Opinion: NZ houses more overvalued than US houses

Data on US house prices released this week by Standard and Poor's and Case-Shiller show prices in the 10 major cities in the United States have fallen 20.3% from their peak in mid 2006, but that the rate of decline may be slowing. The US market is widely seen to be one year to 18 months ahead of trends in the New Zealand housing market. So it's worth asking the question: Could our prices fall more than they have in the United States? To do that it's worth working out how overvalued our houses are compared to US houses and how stretched our households are servicing existing debt. After over a year of watching the Credit Crunch from afar and hearing of the chaos in the US housing market my initial assumptions were that New Zealand home owners were not as indebted and that our bubble was not as bad. The figures tell a different story. Our household debt servicing ratio (interest as a proportion of disposable income) has surged from around 8-10% through 1995 to 2005 to 14.4 % by the first quarter of this year. The US debt servicing ratio has been well above ours for all of that period...until now. Our debt servicing ratio is now slightly above that of the United States. This astonishes me. America has just gone through a credit boom funded by low interest rate loan, mass securitisation and a sales-driven approach to credit cards and mortgages. Deeply flawed lending went on to people who couldn't afford it or who didn't have any security. Americans often have more than 10 credit cards each, whereas we have around 3. These numbers include both consumer credit and mortgage debt. Now the default rates are climbing fast on a good chunk of this US household debt, unleashing a wave of failed loans and revaluations of securitised mortgage bonds. This firestorm of bad debt has already wiped at least US$1 trillion off the market value of the world's banks. Then I thought maybe our debt servicing costs are "unnaturally high" as a proportion of income because our interest rates are typically higher than those in the United States. This accounts for that ratio being relatively close to the US ratio from 1995 to 2005, but it doesn't account for the very sharp sprint up from 10% to 14%. That is all about the sheer scale of household debt added from the beginning of 2004 to the end of 2007. We gorged ourselves on NZ$85 billion of foreign debt through those years and it was wholly used to increase our mortgage debt. Even then I thought our level of household debt as a ratio to our disposable income would be lower than in America, given the explosion of poor quality lending in the United States and relatively slow growth in nominal incomes for most Americans over the last decade as income was skewed to the upper end. But no. Our household debt to disposable income ratio has surged to 163% in the March quarter of this year from around 110% in 2002. We are now substantially more indebted relative to our incomes than in the United States, where the same ratio is at 130%, up from 90% in 2002. So what about the affordability of houses in both countries? Surely the bubble in America is bigger with all the foreign borrowing by both households and government pumping up the cash flow powering around the housing market? Unfortunately for us, our market is vastly less affordable than the American market. The multiple of our median house price to our household earnings was 6.3 at the end of 2007 according to Demographia's report on affordability in Anglo Saxon countries. America's house price to earnings multiple was 3.6 before most of the recent price fall. House prices in the United States have fallen 10% since that multiple was calculated, while New Zealand's house prices have fallen 3.4%. If anything, the disparity between the multiples will have gotten worse. However, we are not in anywhere near as much strife when it comes to paying back our loans on time. The portion of mortgages that are delinquent or behind on their payments in New Zealand is less than 1%. Yet in the United States that figure was 6.35% at the end of the March quarter, up from 4.8% a year ago, according to the Mortgage Bankers Association. Why is that? Lending standards in the United States were more lax. There are far more intermediaries in the United States than here. The lender in New Zealand is almost always the bank which holds the loan on its balance sheet. There is a clear relationship between the borrower and lender and the bank here is much more likely to understand who it is lending money to and what is behind the loan. The borrower here will often have all their banking with the lender, meaning the bank can see every piece of income and spending and spot problems before they arise. In America loans are made by all sorts of banks and other brokers, who then package them up and sell them on to others, including the likes of Fannie Mae and Freddie Mac. It is also easier for borrowers in the United States to walk away from a house and loan. They can send back the keys (known there as 'Jingle Mail') and in many cases walk away from the loan, which is a "non recourse" loan in many states. Whereas in New Zealand, the bank lends to the homeowner directly and can continue to extract the debt from the borrower even after the house has been sold in a mortgagee sale. Yet those underlying signs of debt overload and housing unaffordability are unmistakable in New Zealand. Mortgagee listings have almost doubled in the last 6 months, but remain at less than 1% of listings in New Zealand. In some parts of America foreclosures are running at a rate of one in every 10 households. I can't believe it would get that bad here. But if this is what happens when your debt servicing ratio goes over 14%, then our banks are in for a rough time and house prices will easily drop the 30% we have forecast within a couple of years.