Adding air to a housing bubble

The conditions for property to come roaring back are ripe. Unless banks rein in easy credit, we could again be at the start of a property bubble. That means interest rates and the dollar will have to rise.

Last night’s wave of global optimism, which boosted equity markets increases the danger of a housing market bubble in Australia -- a danger where we are probably unique in the world.

If Australian house prices surge we could see the interest rate reduction door bolted and a further long-term rise in the Australian dollar causing further devastation to Australia’s employment creating industries.

Last night’s global optimism was generated by the better than expected corporate profit results in the US, and German opposition to a Spanish bailout receding.

As our shares respond today, the Reserve Bank officials will increase their surveillance of the Australian dwelling market because there is now an increased risk of a housing bubble being created by the combination of higher equity values and lower interest rates.

Australians have a long-standing, deep love affair with bricks and mortar. And that love affair almost always translates into a rise in dwelling prices as soon as interest rates fall sharply and look like heading lower – i.e., current conditions.

The subsequent rise in house prices makes everyone feel better and they lift their rate of retail spending and that stimulates the economy. However in this interest rate reduction round, the Reserve Bank is anxious to avoid the sharp rises in dwelling prices that normally follow interest rate cuts.

Australian house prices are already well above those in North America and Europe. Any further major rise will create all the ingredients for a bubble in a year or so as the higher dollar lowers employment.

Given lower rates and better equity markets, the only way to prevent Australians bidding up dwelling prices is for banks to be tougher on their lending criteria. My guess is that this is what the Reserve Bank will be urging the banks to do.

There will be no official change in bank lending criteria. What normally happens when banks tighten is that they begin valuing dwellings on a more conservative basis -- often lower than the market. This effectively lifts the deposit requirement and prevents wide spread dwelling price surges. (Isolated areas may still rise).

There are indications that many banks are currently using this mechanism to tighten their home lending criteria but the temptation to let the credit flow in abundance to maintain market share is always there.

Demand for commercial loans are not high so there is some good shorter-term bank profits to be gained by hosing money at home buyers.

And if Europe brightens up then overseas wholesale money will be more plentiful and perhaps even cheaper. But if house prices start to surge on the back of greater bank lending then the interest rates cuts will be off the agenda and we may even start talking about interest rate rises. Either event would push up the dollar. There is a lot at stake.

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