The financial malaise is spreading

Already retailers are feeling the pain. Commercial property tenant enquiries are disappearing, asking rents are dropping, and valuations, which are based on a simple calculation of rent multiplied by the yield, are dropping.

Many observers believe March 2008 quarter valuations will be down by 25 per cent. A huge amount of commercial property that has changed hands in the last three years is leveraged at more than 80 per cent. Those borrowers are now under water. A great many of them have bought high yielding and complex assets that they aren’t resourced to manage. The banks haven’t got the resources to manage them either. I believe the real trouble could be about to start.

There are protracted debates in the UK about whether we are now in 1974, or 1987, or 1999. The events triggering booms were different in nature, commercial property, stock market or dotcom euphoria, but all led to an explosion in consumer confidence, spending, personal debt, a dramatic rise in real asset values, followed by a long and a painful and readjustment of values to affordable values afterwards.

The recent round of results for Australian banks, confirming that they have escaped the worst of the sub-prime crisis is excellent news. However, other indicators are less welcome: rising interest rates have eventually contributed to a collapse in house prices in New South Wales in particular, with signs that the malaise is now spreading to the boom states of Queensland and Western Australia. This will lead to a dramatic reduction in domestic demand, which, anecdotally, is happening already.

Meanwhile, with Australian Dollar interest rates still high, housing remains unaffordable for new entrants, which indicates that resurgence in values isn’t likely in the near future. A cycle of defaults in interest payments and loan to value covenants may yet start to impact the balance sheets as well as the earnings of Australian banks. And so the spiral continues down.

Is it possible that the resources boom and measures being taken to keep its impact in check are disguising the same fundamental problems in the domestic economy that are widely reported in other G10 economies? If so Australia needs to alter its economic policy now.