How the crash will play out

It’s a train wreck that keeps on giving. If there’s a crash, this is where it will come from.

Foreign banks are queuing up to get on board a train that’s already in flames.

Every other day you hear stories about the eye-popping glut in high-rises, about how prices are already falling, sellers are getting more desperate to sell, and about how such and such a bank has decided they wouldn’t touch them with a barge pole.

I’ve been warning buyers for two years now. But still people are buying tickets for a train already coming off the rails.

Isn’t the market marvellous?

In recent weeks we’ve heard how some banks have black-listed lending to foreigners, or are being much more stringent with their loan applications.

(That said, it’s coming off a pretty low base. Apparently you didn’t need to offer any proof of income if you were a foreign buyer before…)

Developers started to freak out. Settlement-risk started looming large, as banks cut the credit taps.

But then Da-Ta-Ta-Daa, it’s small foreign banks to the rescue.

The Australian was reporting over the weekend:

Rich-listers and wealthy private investors are setting up funds aimed at lending to foreign apartment buyers left stranded by the banks’ lending bans, in a move that will create a new tier of subprime lending…

Bill Moss, former head of property for Macquarie Group, expects Asian banks, particularly from China and Malaysia, to enter the Australian market in a bid to bridge the funding gap…

“This is subprime lending,” Mr Moss said. “It is no different to what happened 10 years ago on low-doc lending.”

The loans were made against the value of the asset, not the borrowers capacity to repay the debt, he noted…

“At some stage there will be a problem in the apartment market. There is the risk of a crash and the construction of new buildings will stop”…

Mr Moss said apartment prices in some areas could drop by 30 per cent in a year…

I’m not sure what barrow Moss is pushing. 30% in a year is pretty extreme. But we should all be worried about the entrance of sub-prime players into this market.

Sub-prime, by definition, is lending to borrowers who are too big a risk for the major banks.

And why would they do it? Why would they take on borrowers big banks won’t touch.

Money. Big banks are charging what, like 4%. These subprime mortgages are charging 8% – 12%.

They’re willing to accept riskier borrowers because they’re paying more money. And if the odd one or two go under, that’s ok. The extra revenue from the others will cover the cost.

But when you step back and look at the market as a whole, the whole risk profile changes. Now, you have more ‘riskier’ borrowers in the market. The average ‘riskiness’ of the market has gone up.

Now, I’m looking at the high-rise apartment market and thinking, this isn’t a market that really needs more risk.

You don’t really want riskier buyers at the best of times, but when you’ve got cookie-cutter apartments without much to differentiate them-selves, it’s even more problematic.

Because say one of your riskier borrowers goes over. Their apartment goes on the market. Trouble is, it’s the same as every other apartment. So the price every other apartment can achieve goes down.

That can quickly start pushing the market down, as sellers start competing on the only thing they can compete on – price.

And given we’re worried about the market already, do we really want foreign banks making sure that risker borrower have their chance to take a seat on the train too?

And who’s worried? Well, APRA just came out and admitted that they’re a little wet in the pants about it, and they’re going to start “dialling up” their supervision of large property projects.

Because as the RBA’s Luci Ellis notes, it’s normally property developers who bring economies down.

“While it is true that we tend to see housing booms and booms in housing prices ahead of banking crises, it is usually not the mortgage book that is the issue that actually brings the banks down,” she told the same panel, at an event hosted by the Centre for International Finance and Regulation.

“The thing that has tended to be the casual agent in banking crises…[has been] the property developers [and] commercial real estate – these are the vectors of stress that actually cause a problem for the banking system historically.”

That’s because developers with HUUGE loans go under when their buyer pool evaporates. As they go bust, the banks financing the development take a hit. If enough of them go over together, the whole finance industry takes a hit.

And even if just one bank goes down, the whole economy can go with it.

So APRA should be concerned about what kind of buyers are making up the developer’s buyers pool.

And moves to increase the overall riskiness of the buyer pool should be ringing alarm bells all over the place.

High-rises are a no go zone. Get off the train while you can, folks.

Are you worried about sub-prime lenders showing up?