With Wall Street leaping six percent on Monday and Australian low-end flying off the rack, you could be forgiven for forgetting the world is entering its worst coordinated economic downturn since the Great Depression.
The explosion in the so-called ‘affordable’ sector of the Australian residential property market has been spurred by the Federal Government’s boosted first home owner’s grant from $7,000 to $14,000 (or $21,000 for new properties). The boost has been especially beneficial for the property industry — from real estate agents, to mortgage brokers, to bankers – everyone’s a winner. Kristy Shepherd, corporate affairs manager at Mortgage Choice told The Age last week that “first homebuyers-to-be are in a better financial position than those before them and are taking advantage of the first home owner boost and improved market conditions as a means to get their foot in the door sooner.”
While such a rosy view is commonplace in the property sector, Dan Denning, writing in the Daily Reckoning yesterday, outlined a less popular, but more realistic appraisal of some of the problems which the first home owner’s grant may cause. Denning noted that:
[Utilising the First Home Owner’s grant] could turn out to be the worst financial decision many…couples in their mid-twenties ever make. Why?
They will have borrowed a huge amount of money at just the moment when home prices in Australia are reaching their peak. What’s more, these are the most marginal borrowers left. They are the most vulnerable to losing their jobs. And because they’re just getting started in their careers, they are likely to be under the most mortgage stress of any borrower (paying the largest percentage of disposable income to the mortgage).
These new homebuyers face a dual risk. It’s hard to say which is more dangerous right now, unemployment or higher rates. Most of these new buyers are getting into the market at the low point in the interest rate cycle. Because Australians favour the adjustable rate mortgage, these new buyers will have maximum exposure to rising interest rates.
As Denning later noted, while house prices were not significantly affected by rising unemployment during the 1990-91 recession, that was largely due to falling interest rates. With the cash rate currently at 3.25 percent, the RBA has fewer bullets than in 1990 when rates fell from 17.50 percent to 4.75 percent in three years. Further, with every stimulus package unveiled by the Federal Government, hidden inflationary pressures emerge. While Australia isn’t undertaking any quantitative easing (read: printing money) like the US and UK for the moment, that may quickly change.
Like a smooth conman, a bubble (be it in shares or property or tulips) has a way of convincing ordinary people that there is some truth behind what is in essence, a dose of greed mixed in with a smattering of fear and a dash of envy. During the dot.com boom, it was widely thought that the internet would revolutionize business, like railways or electricity did a century prior, allowing dot.com companies to trade on price-sales ratios of 100 (those companies had no earnings). In the US in the 2000s, it was thought you could make money buying and flipping real estate, which “never went down in value”. As recently as 2007, it was believed that infrastructure assets could be leveraged and packaged in such a way as to both provide a strong return for investors and generate hundreds of millions of dollars for investment banks.
Now, gullible first home owners who weren’t able to save a deposit themselves are fooled into believing it is a wise investment to use a $14,000 or $21,000 gift from the government to buy a property that they probably can’t afford now, and almost certainly won’t be able to afford if they lose their job, or if interest rates rise.
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The only winners from the first home owners grant are real estate agents and vendors, who are receiving an extra $14,000 for their property. And maybe Kevin Rudd, if the next election comes soon enough.