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There may be a signal of very choppy waters ahead for the Australian economy – a possible indication that the Australian housing market (or housing bubble as many have dubbed it) may be approaching the moment for a major reversal.

The Reserve Bank of Australia (“RBA”) cut the base rate by 25 basis points to 1.5% earlier this month to aide the economy. According to some analysts, the RBA’s rate cut was somewhat unusual inasmuch as it was not accompanied by a change in official forecast, although the RBA did extend the existing forecast out an additional 6-months, predicting more of the same low growth and low inflation environment.

Even more unusual was the reaction of the big four Australian banks, who responded swiftly to the RBA rate cut by cutting their mortgage rates (and other lending rates) and simultaneously raising their term deposit rates for savers, in some cases quite significantly.

It’s the later move that may be a signal of very choppy waters ahead for the Australian economy – a possible indication that the Australian housing market (or housing bubble as many have dubbed it) may be approaching the moment for a major reversal. After all, it’s a move by bankers that is rarely seen – increasing their own cost of funds at the very same time that they are reducing their revenues by cutting lending rates, which has some commentators calling it a whiff of panic — a move to secure funding in the face of deteriorating financial conditions.

To better understand the significance of the bankers’ response to the latest rate cut it’s necessary to take a step back and consider a few of the unique aspects of the Australian economy. To start with, it is an economy in which the banking sector is completely dominated by 4 big banks – Commonwealth Bank of Australia, Australia & New Zealand Banking Group, Westpac Banking Group and National Australia Bank. Too big to fail fails to capture the significance of these four banks to the overall Australian economy. Together they holds assets that amount to 220% of Australia’s GDP.

That huge concentration of assets is itself a symptom of Australia’s housing bubble. By some estimates, the big four Australian banks have issued more than 80% of the country’s residential mortgages, making exposure to the domestic housing market a huge concern for the Australian banking sector. And as Australian housing prices have run up over the course of the last few years, in response to record low interest rates, the concentration and exposure has only gotten worse.

And how big a bubble is it? Since 1990 home prices in Australia have risen 350 percent, which far exceeds the 140 percent run up in prices in the U.S. prior to the 2008 financial meltdown. Australian households are the most indebted in the world, based on the measure of debt to disposable income. The only factor that seems to be working to the advantage of the Australian housing market is that lending standards have been maintained at a higher level by the big four banks than was customary in the U.S. mortgage origination market in the last decade, so it is anticipated that when the price correction comes (as surely it must) it won’t be as severe in Australia as it was in the U.S.

Considering the profile of the housing and banking market down under, it is no surprise that short interest in the stock of the big four Australian banks has been growing all year, as betting against the Australian housing market has become one of the most popular trades among hedge funds in the first half of this year. While the timing and severity of the eventual housing market correction may or may not pay off for the short-sellers, it certainly is clear that a correction is coming. For those who are interested in Australian real estate, there should be ample buying opportunities in the coming quarters.

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