Crises come into focus
By Robert Gottliebsen
October 27, 2008
PORTFOLIO POINT: The question is no longer about whether the US and Europe will be hit by recession, but how long that recession will last.
The weekend brought a dramatic show of power from the forces that will shape the future local and global business and investment communities. We have seen an amazing display: a series of crises suddenly coming into sharp focus.
I will start with the housing markets in western Sydney and Melbourne; then move to the impact of the mortgage fund redemption freezing on the sharemarket and particularly on Perpetual, Axa, and Australian Unity; then to the looming collapse of a large number of giant US hedge funds and the impact this will have on shares, mineral prices and our dollar; and finally to the weekend commentators who keep referring to the danger of a recession in Europe and the US when it is already in force. What we seeing on global markets is the sharp adjustment of share prices to the reality of lower profits.
First to housing. I spent some time over the weekend talking to some residents of western Sydney, to be reminded of what a tough housing market is like. That market fell before the rest of Australia. One man made $150,000 on his first house and a couple of years back decided it was time to switch to a much better house for just under $500,000 in the Sydney suburb of Fairfield. Lenders rushed to give him the $350,000 he needed. Today, that house would struggle to sell for $300,000, so he is underwater. Many smaller houses are for sale in Sydney’s west for as little as $250,000. Safety in many areas has become a real issue and is deterring buyers.
In Melbourne an enormous 1100 houses were offered for auction this weekend. Just over half were sold. The rest hang over the market. Prices were down in September and will fall again in October, though lower interest rates and the first-home buyer’s grant will help the bottom end of the market.
In my view we are going to see a big rise in sales of investment and holiday properties from those who used the equity in their homes to borrow large sums. More noticeably, there will be an exodus from very expensive houses by those who can no longer afford them. It's important for both buyers and sellers of residential properties to understand that banks have changed their lending criteria, and so there is less money available to buyers from banks. In addition, the non-bank lenders have dried up. That means buyers simply do not have as much money to spend and that pushes prices down.
At the airport on Saturday, the chief of a small non-bank lender, who has been working with a number of wealthy private families, rushed up to tell me how people should be fostering a close relationship with their bank manager; it’s one of the great assets a business can have today. Banks are helping clients in trouble but are reluctant to finance new business purchases. The exodus of the mortgage funds from the market will depress the value of smaller commercial properties.
On the ABC’s Inside Business, Perpetual chief executive David Deverall described how he visited a Perpetual call centre to talk directly to Perpetual clients who are in a state of panic. That’s exactly what a chief executive should do in such circumstances. It is highly likely that both Axa and Australian Unity had similar experiences in their call centres.
Whenever a company has to freeze redemptions of one product, it normally affects sales and redemptions of all products, including share and property units. Those call centre reactions are just the first sign of trouble ahead. I hope I am wrong, because it could lead to something much more serious.
With the best of intentions, Kevin Rudd and Wayne Swan acted in haste over the bank guarantee issue and bungled it. They will need to rectify their mistakes quickly or the ramifications will spread. For most Australians, bank guarantees are not necessary and those who want them should pay a price, whether they deposit $1000 or $1 billion. A restricted number of other security houses should also be able to market government guarantees on debt products for those who want them; it should be like travel insurance.
Then over the weekend, of course, we saw the biggest problem of them all: the escalation of the forced sales by hedge funds and other leveraged investors. I had hoped the forced selling was over, but clearly there is more to go. The comparison with the Dutch Tulip Mania, which peaked in 1637, is very apt. What we are seeing is the collapse of two tulip booms at once: the debt securities boom and the hedge fund collapses. But it is important to underline that this is more than a hedge fund collapse. In fact, investment banks and brokers are all selling their long positions and not take new ones on except in exceptional circumstances. What we are seeing is a massive deleveraging of the stockmarkets. Of course, the "debt securities tulips" and the "deleveraging tulips" are linked because a large number of banks were stupid enough to lend four and five times equity to hedge fund gamblers on oil, copper, Australian dollars, US shares, our mining stocks and other shares. The banks may be big losers in both debacles.
Perhaps the executives who gambled loan money and lost should be required to repay their salaries. Meanwhile, the question that more informed analysts are asking is not whether there will be a US and European recession, but rather how long the recession and the continued economic downturn will last.
My guess is that it will be at least two years, but it's more likely to be three or four years, despite the fact that the new US President will spend and spend to turn the US around.