Are Australians even less prepared to absorb the shocks of a recession then they were during the GFC? Household debt is at an all-time high and labour rates and house prices are expected to fall as the COVID-19 epidemic bites. The risks to housing now appear greater than they were when the US property market tanked in 2008. Australia may experience a similar meltdown if the virus persists and unemployment rises. AMP chief economist Shane Oliver, not known for his alarmist views, has today mooted a 20 per cent drop in house prices. That is a radical call for a market economist. Here are the risks:
Household debt at an all-time high
According to the Reserve Bank of Australia (RBA), household leverage in Australia, that is, the ratio of household debt to disposable income, is at an all-time high of 186.5%. Household leverage is now 13% higher then it was at the same time in 2007, just before the Global Financial Crisis.
According to the European Central Bank, in the four years leading up to the GFC total US mortgage debt grew by a third, while the total debt to income ratio increased by 0.8. According to the Australian Bureau of Statistics ,in 2019 Australia’s mortgage debt-to-income ratio hit an equal high with 2013. Rising mortgage debt forces households to reduce their consumption. This is particularly true for Australia where, according to the RBA, there is significant evidence for a ‘debt overhang effect’, where households cut back on their non-essential consumption in order to pay down higher levels of outstanding mortgage debt.
Property market risks: 2007 and now
The widespread increase in default rates in the lead up to the GFC and resulting losses in mortgage-backed securities was the result of the combination of falling house prices and severe reductions in labour rates.
In Australia, labour rates have already been falling for a number of years, with a long-term decline in the average hours of work per employee. The monthly average hours worked has fallen from an average of 165.5 per month 40 years ago to 154.0 today. The February job numbers have been released by the Australian Bureau of Statistics show that underemployment has ratcheted up again to 13.7%. These figures do not include the disastrous effects of the coronavirus.
This elevated underemployment rate is only expected to worsen as businesses, both small and large, are forced to either lay workers off or cut hours in the coming weeks and months, as some large businesses have already done. It is yet unclear how COVID-19 will impact the employment rate, but early data from China shows that urban unemployment hit 6.2% the highest on record. Job losses are now mounting dramatically. This morning, Qantas announced it was laying off 20,000 workers.
Besides the weak jobs figures, housing loan arrears rates have been rising in Australia over recent years, albeit from fairly low levels. Higher unemployment rates, rising underemployment and weak income growth in Western Australia and the Northern territory have made households in those states particularly vulnerable, according to the RBA.
Generally, weak housing market conditions make it more difficult for households to repay their debt by selling their property. A significant decrease in housing value may also tip some homeowners housing assets into negative equity, significantly increasing the likelihood of default and leaving the mortgage owner still in debt.
While global sharemarkets have been hammered by 30 per cent we have not yet seen a fall in Australia’s housing market. Real estate markets are far less liquid and move far more slowly than do bond and equity markets but real estate is the biggest market in Australia.
In January, former Reserve Bank Governor Ian Macfarlane said in an appearance on The Jolly Swagman Podcast that he did not foresee a risk of a house price collapse in Australia. That was however without the context of COVID-19 epidemic we now have today. As recently as February, Sydney’s housing market was expecting a 10% rise, according to Trent Wiltshire of Domain’s Property Price Report Forecasts.
This has definitely changed. Last Friday, Wiltshire, a former RBA economist, adjusted his predictions. Considering a situation where COVID-19 results in a substantial and extended economic shock then “there will be a bigger drop off in open for inspection and auction attendance; potential vendors won’t list until the crisis has passed. Demand for new houses and apartments will fall, putting developers, builders and tradespeople under pressure, resulting in construction activity falling dramatically.” Wiltshire also says that “as people are likely to lose their jobs or have their hours cut” potential buyers will “become fearful about taking out a mortgage if they’re concerned about their job and some potential buyers won’t be able to get a home loan if they lose their job.”
Further, Dr Shane Oliver, Chief Economist of AMP’s Capital division, has predicted a 20% drop in Melbourne and Sydney house prices due tighter credit lending conditions, falling capital growth expectations made worse by fears of a change in tax arrangements and an increase in unemployment.
Dr Oliver predicted that unemployment is set to rise to 7.5 per cent which would prompt a 5 per cent decline in property prices. This is not the worst case scenario though.
“A sharp rise in unemployment to say 10 per cent or beyond risks resulting in a spike in debt servicing problems, forced sales and sharply falling prices,” he said.
“This could then feed back to weaken the broader economy as falling home prices lead to less spending and a further rise in unemployment and more defaults and so on. This scenario could see prices fall 20 per cent or so.”
Auction clearance rates have already fallen approximately 7% in a week, yet this is still up from 49% this time last year. It is yet to be seen what the extent of the impact COVID-19 epidemic will have on Australia’s housing industry.
Source RBA, ABS. Quarterly reports for March 2020, which would show the rapid fall in the equities market have not yet been released.
Australia’s residential housing market accounted for 8.6% of gross value added to the Australian economy in 2019. As of 2016 51% of Australian household wealth is held in real estate, with 39% of that consisting of a primary home.
Therefore, any potential increase in default rates due to falling house prices and falling labour rates would have significant consequences for the overall economy.
Australia is now more than ever vulnerable to a recession as households are burdened with debt at record levels. Debt-laden Australian households are unlikely to be induced to spend, with the potential falling house prices and labour rates just around the corner.