Australia’s central bank is warning home prices may threaten the country’s financial stability. Reserve Bank of Australia assistant governor Michele Bullock gave a housing update this week. She warns the quality of borrowers has been deteriorating, as they take on more leverage. As the share of these borrowers surges, so does the risks they bring with them. The central bank warns this can present a risk to financial stability, and as a result they’ll be watching them closely.
Highly Indebted Mortgage Borrowers Are On The Rise
The Reserve Bank sees two risks forming around banking and households. In regards to banking, housing makes up about 60% of outstanding loans. Concerns had brewed between 2014 and 2017 about a deterioration in borrower quality. However, the country addressed this with various tightening measures. This worked until the pandemic.
Recently Australians have been taking on higher and higher debt loads to buy a home. The share of mortgages with a debt to income (DTI) ratio of more than 6 now represents over 20% of originations. The deterioration is similar to the trend in Canada, after the pandemic-driven, low-rate housing boom. The Reserve Bank said they’re monitoring the situation closely. Strangely that’s also what Canada said.
Households Lose Flexibility and Become More Vulnerable As Their Debt Loads Increase
A more direct risk to households is also forming — a lack of financial flexibility. Most household debt is real estate related, and it takes a lot of debt to buy at these prices. Larger debt loads are more difficult to carry in an emergency.
“Households that have borrowed a lot to purchase a home relative to their income could, in the event of a shock to their employment status or income, find they are unable to continue to service their loans,” said Bullock.
If a person were forced to sell their home with a mortgage smaller than the value of the house, they can always sell. This is why you see few defaults during a bubble — if you get into trouble, you can just sell and walk away with a profit. It’s not because homeowners never go broke. It’s because it’s easy to walk away with a better outcome, also known as a “self-cure.”
Highly indebted borrowers with little equity are a totally different story. If prices make a sharp drop, they have negative equity. That would require topping up with money they don’t have before they sell.
“If the value of the home has fallen substantially since they took out the loan, they will be unable to ‘self-cure’ in this way,” she said. “In these circumstances, banks would incur losses and if there are enough, like in the GFC, there could be a substantial impact running from households to banks.”
Both of these risks are the result of the same issue — highly leveraged households. “… there is quite a bit of international and domestic evidence that suggests that households that have high levels of debt are more likely to curb consumption in response to shocks in income or wealth,” she said.
Curbing consumption tends to amplify economic shocks, by removing revenue from producers. This can result in fewer jobs, and less revenue — which ripples through the economy. If that happens, a home price correction can turn into a much larger, cross-industry issue.
“A large number of highly indebted households reacting in such a way to an economic downturn or decline in housing prices could amplify the economic shock,” she said. “A boom in the housing market, accompanied by an increase in housing debt could therefore make the economy more susceptible to downturns.”
Despite the tone, the central bank says they aren’t concerned about a housing bubble. They’re just monitoring highly indebted households, to see if action needs to be taken. “Whether or not there is need to consider macro-prudential tools to address these risks is something we are continually assessing.”
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