Part1: A big-short scenario for Australia has been getting a lot of attention this week. John Hempton, Bronte Capital‘s chief investment officer (a hedge fund) and Jonathan Tepper, an economist and founder of Variant Perception (an Independent Global Macroeconomic Research that presents itself as “contrarian investment analysis”) believe that Australia is heading to a scenario eponymous to the book and movie, which describe how the 2007 sub-prime crisis originated and how a few people saw it coming and made money betting on it. Below is their thesis copied from the Australian Financial Review, which I wanted to capture to have forensic reference if/when it happens/or not.
A 2nd post details why other analysts don’t think it will happen that way. And a 3rd piece says the Regulator ASIC has got such a scenario covered. Who’s right? Only history will tell…
Uncovering the big Aussie short
It was like a scene from the film The Big Short. A hedge-fund manager and an economist pose as a gay couple on a combined income of $125,000 and tour Sydney’s western suburbs viewing housing developments and meeting mortgage brokers for research to determine if there’s a housing bubble.
The conclusion is it’s worse than they thought.
“The further west I went, the more irrational it felt. Lots and lots of supply and prices that bore no resemblance to construction cost and income of people around there,” says John Hempton, Bronte Capital’s chief investment officer.
He joined with Jonathan Tepper, an economist and founder of Variant Perception, and toured suburbs across north-west and south-west Sydney and met 20 mortgage brokers three weeks ago.
What they discovered repeatedly was that mortgage brokers were advising them to lie on loan application documents about the deposit for a house and about income.
As Tepper has written in a report, “we asked if the bank would call our employer, and both reputable and disreputable brokers said banks rarely verified payslips”.
Hempton says they were also told the checking of documents was sometimes done by Indian call centres. What also concerned Hempton was that on loan applications low-income earners were often offered discounts on the advertised mortgage rate of up to a 1 percentage point, increasing the vulnerability of the banks if there were a correction.
“The banks have always said their underwriting is of high quality,” says Hempton. “We just went around and this was not the story we were told. We were coached on how to get things through banks.”
Hempton says an oversupply in apartments and housing, particularly in west and north-west Sydney, surprised him as did the prices. He says around Parramatta he saw apartments selling for $11,000 a square metre as their listing price.
“Hong Kong is about $11,000 a square metre and Manhattan averages about $14,000 a square metre.” However, others claim Hempton significantly underestimates the value of Hong Kong property.
Hempton, who has short positions on there being a correction in the Australian housing market, helped expose the superannuation fraud at Trio Capital.
Tepper in his report bluntly warns “Australia now has one of the biggest housing bubbles in history”, noting the country’s real estate value to GDP is 3.8 times compared with Ireland and Japan, which both were at multiples of 3.5 times before they before they experienced a housing market crash.
In Japan’s case real estate prices fell 80 per cent over the next decade and in Ireland they fell 50 per cent in the following six years.
He is predicting falls in the Australian housing market of up to 50 per cent in Sydney and Melbourne and of about 80 per cent in mining towns.
“Australia now has the highest level of household debt to GDP in the entire world.”
Tepper, who has previously predicted a housing bubble in the Australian market would burst, is also warning of a sharp fall in Australian bank stocks.
“Australian banks require large scale wholesale funding. In the event of a banking crisis, it will be difficult to roll the wholesale funding without any public sector guarantees. The Reserve Bank of Australia will guarantee the banks and charge a fee, as it did in the 2008 financial crisis. We anticipate most bank shares will cut dividends entirely, raise capital and stock prices will likely decline 80 per cent.” He also predicted the Australia dollar could trade to 40c against the United States dollar.
“A weakening currency is what we have seen in almost all other banking crises.”
Tepper says in the research both men encountered many investors who were able to get revaluations on their properties to increase their equity for speculative purposes. “We met one who was able to do this 20 times in a year with their property portfolio.”
Hempton says in north-western Sydney they met one mortgage broker who told them which of the big four banks would revalue properties quickly. “They wanted to put you in 10 to 15 apartments. The only way they could do that was getting the bank to revalue the property so you could borrow more money. They were acute about which banks had bad practices.”
Tepper writes of getting a ride with an Uber driver who said he had his own house, had bought five investment properties in Queensland with no cash deposits, and went guarantor for his daughter who bought a $2.2 million home.
His report noted that “over the past few years over 40 per cent of all new mortgages originated have been interest-only mortgages”. “This is truly Ponzi financing, where home buyers only make money if their houses keep rising in value. Paying interest only and revaluing property allows for a Ponzi dynamic. As prices rise in a Ponzi fashion, more equity allows for more deposits. This will reverse viciously when prices fall.”
In the research of meeting brokers and touring western Sydney, Tepper and Hempton also met property experts, banks and government officials.
Their research is an unrepresentative sample of all of Australia but Hempton challenges anyone to go out and start looking at the glut of property that exists in the west.
“Go drive around western Sydney at the moment. It was pretty obvious to us there was a lot of unsold inventory.”
Tepper’s report quotes BIS Shrapnel, noting that dwelling starts had reached a new record nationally in 2014/15 and exceeded underlying demand in all states.
TAKING OUT INSURANCE
Hempton says in their research they encountered developers lying about units and houses being sold in the west. “You’d go into a building in Parramatta and it will mark the apartments as sold. You say, ‘I really want the one on the north-east side’ and suddenly one will be unsold.”
Tepper’s report says the prices of properties for sale of $500,000 to $700,000 in Blacktown, Rooty Hill and Mount Druitt in Sydney’s west were in some of the city’s poorest areas, where there were many pawn shops and money transfer establishments, was a surprise and crazy.
He notes that Blacktown’s median prices are now $640,000 and are up over 50 per cent since December 2012. Prices in Mount Druitt and Rooty Hill have also doubled since 2012. In those areas, he says, the house prices are at least eight times income and more.
The report also notes that prices have doubled in the outer suburbs of Melbourne, such as Sunshine, since 2012.
Hempton says before driving around he would have said houses prices in Manly were crazy but now believes they’re more extreme in areas such as Rouse Hill. He says while a planned north-west train line is being credited with boosting house prices, there are suburbs in south-west Sydney with existing train lines where prices are nowhere near as inflated.
He also noted that as they drove west they saw more and more advertisements for deposit guarantees, which meant rather than putting a deposit down on a house you can take out an insurance contract that will pay the deposit if you default.