Dan Denning is in Baltimore this week. We haven’t heard from him, so we can only hope he isn’t stranded beneath 6ft of snow (he’s only 5ft 11in). In Dan’s place, Money Morning editor Kris Sayce explodes more property market myths…
[This article first appeared in Money Morning on Thursday, 25th February]
It seems that property bandit Christopher Joye can’t help but make a fool of himself while feeding misinformation on property to his readers.
Yesterday, by all accounts, El Joye was debating Steve Keen at the Perennial Investment Partners conference in Melbourne.
As Joye loudly and proudly pointed out on his Business Spectator blog yesterday afternoon:
“Update: Christopher Joye won his debate with Steve Keen in an electronically scored result in front of an audience of 500 investors at the Park Hyatt in Melbourne.”
We think the words, ‘three year-old,’ and ‘child’ spring to mind – “Tell them I won, tell them I won…”
We’ve held back on Joye recently, but it’s time to put his claims under the spotlight again…
First, let’s take a look at a couple of the comments in the same Business Spectator blog:
“The total value of privately-owned residential property is around $3.5 trillion. The total value of outstanding mortgage debt is circa $1 trillion. Australia’s mortgage debt LVR is therefore slightly less than 30 per cent – ie, incredibly low. But Keen ignores this.”
El Joye wrote that in response to Steve Keen’s method of measuring household debt, which is to compare mortgage debt to GDP.
According to Joye, using mortgage debt to GDP is a:
“…Pretty meaningless benchmark. If you want to understand the viability of debt levels, you can use two key measures: debt-to-assets ratios and debt-to-income. This is exactly what any intelligent investor would do when appraising a company’s leverage.”
And then El Joye explains how the Australian mortgage debt LVR is only about 30%. In other words about 30 cents of debt for every $1 of ‘assets.’
Can you see a problem with El Joye’s method? For a start, where’s the $3.5 trillion come from? As investors with Storm Financial well know price and value are two different things.
And when the price readjusts to reflect the real value, that’s when the problems arise.
But apart from that, the other problem with his claims are this, when you’re valuing a company and assessing the ability of a company to honour its debts, the last thing an ‘intelligent investor’ would do is look at the ratio for the entire market.
What would be the point of that? Would any ‘intelligent investor’ really look at the balance sheet of Duet Group [ASX: DUE], which has 81% of its capital as debt, but then ignore that and invest anyway on the basis of the overall market only having a debt to capital ratio of 30%?
We could be wrong, but we’re not aware of any ‘intelligent investor’ that would do such a thing. But then again, we don’t mix in the same circles as Christopher Joye. He’s clearly got a monopoly on intelligence.
Then he makes his second point:
“We know that total household interest repayments as a share of disposable income are only about 10 per cent today. This is exactly the same as what they were 20 years ago.”
Do we really know that? I don’t think we do. Is El Joye really suggesting that mortgage repayments only comprise 10% of household disposable income? It would seem he is.
So, let’s go to the source, his pals at the Reserve Bank of Australia (RBA). And if you look at the numbers, well, they’re not quite as Joye would have you believe.
Because according to the RBA, ‘Household Interest Payments to Disposable Income’ is indeed around 10% (actually 9.8%), and if you do cherry-pick 20 years ago then you will find the number was 8.7%. Which we’ll give some leeway and concede is “about” 10%.
But go a little further back and you’ll see that the date Joye cherry-picked – December 1989 – was the peak following an increase from 5.2% in 1977. And funnily enough, between 1989 and the late 1990s it fell again.
Anyway, look at the spreadsheet for yourself by clicking here. Whichever measure you look at, the debt burden has ballooned:
Debt to Assets – 7.2% in 1977, 19.9% in 2009
Housing Debt to Housing Assets – 8.8% in 1977, 30.2% in 2009
Debt to disposable income (total) – 33.2% in 1977, 152.7% in 2009
Debt to disposable income (housing) – 24% in 1977, 135.4% in 2009
But the important part of this is that as any ‘intelligent investor’ will tell you, making assumptions about the ability of an individual to repay their debts based on the repayment ability of a much larger sample of people is statistical chicanery at best, and outright deception at worst.
Let’s look at a simple example. If you have two households, one with 60% of their disposable income going towards interest repayments and the other with just 5% of their income going towards interest repayments, it’s hardly fair to say that no-one is in mortgage stress because the average is only 32.5%.
The reality is much worse than Joye’s rose-tinted vision would make you believe. And it doesn’t fit in at all with the numbers that show borrowing levels have reached an all-time high, in part thanks to the first home buyers bribe.
Take this example. According to the HIA-Commonwealth Bank first home buyer affordability report: “Monthly loan repayments on a typical first home mortgage in Melbourne surged from $2114 to $2600 in the year to December as federal grants were wound back and other costs jumped.”
Got that? That’s a 22.9% increase in monthly repayments. It’s an extra $5,832 of after-tax income each year that is diverted either from savings or other spending, and is instead spent on feeding the ponzi banks.
But not only that, it rather makes a mockery of Joye’s claim that interest repayments are only 10% of household disposable income. Do the maths. With an annual mortgage repayment of $31,200 (most of which is interest in the early years) Joye obviously believes everyone is on the same kind of wage as he is.
Maybe the flash-Harry’s at Rismark earn $312,000 of after tax income each year, but most normal people don’t.
And even if you take Joye’s previous claim that household disposable income is over $90,000, then you’re still looking at over 30% of disposable income going towards interest payments.
That’s backed up by Joye’s pals at the RBA who have Housing Loan Repayments at nearly 30% of household disposable income:
So for El Joye to come out and claim “We know that total household interest repayments as a share of disposable income are only about 10 per cent today” is downright misleading.
Look, let’s forget all the stats and ratios and percentages. Let’s think about this logically. In 2009, 191,000 first home buyers hit the market, that’s more than a 50% increase on the previous year.
Common sense tells you that these 191,000 first home buyers aren’t spending just 10% of their disposable income on interest and mortgage repayments. Even if these buyers were uber yuppies with a disposable income of say $150,000 can you really imagine they are only spending $15,000 a year on interest?
That would mean a mortgage of just around $200,000. Maybe we’re wrong, but that would need a huge stretch of the imagination and suspension of reality to believe that’s the case.
Besides, even if you take Joye’s disposable income of around $90,000 then you’re looking at annual interest of $9,000 and a mortgage around $120,000. The numbers just don’t add up to reality.
Of course, Joye’s pal, Macquarie Group’s Rory “Output Gap” Robertson has chimed in as well:
“The ‘bubble crew’ seem to keep missing the main story… There’s extraordinary and ongoing rapid growth in the number of actual people in Australia with money wanting to own or rent houses in which to live – as opposed to living in tents and shipping containers – while the underlying long-term trend in homebuilding remains flat near 150,000 per annum.”
His arrogance never ceases to amaze. The actual people with money, are actual people being cajoled into taking out massive debt burdens. Cajoled by the likes of Robertson and Joye who believe Australia is immune from the realities of excessive debt indulgence.
But that’s not all, because it seems as though Joye has another visual impairment. Not only does he suffer from rose-tinted vision, but he’s had a bout of tunnel vision as well.
Last week Joye offered, “Exposing the sharemarket sham.”
The conclusion of his article? Wait for it. It’s a barnstormer. You’re not going to believe this…
The stockmarket is risky! He’s even managed to put a number on it. It’s “11.6 times riskier than ‘cash’”.
Well we could have told him that. In fact, 97.9% of ‘intelligent investors’ could have told him that. We hope Rismark clients didn’t have to pay too much to receive that pearl of wisdom.
But at least he’s not afraid to spruik for property investing at the same time, because as he informs readers:
“Australian equities also don’t stack up relative to fixed income investments, such as bank bills and government bonds. I am pretty sure one could also add AAA-rated Australian home loans and A1+ corporate debt to the fixed-income outperformers, although it is difficult to quantify their long-term returns due to a lack of suitable time-series data.”
It seems that investors should forget about the stock market. They should forget about investing in companies that make things or dig resources from the ground or provide services to people.
According to Joye you’d be much better off if you could invest in AAA-rated Australian home loans. Oh Lordy. What a fabulous idea. And as luck would have it, Rismark is just the firm to help you out. It has been trying to flog the idea of investors investing in Australian residential property securities for years.
And from what we can see, without much success.
But anyway, here’s a link to the proposal Joye put to the [hehem]… Fannie Mae Foundation seminar in October 2003:
“Consider a $250,000 house that is purchased with a downpayment of $25,000. The homebuyer uses standard mortgage finance of $125,000. The remaining $75,000 is raised using equity finance in the form of a specific SRR mortgage that works as follows. There is no interest due on the SRR mortgage until the house is sold. If the house is ultimately sold for more than it cost, the interest due corresponds to 60% of the appreciation. If the house sells for less than its purchase price, no interest whatever is due, and the amount of the initial loan is written down in proportion to the decline in the property price.”
You remember Fannie Mae, it was nationalised by the US government last year when a whole bunch of its mortgages went proverbial up.
The gist of the proposal – as we can figure it – seems to be that you buy a house but only take out part of the mortgage, the rest of the cost is paid for by an investor or group of investors through some sort of security. They call it ‘shared equity.’
That idea is probably ringing a few bells for you.
Well, it was less than five years later that Joye was proposing an Australian version of Fannie Mae and Freddie Mac to be called ‘AussieMac.’
In that document he states:
“We propose that the Commonwealth Government sponsor an enterprise – ‘AussieMac’ – that would leverage the Government’s AAA-rating to issue low-cost bonds and acquire high-quality mortgage-backed securities from Australian lenders just as Fannie Mae and Freddie Mac have done in the United States.”
And this comment, which was made before Fannie and Freddie went bust, but after the first signs of trouble had emerged:
“While Fannie Mae and Freddie Mac have been extraordinary successful institutions for the best part of 50 years, they too have been occasionally embroiled in governance sagas that tend to at one time or another afflict all major corporations.”
And this:
“Indeed, there is a compelling case that liquid markets for securitised residential mortgages would never have emerged in the US, or for that matter anywhere else in the world, were it not for the establishment of Freddie Mac and Fannie Mae, which were the pioneers of the securitisation process and for many decades the only providers of off balance-sheet funding to US lenders.”
Joye seems to say, “All hail Freddie and Fannie!” Whereas we say, “To hell with Freddie and Fannie!”
We assume Joye is still intent on establishing an ‘AussieMac’ in Australia and therefore is set on importing to the Australian housing market the very same housing disease suffered by the American market.
But getting back to the ‘Shared Equity’ proposal, isn’t it a great investment idea? Wouldn’t it be good if investors could help buy into residential property? We’re surprised it hasn’t caught on. We’ll tell you why it hasn’t caught on, because it’s a terrible idea.
First off, it would do no more than gradually push prices even higher as more capital is allocated towards the residential housing market. Of course, it wouldn’t happen overnight, but the gradual trend would be to expand the housing bubble further.
But secondly, what investor or investment firm in its right mind would buy into an over-priced illiquid asset, an illiquid asset that they earn absolutely no income on until the property is sold, and then they only get paid interest if the house is sold for a profit?
What the academic in Joye forgets is one simple thing about housing. And that is, there’s potentially more money to be made from lending money to sucker property investors than there is to be made from owning the actual property.
Investment pros are too smart. They may spruik to push prices higher, but they’re not dumb enough to put their own clients funds at risk when they can make more money from lending cash as a loan.
But back to Joye’s “risky sharemarket” article. Because there was another hilarious line we just couldn’t ignore:
“Unfortunately, most of us underestimate risk (including many supposedly sophisticated investors), and focus obsessively on returns… And that touches on a sobering fact that one should never lose sight of: risk represents the probability of loss. This is precisely why any person who tells you that shares are ‘the best place to be’ is mad: the only way they can possibly arrive at this conclusion is by completely ignoring risk, or by assuming that you are trying to generate unusually high returns.”
And yet, it’s Joye and the band of property spruiking bandits who every day ignore even the faintest possibility of downside risk in the housing market.
Shares are risky, and they always have been. We’ll be the first to tell you that if you didn’t already know. So we’ll agree with Joye on that score. If you’re not prepared to accept the downside risk then you shouldn’t invest in shares.
But for Joye to point to the risks of share investing without even mentioning the potential risks of investing in a property market that is close to bursting point shows his complete lack of investment objectivity.
It’s up to Joye to put the record straight and finally admit that there is risk in taking out a massive loan that’s 6 or 7 times your annual income and buying a depreciating asset, which provides a negative income stream, at the height of a thirty year property boom.
That’s what we call risky. In fact, we’ll say it’s just as risky as investing in shares – and that shouldn’t be the case for property. Property should be low risk, but thanks to the spruikers it’s on par with the risk of shares.
Look, we’re not claiming that everyone’s perfect, certainly not your editor. But we do object to the propaganda that the spruikers infest the mainstream media with, that the Australian housing market is unique, like no other in the world.
And that Australia’s record high level of debt is of no concern, because, well, this is Australia and we’re different.
The reality is, to use an analogy, while the bus journey from prosperity to household economic debt Armageddon may have taken a different route to that taken in the US and UK, the ultimate destination is the same.
It’s just that Australia is taking the scenic route. And whether we like it or not, the property spruikers are the one’s driving the bus.
Cheers.
Kris Sayce
for The Daily Reckoning Australia
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