The end game for banks and property

I hope you don’t mind me returning to a subject that I have written extensively about – the credit squeeze and the problems with the banks.

But this week material crossed my desk that increased my apprehension about the possible end game from this very serious situation. I learned that one of the major class action claims legal firms has actually paid out its bank overdraft and replaced the borrowing via the private bond market.

The reason for the move is that the lawyers can see a huge market coming in suing banks and they don’t want a conflict of interest. Already the provisions and write-offs from the big four banks and the AMP is around the $7 billion mark, and we really haven’t started on the claims that might be levelled from customers, particularly in the wealth management and insurance areas. There might even be actions from shareholders who are losing heavily on their bank shares.

The attacks on banks and property

As many of you know, Harry Triguboff is an old mate of mine and I have been yarning with him about property and similar subjects for a long time. As you would expect, as the largest owner and developer of apartments in Sydney, he knows the Sydney property market better than anybody else.

This week I had a conversation that was different from any previous one – he can see the real possibility of a looming disaster. And so he used the words “the situation is very dangerous … the market has deteriorated again. If it continues like this the people will lose a lot of their wealth because their houses are losing value. The banks will drop in value too”.

Harry has never seen so many simultaneous attacks on the residential property market, led by his apartments.

We can expect a whole series of bank restrictions from the Royal Commission; ASIC people are planning to infiltrate the management of big banks; APRA has completely rewritten the lending rules for banks; and bank executives are petrified and are taking a lot of time making borrowers answer the most detailed and petty of questions.

There are a whole raft of measures to dissuade investors from buying property including higher interest rates, severe restrictions on interest only loans, and higher stamp duty, preventing the depreciation of “used” buildings, and the proposed end of negative gearing by the ALP on existing dwellings.

The biggest investors were overseas Chinese, and they now can’t borrow here and it is extremely difficult to get money out of China. Dwelling prices are falling, and under that sort of barrage they will fall further, although the fall won’t be uniform in all property markets.

And that fall in residential dwellings when combined with higher power, gas and petrol prices will reduce retail spending. Once you kill the flower of confidence in the building and residential markets, it is extremely difficult to restore it.

In all, the big banks and AMP have provided $7 billion in losses, write-downs and customer refunds as a result of the scandals and we haven’t even started to see the likely big rise in housing bad debts. Investment bank UBS says that NAB will require a payout ratio of 96 per cent to maintain its dividend.

The economy will be a lot healthier if there is a 5 to 10 per cent fall in residential property prices, but if the fall gets closer to 20 per cent it will affect a vast array of other activities including retail sales.

It is this nervousness about the banking sector and the activities that depend on it that is causing the Australian market to fall behind Wall Street.

I have been advocating people lower their banking stock levels – the shares have fallen substantially and you might now be prepared to ride it out, but you need to be aware of the risks.

Fallout from China

Meanwhile, China and Japan are no longer big buyers of US bonds but President Trump needs to increase American borrowing to fund his deficit without the support of Japan and China.

Accordingly, interest rates are creeping up. The Chinese believe that, because America needs their money, they will win the trade war, but President Trump is no pushover.

It now appears the Chinese Government originally thought that American actions over trading terms would fizzle out, as it had done with many presidents in previous years. It is now very clear that Donald Trump plans to rewrite the trading terms between China and the US and will keep the pressure up until it does. And the impact on the Chinese economy is starting to be felt.

Residential property sales in 10 major Chinese cities have halved in the first weeks of October. Chinese developers stepped up promotions and discounts, but that didn’t stop sales in Beijing and Shenzhen falling dramatically during the week. And car sales are down.

China has now also dug in for a fight and this might go on for a long time, damaging both economies and share markets. The Chinese share market has fallen dramatically, and further big falls could easily take place. China will try to stem this decline with greater bank credits and government incentives, including stimulation of infrastructure. The turbulence in China will keep a lid on our commodities exports.

The need to tread carefully

Here in Australia, of course, we are watching the unions becoming more and more aggressive in attacking casual labour and forcing companies to pay more. If an ALP government wins the election, then in the early months there will be a very active union movement trying to increase wages at a time when there is a credit squeeze clamping down on the availability of credit and subdued consumer demand.

That is a lethal cocktail and we have to hope that wiser heads prevail if the ALP gains power next year.