Hogwash!

There’s a few other words we could use, but that’ll do for now. The boys and girls at Fitch Ratings have given Australian banks the all-clear.

According to Bloomberg News, “Australia Can Handle Worst Mortgage-Loan Defaults, Fitch Stress Test Shows”. Well that’s alright then.

Bloomberg reports that:

“Banks would see a maximum A$10 billion ($9.9 billion) of losses in the third year of a severe mortgage stress scenario and mortgage insurers would lose a little more than A$7 billion.”

OK, what about the first and second years? Anyway, Fitch used three stress-test scenarios:

“Fitch is testing… mild stress, with mortgage defaults of 2.5 percent and a 20 percent drop in home prices; medium stress with 6 percent defaults and 30 percent decline in prices; and sever stress with 8 percent defaults and a 40 percent price slump.”

Let’s not kid ourselves on where we think the housing market is heading. We’ll ignore the “mild” and “medium” stress tests because those are nothing more than McDonald’s cheeseburger-sized blips en route to the Eagles cheeseburger-sized housing crash:

Not your editor eating a 5lb cheeseburger

Source: Eagles Deli, Boston

I mean, do the numbers. The estimated size of the Australian housing market is $3.5 trillion. Which is helpfully inflated by around $1 trillion of mortgage debt.

Those are pretty big numbers by anyone’s standards. It means you’ve got a loan to value ratio (LVR) of about 28%.

So if we take the value of Australian housing and apply the severe collapse in prices as modelled by Fitch, the total value of the Australian housing stock will fall to just $2.1 trillion.

And the LVR will increase to just under 48%.

Of course, that’s based on the entire housing market. But as the property spruikers are keen to tell us, about 30% have a mortgage, about 30% of people rent, and about 30% of people own their home outright.

So, we’ll adjust the numbers. Trouble is, it makes the result even worse, and we’re not even factoring in the super-leveraged investment property mortgages where paper profits are used as a “deposit” on an additional investment property.

But if we just look at the 30% of owner-occupiers with a mortgage, that puts the value of their properties at a total of $1.05 trillion. And according to the latest numbers from the Reserve Bank of Australia (RBA), residential mortgage debt stands at $672 billion.

That’s an LVR of 64%. More than twice the LVR than if you look at the mortgage position across all properties.

Now, if we assume a 40% drop in house prices as modelled by Fitch, you’re looking at the total value of the housing stock owned by those with mortgages falling to just $630 billion.

In other words, that segment of the market, those with mortgages, would be in negative equity.

Now, of course that assumes owner-occupiers don’t sell, or if they do then the buyer is buying with a similar amount of leverage.

And, considering that so much of household wealth is tied-up in the family home, the effect of those without mortgages selling into a falling market shouldn’t be discounted either.

If all you’ve got to live off in retirement is the equity in your home, odds are you’ll want to bail out while there’s still some value left in it.

But if we take Fitch’s numbers and say that 8% of this segment of the market defaults, that works out to around $53.8 billion of housing that the bank is left in the lurch with.

$53.8 billion of housing that it would need to sell into a depressed housing market. A housing market that has just fallen by 40% mind you.

How are they going to do that we wonder.

And considering a bank such as the Commonwealth Bank [ASX: CBA], currently holds around a quarter of all Australian mortgages, that puts its potential liability at at least $13.4 billion.

Even if you assume mortgage insurance will mop up say $5 billion, you’re still looking at the CBA holding $8 billion worth of property and defaulted mortgages.

And here’s the thing. You’ve got to remember that people’s behaviour changes under such extreme stress. Anyone can do some sober back-of-the-envelope analysis today when the markets are booming and flowers are blooming.

But all that goes to pot when the fit hits the shan.

Think about it this way. In late 2008 the Australian housing market didn’t collapse. It didn’t fall by 10% let alone 40%.

Yet how did the banks behave? What condition did the banks find themselves in during a time when the value of their biggest asset didn’t fall?

That’s right, the banks went crawling and begging to the Australian federal government for a bunch of taxpayer handouts. Handouts that prevented each one of them going bust.

Never forget this…

If it wasn’t for the Australian government guaranteeing the deposits of every dollar in a savings account, Australia’s banking system would have collapsed.

If it wasn’t for the Australian government guaranteeing the wholesale debt issued by Australian banks, Australia’s banking system would have collapsed.

If the Australian Office of Financial Management hadn’t agreed to use taxpayer dollars to buy residential mortgage backed securities, Australia’s banking system would have collapsed.

And if mortgage funds – such as Commonwealth Bank owned Colonial – hadn’t frozen redemptions on those mortgage funds, Australia’s banking system would have collapsed.

That’s why I tell you that the so-called stress test by Fitch is hogwash. We dare say it’s based on fancy computer models. Computer models that are based on various inputs. Perhaps they’ve factored in job losses and higher interest rates too.

But there’s one thing no fancy computer model can accurately predict, and that’s human behaviour.

When people are put under stressful conditions they may do and act in ways that no-one could possibly imagine. I mean, even in non-stressful conditions people do things that defy logic.

But there’s something else which we dare say the brain-bods at Fitch haven’t considered. And that’s the Ponzi nature of the banking system.

Banks exist on the basis that the supply of money into its vaults will constantly increase. As long as more money is created it means more money will be deposited and therefore it can use that as capital to create even more money.

The problem arises when the flow and creation of new money stops – deflation.

If a bank such as the CBA has lost several billion dollars on mortgages, it has to cover that money from its own pockets to make sure depositors are made whole on their deposits.

And, if property prices have just fallen 40%, even if there are people who are prepared to borrow, they’re going to need to borrow less as property is cheaper.

And of course, not forgetting all those defaulters – 8% of borrowers – who are no longer credit-worthy. Ask any business what the impact on their revenues would be if 8% of their customers were suddenly not in a position to buy from them anymore.

We doubt that they’d just shrug their shoulders and not worry about it.

That’s why it’s important to consider how banks really work. This is where we get back to fractional reserve banking.

Remember how people swarmed the banks in the UK and the US to withdraw their deposits as soon as there was a whiff of trouble at the banks. Well, take a look at the latest Commonwealth Bank annual report.

The CBA records in its balance sheet that it holds $374 billion of “deposits and other public borrowings.”

Yet, if you look in the Assets column you’ll see the bank holds just $10.1 billion of cash and liquid assets. And if you drill down further you’ll see that the CBA holds just $3.09 billion in “Notes, coins and cash at banks” in its Australian vaults.

In other words, it tells its customers that their cash is available when they want it, yet less than one cent on the dollar is sitting in the CBA’s vaults.

So, run it past me again. If Australia’s property market collapses by 40%, according to Fitch, this will only have a negligible impact on the banking system.

Yeah right.

In the Utopian world of the ratings agencies they seem to believe that individuals will just grin and bear it. That there won’t be a run on the banks, people will continue taking out new mortgages to buy up all the cheap properties, and the government won’t need to put taxpayer dollars on the line again to bail out the banks.

As we said at the start, that’s utter hogwash. You saw the panic that consumed the bankers, the government and the bureaucrats in 2008.

And you saw how individuals reacted both here and overseas – they panicked too.

We wrote yesterday about Black Swan events. Events that are unpredictable.

Well, it’s likely that the housing market will collapse as a result of an unpredictable event. Whether that’s something that causes a rise in unemployment or something else – we don’t know.

But what we do know is that an analysis of the Australian banking system and its exposure to the housing market can’t be analysed in isolation. The housing and banking collapse will have a major impact on other sectors of the economy and that in turn will feedback to impact the housing and banking markets.

As much as the pointy-headed graduates who fill the corridors of the ratings agencies, the banks and government bureaucracy believe that they can model for and avoid a collapse of the banking industry, the fact is they can’t.

The very structure of the Australian housing and banking system means that it is ultimately destined for collapse. Reports such as the one from Fitch, only succeed in spinning the tired and stale old yarn about Australia being different.

It isn’t. It’s exactly the same as everywhere else. The only difference is that most people haven’t figure that out yet.

Cheers.
Kris Sayce

Yep, yet again the same old articles telling you everything is okay with our property sector, have hit the papers again.

In fact, this one must have fired many of our readers up, as within hours of the article being posted on the web, the Money Morning inbox had received about ten emails, begging Kris to ‘Make a meal of it’. ‘Tear ‘em to shreds’ was another suggestion.

Now while it’s extremely tempting to ‘Tear it to shreds’, there’s no new ideas to explain why property’s in a bubble. Then you have this article, where they’re just rehashing the suggestion that those who say ‘property’ and ‘bubble’ are just a bunch of doom and gloomers.

It’s the same old reasons you’ve been hearing now for a couple of years – that Australia has a massive under supply of housing, we don’t have a subprime market like America, we have low mortgage delinquency rates, the cash rate is returning to normal, and my favourite, ‘immigration’…

These ‘ideas’ used to support that housing isn’t in a bubble aren’t new. But I’m sure you’re tired of them.

Many times over the past twelve months Kris has pointed out why each of these reasons just doesn’t hold up. Especially when the ‘chronic’ under supply of housing figures are based on statistics of homeless people.

In fact I’m sure you’ve heard about it so many times I won’t go into it again! But you can refresh yourself on his thoughts here…

Look, Australia doesn’t have a subprime market, but we still have home owners that were lured into the market at the wrong time for them. Yet, it was right time for banks and real estate developers.

When these first home buyers in particular, put their hands out, they were fed with cheap credit. And because of this, they were able to get their own little piece of the Australian property dream.

Low rates, 105% loan value ratios (LVR) and interest-only mortgages was the diet of choice to enter the property market.

It’s pretty easy to suggest that we don’t have a subprime market, and perhaps we don’t in the strictest meaning of the word. But, we do have an alarming number of people that entered the market on high LVR’s, helped by first home buyer hand outs from both the federal and state governments.

Not to mention that an overwhelming number of these people would be in the group that pays 50%of their wage to their mortgage.

It’s this group of people that are now beginning to feel the effects. Unlike America, we are at all times responsible for our debt. We can’t just hand the keys in and walk away, which was an option for hundreds of thousands of people in the U.S.

And yet, this group isn’t considered subprime. Yet any collapse in property would cripple this group first.

Just like the in U.S. where the subprime borrowers were the first to be hardest hit.

Then you have the most recent figures from the Reserve Bank of Australia showing that the household debt to disposable income ratio. This means that Australians are ‘re-leveraging’ at the wrong time.

However, with some experts tipping the cash rate to increase as much as 1.25% over the next twelve months, we might not be looking at a subprime crisis, instead we could be looking at an ‘everyone’ crisis.

Basically you have an enormous group of people that potentially could end up paying as much as 60% of their disposal income to their mortgage.

What happens if this over-leveraged group lose their jobs? This could be the biggest threat to the housing market.

‘As long as people keep their jobs, it should be OK,’ Said Dr Edda Claus, a research at the Melbourne Institute.

So an overwhelming number of home owners are relying on the unemployment number to remain at 5.1% or better.

A level at which many believe is the height of the employment market. If that’s the case, isn’t it all downhill from here?

If that’s not a cause for concern then I’m not quite sure what is.

Now let’s have a look what happened on the markets yesterday…

The S&P/ASX 200 edged slightly higher to finish 8 points up, closing at 4,633.60. The Aussie market has opened down, and one dealer has tipped the Aussie market to close 70 points lower today.

The Dow Jones Industrial Average fell 76 points, closing at 10,662.42. Jobless claims surprisingly increased for last week.

The FTSE was slightly lower, closing 4 points down to 5,541.08. There were come concerns over European data showing that growth in for services and manufacturing in the Euro zone was slowing.

And finally the Nikkei dropped 35 points, ending at 9,566.32. Many analysts have tried to understand the ‘never-ending’ decline to the Nikkei without success. Read more about it here.

The price of spot gold in Australian dollars is trading at $1,363.04 while in US Dollars it is trading $1,294.07. The price of silver in Aussie dollars is $22.27 and in US Dollars it is $21.14.

The Aussie dollar versus the US dollar was USD$0.9493, and against the Japanese Yen JPY 80.23.

Crude Oil was higher, closing at USD$74.84.

For the biggest movers on the market yesterday click here…

That’s all I have you this Friday, have a great weekend.

Shae.

Right now, Kris is on a plane from Baltimore to Boston, so he won’t be joining you for Money Morning today.

But he will return next week with all of the highlights from his trip. And yes, we may even be subjected to another cheeseburger rating!

***

Those ‘bad’ Australian banks are back.

They’ve returned to their ‘reckless’ lending practices once again.

And while the PR that is surrounding these renewed lending practices is all about ‘Helping those first time home buyers’, it actually reeks of something much more sinister.

Three of the major the banks have actually lifted their loan to value ratios (LVR), which means that in some cases, you can now borrow up to 92% of the value of the property for new borrowers.

But if you’re an existing borrower you could get a loan for as much as 97%!

The idea is that if they increase the LVR’s people are able to borrow more. And save less of a deposit, and that they are helping people get into their first home, or a bigger home.

And, clearly, adding to the property bubble.

But the banks have denied they’re fueling the house price growth problem (go figure), with Westpac releasing a statement saying: ‘This change reflects our growing confidence in the economic environment, reflected in the low level of delinquencies for this market segment.’

Isn’t it a relief to know the banks are only trying to help us?

However, Professor Steve Keen explains best what happens when you raise LVR’s:

“Banks need to keep on lending but, with house prices rising, they have to lend more – Westpac customers will now be able to borrow almost double what they could before.

“Little changes in LVRs have a massive impact on what you can borrow. If you need a deposit of 13 per cent and have $50,000 saved up, that cash will enable you to spend $384,000 on a property.

“But if the bank will lend 92 per cent, your $50,000 will allow you to buy a property worth $625,000.”

Then you have Mortgage House, a non-bank lender, which has said due to demand it will offer 105% loans against the property’s value as of next month. It already offers 99% loans.

One property investor and blogger was clearly over the moon about the new lending criteria…

‘…banks are FINALLY noticing that they need to do something to get the property cycle moving again.’

Yes, big bad banks. It’s all up to you to get the property sector moving along again. So no matter how many times the mainstream press ignore that lending has played a major role in the housing boom, one lone property investor has managed to put the two together.

And yet, the banks are still trying to assure you that it’s not one final attempt to ramp up the overheated property market, but more a response to economic conditions?

Puh-leese!

The whole move to increase the LVR is really just one last attempt to get some new lending on the books for the banks, before, as the Saycemeister would say, the whole ponzi scheme falls in on itself.

The property blogger, doesn’t see it that way.

Let the last lending frenzy begin…

Too many eggs in the banking basket?

And while we’re on the topic of banks, retail investors that hold shares have on average a 65% exposure to financial stocks in their portfolio.

This is compared to institutional investors that have about 20% of their portfolio in financial stocks.

Is it simply a case of retail investors wanting a share of the banks enormous profits? Or is it just that people view Australian banks as ’safe’?

Dare I suggest that it could be lazy investing? ‘Everyone else is buying bank shares so why don’t I?’ sort of attitude?

As you know, your editor Kris Sayce wouldn’t buy bank shares if you paid him to. In fact, he’s always looking for a shorting opportunity with the banks.

So, if an alarming number of mum and dad investors have the majority of their money invested in banking shares, what does this mean when the housing sector inevitably falls over?

Not only are you looking at a bunch of shocked and debt laden property investors, but chances are you are going to be hearing from confused and very unhappy shareholders demanding to know what went wrong.

After all, how could something go wrong with Australian banks? Aren’t they one of the strongest in the world according to the ratings agencies Fitch and Standard & Poor’s?

Don’t forget, that rating of ’strong’ comes from the very same companies that rated subprime mortgages on sold to investors as AAA.

Now let’s have a look what happened on the market’s yesterday…

The S&P/ASX 200 wiped off 56 points, closing to 4,605.30. The market has opened higher this morning despite the mixed lead in from international markets.

The Dow Jones Industrial Average added 22 points to end the day at 10,594.83. FedEx [NYSE: FDX], while not a component of the Dow, dropped 3.8% after announcing that it would shed about 1700 jobs in an effort to save money. This move comes as the company reported its profits doubling I their first quarter revenue.

The FTSE lost 15 points, closing at 5,540.14. The market fell as a report showed an unexpected decrease in retail sales for August.

And finally the Nikkei lost 7 points, finishing at 9,509.50. The yen weakened slightly overnight and the Japanese market has been tipped to open higher as a result.

The price of spot gold in Australian dollars is trading at $1,360.52 while in US Dollars it is trading $1,273.78. The price of silver in Aussie dollars is $22.12 and in US Dollars it is $20.71.

The Aussie dollar versus the US dollar was USD$0.9359, and against the Japanese Yen JPY 80.36.

Oil was lower overnight. Crude Oil closed at USD$74.55.

For the biggest movers on the market yesterday click here…

That’s all I have you this Friday, have a great weekend.

Shae.

[Please note: neither the authors nor any of the employees of Port Phillip Publishing own shares in any of the stocks discussed in Money Morning unless specifically stated. The articles do not give trading or personal investment advice, but are intended to provide a useful, independent news and analysis service to supplement your own investing and trading. Consult your financial advisor before making any investment decisions.]

We were heartened by news yesterday that Standard & Poor’s (S&P) had given an AAA rating to $920 million worth of residential mortgage-backed securities issued by Westpac Banking Corporation [ASX: WBC].

According to S&P:

“The preliminary ratings reflect our opinion of the transaction’s credit support, collateral pool, servicer, and other features based on our current criteria and assumptions.”

But let’s make one thing clear, the mortgages backing these securities are – apparently – ‘prime.’ In other words they are not ’sub-prime.’

Based on the details in today’s The Age newspaper:

“The weighted average loan-to-value ratio (LVR) of the mortgage pool is 58.3 per cent and less than 1 per cent of the loans have an LVR greater than 80 per cent. The average life of the loans is three years. There are no low-documentation loans in the pool.”

That’s alright then. But Westpac did also take the opportunity to throw some rubbish out as well. It’s flogging $55 million worth of AA rated securities, and $25 million worth of unrated stuff as well.

So, what does this all mean? For a start this $1 billion issue of residential mortgage backed securities (RMBS) is a mere drop in the pond of the total RMBS market. According to the Reserve Bank of Australia there is over $128 billion of RMBS outstanding.

Of that amount, about $7.7 billion is owned by the Commonwealth Government through the Australian Office of Financial Management.

And it’s just a drop in the ocean compared to the $12.9 trillion worth of off-balance sheet business the banks have floating around in OTC forwards, OTC swaps, credit derivatives and other tasty morsels.

But what this RMBS issue also means is that the bank is desperate to get its hands on more cash.

You can see that from the banks’ advertising. If you look at the interest rates being charged on loans and compare it to the rates being provided on term deposits it’s a revealing picture.

Take out a variable rate home loan with Westpac and you’ll pay around 6.11% in interest.

Take out a 12-month term deposit and you’ll receive up to a 6.8% interest rate.

But even if you compare the term deposit rate with the fixed mortgage rate Westpac is still running it at a loss for the first year. Its 1 year fixed rate is currently 6.54%.

Clearly the banks would only do this if they believe interest rates are going to rise further. You can take that 6.8% term deposit rate as the low-ball figure of where mortgage interest rates will be by the end of next year.

In fact, you should try something closer to 8%.

The issuing of the RMBS means that Westpac gets to flog off a bunch of mortgages and in return it will get cash from the investors in those securities. Naturally, it can dish the cash out to provide even more home loans.

And so the lending glut continues. It can never stop.

Although there could be trouble on the horizon if lending by the banks does drop by 9% next year as forecast by Market Intelligence Strategy Centre (MISC).

It believes the value of new home loans will be $14.4 billion lower through the year to September 2010.

If there’s one thing that events over the past twelve months have shown you, it’s that banks are as far from being stable and conservative investments as you can get.

Their actions truly are a sign of desperation. Now, don’t get me wrong, I’ve got no problem with the banks putting up interest rates. They never should have been slashed so low to begin with.

The very reason the banks are so desperate for cash now is because they’ve gorged themselves on giving out ultra-cheap money over the last twelve months.

While the mainstream press slams the banks for increasing interest rates just in time for Christmas, we slam the RBA and the banks for enticing borrowers to load up on cheap debt. Cheap debt which they know full well will lead to pain for borrowers twelve months from now.

And we slam the mainstream press for supporting them with their “Houses set to boom forever” headlines.

But it’s not just Westpac. It’s all of them. It’s the entire framework of banking that’s rotten. You may recall we likened the ANZ retail share offer earlier this year as being like taking “Lambs to the slaughter.”

At that point ANZ Bank [ASX: ANZ] shares were being offered to the market at $14 per share. Don’t touch them with a barge-pole was our general advice.

Since then ANZ Bank shares have risen by 50% and those investors that bought at $14 would have done quite nicely.

Do we regret missing out on that price action? Are we embarrassed that we got the call so wrong?

Nope.

As we’ve written before, with over 1,800 shares listed on the Australian stock market we just don’t see the need to take such a massive risk on four rotten companies (ANZ, Commonwealth Bank, NAB and Westpac) that claim to be ’safe as houses’ but which are nothing more than super leveraged bets on themselves and the housing market.

As far as I’m concerned, investing in bank stocks is no less risky than playing Russian Roulette. An investor may have been lucky over the last few months, but soon enough the banking crooks will deliver a ‘bullet’ to investors’ heads.

Besides, when we looked at the issue of the RMBS by Westpac, something else struck us.

It was this comment by S&P:

“This will be the first issuance of securitized mortgage loans originated by Westpac Banking Corp. (AA/Stable/A-1+) for 2009.”

We won’t claim to be an expert on the workings and theories of ratings agencies. I’m sure they’ve got all kind of fancy models that gives them guidance on the rating level.

And we’re sure there’s a bit of subjectivity in there as well.

But here’s the thing that amused us. It’s the fact that S&P considers a bunch of home buyers to be a better credit risk than Westpac. In fact it considers a bunch of home buyers to be a better credit risk than all Australia’s banks.

After all, the best rating the banks can get is AA. Whereas ‘moms and pops’ in the suburbs can get themselves an AAA rating – providing they’ve got a mortgage!

I know we’re only talking the difference between AAA and AA, but the difference is perhaps somewhat symbolic and telling.

It’s a good indicator of how leveraged and risky the Australian banks are. Let’s look at this comparison. If you’re a lender and you had the choice of lending to Party A that was leveraged by about 12 to 1 or to Party B that was leverage by around 2 to 1, you’d see that Party B provided the lower risk.

And that’s exactly the conclusion S&P have made. Banks are leveraged to the eyeballs. Sucking in cash from sucker depositors and then lending it out to anything with a pulse.

That’s what makes the rating so bizarre.

Normally you’d expect investors to have greater faith in a big company to repay than you would in individuals.

Especially when the big company – the bank – has a diversified range of assets at its disposal whereas the home buyer has most of his/her assets concentrated in just the home.

I mean, if BHP Billiton sold securities against individual assets to investors, you’d think that most of those assets would attract a lower risk rating than that given to BHP.

But look, maybe I’ve got all this wrong. Maybe it’s normal for individuals or groups of home buyers to have a better credit rating than a multi-billion dollar bank.

Maybe this is just how things work in the banking and finance sector.

Who knows? On this occasion perhaps the ratings agencies have got it just right.

But for your editor it’s another reason to give banks a wide berth and allow other investors to ‘enjoy’ the returns they’re getting from those ’safe and dependable’ 4 Pillars.

Cheers.
Kris.

60-Second Market Round Up
by Shae Smith

The S&P/ASX200 finished up slightly yesterday to 4,654, higher by 18 points. The news of the Dubai debt relief lifted the market higher at the end of the day.

The Dow Jones Industrial Average added 29 points to close at 10,501.05. Citigroup has come up with a plan to repay the bail out money.

Overnight in the UK, the FTSE finished higher to 5,315.34, up by 1.02%.

The Nikkei finished the day at 10,105.68, up by a tiny 2 points.

The price of spot gold in Australian dollars is trading at $1,230.20 while in US Dollars it is trading at $1,126.99. The price of silver in Aussie dollars is $19.00 and in US Dollars it is $17.41.

The Aussie dollar versus the US dollar is trading at USD$0.9173, and against the Japanese Yen JPY81.27

Crude oil has continued its downhill run, closing at USD$69.59.

For the biggest movers on the market yesterday click here…

You may have seen the press reports about China signing a $50 billion deal for a gas supply from the Gorgon field off Western Australia.

The great thing is, this is just the tip of the iceberg for Australia’s LNG industries. I’ve been banging on this drum for the past year, picking up some massive gains for Australian Small Cap Investigator subscribers.

The good thing for you is that it’s still not too late to get in on the action. Click here to find out more…

Australia’s Mortgage Insurance Time Bomb

What a relief the Australian banking system is in much better shape than those awful banks in the UK and US.

You remember how bad they were. So bad they collapsed. They collapsed, in part due to dodgy lending practices and over-valued property prices.

Something we are told will never happen here.

I’ll go through the details in a moment.

But first, if you thought the housing market was going to crash, well, just get over it. It’s not going to happen. Who says? David and Libby Koch that’s who.

In their joint column for News Limited, Dave & Lib tell readers:

“It is very unlikely that the Australian residential property market will plunge anywhere near the extent of that in the US, because we haven’t been through a huge construction boom, borrowers haven’t leveraged themselves to quite the same extent and we have strong immigration to underpin demand.”

That’s right, as much as you may think Australia has been through a construction boom, it hasn’t.

And as much as you may think Australian borrowers have leveraged themselves up on real estate, they haven’t.

Not only that, but we have lots of immigrants who are buying the houses the non-construction boom hasn’t built.

Therefore we can thank Dave & Lib for putting everyone straight on the Australian property market. If only we’d known before, we wouldn’t have wasted your time writing about a property crash.

But before we hang up our boots, we’ll make the effort to finish their article.

Let’s see what else they have to say:

“The banks are starting to ration credit that means they’re making it more difficult for people to borrow money. The banks are lifting their standards.”

“We’re starting to see the good old-fashioned request for a 15-25 per cent deposit on a home loan and mortgages where the repayments must be less than 30 per cent of the borrower’s income.”

“Tightening the criteria for home loans means fewer borrowers will be eligible for a loan than before, so there will be fewer potential buyers and less competition in the market.”

“Last week’s housing finance figures saw new housing loans at 17-month highs and loans for new home construction at a seven-year high as first-home buyer grants from the federal and state governments kicked in.”

“The only concern is the property bubble at the first home-owner end of the property market for existing homes could deflate when these incentives finish.”

“Hopefully, investors will come back in to the market at that time and fill any void that first homeowners leave.”

“First-home buyers still account for 27 per cent of all new home loans being written, while investor lending continues to fall.”

“Investors should come back to the market in the not too distant future as interest rates stay low, the share market continues to improve and rents remain high.”

“The key is the rental market. As vacancy rates stay low and rents continue to rise, investors will start to trickle back in to the property market. A problem at the moment is that many investors target the currently inflated first-home buyer unit market and are simply waiting for that to cool off before they move in.”

Boy! It looks like we were about to hang up our boots too soon. Seems like Dave and Lib have got absolutely no idea how markets function.

The more they write about there not being a property crash the more they bolster the argument for a crash.

It looks as though they truly believe the combined efforts of the Government, RBA and the banks are capable of micro-managing a ’soft-landing’ for the housing sector. We can picture it now…

“Tighten the interest rates… no, not that much, that’s it… tighten the lending criteria… nearly… a little bit more… stop construction, no not yet… NOW! Oops! One house too many, right ease interest rates, loosen the lending, and… Who let that immigrant in? Now we’ll have to start again!”

Not only do Dave & Lib believe the policy makers can micro-manage an economy, but those trying to manage it also believe they can pull it off.

But rather than analyse every word of a third-rate property spruik, we’ll simply cover off the single underlying theory to Dave & Lib’s argument…

That the banks are much more conservative because they have tightened their lending standards… which apparently were never slack to begin with.

The banks like to spin the line that they are lending responsibly, and the bank-loving commentators lap it up. “Australian banks are better than anywhere else because they haven’t collapsed” seems to be the gist of the argument.

So, we thought we’d take a look at the facts. Have the banks really tightened their lending standards? Well, they may tell you that, but the reality is far different. Here’s a snippet from the CBA website:

“If you have been a home loan/personal loan/credit card customer of the Commonwealth Bank for the past 6 months, you may be able to borrow up to 95% of value of the property, as long as you are not in arrears or have missed any payments. Your account needs to be currently open.”

“If you have not been a home loan/personal loan/credit card customer of the Commonwealth Bank for the past 6 months, or if you are a new customer to the Commonwealth Bank, you may be able to borrow up to 90% of value of the property, as long as you contribute 5% of the deposit in genuine savings, (excludes the First Home Owners Grant).”

In other words, existing lending customers of the CBA can borrow up to 95% of the value of the property. And that can include the first home owners grant.

Why is the CBA offering 95% mortgages when we’re told it lends responsibly?

Simply because of something called Lenders Mortgage Insurance (LMI). LMI isn’t new, it’s been around for years. I’m sure you’re familiar with the concept. And you may also know that LMI is available in those rotten UK and US markets as well.

But just in case you aren’t familiar with how it works, here’s Lenders Mortgage Insurance 101…

In a nutshell it allows banks to dish out loans to almost anyone and palm off the increased risk to an insurance company. But don’t think they palm off the entire risk, because they don’t.

In effect, with a 95% loan the bank is only getting out of the difference between 80% (the amount at which LMI cuts in) and the 95% level.

In other words if a borrower takes out a loan for $300,000 on a $315,000 house and then fails to keep up repayments, the bank will only suffer a loss on its books if the house fails to sale for at least $252,000.

Of course that would mean property prices would have to fall by 20% for such an event to happen.

That’s not likely. Is it? Well, not if you believe Dave & Lib, Michael Pascoe, Christopher Joye or Rory McGrath. But if you take a look at the table below from Global Property Guide, you’ll notice that prices haven’t had to fall by a huge amount for it to have a massive impact on the banking industry:

US regional banks are still going bust. About 70 have gone out of business so far this year. And more will follow.

But don’t forget one very important thing. A major reason behind the collapse of markets in the US and the UK wasn’t just because of what the banks were carrying on their balance sheets.

US and UK banks, just like Australian banks, were able to lay the risk exposure off elsewhere. In the US it was laid off to Fannie Mae, Freddie Mac, AIG, Lehman Brothers, Citigroup, etc…

That meant the financial institutions accepting the loans were prepared to accept higher risk clients because they knew they could pass the risk on and only face any exposure if the ‘impossible’ happened and the housing markets collapsed.

Only that was the other problem. The banks leveraged themselves up so much to the ‘impossible’ never happening that it took a much smaller rise than expected in delinquencies for it to have an impact.

You know what they say about leverage increasing your returns and your losses. It seems as though the banks and insurance companies made a classic schoolboy error of underestimating the downside risk.

So, what about Australian banks? Well, now might be a good time to take a look at where our banks lay off their risk.

In the case of Commonwealth Bank, it offloads its LMI risk to a company called Genworth Financial Inc. They’re the ones that take on the risk of a defaulted property price falling from $315,000 to $252,000.

This is where we get a real picture of the lending standards in the Australian market. Take a look at this snapshot from the Genworth Financial underwriting policy:

Click to enlarge

You’ll notice it says “Borrowers who have saved a deposit are generally more likely to be prepared for difficult circumstances.”

Yet despite that, the ‘Homebuyer Plus’ LMI product states the deposit requirement (Genuine Equity Requirement) is “Nil.” That’s right, no genuine savings required.

And who is the ‘Homebuyer Plus’ product aimed at? Again, the Genworth underwriting policy explains all:

“Suited to borrowers, including First Home Buyers, wishing to purchase or construct owner occupied property with limited or no savings… Borrowers do not have to contribute any of their own savings, allowing these funds to be used for stamp duty, renovations or setting up their own home. This also means a borrower does not need to wait to save up their own deposit before entering the property market.”

There you have it, our financially conservative and responsible banks are not financially conservative at all. They are – and have – taken on virtually any risk profile of borrower they like.

Or rather, any borrower that satisfies the non-rigorous standards of Genworth.

And to put it in perspective, Genworth boasts it insures “over 5,000 residential mortgages every week.” That’s a lot. In fact, based on the recent Australian Bureau of Statistics (ABS) numbers for housing finance, that equates to about 32% of all mortgages that require LMI.

In fact, according to Genworth’s 2009 Mortgage Trends Report:

“58% of borrowers who took out a mortgage in 2009 did not have a 20% deposit, compared to 47% of those who took out a mortgage in previous years… Overall, 35% of borrowers in 2009 took out a loan with a 90%-100% loan to value ratio (LVR), compared to 21% in 2008.”

I’ll just leave you with these comparisons from the recent Commonwealth Bank analysts’ presentation. It was another attempt by Ralph Norris to explain that the CBA is so much safer than UK and US banks due to CBAs high exposure to residential property.

As you can see on the top two charts, the UK and US have 17% and 15% exposure to home loans…

Click to enlarge

… by contrast, CBA has on this following chart a 49% exposure (although elsewhere it claims it is 56%, so we don’t know what to believe!)…

Let’s get one thing clear. Whether CBA has a 49% or 56% exposure to home lending, it is not something for them to crow about.

The facts are clear, Australian banks and the mortgage insurers now find themselves near the precipice. The property ponzi scheme is nearing its final crescendo.

It is the point at which the final burst of activity pushes the market on one last great leap forward before the whole sham falls apart at the seams.

And the best the property spruikers can come up with is some vague and unquantified notion of a chronic housing shortage, and that immigrants will keep our home prices from falling.

They’re gonna have to try better than that.

Other Stuff on the Markets

The S&P/ASX200 fell 0.12% yesterday, while there was marginally better news overnight on Wall Street with the Dow Jones Industrial Average adding 4.76 points. In Europe the FTSE100 gained 0.45% and the CAC40 added 0.54%.

The price of gold in Australian dollars is trading at $1,164.97, while in US Dollars it trading at $914.06.

The Aussie dollar strengthened slightly versus the US dollar and Japanese Yen, trading at USD$0.7846, and JPY72.79.

Further strength for Crude oil overnight, closing at USD$60.74.

For the biggest movers on the market yesterday click here…