Best way to short Australian real estate, or “widow maker trade?”
It has been called the “widow maker trade,” based on how short sellers have been dealt with over the past few years.
The fundamentals have been inviting: Australia has been in a fully blooming housing bubble. Households are the most indebted in the world, based on debt to disposable income. To maintain the housing bubble, the central bank slashed interest rates to record lows (1.75%). The government wants to keep the bubble going for as long as possible. So regulators close their eyes, according to media reports, to questionable or even illegal lending practices. Home prices, after soaring for years, are clearly unsustainable.
But just because it’s a bubble doesn’t mean it has to implode on schedule. It will implode, as all bubbles do, but on its own time. If short sellers get the timing wrong, they’ll get run over by market euphoria. Hence, “widow maker trade” for betting against the housing bubble by shorting the banks.
The biggest four banks in Australia are special creatures. Total assets of Commonwealth Bank of Australia (CBA), Australia & New Zealand Banking Group (ANZ), Westpac Banking Corp (WBC), and National Australia Bank (NAB) amount to 220% of Australia’s GDP!
The assets (mostly outstanding loans) of the big four Australian banks have skyrocketed. For example, in 1999, CBA’s assets amounted to 14% of GDP. That was already high, for just one bank! By the end of 2014, they reached 51% of GDP. How’s that possible? A housing bubble with sharp price gains funded by ever larger mortgages extended by ever blinder loan officers. If these four banks topple, as we noted almost a year ago, they can sink the entire Australian economy.
These banks are powder kegs. The housing bubble is already toast in a number of smaller cities, particularly those tied to the mining bust. It’s starting to wobble in other areas. So hedge funds have redoubled their bets.
Short positions on the big four Australian banks have soared 50% this year to over 9 billion Australian dollars (US$6.49 billion), and are up 350% since 2014, according to the Wall Street Journal – “the highest level since regulators began compiling data six years ago.”
Earlier this year, Sydney-based asset manager John Hempton teamed up with Jonathan Tepper, who runs U.S.-based hedge-fund consultancy firm Variant Perception, for an undercover investigation of Australia’s property market. Posing as a gay couple, they drove around Sydney, from glitzy beachside suburbs to the shabby city fringes, to probe potentially risky lending practices. What they found was considerably worse than what they had expected.
“We witnessed a mania in all its crazy excess,” Mr. Tepper told clients. “Australia now has one of the biggest housing bubbles in history.” Among the trades he recommended in anticipation of a major property-market downturn: shorting Australian banks.
We reported on their escapade at the time and included the Australian 60-Minutes video on the topic that caused a huge stir in Australia [see… Signs of Mortgage Meltdown in Australia].
On May 11, Moody’s added fuel to the fire when it warned about the big four banks:
More difficult operating conditions have become prevalent over recent months, resulting in a sharp rise – from an exceptionally low base – in large, single-name loan impairments in the banks’ corporate portfolios.
The expected pressure on asset quality – which currently appears moderate – will derive from multiple headwinds, including … a worsening outlook for residential property developments….”
Moody’s notes “that further deterioration” of their loan portfolios is likely. But ratings agencies aren’t ahead of the curve, as the world found out during the mortgage meltdown in the US. Hedge funds know: if you want to short banks to profit from a housing and mortgage meltdown, you can’t wait until ratings agencies wave a red flag.
Bank stocks have started to sag, after a phenomenal run between 2012 and their peak in April 2015. It was the era when shorting the housing bubble via the banks earned the moniker “widow maker trade”: NAB shares soared 105%, ANZ 127%, WBC 139%, and CBA 140%.
But since April 2015, ANZ is down 25%. Earlier in May, it had become the first of the four to slash its dividend. It confessed that bad-debt charges had more than doubled in the six months through March and net profits had plunged by about 25%.
That didn’t go over very well. Analysts at Morgan Stanley, Goldman Sachs, and UBS then came out and said that further dividend cuts, according to the Wall Street Journal, “appear to be inevitable.”
CBA is down 14% from its peak in April 2015, WBC is 16%, and NAB 20%. Shares were down more but have recently begun to rise again, with the leitmotif of “widow maker trade” once again playing in the background.
No one (outside of the short sellers) wants home prices to go down or these banks to topple. Not the housing industry, the realtors, the home builders. Not the media that depends on advertising dollars from the banks and the housing industry. Not the taxing authorities. In short, all those that feed off this housing bubble. And certainly not the homeowners, who are voters! And therefore, certainly not the government.
Since the resource bust, the health of the Australian economy has become even more dependent on housing, and no economic player wants that bubble to implode or the banks to collapse. It would be a fiasco. They’ll do what they can to keep it going.
And the Reserve Bank of Australia doesn’t want to even think about how to bail out four banks whose assets are over four times the size of the economy. It would rather cut interest rates and come up with all kinds of shenanigans to keep the bubble inflated for as long as possible, and keep the banks upright another day.
That’s what short sellers are up against.
And regulators close their eyes, hoping that this housing bubble doesn’t collapse on top of them, at least not on their watch. Read… US-Style Mortgage Fraud a ‘Nuclear Bomb’ to Australian Banks
Enjoy reading WOLF STREET and want to support it? Using ad blockers – I totally get why – but want to support the site? You can donate “beer money.” I appreciate it immensely. Click on the beer mug to find out how:
Would you like to be notified via email when WOLF STREET publishes a new article? Sign up here.