if the Government’s expanded first home buyer grant was going to work as the politicians intended, the banks had to come in behind it and lend to low income people who had little or no deposit except the grant. Officially banks have asked for at least a 3% deposit, but in practice that is not how it worked, particularly in new homes.

The banks got the message and loaned very large sums with little or no deposit required. Not only was this bad banking but, as we can see, the lending was so great that it threatens their AA rating.

Sub-prime was a terrific boost to the US economy until someone pulled the plug and stopped lending. In Australia our home starts, particularly in South Australia and Victoria, have been a huge boost to the economy at a time of global financial crisis. However, I have learnt from lengthy discussions with real estate agents that in the past few weeks our banks have pulled the plug on “no deposit” lending and now are requiring deposits – exactly what they should have done from day one.

I emphasise that this is not a sub-prime crisis or anything like it, because the Australian first home borrowers do have reasonable levels of income. But because the change in lending rules comes as the grant is being reduced, it will mean that the prices of houses in the lower brackets may fall back to where they were prior to “no deposit” lending.

A lot of first home owners who bought at the inflated peaks will have negative equity. As long as the families hold together and employment is maintained, that will not be a problem. But if Treasury is right about unemployment there is a clear danger.

The politicians are right to blame bad capitalism for the US crisis. However, what they must also recognise is that the bad capitalism in the US stemmed from a toxic combination of social engineering by US governments and bank lending to back it.

In Australia the first home buyer grant was not a bad thing on its own. What made it dangerous was its combination with no deposit lending. Like the US, it’s the combination that is potentially toxic. It’s important for Australia that Kevin Rudd understand these principles when he comments on the nature of capitalism.

This article first appeared on Business Spectator.