‘How house prices could fall 50pc’
The Reserve Bank could be forced to step in with a $300 billion bailout program to rescue Australia's banks if the housing credit crunch accelerates into a "doom loop" that causes property prices crash by 50 per cent, plunging the country into recession.
That's according to Saxo Bank's latest "Outrageous Predictions" report, which outlines a series of "unlikely but underappreciated events" that could send shockwaves across financial markets if they were to occur.
"This is not an official forecast, it's an outrageous forecast that could happen if certain factors were to fall into line, but something we put maybe a 1 per cent probability on," said Sydney-based Saxo Bank market strategist Eleanor Creagh.
It's the first time Australia has featured in the Danish investment bank's annual list, which this year includes scenarios like Apple snapping up Tesla for $US520 per share or a solar flare striking earth, wiping out satellites and causing $US2 trillion worth of damage.
"The 'Australian Dream' was financed through an epic accumulation of debt as interest rates collapsed, with household debt standing at 189 per cent of disposable income," Ms Creagh writes in the report.
"The Great Financial Crisis was responsible for deflating housing bubbles in other advanced economies, but not in Australia. In a bid to stave off the crisis' effects, Canberra's 'economic security package' further fuelled the spectacular run-up in leverage, kicking the proverbial can down the road.
"In 2019, the curtains close on Australia's property binge in a catastrophic shutdown driven most prominently by plummeting credit growth.
"In the aftermath of the Royal Commission, all that is left of the banks is a frozen lending business and an overleveraged, overvalued mortgage-backed property ledger and banks are forced to further tighten the screws on lending.
"The confluence of dramatic restrictions in credit growth, oversupply, government filibusters and a slowdown in global growth cement the doom loop; property prices crashing by 50 per cent.
"Australia falls into recession for the first time in 27 years as the plunge in property prices destroys household wealth and consumer spending. The bust also contributes to a sharp decline in residential investment. GDP tumbles.
"The blowout in bad debt squeezes margins and craters profits. The banks' exposure is too great for them to cover independently and to skirt the risk of insolvencies and collapse, the RBA moves in to purchase securitised mortgages and fund the government's recapitalisation of its major banks with a whopping $300 billion QE/TARP programme.
"The grand irony is that Governor Lowe's hand is forced toward unconventional monetary policy and he implements QE1 Down Under.
"With the banks at the forefront of financial stability they are deemed 'too big to fail', not least because Australia's Baby Boomers and superannuation investment pools rely heavily on the banks' consistent dividend yields."
Ms Creagh said a repeat of the US Federal Reserve's first round of quantitative easing known as QE1, unleashed during the 2008 financial crisis, and the $US700 billion bank bailout dubbed the Troubled Asset Relief Program, would be "ironic".
"Governor Lowe has never been a proponent of low interest rate policies," she said. "He's made it quite clear he will only cut rates in the worst-case scenario and a lot of his academic work is on the need for higher interest rates to deflate asset bubbles."
Ms Creagh said the current decline in house prices was "orderly" but her scenario involved more stringent lending standards after the banking royal commission's final report in February, combined with an "exogenous growth shock" such as a slowdown in China.
"That would spread and cause contagion effects," she said.
"In that scenario we could see a negative feedback loop that would build on itself, whereby the banks have tightened lending conditions and unemployment increases, particularly in the construction industry as prices fall and the market starts to weaken."
Soon the general economy falls off. "You get people defaulting on loans, forced sales push prices down, a self-perpetuating loop," she said. "This is when you get the dramatic drop in residential investment, a plunge in house prices, that depresses spending and destroys consumer and business confidence."
Stressing the report was "not an official forecast", Ms Creagh said it was not about fearmongering. "These predictions are (intended) to spur debate and increase awareness about potential problems that might be lurking in the background," she said.
"It's very important to understand the risks out there in the economy if you are investing and trying to build wealth and a portfolio, it's reasonable to consider every outcome that may occur."
Saxo Bank chief economist Steen Jakobsen said the theme of this year's report was "enough is enough". "A world running on empty will have to wake up and start creating reforms, not because it wants to but because it has to," he said in a statement.
"The signs are everywhere. We think 2019 will mark a profound pivot away from this mentality as we are reaching the end of the road in piling on new debt and next year will see us all beginning to pay the piper for our errant ways."
Mr Jakobsen said the "great credit cycle" was already showing signs of strain and would "rip through developed markets next year as central banks are sent back to the drawing board".
"After all, their money printing efforts since 2008 have only dug a deeper debt hole, and it has now grown beyond their mandate to manage," he said.
If some of the report's predictions come true, "we might finally see a healthy shift toward a less leveraged society, with less focus on short-term gains and growth, and a new focus on productivity".
Mr Jakobsen added, "On the negative side, we could see considerable worsening of central bank independence, a credit crunch, and big losses in the asset where everyone is too long: real estate."