Kenneth Hayne’s royal commission report could be economy’s tipping point

Things in property and the broader economy are in a delicate state, and it’s within Kenneth Hayne’s power to tip the balance.

Financial services royal commissioner Kenneth Hayne QC AC. Picture: Supplied.

Australians have reason to be apprehensive about the looming royal commission report into its banking and finance system.

If Kenneth Hayne concentrates on improving bank ethics and management practices, then we can all rejoice.

But if the report intensifies the current credit squeeze and breaks the current banking truce keeping troubled developers alive then, when combined with other looming forces, the royal commission could trigger an Australian recession in 2020.

It will be a very fine line. The task for Hayne will not be easy. Until very recently, bunkered down in Martin Place, the Reserve Bank of Australia did not even recognise that there was a credit squeeze, let alone a severe one so its growth projections were wrong.

Accordingly, Hayne might be unaware of the dangers.

The fall in house prices is caused by the credit squeeze and the withdrawal of Chinese buyers from key markets. In many areas of Sydney and Melbourne that decline is gathering momentum. In the apartment market, it is accentuated by an oversupply of small units in Sydney and Melbourne and an under supply of larger apartments, which is where the demand is strongest.

When the fall started it could be viewed as a healthy correction.

But it is gathering momentum and many developers are in deep financial distress because they can’t sell their apartments and their land has slumped in value. To date banks have not pulled the plug. In outer suburban Melbourne, and to a lesser extent Sydney, there is a huge current workload, but new orders have collapsed. That will not reduce 2019 building activity, but it will hit in 2020.

If large numbers of bankers suddenly face criminal prosecutions and potential jail time, I fear the developer truce will be broken. So developers will implode and the fear within bank branch people will intensify. That will make the credit squeeze much worse.

Very few central bankers and bank regulators, let alone bank executives, were around in the 1960s and 1970s to experience how a credit squeeze works. This one is particularly nasty because in essence we changed the lending credit rules so banks cut the amount they would lend in a transaction by roughly 25 per cent.

As Turi Condon reports in The Australian, banks are rejecting up to half of all loan applications.

The exact rules have yet to be determined so bank lending staff are very cautious. A mistake could cost them their job and if they over-lend, their bank might be liable for losses.

A series of forecasters is now saying that dwelling prices in Sydney and Melbourne will fall by 20 per cent plus, which is the rough level by which bank lending has been reduced. Already, on the basis of anxious seller auction results small Sydney inner city apartments have fallen by about 25 to 30 per cent and they are still falling. Negative equity situations are rife.

But for the most part, people are keeping up their payments, so I do not expect a big rise in bank bad debts. But if the royal commission makes life much worse, as its “remedies” for bank sins take effect, then that situation might change, particularly if there is a sharp rise in unemployment

Of course, first home buyers who were locked out of the market by the boom are rejoicing. But there is a side effect.

As the dwelling price decline gathers pace, it dents confidence and reduces retail sales of discretionary items. In particular, consumers become more price conscious, so inflation is below expectations. And the increase in employment is at the casual and part time end, because employers are nervous.

The Australian community is very angry with the Coalition government’s instability and opinion polls tell us that it intends to replace the Coalition with an ALP government. But while in some areas the ALP looks ready for government in others it is starting to look as though it is simply not ready.

The handling of the retirement and pensioners tax (cash franking credits) can only be described as appalling. My readers are well aware of the detail and I will not repeat it here.

And while the negative gearing policy was good policy when It was conceived some three years ago — we might not be in this mess had the ALP come to power and introduced it- the policy is now dangerous because it is coinciding with a credit squeeze.

There seems to be no understanding in the ALP that its negative gearing proposals must be linked to a moderation of the credit squeeze. It’s not that the proposals are wrong longer-term, it’s just that at this delicate time, on their own, they would be catastrophic.

The ALP could be in power in four or five months and in these areas, it is not looking like the alternative government.

This makes the community very nervous and adds to the impact of the credit squeeze.

So, Kenneth Hayne, we are on the edge of our seats, awaiting your report and what happens next.