Safe as houses?

As I wrote about last week, people are fretting about the housing market. In Australia, New Zealand and Canada, among the world’s frothiest markets, home prices have been declining in recent months, in some cases sharply, with the prospect of tighter credit and higher borrowing costs to come for their already-stretched borrowers and their tottering castles of mortgage debt.

Enter Reserve Bank deputy governor Michele Bullock, trotting out on Tuesday what may be the bank’s mantra on the housing market for some time: Keep calm, carry on, most borrowers will be fine.

The argument goes like this. Now, most mortgagees have large cushions of savings (courtesy of the pandemic) and even larger cushions of equity (courtesy of house price madness). Those with the highest debt loads are often the wealthiest, which better enables them to service debt. In short, while most borrowers will find the payment shock an unhappy surprise, deadly electrocutions will be exceedingly rare.

Here are four reasons to worry more.

First, it’s a red herring to focus on the households that will sail through, relatively unscathed.

Most people survive crises. Systems crush under the weight of the most vulnerable. During the worst of the Great Depression in the 1930s, unemployment reached a high of about 20% in Australia and 25% in the US. In the worst economic crisis in modern history, four times as many workers kept their jobs than were laid off. Mortgage delinquencies in the US topped out at 11.4% in 2010 in the aftermath of one of the worst housing crises in history. During Spain’s epic housing downturn, delinquency rose to 13.6% in 2014, according to Statista.

One in 10 delinquent mortgages is a catastrophe. Unemployment or delinquencies move into double digits, stay there and keep climbing, and you’re on the brink of social collapse.

What number should worry us? Nobody knows, but it would likely be in the single digits – think across two hands – according to REA Group senior economist and former Reserve Bank staffer Paul Ryan:

“It’s THE 64-million-dollar question in financial stability,” he says. “What’s the one number that you have to pay attention to? You do have a segment of people; it's probably in the low single digits that would create problems for the financial system.”

So what share of households appear to be in a precarious position? Just half of Westpac’s home loan customers, as measured by account balance, are a month in advance on their repayments. About a quarter of those borrowers are risky new customers. One-third of Commonwealth Bank’s home loan portfolio had fewer than 30 days worth of buffer, and of that about a quarter were new customers.

“Those are enough of a chunk of people that you’d start to worry about the delinquency rates,” Ryan says.

Second, a lot of those vulnerable households are in for a massive repayment shock.

I noted last week that the Reserve Bank’s scenario analysis from April 2022 which assumed a 2 per cent increase in interest rates was recklessly out of date. Somebody must have been listening! Bullock released new statistics that indicate if there is a 3 per cent increase in the cash rate, one third of variable-rate borrowers will have their repayments increase by more than 40 per cent. And with the Reserve Bank’s research not including split loans, these figures are believed to be higher.

Some of these borrowers might be the least buffered. You don’t need to have a lot of it to get nervous.

Those who hoovered up fixed-rate loans during the pandemic face a harsher shock. The vast majority of the loans will come to an end in the next 18 months and the Reserve Bank has calculated that just less than half will have to endure repayments spiking by 40% to 60%.

The bathtub-plug effect also applied to fixed-rate borrowers. These households have months, the Reserve Bank rightly notes, to prepare for higher rates. But millions of borrowers saving money for a rainy day imposes an economic cost. Each dollar stashed would otherwise have paid wages at a cafe, or a cinema.

Third, even for those with savings cushions, some may not draw them down entirely.

The Reserve Bank has been spruiking the $260 billion of household saving as a buffer against the looming mortgage repayment shock. But Ryan says households that have fallen behind on their bills will not continually empty savings. They’re less likely to proceed with cuts in cities, which in turn could put more pressure on some of the property market, or on spending, threatening a rise in unemployment.

“Borrowers get to a point. We can’t pay our mortgage. We have some savings but we can’t do this long term. It’s at that point that they start thinking about what they can do to solve that situation.”

Lastly, Bullock’s modeling doesn’t allow for the risk of higher unemployment, arguably the primary driver of mortgage stress.

The exclusion is not entirely unjustifiable: Little good actually can come from a mortgage facing the loss of its primary breadwinner. Why model a comet strike? It will be messy.

It certainly appears that the Reserve Bank is awake to the unhealthy feedback loops between housing and the economy. Here’s Bullock signing off for her speech:

“Job is the best way of making sure that you can meet repayments of your loan. How far the Board lifts rates will depend on the way the economy evolves, and in particular how borrowers respond to higher interest rates.’ “We will continue to judge where the risks might emerge.

Even if Armageddon is averted, mortgage stress is bad for Australian investors, who are highly geared to banks. Evictions are slow, costly and unsightly. Banks have plenty of motive to assist borrowers who are facing hard times by postponing or temporarily reducing repayments. Profits will take a hit.

Catch up on what you missed earlier this week right here. For a look at the ANZ-Suncorp merger, my colleague Nicola has you covered.

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