Irrational Exuberance Down Under

Housing is one of the three main pillars of the Australian economy. Unfortunately, all three are dangerously vulnerable to a Chinese slowdown.
Chinese buyers are snapping up Australian homes, but for how long?

Lindsay David's new book on Australia deserves a medical disclaimer: Reading this will greatly raise your blood pressure.

In "Australia: Boom to Bust," David sounds the alarm about an Australian housing bubble he argues makes the 12th-biggest economy a giant Lehman Brothers. His thesis can be boiled down to the number 9 -- the ratio of home prices to income in Sydney. The multiple compares unfavorably with 7.3 in London, 6.2 in New York and 4.4 in Tokyo (Melbourne is 8.4).

Housing is one of the three pillars of the Australian economy, along with financial institutions and natural resources. Politicians and investors alike, David writes, don't get "how deeply intertwined and connected" these sectors are and "how they can easily take each other down in a domino effect." The most obvious trigger would be a Chinese crash that simultaneously hits bankers, miners and households hard.

I caught up with David last week in Sydney at a Bloomberg conference where I helped grill Treasurer Joe Hockey about these very topics. When I asked Hockey point blank whether Australia faced a huge property bubble, he dismissed the entire premise out of hand.

"It is just an easy mantra for international commentators and for analysts based overseas to say, 'Well, there's a bit of a housing bubble emerging in Australia,'" Hockey retorted. "That is a rather lazy analysis because fundamentally we don't have enough supply to meet demand."

Two hours later, Australia's central bank raised concerns about "speculative demand" that "could amplify the property price cycle and increase the potential for property prices to fall later." If not exactly Australia's version of the "irrational exuberance" warning that will forever color the legacy of former Federal Reserve Chairman Alan Greenspan, that's still pretty strong language from a Group of 20 central bank.

The Reserve Bank of Australia wasn't rebutting Hockey; its concerns about an overheated housing market came in the minutes of its Sept. 2 meeting. Lazy analysis on the part of RBA Governor Glenn Stevens? Hardly. Nor are the folks at the Bank for International Settlements snoozing on the job when they warn that Australian housing is among the most overvalued anywhere.

There's something dangerously wrong when Australia's top economic official is blowing off fears of asset bubbles and heightened leverage. Sure, David's analysis can be hyperbolic in places. His bet that at least one of Australia's big-four banks will go bust, Lehman-style, or get nationalized puts him a bit out of the mainstream. On the other hand, Hockey's acerbic dismissal of the danger smacks of hubris. Home prices are seen rising between 8 percent and 12 percent in 2015 in Sydney and roughly 9 percent across Australia's major cities. How can that make sense, in an already frothy market?

The RBA could start raising interest rates, but that would slam homeowners. Better to address the problem via macroprudential policy steps like setting limits on leveraged lending, lowering price-earnings ratios and raising minimum deposit levels. Federal lawmaker Kelly O'Dwyer, who leads a parliamentary inquiry into foreign investment, wants stronger policing of rules restricting overseas purchases; Chinese demand is partly responsible for price surges in Sydney and Melbourne.

In a striking bit of serendipity, G-20 officials met in Australia over the weekend to chew over the very risks Hockey had just dismissed. The communique they issued concluded: "We are mindful of the potential for a build-up of excessive risk in financial markets, particularly in an environment of low interest rates and low-asset price volatility." In other words, low volatility will become problematic once rates rise. As the Financial Stability Board chaired by Bank of England Governor Mark Carney said on Sept. 18, investors are becoming complacent about financial-market risks.

On Sept. 16, Hockey made his own plea against moral hazard, saying "complacency is the enemy of economies around the world and none the least Australia." But one wonders if Hockey isn't engaging in a similar kind of denial. As I've written before, Australia needs to work much harder to diversify growth engines that seem to become more China-centric with each passing year.

Arguably, no top-12 economy will be hit harder and faster if China falters than Australia's. So feel free to focus on the good news in the so-called Lucky Country: an enviable 3.1 percent growth rate and 6.1 percent jobless rate in a nation that's been recession-free for over 20 years. But as author David contends, it's a "Disneyland" fantasy to think housing prices can't crash in a place whose future is so linked to Beijing's bubbles.

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