Residential lending may hurt us in the long run
While politicians and the media laud Australia’s "world-beating" property market, precious capital is being greedily soaked up by an asset class that confers minimal economic benefits.
In a somewhat rare event, two bankers -- one from the United States and one from Australia -- made an extraordinary amount of sense yesterday. This appears to be an isolated instance, unlikely to be repeated.
The Financial Review reported that NAB’s head of business banking, Joseph Healy, warned of excessive lending to the residential housing sector, at the expense of businesses. Healy stated that "a banking system which allocated capital away from the most productive areas of the economy -- business -- is ultimately bad for growth, bad for competition, bad for jobs, bad for business and in the end, bad for Australia."
Healy also noted that part of the reason for the bias towards mortgage lending over business finance was due Basel II requirements, which allegedly "create an economically unhealthy bias towards residential lending and distorts capital allocation from more entrepreneurial and productive sectors of the economy".
Healy’s comments are so prescient he may find himself looking for a new job -- such sense is usually not welcome in our banking oligopoly. While the media devotes most of its attention to variable home loan mortgage rates, it pays little attention to business lending rates, credit card rates or deposit returns. This obscures the fact that placing too much wealth in housing, as Healy noted, is a sure-fire path to financial ruin. Japan and the US are examples of that.
With the exception of providing shelter, housing provides minimal benefits to the economy (after the initial construction), unlike business and capital investment, which further technological improvement and create lasting employment. Lending money to fund an over-priced property sector is even worse, wasting previous capital on an asset that is far removed from its intrinsic value. That capital could, and should, be used on in its most efficient manner -- over-paying for housing is certainly not efficient.
Meanwhile, over in the US, minutes released from a recent Federal Reserve meeting indicate that hawkish Kansas City Fed Chief Thomas Hoenig said what most US officials cannot bear to mention -- that interest rates at zero percent are unsustainable and will lead to inflation.
Hoenig was the lone dissenting voice at the most recent Fed Open Markets meeting. Hoenig stated "it is a fact that the current outlook for fiscal policy poses a threat to the Federal Reserve’s ability to achieve the dual objectives of price stability and maximum sustainable long-term growth." Hoenig’s views are hardly groundbreaking -- widespread quantitative easing (also known as printing money), which is currently occurring in the US will almost certainly lead to inflation … eventually, it is just that no official has ever been brave enough to say as much.
Is there a link between Healy's and Hoenig’s views? Quite possibly. Australian banks have profited recently from the increased lending to the residential sector. This was largely due to banks lending more as house prices rise. In the past five years, the ABS has found that median prices have risen by upwards of 60%, however, banks are willing to lend a similar (albeit slightly lower) percentage of the total purchase price. That means that banks are now lending substantially more (in a nominal sense) for the same property.
A substantial portion of this funding has come from overseas. If Hoenig is correct and US rates rise (as they must eventually), the cost of funding for banks will increase, and the cost to borrowers will rise. This will lead to higher local interest rates, which will cause a higher rate of delinquencies and reduce the buying power of those purchasing a property.
While politicians and the media laud Australia’s "world-beating" property market, the view of Joseph Healy is far more correct. Precious capital is being greedily soaked up by an asset class that confers minimal economic benefits. This capital distortion, which has been furthered by foolish government policies such as the first-home-owner’s grant and wholesale funding guarantees, may prove very costly in the years to come.