Oh what a tangled web we weave, When first we practice to deceive. Scottish poet Sir Walter Scott penned those lines in the nineteenth century, but the essence of his words applies to much of what happened in the Great Financial Crisis, as well as to things yet unseen. Perhaps you think the word “deceive” is too harsh to apply to a chain of economic calamities few foresaw and no one could prevent. Deception implies a deliberate attempt to mislead; to create a false impression through false information. Was there outright deception? The now defunct Australian hedge fund, the Basis Yield Alpha fund, thinks so. They filed suit against American investment bank Goldman Sachs in June 2010 for a “series of fraudulent and deceitful acts” relating to the way Goldman marketed its now infamous Timberwolf fund. However, those rare instances of outright deception pale in comparison to the confusion created by the creation of public relation firms the world over – spinning. In almost every facet of contemporary life, information is presented in a way that makes something seem good or less bad. Spinning has become an art form in the western world. So it is that if you try to unravel the tangled web of what is really going on with household debt and the mortgage situation in Australia, you must learn to sort through the spin. For example, although few would argue against the belief that Australian housing is among the most expensive in the world right now, some experts tell us this is not really a bubble. Why not? Well, we have a housing shortage they claim. You can read similar opinions from members of the Royal Bank of Australia as well as from experts at Australia’s largest commercial banks. The property research firm SQM research claims property listings in Australia increased 44% between 2009 and 2010. Here is what Louis Christopher, managing director of the firm, had to say about the increase in listings: • “It's still very clear to us that listings are now at levels that would suggest a downturn in the housing market, although the stock levels have fallen seasonally. The overall number is up now by 44% across the nation. I wouldn't like to see another interest rate rise anytime soon – it will accelerate the downturn.” The latest figures from the same company show an increase in the supply of residential housing of 30% so far in 2011. You do not need a Nobel Prize in economics to know when supply increases and demand stays the same, prices fall. If the truth about the housing shortage is one strand in the web, another is demand for homes and home mortgages. Despite the astronomical price of many homes, experts are not worried about housing demand as both our population and our incomes are growing. Yet in April 2011 the Bureau of Statistics told the nation our population increased 1.6% to 2010, the lowest increase since 2006. Is this a trend or an inconsequential blip on the radar? And what of demand for housing right now? Here is what property guru Rick Otton had to say on his website: • April sales volume fell nationally by 21% as compared to same month in last year. More than 10,000 real estate agents decided to quit their profession due to low sales volume and falling commissions for last few years. According to many veteran industry professionals, this is one of the toughest times ever. According to census of 2006, there were 72,000 real estate agents and from that only 50,000 remained. • Properties are taking much longer to sell and the number of listing is 31% higher than they were a year ago as weak demand fails to absorb 130,000 homes for sale. If you believe there is no bubble, you can find “spin” that paints a picture of short supply and consistent demand. If you believe there is a bubble, you can find the opposite spin. The same can be said of the next strand in the web – housing prices. Here is what the Australian Associated Press (AAP) had to say at the end of June 2011: • House prices have fallen almost three per cent so far in 2011 as potential home buyers choose to save their pennies rather than bid for real estate. • The RP Data-Rismark Hedonic home value index shows a 2.7 per cent decline in Australia's capital cities house prices through the first five months of 2011. In the 12 months to May, prices fell 2.3 per cent, the report said. The tangles continue with another cherished belief to support the claims of many experts that a bursting of the bubble cannot happened here – Australian lenders are more responsible than their American counterparts were prior to the unraveling of their web. An article posted on the website of the Herald Sun on 07 June 2011 begins with the following headline: Banks and lenders in race to the bottom as mortgage demand slides The author, Peter Taylor, goes on to say in the article we are now seeing lending practices in Australia similar to those that led to the crisis in the United States. RateCity, a financial research group, studied 2500 mortgage products currently offered in Australia and found 62% used extraordinarily high Loan to Value ratios, some as high as 97%. That ratio means some banks are willing to loan a potential borrower 97% of the value of the home, with only a 3% down payment. Of course, these loans come with significantly higher interest rates; placing the borrower at greater risk should interest rates rise in the future. That is exactly what happened in the United States. People with little available cash for a substantial down payment are less likely to be able to withstand the shock of increased mortgage payments should interest rates rise. These high loan to value offerings also place the banks themselves at risk. Should interest rates rise or housing prices fall to the point homeowners cannot keep up, the banks themselves will absorb the loss. Australian banks keep mortgages on their books and home mortgage loans are a huge part of their business. Mortgage loans are so important to them; it appears they are engaging in a price war to stimulate growth in the demand for home loans. They are discounting rates to promote refinancing and lowering standards to promote loan originations. Some market analysts are expressing concerns about the future of their profit margins. Yet Australia’s banks are still the “envy of the world” many experts say, even though Moody’s recently downgraded our four largest banks. And now another thread threatens to weave its way into the web – Standard & Poor is changing its rating system and speculation is rampant they will follow Moody’s lead and downgrade Australia’s biggest banks as well. If that happens, the big banks may have no choice but to raise interest rates out of cycle, regardless of what the RBA does. Why would they need to do that? Our banks borrow money overseas to be able to make those mortgage loans to us, and a credit downgrade would inevitably lead to a rise in their borrowing costs. Rising interest rates are the thread that could unravel it all. Everybody loses. • Homeowners are faced not only with higher mortgage payments, but with higher interest charges on their credit cards and installment loans. • If foreclosures escalate, banks may be forced to increase overseas borrowing, at greater cost. • Businesses facing higher borrowing and related costs could layoff people. • When businesses stop expanding, job seekers suffer. • Home sales could go down as buyers sit on the sidelines over uncertainty about more rate hikes in the future. To spur sales, asking prices drop. If the slight downward trend in home prices we are already seeing escalates, the walls may very well come tumbling down. In an article on interest rates appearing on the website news.com.au, Southern Cross Equities analyst T.S. Lim said that if the Australian banks were downgraded by S&P, the interest rate they paid for funding would likely rise by about 0.3 percentage points. 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