Housing booms: Australia vs. U.S.
SYDNEY For investors wondering whether the U.S. economy risks being seriously wounded by a housing market downturn, Australia's experience of the past three years holds a potentially valuable lesson.
If anything, the Australian boom was far bigger than that in the United States, with average house prices doubling from 1996 to 2003. Four interest rate increases during 2002 and 2003 took the wind out of housing, but the resulting slowdown was remarkably modest by historical standards. Indeed, the local housing market has showed clear signs of strengthening again this year and was one reason the Reserve Bank of Australia resumed tightening, with increases in May and August.
On the surface, Australia's experience suggests that Americans might have little to fear from the slowdown in their housing market. But while the similarities are instructive it is the differences that could really matter, for better or worse.
The cautionary case was laid out last week in a report by two economists at Goldman Sachs. Looking at the experience of Australia and Britain, they concluded that though these two countries' experiences were relevant for the United States, the wrong lessons were being learned.
"The U.K. and Australia provide important lessons for the U.S., but the implications are far from benign and support our view that the Fed will need to cut rates by 125 basis points next year," the two economists, Mike Buchanan and Michael Vaknin, said in the report.
They argued that a downturn in housing would have a far greater impact on U.S. consumption than in Australia because U.S. consumers had largely used equity withdrawn from their homes to fund spending. Although Australians had withdrawn just as much equity as Americans, equal to about 10 percent of disposable income, they spent far less. A survey released this week by the Reserve Bank of Australia showed that the bulk of equity withdrawn during 2004 had been invested in assets, with 18 percent used for consumption.
Just as important, the housing market in Australia peaked right as the country began to benefit from the global commodity boom. Company profits have surged, allowing businesses to pay and hire more while propelling a bull run in equities that has almost doubled the main share index since 2003.
Since more than half of adult Australians own shares, the strong market has bolstered personal wealth and cushioned the blow from a flat housing market. The boon also led to a windfall of tax receipts that allowed the government to slash taxes, eliminate net debt and still run sizable budget surpluses.
Clearly, the same could not be said of the United States. There, a string of budget deficits has lifted the U.S. national debt to $8.5 trillion – 13 times Australia's annual economic output.
"The global commodity boom came just as the housing market was tipping over and saved Australia from a likely recession," said Su-Lin Ong, senior economist at RBC Capital Markets. "What will save the U.S. as their housing market turns? Consumers are in debt up to their eyeballs and fiscal policy is maxed out."
Still, there is another fundamental difference between the two countries' housing markets that can be a potential savior for the United States. In Australia, about 85 percent of mortgages are variable-rate loans, so repayments rise and fall with every move in the central bank's short-term cash rate.
In the United States, about the same percentage are fixed-rate loans, providing insulation for existing borrowers from moves in the Federal Reserve funds rate. Further, most mortgage rates are tied to long-term bond yields rather than the short-term rates the Fed influences. This link often acts as an automatic stabilizer, with yields swinging on investors' perception of the health of the economy