Thursday, April 24, 2008

Can sub prime happen here?

Can sub prime happen here? It’s fair to say that a lot of people in Australia don’t have an understanding of why the US market has taken such a severe downward spiral. While there has been much concern that the recent crash in the US market may cause a ripple effect through to the Australian property market, this is unlikely to be the case - according to this article from Australian Property Monitors.

The toll from the sub prime collapse is now estimated to be worth as much as half the value of the Australian economy’s GDP. In other words, the pain endured by the mortgage meltdown in the US may be upwards of $500 billion in credit losses. It is timely to ask what exactly is the US sub-prime crisis and can it happen here?

Early this decade US mortgage rates were about 3%. At the same time the US economy was booming. You don’t need three guesses to work out that property values shot up in line with an explosion of cheap and easy loans. Borrowers that once may have been knocked back because of poor credit history or serviceability (sub prime) now found willing lenders easily. US lenders with advanced risk appetites were falling over themselves to lend money.

Busy US lenders needed funds (liquidity). So they bundled mortgages together into securities (bonds) which are then graded by the ratings agencies so they can be priced and sold. This is called securitisation. The low grade bonds are called junk bonds, but companies called monolines could wrap these bonds in insurance to secure a better rating, effectively taking the junk out of junk bonds.

Super funds, banks and even local councils bought these bonds as investments which offered good cash flow. The original lender appeared to have no incentive to write good loans because they remained at arms length from the ultimate risk. No wonder then in that booming US economy non-bank lenders flushed with funds stopped adequately pricing risk into their loans. The market became so competitive that it appeared as if every man and his dog could successfully apply for a loan at low rates.

There was a sting the tail. Hapless US borrowers took out loans with ramping repayment schedules that would inevitability become too much to handle. For instance borrowers would take adjustable-rate mortgages (or ARMs) which only deferred the pain. Everyone assumed wrongly that property prices only ever go up. So when house prices started dropping, areas like Cleveland, Ohio went into meltdown. Massive corporate write offs reared their ugly head and credit standards began to tighten. Enter the credit crunch.

Personally I don’t think that an Australian version of the US sub prime woes will happen. There are significant differences for related Australian markets. On the surface, property markets look highly vulnerable as more mortgaged households stare down breaking point. Thankfully though, honeymoon rates and ARMs have not penetrated as deeply into our market as they have in the US. Our economy is in much better shape also as it is still expanding, buoyed along by a resources boom. The US economy, on the other hand, is retracting and rates are being slashed to prop up struggling local financial markets. Don’t get me wrong, Australians mortgage holders are exposed to the effects of rising interest rates and a slowing economy, but I would argue much less than our friends across the pacific.  (Written by: Michael McNamara – Australian Property Monitors)

With the market steady, feel free to contact any of our staff at Toop&Toop to assist you with your real estate needs.

Karen Raffen, CEO <>

© Toop Real Estate Group

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