Abraham Lincoln once opined that you may fool all the people some of the time, you can even fool some of the people all of the time, but you cannot fool all of the people all the time. It appears that the real estate lobby and the banks have been doing a good job of fooling a lot of people, for quite some time, but the fooling finally appears to finally be coming to an end.

Last week, Australia’s biggest-selling paper, the Herald Sun, led its Saturday edition with the warning that Melbourne’s housing bubble has burst. The dire prediction came as the median Melbourne house prices fell by $36,000.

But not everybody has quite jumped off the capital-city housing bandwagon yet. Even esteemed Business Spectator scribe, Robert Gottliebsen last week claimed that a price crash is “unlikely”, noting:

Late last year we saw Australia’s largest mutual, the RACV, buy a recently completed apartment complex in Noosa for just $60 million.

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The Resort Corporation’s ‘Noosa Sanctuary’ had cost $210 million to develop but had been valued above $250 million.

In effect we saw a fall in value in the vicinity of 75% — which is similar to the US falls.

The Sunshine Coast market is now flooded with apartments and if there was a forced liquidation that Noosa Sanctuary price fall could be duplicated.

However, it is most unlikely that will happen …

Gottliebsen claimed that he is not concerned of a price drop in other Australian capital cities for two reasons. First, “banks are deliberately restricting supply of dwellings by making the criteria for financing developers tough”, and second, “Australian … banks are flooding consumers with loans”.

The only problem — both of those reasons are a reading of the current (or historical) situation, not what will happen to the housing market in the future.

The supply shortage argument is often proffered by bodies such as the Real Estate Institute or the HIA as a rationale for houses providing a terribly low yield. That explanation requires purchasers to perpetually ignore current returns on the basis that other people will always pay more for the asset in the future. Such schemes cannot last forever — and the reality is quite different. With slumping immigration, dwelling construction will exceed demand this year (as it has done for almost every year, other than 2006-2009). This is most evident in Melbourne (the epicentre of the housing boom), which has seen house prices rocket, but median rents remain extraordinarily steady in recent years.

Instead of restricting supply of dwellings, it appears that in Melbourne especially, banks appear to be doing the opposite. A summary prepared by Oliver Hume indicated that in the first six months of last year found there were 262 medium and high-density projects being marketed across metropolitan Melbourne equating to a potential supply of 28,316 units. Since then, several new large projects have started and the newly elected Liberal government is also planning a new suburb in Fisherman’s Bend, which could house up to 15,000 dwellings. Banks appear all too willing to lend to developers, based on off-the-plan sales to largely overseas-based purchasers.

Of course, this could very quickly change, like in the early 1990s. Banks may suddenly realise devoting almost two thirds of their asset base to residential dwellings may actually be risky after all and restrict future lending to developers to fund construction. But if this occurred, it would almost certainly coincide with banks curtailing mortgage lending to home buyers as well. That is the second plank of Gottliebsen’s ‘property prices won’t fall’ argument.

That is, banks are currently maintaining prices by flooding consumers with loans.

For while greedy bank executives (motivated by profit-based short-term bonuses) may be happy to boost profits by ostensibly “safe” mortgage lending, those same executives could very quickly become fearful in a short space of time. For example, if borrowers start defaulting on their loans, the “price” of collateral being held (the dwellings themselves) will also fall. This happened during the GFC (when banks reduced loan-to-valuation ratios) and remains the case in the US.

So while looking backwards, Gottliebsen is entirely correct –Australia’s borrowing binge, which has led to the mortgage debt-GDP ratio increasing from about 25% to almost 90% in a decade would come to a very rapid end. The Financial Review last week noted that a Merrill Lynch report found Australian banks are “willing to lend mortgage customers larger amounts while substantially underestimating people’s living costs, which could affect their ability to make repayments”.

Product disclosure statements remind readers that past performance is no indication of future returns. That statement will hold very true in the residential property market in the years to come.