The Joe Walker Podcast - Housing Bubble Week: Getting Things Done In Western Sydney - John Hempton

Episode Date: May 20, 2019

The logic is inevitable: credit is as much a feature of housing bubbles as the moon is of...See omnystudio.com/listener for privacy information.

Hello there, ladies and gentlemen, boys and girls, swagmen and swagettes. I'm your host, Joe Walker, and this is the Jolly Swagman podcast. Welcome to episode six of Housing Bubble Week. In introducing this episode, let me start with the big picture before honing it down to the focus of the conversation you're about to hear. So far, a single four-letter word has been conspicuously lacking in this series. It's a four-letter word that in some people can summon dread, and that for many of us evokes an image of a millstone around the neck. It's a four-letter word that describes an idea which, as David Graeber reminds us,

has been with humanity at least as long as money itself. The word is debt. Debt is a permanent feature, not just of civilization, but indeed of our individual lives. Some debts are with us for life. In fact, the word mortgage originally comes from the law French, or old French, for death pledge, with mort meaning death and gage meaning pledge. Although I should add that this didn't refer so much to the fact a mortgage took a lifetime to repay, in the US after all, multi-decade mortgages weren't available until after 1933, as to the fact that the pledge would only end or die when either the obligation was fulfilled or the property was taken through foreclosure. Either way, it was as solemn an obligation as any marriage, till death do us part indeed.

Debt may be burdensome, but is debt all bad? The flip side of debt is, of course, credit. Credit is an invention that has lubricated the wheels of human progress. As historian Neil Ferguson puts it, The Ascent of Money, the evolution of credit and debt was as important as any technological innovation in the rise of civilization. If you have the wit but not the wherewithal to start something new, credit ensures that the world is not deprived of your ideas. And yet credit is productivity agnostic. Joseph Schumpeter warned us in 1939 that, quote, However, this turn of phrase must not be interpreted to mean that that design cannot be altered.

Of course it can. The existing machine could be made to work in any one of many different ways. End quote. In other words, there's no natural reason why a credit can't find itself being shoveled into increasingly less productive assets. Now, for most of this series, I placed an emphasis on speculation. That was deliberate. I think speculative behavior is essential to understanding both bubbles and crashes. As I said in the introduction to my episode with Chris Joy, crashes are stitched into bubbles by the hands of speculators. And yet the role of speculation hasn't, at least in my

opinion, been adequately analysed in most of the commentary on the Australian housing bubble, to the extent that debt and credit have. So I wanted to raise more attention to it. But where there's a will, there's a way. And if speculation or animal spirits are the will, then easy credit is the way. Credit is as much a feature of housing bubbles as the moon is of nighttime. This is for a very simple reason. Buying a house is the biggest purchasing decision most of us will make in our life. Yet few of us have a spare $1 million lying under the bed to buy one outright. Credit, enter the picture. Grasping the role of credit immediately gives you a powerful tool with which to understand the contours of housing bubbles.

It stands to reason that if you channel ever-increasing amounts of money into a relatively steady supply of dwellings, you're bound to see price increases like the stupefying ones we've witnessed in Sydney and Melbourne. It's no coincidence that those two conurbations remain in the world's five least affordable cities by price-to-income ratio, and that Australia also has, after Switzerland, the second highest household debt to GDP ratio in the world. Now, on top of everything I've just said, let me add a dirty little secret. This is a secret that lies at the heart of this, the penultimate episode of Housing Bubble

Week. To sustain such price rises, ever more credit must be extended to ever more borrowers. Run out of borrowers and you risk killing the bubble. As Dean Baker, the first guest in this series, said in 2002 in regards to the run-up in US house prices, such a bubble must inevitably burst when there are no more buyers to be found. This insatiable appetite for credit has an inevitable logic. Eventually, incentivized bankers, who by the way speculate on prices in their own way, have to start getting more creative. They might begin lowering underwriting standards to permit more borrowers to enter the market, people who in normal times would not be considered creditworthy.

It's the entry of the least creditworthy borrowers that at once tells you the bubble is alive and also that it is doomed. Michael Burry of the big short fame put it this way in a speech to Vanderbilt University in April 2011. Quote, The point at which the provision of credit was most lax would mark the point of maximal price in the asset. I imagined the top in the housing market would be marked by a mortgage in which homebuyers of subprime quality were enticed to buy with teaser rate monthly payments near zero. I was very aware lenders would take this to the nth degree. End quote. Importantly, the effect of the lowest quality borrowers isn't limited to the lowest quality homes.

It has ramifications for the entire housing market because the people buying the lower-priced homes allow those selling them to trade up. Bill Gross, billionaire American investor and founder of PIMCO, called this plankton theory. The entire housing ecosystem, in Gross's mind, is dependent on the first-time buyers and the leave-it-up investors. As Gross said, to gauge the health of the housing market, first look at the plankton. What all this tells you is that in a housing bubble, it's really the

availability, not the cost, of credit that sits in the driver's seat, on the way up and down. That's why, in my opinion, the Reserve Bank of Australia now has as much power to arrest house prices falls as a ring-tailed possum has to put out Orion with a flicker of its tail. One person who knows more about the underwriting standards of Australian banks than almost anyone who doesn't work at a bank is John Hempton, our guest. John is the co-founder and chief investment officer at Australian-based hedge fund Bronte Capital. He's a legendary short seller whose work shorting Valiant Pharmaceuticals, for example, saw him as one of the protagonists in an episode of Netflix's Dirty Money series.

But my specific reason for speaking with John was because in 2016, he toured Western Sydney undercover with friend of the pod and former guest Jonathan Tepper of Variant Perception. Their mission was to investigate mortgage broker techniques, bank underwriting standards, and how easy it was to borrow too much money. John and I discussed the trip, its core hypothesis, and what the two men uncovered. We also discussed the likelihood of an Australian recession in the next two to three years, thereby bringing this series closer to its logical end point

and to our finale episode tomorrow. So without much further ado, please enjoy my chat with John Hampton. John Hampton, thank you for joining me. Thank you. In 2016, more than three years ago now, you and Jonathan Tepper, a variant perception towards Sydney, investigating underwriting standards in the property market. I don't think you've given the full details publicly before. I've given a fair bit, but the key bit was that we just decided to go a little further out or

even a lot further out than the average Sydney finance guy. So pick stuff on the periphery of Sydney. We went out to Rouse Hill. We went to equivalent places down the south. We went also to the big apartment builds in Parramatta and places like that. And we talked to lending offices. We talked to brokers. We talked to bank officers. We talked to people buying houses at auctions. We just sort of surveyed. The key thing that we did was we talked to three types of mortgage brokers. And the first type of mortgage brokers were ones that were recommended to us by friends and were honest. And the question was, how much money could we borrow? And if you read the bank underwriting standards and translated it, you could borrow according to the underwriting standards 6.8 times your income. Now, you know, if you look at Irish banks at the moment, you're now,

you're not allowed to borrow more than three and a half times your income. But 6.8 times your income is a number that is theoretically affordable, but it's going to hurt. And we asked them, you know, what if I wanted to borrow 6.9 times? And they said, yeah, I can do that. Right. What about seven times? I could do that. What about seven point? It turns out that what about eight times? And they say, I can't, I know somebody who can get things done. And the actual number was, although the official number was 6.8 times your income, the unofficial number was 7.2. And the honest brokers would happily lend you 7.2 times their income, and they would tell everything truthfully to the banks, and the banks would accept that

letter. If you wanted to borrow eight times or nine times your income, they would have to send you to somebody else who just knew all the loopholes and was playing fast and loose and the expression they used and we kept hearing it again and again and again is I know a bloke who can get things done. The second way we found blokes that could get things done was we went to visit property developers and we deliberately chose a property we couldn't afford. And we'd asked them to send us to their favourite mortgage broker. And it turns out their favourite mortgage broker was also blokes who could get things done. And when you say you couldn't afford, obviously...

Well, yeah, we decided this is the bit that everybody remembers. We had to pretend what our income was. And Jonathan Tepp is a Rhodes scholar and a sort of erudite Englishman who speaks half a dozen languages. And I don't sound poor. So we had to make it plausible. And so what we were, we're a pair of gay graphic designers. And we would describe our income as low and variable. And the beautiful thing about variable was variable gave the mortgage brokers all the data that they needed in order to get things done.

Right. Variable was all they needed. They didn't care about our low. But in order to make this plausible, because we were were buying houses we had to really look like a couple so we'd actually walk into mortgage brokers holding hands and things like that and even to this day because this is a good story we get journalists ring us up and they say they just want to fact check this story and the only thing that they want to fact check is did we really hold hands and i promise you we did did you act like a couple in yeah we like we would look for apartments that were too small

right because that was all we could afford and the too small apartment would have a nook that you know you might be able to set a desk up at and because we were graphic designers we would fight over who was going to get that desk right right, just in order to make it plausible. But it was an exercise in meeting the blokes that could get things done. And, I mean, if Jonathan Tepper had been a 27-year-old woman, we would have told them we were expecting a baby, right? But, you know, he was a bloke, so he had to be gay. It just needed to be done yeah right because otherwise our whole ruse of appearing like a real couple didn't work yeah now the third type of

broker we saw were the ones you know there's a guy called nathan birch interviewed him who runs a thing called Be Invested and Nathan tried to get you to buy 30 properties or 10 properties and the way you did this was that you got the first one revalued you then borrowed against the revalued property in order to get the second and third one you rinsed and repeated and eventually you're extended out to the eyeballs but as property only goes up it works just fine and nathan birch claimed and i don't know the validity of the claim but he claimed to have 180 properties and my reaction to this was you've got 180 properties and the bank owns 150 of them right market's gone up a long way you should be in the black for fuck's sake cash it because if you own 30 properties unlevered you are set up beyond all measure for the rest of your life

there is absolutely no reason to own 180 properties levered it's just sort of financial insanity right but he had a mortgage broker attached to him. And the mortgage broker ran a line in explaining to you how, and in fact courses explaining to you how to fool the bank into believing that your property was revalued upwards. So you met this guy? Yeah. Nathan Birch's mortgage broker? Yes.

In Sydney? Yes. Huh. So this was the third category? That was the third category, the really, really, really, you know, aggressive mortgage broker. And what did he say? Well, the most important thing he said, I'm going to say it publicly, was that he hated National Australia Bank. And the reason he hated National Australia Bank was that National Australia Bank strictly would not revalue any property up that was owned for less than a year. But Westpac and Commonwealth would. And his definition of a good mortgage wasn't one that was cheap, but it was one that you could expand. Because if you're Nathan Birch and you're selling these property seminars, what you've got to do is convince the person to borrow

two billion two million three million five million twenty million right and so you know Nathan Birch's mortgage broker whose name escapes me now his definition of a good mortgage wasn't the cheapest mortgage it was the most expandable mortgage the one you could borrow most on and that was not National Australia Bank. And in fact, most of the time when we looked, there was a sort of hierarchy of banks with National Australia Bank being bad, but the best of a bad lot. It was kind of odd to me that the Royal Commission had the outcome that the only bank CEO and chairman that resigned was National Australia Bank. In fact, you know, the Royal Commissioner was flat wrong, right? By far the best of a bad lot, and they're all bad, was National Australia Bank. The only one that shouldn't have resigned was the National

Australia Bank one. Now, I admit I'm friends with the National Australia Bank chairman of the time. But, you know, I went and took all the data to him and National Australia Bank actively tried to improve where we thought they were faulting. And we know for a fact that they did in certain instances. And by contrast, nobody from Westpac rang us. But it was pretty clear that bad practice was ubiquitous and the further you went from Sydney, from the centre of Sydney, the worse the practice got. In particular it got bad if you went north and west, right. So that you know, Norwest Business Park and the suburbs around Norwest like

Kellyville and then further out to Rouse Hill, they were surreal, right? Whereas if you went south and west, they were just wacky, but north and west, right, the whole culture was surreal. I argue that the centre of the Sydney property bubble is Rouse Hill, which is kind of absurd because you can go to Rouse Hill and there's a lovely shopping centre which is upper middle class I'd be perfectly happy shopping there with my wife but in fact it's just grass to the blue mountains and we went and visited just a bank branch not National Australia Bank but a big bank branch in Rouse Hill and we're talking to the lending officer you know saying we knew we weren't actually giving her numbers at this point we're just to the lending officer you know saying we you know we weren't actually giving her numbers at this point we're just trying to find out attitude and she told us that we should and

this is a bank lending officer who's not paid commission a broker who's paid commission right you know that's a different thing she probably has lending target, so she's pretty keen to lend to you, but she's not paid commission. She told us that we should draw our credit card to the maximum to get the biggest deposit we can so we could buy a house now rather than save for a deposit. And the reason she said this is that the house price goes up faster than you can save. And then she said it'll go exponential

she didn't know what exponential meant but this was a 55 year old sort of older lady who'd probably been you know a bank officer for 15 years and had somehow rather moved to outer western sydney and there wasn't a skerrick of financial sensibility about her. And, you know, the idea that a bank officer who's not paid commission tells you to draw a credit card, oh, and she told you, look, you know, you should get credit cards against other banks so that it doesn't show on our system.

It's pretty astonishing. We were, you know, but it was bad everywhere, but the further north and west we went. In fact, you know, one of the jokes, for instance, is that the median house price in Mount Druitt was over a million dollars and the median household income in the tax stats was about $55,000. And, you know, the median household income in Rose Bay is not huge, but I don't really believe the tax stats at that point.

There's a lot of assets there. But when somebody's a PAYE tax earner, the tax stats are fairly accurate, which are done by Suburb, are a fairly accurate appraisal of the income of that house. And we sort of did mismatches between, we also targeted suburbs with the largest mismatch between taxable income and house price, where we thought there were over 90% PAYE owners. And Mount Druitt and Rooty Hill were two adjacent suburbs, neither of which is salubrious. Mount Druitt used to be all government housing and Rooty Hill was sort of fibro housing and it was private. And once upon a time, Rooty Hill was a premium to Mount Druitt because Mount Druitt's government housing. And now Mount Druitt was a premium to Rooty Hill because it's government housing it was built to last so you can put tenants in it

they won't destroy it and the question was who was buying it and the answer was people who attend eight suburbs back towards the city were buying it because they couldn't afford a house in where they wanted to live so they were just leveraging up rental properties in the hope that they would get enough money to buy the house that they actually wanted it was kind of bizarre and we actually walked through suburbs Jonathan Tepper's parents were missionaries in Spain who ran drug rehab clinics and JT has a weird skill which is that he can walk down a street and say that woman's just shut up and he just knows a junkie by looking at them just looks at their eyes and he knows they're a junkie we followed her back and out of a little laneway and

yeah there's syringes on the ground she had just shut up and you walk down the street and there's you know there's a street with about seven or eight porn shops in it in Blacktown. And the houses just around the corner from the junkies in the porn shops were 900,000. It's astonishingly silly, right? I mean, I actually have no particular problem with a waterfront house at 20 million, right? The waterfront house at 20 million is a trophy owned by rich people. And the value of that house depends entirely on how many rich people there are. I'm amazed that income distribution is where it is, but if income distribution keeps getting wider, trophy waterfront homes just go up.

What astonishes me, nobody grows up desiring to live in rooty hill you live in rooty hill because you can afford it and that's what happens right you know it's it's not a it's not an aspirational place in non-aspirational places houses were trading at 17 or 18 times income right it's just and the lending officers were telling you to draw your credit card to the max so that you could buy them. All we went and did was prove that the lending standards were really, really low.

Now, if only 5% of the loan book is lent to those standards, there's not really an economic problem. Some people are just going to lose a lot of money, but there's no disaster that's going to befall the society. But if 40 percent of the loan book is led to those standards, then you look more like Ireland at the end. All the banks get wiped out. There's reconstruction. And we couldn't answer that question. We could prove that beyond reasonable doubt that the lending standards were completely atrocious everywhere except national australia bank and they were just bad at national australia bank right um but we couldn't say whether five percent

of the loans were at that standard or fifty percent of the loans were at that standard and if five percent of the loans are at that standard. And if 5% of the loans are at that standard, this bubble will end with a soft landing of some description. And if 50% are of that standard, this bubble's going to end with a very, very, very hard landing. And I don't know the answer. Previously, you've said if even 25% are bad, it could be... If 25% are bad, the banks will survive,

but their dividends will go, there'll be a recession, there'll be, right? But it'll be a garden variety recession. Yeah. Meaning we have a few years of subnormal income, bank shareholders discover that, you know, these things don't work very well sometimes right but it's a garden variety recession unemployment peaks out at sevens or eights on right but not at 14. if 50 are bad

then it's not a garden variety recession it looks more like ireland and unemployment peaks out with two in front of it. And it may not last very long. But that's not garden variety. That's epochal. I suspect that it will be a garden variety recession with a bunch of very sore losers. And why do you suspect that? Just because almost every other housing bust except the u.s and ireland has looked like that it's you know nine ten percent twenty five percent unemployment rates in australia would be bizarre the australian dollar can move down a long way yeah right the sort of end game

is that you get a recession australian dollar is weak weak, the Australian dollar goes to 50 cents or something like that. A 50 cent dollar and a $80 iron ore price is 160 Australian dollar iron ore price, which is where it was at the height of the mining boom. A weak Australian dollar restarts things. Then you get a bit of wage inflation. The loans are not as bad as you look. There's a garden variety recession.

You don't want to own banks. And you don't actually want to own retailers. In fact, you don't want to own anything that suffers from a weak Australian dollar. But the miners could be fine. It would be a weird macroeconomic outcome. But this notion that the adjustment mechanism is the A dollar. but the miners could be fine. It'd be a weird macroeconomic outcome, but this notion that the adjustment mechanism is the A dollar, and if the A dollar goes down far enough, wages go up.

The economy booms in another sector, and that solves a lot of ills. What do you think the probability of a garden variety recession is at this point? 70. Right. In the next two years two three years yeah yeah right um just going back to this tour of western sydney what was the most you were you were offered in terms of a mortgage compared to your income we proved that you could

borrow 10 times your income now it's kind of 10 times is a magic number and the reason is that at 10 times your income you're left left with $300 a week. And it actually doesn't matter what your income is because tax rates are progressive. So if you borrow 10 times $100,000, you're actually left with slightly less than if you borrowed 10 times $50,000. Now, that worked when interest rates were at four. The interest rates are a bit lower now. But nonetheless, the question was could you borrow 10 and i can't conceive of how you managed to get your expenses below living in sydney below

300 a week yeah right it's just it's not as soon as you've got a kid that's inconceivable right but you could borrow yourself to $300 a week. Now, as a couple, that's a bit better because you could borrow yourself to two times $300. And we were a gay couple, so children might not be accepted. Right. But if you're an ordinary couple buying a house, the next thing that happens is babies. Right. And your incomes go down and your expenses go up and

10 times your income is diabolical if you borrowed 11 times your income after minimum repayments you were left with zero or slightly negative and it also didn't matter what your income is because it's progressive so we proved that you could borrow 10x your income despite the fact that the bank standard was 6.8 or 7.2 depending on who you asked who offered you the 10x the blokes who could get things done yeah all of them which category any category all of them right right there were tricks for doing it there's mechanisms for faking but you know they would tell you where the weakness is in the bank's monitoring. What were some of the classic tricks? The most extreme one was just fake tax returns.

Literally software to develop them. Someone showed that to you? Yeah. What's some of them? Not going to say. Right. Gives too much game away. Okay.

Right? But I'm not even sure. They showed me the output of some tax returns right they look pretty real right um and tax returns are secret so who knows right but it didn't seem you know there was a culture of mortgage brokers lying and a culture of banks accepting. And that culture, when we wrote it up, sounded bizarre. And post the Royal Commission, it sounds absolutely expected. The Royal Commission demonstrated that banks had a culture of not checking because they had volume targets

and things like that right so but again i don't know whether it's five percent of the book in which case it's a slightly bloody nose for the banks or whether it's 50 of the book given i really don't know given how opaque the bank's books are how would you even approach trying to figure out that you can't tell that without the bank's internal are how would you even approach trying to figure out that you can't tell that without the bank's internal data okay there's no way and there's just it there's just no way yeah right it's the only way that you can really tell is to measure the bank's culture right in the sense that you know if it's culturally really bad it's likely to be higher incentives trump ethics right yeah incentives trump ethics and in the bank culture thing there was a definite hierarchy with the

two bad banks being commonwealth and westpac and the good bank being national australia and anz okay and that you know if we get a big washout that's the order that the washout will happen into yeah but i genuinely don't know how much of the book is like that i wish i did you know all we proved was that there was white it was widespread it was dead easy to find people that would help you fake your income it was dead easy to get find mortgage brokers who will help you navigate the underwriting standards and the banks had incentives to turn blind eye we proved all that the royal commission proved it again and now do you know if anything was anything similar was happening in melbourne We didn't do Melbourne. Yeah. We didn't do Melbourne.

Have you heard anything? I've heard stuff, but I don't know whether it's been... Right. You never checked. Right. I don't want to tell you I know when I didn't check. Yeah. Right. And also, it's fair to say that the cultures were uneven even throughout Sydney.

Right. When I said it gets worse as you go north and west, I really meant it. It wasn't even a little bit worse. It got a lot worse as you went north and west. The fantasy was deeper. Now, the rail line that's going out north and west was part of the fantasy.

It was like all these suburbs that are miles out will soon be inner suburbs without realising that it's still an hour on the train. I mean, it's a fantasy. But people construct fantasies around whatever the asset bubble is. Yeah. There are always post hoc rationalizations. Yeah.

I wish I knew how to quantify it. Yeah. I certainly knew which side of the trade I wanted to be on at the end. Right. You know, bad culture and the cultures were really bad. Yeah. Begets bad outcomes. Yeah.

But it's not linear. You know, things went up for a year and a half after we wrote the report and nobody believed us. I thought Jonathan was treated quite unfairly by the media. There's a real sense of conformity and tribalism when it comes to a national bubble and he was treated as you know the foreigner the hedge fund shill yeah incredibly unfair we expected it yeah right we expected it um i was very keen to say it was jonathan tepper's. And the reason is I just didn't want to go through that shit. Right. And to some degree, yeah, it was Jonathan Tepper's report.

You know, I was his guide and driver through Western Sydney. And boyfriend. And boyfriend, yeah. He's a good-looking guy, too. You know, any single ladies out there, you know, he really is a good-looking guy. I'm married, so, you know. Keep trying to pair him up with people.

I thought he had the FinTwit girlfriend. Oh, he did for a while. Oh, okay. The problem was there was a long distance relationship. I wouldn't mind him having a long distance relationship in Australia because then he'd visit me more often. Now, what's interesting about this partnership or union is that you're, you know, a marriage, sorry. I'm trying to be politically correct.

You're a dyed-in-the-wool, bottom-up micro guy. Jonathan's a dyed-in-the-wool, top-down macro guy. Yeah, and the weird thing about Jonathan and myself is we don't agree very much because we're so dyed-in-the- the wool about how micro and macro we are. When we agree, we're almost always right. And it's happened a couple of times. It happened on various shale oil stocks. And I was finding 30 frauds and he was finding top-down capital misallocation.

And guess what? It turns out that where there's lots of money sloshing around you get fraudsters right I find the fraudsters he finds the lots of money sloshing around hmm right it's still approaching the same you know we're getting to the same point just a different way and when we do the money's not sloshing around sensibly it's sloshing around pointlessly because it's been given to fraudsters as well so people are not doing their due diligence yeah right that when we when we agree it tends to work beautifully i'd like to know all the places we agree

most of the time i just listen to him and think i don't have a fucking clue what you're talking about yeah and he probably look listens to me and says the same thing and that's fine too yeah different ways of skinning a cat yeah so a lot of people now are saying that we're headed for a soft landing or at least wishing that we are um this argument i think i think it's going to be a medium landing i don't think it's going to be spain yeah right i don't think unemployed i'd be very surprised if unemployment didn't have a seven in front of it at the worst and i i'd be very surprised if unemployment didn't have a seven in front of it at the worst and i'd also be very surprised if unemployment were double-digit at the worst what are your reasons for thinking that because on certain relevant metrics like you know

household debt to gdp the main reason is we look pretty bad the currency is so freaking flexible the shock absorber right it's just such a good shock absorber yeah um before he was to ic of the central bank i used to be regular friends with you know have a irregular chat with um guy de bell and i don't have it anymore because he's in a position of power as much as anything else but you know one of my questions to him was, you know, if my extreme version of what could happen happens, will you defend a 60 cent Australian dollar? And he says, no.

Will you defend a 50 cent Australian dollar? And he says, no. Will you defend a 40 cent Australian dollar? And at a 40 cent Australian dollar, large parts of Australia are just flying. Right. I mean, Australia suddenly becomes the cheapest place in the world to have a nice beach holiday. Right. So all those Queensland resorts are full of British backpackers and English tourists and Japanese tourists.

And the tourist industry is flying at a $0.40, right? I mean, it's just, you know, there's a boom all the way up the coast of Queensland, right? At a $0.40 Australian dollar, Australian iron ore is back to 190 Australian, right? You know, it's right back at the top of the bull market. So the whole mining boom is, right? So it's pretty clear that the top of the bull market so the whole mining boom is right so it's pretty clear the 40 cent australian dollar you know solves all the ores right now

it doesn't solve the ill of western sydney right northwestern sydney is still going it doesn't benefit from a mining boom and it doesn't benefit from a tourism boom right the only thing the business of northwest and sydney is building houses for people who live in northwestern sydney the slump there is ugly but there's a safety valve and the safety valve is that there's big streams of income coming elsewhere in the australian economy yeah so when i said would you defend a 40 cent australian dollar he says no right at this point I realized the Australian dollar is enough enough of a you know buffer then I asked him because I was being cheeky would you

defend a 25 cent Australian dollar and he looked back and said I wish you wouldn't ask me right so somewhere in there the central bank gets worried between 40 cents and 25 cents. Right. But the answer is the Australian dollar can fall far enough that large sections of the Australian economy just fly. Yeah. Right. Now, if you have a house in northwestern Sydney, that doesn't save you from being a long way underwater in the mortgage, but it does mean you can go work in the mines or your kid can go work in the mines and get a bit of income, right?

And that income will look large relative to your past income. In other words, there are some safety outlets. Yeah. The pain will be selectively not generally applied at that point. Gotcha. Right, whereas double-digit unemployment suggests that the pain is going to be generally applied. I point gotcha right whereas double digit unemployment suggests that the pain is going to be generally applied i don't think that's going to happen so in other words in in terms of the macroeconomic implications of their housing bubbles which were

severe the key difference for ireland and spain was that they were yoked to the euro fixed currency whereas we have the floating dollar. Yeah. Do you know if Jonathan agrees with you on that analysis? Because I know some people disagree with you on that. I think so, but I'm not sure. Yeah. I mean, if you think about the sort of two extremes,

America has a housing bubble and everybody loses their job and there's big... Norway has a housing bubble and the kroner just drops two-thirds. Yeah. And the kroner is like... Was this the 80s, 90s bubble? When they were... The 92, the kroner was pegged and the banks all started failing

and then they de-pegged the kroner and within six weeks the problem had gone away. Yeah. But the krona was pegged and the banks all started failing. And then they de-pegged the krona and within six weeks, the problem had gone away. Yeah. But the krona dropped. Yeah. The krona, I think, is sort of like the Australian dollar. And they had a garden variety recession. It was a bit more than garden variety while it was pegged. There's a lovely book on the Norges Bank website about how they dealt with the norwegian banking crisis and the

the the um it was written from a bureaucrat's perspective as a sort of manual on how you deal with banking crises that's great and i printed it out and gave it to ken henry in 2005 yeah and the reason i said was you know we're about to have a banking crisis, please break glass. You don't have to read it now, but break glass in time of emergency. Yeah. And he broke the glass and read it one night. Oh, was this the go hard, go early, go households? There's a little bit of that. A little bit of that. Okay. You could see a little bit of that book in the response. That's interesting. So, a lot of people actually hold up the swedish response as the model yeah sweden and norway were pretty similar responses actually were they

yeah the key thing was the float the the depegging of the currencies yeah right um the depegging of the currencies turned what was a horrific crisis into a small one yeah right and but you know it's it, if you think the Australian dollar floats, you know, think of one of these countries with 4 million or 6 million population, completely open economy, right? They float like crazy. The way to think of the kroner is roughly

the Australian dollar on steroids. You know, Norway exports oil, the technology for drilling oil in deep water shipping and shipping services all those things are tied China well right they're all basically commodities tied China and so the Norwegian Krona sort of tracks the same it's West Australia by on steroids by the Balt. That's the way to think of that economy. And the Krona does all the adjustment, all of it. But, you know, they're in a very privileged position.

They have no foreign debt. They've got this huge sovereign wealth fund. Every time the Krona goes down, they're richer. You know, it's like you wish Australia were managed. It wasn't. You know, we left a mining boom with... They left an oil boom with a sovereign wealth fund owning 3% of global equity markets.

Yeah. We left a mining boom with a bit of a hangover and a good party. It's called the hair of the dog strategy, John. Right. Well, maybe. Maybe it wasn't exactly... It wasn't exactly Australia's finest mode in asset liability management. That's a good way to put it.

Just finally, what do you think the likely extent of house price falls for Sydney and Melbourne will be? Depends where you live. If you live in northwest Sydney, I would think over 50. Right. Rouse Hill is like the centre of the bubble. If you live within 100 metres of a beach in a desirable location, the answer is tell me what wealth distribution will look like. Nothing to do with Australia in particular, right?

The reason why upmarket housing has been so strong is the same reason why you know is the same thing that's driving wealth distribution or wealth distribution drives it if you think that the small elite are going to be richer and richer and richer relative to the rest of society then the end game for point piper property is it goes up if you think the wealth risk distribution goes back to 1973 levels right which i don't think but if you did think that then wealth distribution goes then point piper property goes down but i don't think the bubble per se is in those, you know, what people think of as expensive property. I actually think it's in mid-market and lower market property.

If you're in non-aspirational suburbs of Melbourne, I'd think 40% too, right? If you are in country towns that are shrinking i mean the idea that wulongong's house prices relative to income if you somebody told me the other day and i believe them that if you line up all the cities in the world by house price relative to income they're the only ones that are less than a population of 200,000 happen to be in Australia. Tamworth's in there. Right.

It's just bizarre. Tweed Heads, Coffs Harbour. Now, partly they are, because they're desirable places, to live on the coast. Yeah, not Tamworth. Not Tamworth. Right. But you get the idea.

Yeah. Some of the less desirable ones, suburban newcastle could drop 85 right because this doesn't really have a reason to exist yeah right um i mean in america some houses dropped 100 right there are you go to the american real estate sites and you look at houses in outer Cleveland. They literally went to $1. All you needed to do was pay the back taxes and the house was yours. The house price in Detroit went to $1. $1.

You could buy the whole street for $30. That's a pretty good deal. Well, was it? It turned out actually to work out all right in most of those cities. Yeah. Right? But, you know, there's no conceivable reason why some of these less desirable places to live don't go to $1. And do you have any sense of average national price falls then?

No. Too hard to say? Too hard to say. You know, the average is, I mean, I understand why a waterfront house in Point Piper is $40 million. It's $40 million because there are a bunch of billionaires who have nothing better to do with their money. And it's, you know there are a bunch of billionaires who have nothing better to do with their money and it's you know if you've made a billion dollars what's dropping 40

on a house if you go well pick bronte my suburb right and you go to a mid-market house in bronte i no longer understand the price the person in a mid-market house in Bronte. I no longer understand the price. The person in a mid-market house in Bronte is a partner of a law firm or something. A partner of a law firm earns $400,000 for 10 years or something, or $500,000 for 10 years, which is only $250,000 post-tax. And you can't be a partner for more than 10 years, right, because you get squeezed out and it turns out that the houses that the partners live in are more valuable than the

cumulative lifetime income of the partner or at least the post-tax cumulative lifetime income of the partner which i guess is okay if their heirs and descendants you know also pay part of the bill right but you know it's like the land of eternal mortgages in japan in 1999 so that doesn't quite make sense to me but it's not as stupid as a house in outer northwestern sydney for where it's grass to the blue mountains so there's no constraint here right where it's it's $1.4 million. That makes much less sense to me, especially as there aren't that many people earning what a partner of a law firm lives and living in Rouse Hill. And I don't mean to, you know, pick on Rouse Hill. It's just

the most extreme place we found. And that was only because it was the furthest Northwest. It just happens that Northwest was bad. What about inner west? Like, what sort of price levels would you be looking at there? I don't have an opinion. Not sure. Don't have an opinion. Yeah. I mean, certainly, I look at the house prices

and the incomes of people I know, and it don't match. Yeah. Right. But, again, I don't know whether that's the norm. Right? I just don't have an opinion. Yeah. My guess is down probably a fair bit.

But to be fair, inner west was worse than inner east, rationally. But it bears no resemblance to outer Sydney. Outer Sydney, the further we went away from the CBD, the more insane the bank branch officers or the brokers were. Right. It really was inversion. I mean, I expected when I looked at this, the bubble to be in the inner part, you know, where houses were expensive. I completely changed my mind. The bubble's in the outer part.

It affects ordinary people reminds me a lot of uh galbraith tells the story of the 1920s florida land boom which is actually more of a u.s housing bubble than a florida land boom even though that's how he retells it um chicago went crazy a few other cities went crazy but in florida they were selling quote-unquote beachfront properties which were miles from any water yeah and and the bubble sort of emanates outwards and becomes less sensible the further it moves that was that's exactly it yeah sydney is one of the most attractive cities to live in the world, period. It is just delicious, right?

It's got really good restaurants. It's got a really good climate. It's got really good beaches. And almost none of those apply if you go an hour and a half, an hour and 20 minutes in traffic west. The only thing that applies is the Sydney price. Right? But it's not desirable in any sense. No.

Right? I can understand the desirable, the quality stuff being expensive. I can't necessarily square its price. I mean, a waterfront home in Point Piper is worth what a waterfront home in Point Piper is worth, which is what a rich guy will pay for it. Yeah. Even a house in Bronte is pretty desirable.

Right. It's not, right. But it's still, you know, a partner of a law firm aspirational. Yeah. A house, the houses in Western Sydney made no sense no matter how we cut it. And you could see that in the behaviour of the mortgage brokers who were more crazy no matter how you cut it. You know, I can't imagine an eastern suburbs bank branch officer telling you to draw your credit card to the maximum so you could have a deposit.

It just doesn't work. Yeah. But it sure as hell works in Rouse Hill. Final, final, final question. Before we were recording, you told me an interesting story about the behaviour of residential mortgage-backed security in the US subprime mortgage crisis.

Okay. Can you tell this one? Yeah, okay. This is looking at the very last securitisation Lehman did of HELOCs, Home Equity Line of Credit. It was about 1,100 loans and 80%, so 870 or 880 of them failed. Now, if I told you to pick 1,000 borrowers who are going to default, who you thought were going to default, I was going to pay you for picking the worst borrowers

you could find. But they're legitimate looking borrowers, but I'm going to pay. I don't think you could pick 800 in 1000 that defaulted when only like 3% of the country or 4% of the country defaulted. Right? It cannot be random. Now, it turns out that what happened is that there's a class of borrowers who can't pay. And they've worked out that they don't need to pay, they just need to refinance it every six months. And they take a bit of cash out and that pays the coupon while they refinance it. And then they refinance it again and they refinance it again. And the slogan is a rolling loan gathers no loss. And these loans rolled from securitization to securitization to securitization.

And then they sat in the last securitization, and then the mortgage market stopped, and they couldn't be rolled again. So every loan that had been bad for years and years and years and had been rolling and gathering no loss stopped in one place. And so you had 80, 800 and 1,000 loans go bad. It wasn't bad luck. It was systematic refinancing of bad mortgages now to be honest i haven't seen that in australia right right you know there are some rolling loans here and we were told by some of these mortgage brokers how to expand your credit and then you right there's clearly some of it going on and there's a whole lot of helox or line of credit loans, right? But I don't know a systematic culture of rolling them.

So bad but not Armageddon. Yeah. Right? Yeah. If we pegged our currency, it would be Armageddon. Yeah. But we're not stupid enough to peg our currency and Guy DeBell won't defend a 40 cent Australian dollar.

Cheers to Guy. Thank you. I'm glad he's our central banker. Incidentally, all told to me before he was in a position of power. Just to clarify that. Just to clarify that. Because I really don't want to put him in the shit with that. Yeah.

Well. But, you know, that's clearly how they think. Yeah. And they're right. Yeah. Well, thanks so much, Don. Cheers. Thanks so much for listening.

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