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Will real estate debt ignite a recession?

Your Money hosts the "property punch-up of the century".

Jack Derwin

Digital Journalist, Your Money

The property market is always a hot topic, but could a crash be on the way, derailing 29 years of continuous growth and creating an Australian recession?

While it might sound like a worst-case scenario, it’s exactly what economist John Adams predicts will transpire.

In a much-hyped debate on Money Talks this week, Adams went head-to-head with Coolabah Capital founder and Australian Financial Review columnist Christopher Joye on that very topic.

Watch: Adams v Joye on Money Talks, Monday 26 March 2019

It came after weeks of sledging over Twitter.

It even drew the attention of News.com.au, which quoted Switzer’s dubbing of the segment the ‘property punch-up of the century’. 

Here’s how it went down.

Deadly debt

Adams has been arguing publicly for years that Australia’s high debts levels threaten to destabilise the entire economy and create a domestic recession.

“We had an admission from the Reserve Bank of Australia in 2007 that the amount of credit in the economy at that point was bigger than the 1880s and the 1920s. Why is that significant? Because we had a depression in 1892 and 1931,” Adams explained.

“Today the debt is [even] bigger than 2007,” he added.

Household debt to GDP (Australia)

“This is the biggest level of domestic debt we’ve ever had, both in normal terms and proportional terms as well.”

The real estate recession right hook

So why does that matter and what does it have to do with real estate?

“If we’ve got the biggest debt bubble in the history of this country, where is this debt? The debt is in property,” Adams said.

As house prices have risen around many parts of the country over the last three decades, and markets in Sydney and Melbourne have skyrocketed, buyers have been required to borrow larger amounts of money.

Read: Looking back at the housing boom

Accordingly, household debt growth has outpaced the economy, meaning the amount of debt relative to GDP rose significantly, as shown in the graph above.

John Adams vs. Chris Joye
Adams and Joye sizing up in the Your Money newsroom before the debate

The problem with that debt is when it can’t be paid back.

“If we default on the debt – for example, if households can’t pay their debts and the banks get in trouble – then this could lead to extremely sharp falls in property, from 40 to 80 per cent depending if the banks survive,” Adams explained.

In such a scenario, Australians would find their wealth disappearing as the value of their homes and investment properties crash while they still owe the original value of their mortgages.

In order to arrest the crash, Adams believes it would be possible that the RBA, the Australian government and other institutions would intervene, opening up a second worst-case scenario.

“They could stabilise house prices, the falls could be less than the more extreme forecasts but that comes at a cost, and the cost is the Australian dollar,” he explained.

As institutions intervene to save the property market and the banks that hold the weight of Australia’s mortgages, it would sink the Australian dollar as confidence wanes in the country’s ability to pay back foreign debts.

That, in turn, would drive up the cost of our imports, making goods more expensive and hurting the economy further.

“So what I’m saying is that [economic] Armageddon is either a housing crash or a dollar crash but we can’t get out of this problem because the amount of debt in the economy is unparalleled,” he concluded.

The counterpunch

So what’s the issue with Adams’ argument?

Firstly, the economy today isn’t what it was back in the 1930s, when home ownership was at around 30 per cent, according to Joye.

Today it’s closer to 70 per cent.

“It’s not just about debt. It’s about the serviceability of that debt. It’s about income and interest-rates,” Christopher Joye countered.







That’s because Australian house prices haven’t risen in isolation, according to Joye.

“Aussie household prices over the last forty years can be completely explained by income growth and the huge reduction in mortgage rates,” he explained.

“The average mortgage rate in Australia between 1980 and 1995 was about 12.5 per cent. The average mortgage rate since 1995 has been about 6 per cent,” Joye added.

That has helped more Australians borrow to buy a house, as mortgages became cheaper and their incomes grew, granting them more buying power.

While those looking to get into certain markets have long bemoaned the lack of housing affordability, according to Joye, property overall is actually trading at a discount.

“According to this analysis, if you take the 1980 price and gross it up by incomes and interest rates, it’s actually 3 per cent cheap compared to the theoretical fair value,” he said.

“Mortgage repayments as a share of income are actually quite low.”

That analysis is of course based on the current official interest rate of 1.5 per cent.

If interest rates were to rise, however, and mortgage repayments with them, then that would start to change.

“[For example,] if you think interest rates are going to go to 2.5 per cent, houses are 3 per cent expensive,” Joye said.

“I don’t think that there’s any compelling case at all that there’s going to be this cataclysmic 40 to 80 per cent drawdown in house prices. Unfortunately for John he’s going to be proven relentlessly wrong like other experts in the past.”

The common ground

While those arguments form the crux of the debate, Adams and Joye did agree on a couple of key points, particularly on Australia’s debt problem.

“I’ve argued that Australian debt levels are excessively high, I’ve argued that consistently but I don’t think we necessarily have a debt bubble,” Joye said.

Importantly, Joye also conceded that if a global recession was to be triggered overseas that that would spell serious concerns for that debt and how Australians would repay it in a crashing economy.

“All bets are off if we go into a global recession, we’ll have a big problem.”

The verdict

Money Talks host Peter Switzer said that, while it was up to viewers to decide who won the debate, for him the winner was clear.

“I think Joye confidently batted off most of John’s points and was a better debater,” Switzer concluded in his post-debate write-up.

“Some might call it a knockout to Chris but I’d make it a points decision by a healthy margin.”

It’s a decision that won’t be shared by everyone.

Watch debate highlights in the above and see the entire episode in full here.

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