Australian Housing Bubble Could Pop, Expert Says

Australia faces a "real risk" of a US-style financial crisis prompted by a possible housing market blow-out.

Aging interest-only loans and a credit crunch could all be pointing to a sudden, rather than slow, property market downturn fueled by steepening credit costs, an Australian economist has warned.

But the fact we are in this position at all should be a cause for concern, said Professor Richard Holden, economist at the UNSW Australia Business School, pointing to the potential for a US-style financial crisis in Australia.

"It's worth pausing to reflect on how got ourselves into a position where we have some real chance of what happened in US a decade ago happening in Australia," he said.

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Banking regulators "have been asleep at the switch," Holden said and are "reacting too late" to this volatility.

"For now we’ve got to cross our fingers," he said.

The warning comes after an AMP forecast just days ago predicted property prices to fall in Melbourne and Sydney by around 20 percent by 2020.

But a sudden turn-around could come quicker than expected, Professor Richard Holden, with a one in four or five chance "something could go seriously wrong."

As property prices continue on a downward trend and credit constraints continue, Holden says that a property bubble bursting is a real risk.

Although the decline in property prices is currently on a steady, rather than sudden deflationary trend, potential defaults on the 15 percent of loans that are interest-only loans could set-off a chain reaction in the market, causing the property bubble to burst suddenly.

Almost $400 billion of these loans are due to be rolled over in the next three years and if they are not, they will convert to principal-and-interest loans. This would cost consumers up to 40 percent more and ultimately cause some to default and sell-off. This in turn would create a massive slump in demand, according to Holden.

"In terms of interest-only loans, I've been saying for a couple of years now when we have as many as 40 percent loans interest-only it's a staggeringly high amount and we have to worry about what happens when the interest-only period ends," he said.

Whisperings from inside the Reserve Bank are another cause for concern, Holden says, with a board meeting suggesting a crackdown on credit in response to the Royal Commission.

"Banks are lending 20 to 25 percent less," Holden says.

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A credit crunch combined with increasingly costly loans will constrain demand in the market by limiting credit, in-turn forcing those selling to lower their prices.

This would be devastating for home-owners, Holden says, potentially completely wiping out their equity and causing only those who are desperate to sell at extremely low prices – and ultimately deepening the downturn.

But a burst would be great news for entrants to the property market, although youngsters shouldn't necessarily wait to purchase if they can afford to buy, he says.

"It's good news for first home buyers. Having said that it’s a bit of a two-edged sword, prices may have gone down but credit is harder to get so it's not obvious if first-home buyers are going to be in a better position even though prices have dropped."