Ben Elthm at newmatilda.com asks, Is There a Recession Brewing in Our Housing Bubble?

It has some fairly serious implications for those of us who don’t own a home but are looking a buying. I’ve personally been staying out of the property market in Sydney because of the huge unaffordability of it. What Ben’s saying seems to be validating that choice.

Lets go over a few key points of his piece:

Surprise, surprise: it turns out that this was not a good thing. The Australian colonies’ unregulated banking system produced a property bust and banking crisis that looks eerily familiar in our own time. As land prices plummeted, borrowers defaulted, taking banks and building societies down with them.

Here, Ben is referring to the land boom of the 1880’s in Melbourne. The important thing to note here is that when land prices plummet, borrowers default, which causes Banks to take a loss on the loans. Enough losses and the Banks become insolvent.

As I have remarked here many times before, Australian house prices are highly over-valued. In 2007, house prices in cities like Sydney and Perth briefly reached an astonishing nine times median incomes — among the most over-valued in the entire world.

And we know this. Anyone who has actually gone out to look at properties knows how overvalued they are. I looked at an apartment building on the weekend and the quality of the fittings in the apartments was horrible; the absolute cheapest fittings they could find. If you look at buildings made more than 10 years ago, you can see that things were of a much higher standard. $400k for a 1br apartment in Mascot? Ugh. Horrible.

The result of this asset price bubble has been unsustainable levels of household debt. The Reserve Bank of Australia’s household finance statistics tell us that Australian households now hold debts equal to 160 per cent of disposable income — higher even than in the US. Unsurprisingly, RBA Governor Glenn Stevens thinks that consumers may be reaching their borrowing limits. This huge debt burden is one reason why house prices must fall, and soon. Like their US counterparts, Australian households simply can’t keep borrowing and spending indefinitely. Inevitably, balance sheets must be repaired as consumers begin to save again. In the long-term, this is a good thing. But in the short-term, this means much lower consumer spending — something that Gerry Harvey says we’re already seeing.

So due to the large debt burden, house prices must fall. And when they fall, there will be defaults. More defaults mean more house prices on the market, which means house prices will fall further.

One argument popular among real estate analysts is that there is a still a significant lack of housing supply, which means prices shouldn’t fall too much. There is some validity in this point — Australia built far fewer houses during its property boom than the US did. But even a shortage of properties won’t stop house prices declining rapidly if demand drops off a cliff. And if home owners default, foreclosure sales will depress house prices. A vicious cycle can ensue, as the US experience demonstrates.

Real estate analysts like to argue these things because they themselves are up to their necks in it. These guys will say anything it takes to try and keep the bubble going. But as we all know, bubbles burst eventually. This one is no different, and its on it’s way out, in a big and nasty way.

No wonder the housing industry is “pessimistic”. Perhaps we should all be.

If you’ve managed to live within your means, and save a little, in the next year or so once the dust begins to settle, you might be able to leverage those savings into a cheap house purchase. At least, thats my hope.

Seeing as I have no skin in the game, I’m optimistic.