As we all know, the Rudd government recently extended the increased First-Home-Owner-Grant (FHOG). The FHOG grant in itself is so controversial that even government advisers are questioning the wisdom of that scheme (see Rudd advisers criticise home buyers grant). Government propaganda hailed the FHOG as a means to help young Australians achieve the Great Australian Dream of home ‘ownership.’

Sadly, a lot of young people fell for that propaganda. One of the first tools of propaganda is to subtly twist the meanings of words.

For example, when a person borrows money to ‘buy’ a home, he/she do not really own that home in the first place. Instead, what happened was that the home ‘buyer’ had basically entered into a financial lease contract with the bank. The home ‘owner’ may have more freedom than a renter, but he/she has more responsibility in return. A large part of that responsibility includes financial accountability and trust to repay debts. There are many anecdotal reports that many first home ‘owners’ are not acting very responsibly.

There are also many applause that housing has never been more ‘affordable’ than before, due to record low interest rates. But the vested interests who gave the applause forget why interest rates are so low in the first place. The whole point of the RBA slashing interest rates is to reduce the debt servicing burdens of Australians (in the face of forecasted rising unemployment), not to encourage them to gouge on more debt. The FHOG, by its very nature, defeats this purpose by encouraging young Australians to go further into debt. Most worryingly, when interest rates are at record low, most of these first home owners are not hedging their gamble by fixing their mortgage rates. When the time comes for raising interest rates, many of these ‘affordable’ homes will become unaffordable.

Obviously, the Rudd government’s FHOG policy is a bad policy that will do more harm to Australia in the longer term. We are sure the government knows this. Yet, why did they go ahead with that foolhardy scheme, knowing that it is foolish in the first place?

Well, our theory (or rather, speculative guess) is that the real reason is not as stated in the propaganda (i.e. ‘helping’ young people achieve that ‘dream’). Instead, the true reason is to prop up (and if possible, blow a bigger price bubble) property prices for as long as possible, until China comes to rescue us. Why should property prices be artificially propped up? Let’s take a look at this chart:

As you can see, for the past 20 years, housing loans take up a larger and larger portion of the total private debt in Australia. At its peak in January 2005, housing accounts for 55.6% of debt. As in March 2009, it is slightly down to 53.1%.

At the same time, every mainstream economist are forecasting significant rise of unemployment rate. And as we said before in RBA committing logical errors regarding Australian household finance,

Given Australia?s high household debt (see Aussie household debt not as bad as it seems?), prime debt can easily turn sub-prime when unemployment rises. As unemployment rises (which all mainstream economists in the government and private sector are forecasting), it will eventually reach a critical mass of prime debts turning sub-prime. Once this critical mass is reached, the deterioration in the Australian economy will accelerate (see what?s happening in the US and UK today).

Rising unemployment will result in rising number of housing loans going bad. With housing loans taking up more than half of all debts in Australia, the sheer number of bad debts will threaten the stability of Australia’s banking system (bear in mind the amount of leverage in Australia’s banking system. See Small loan losses can wipe out banks). Unless…

What if the government succeeds in propping up the ‘value’ of the collaterals (homes) under-pinning the bad debts? In that case, the banks can take over the homes (and not liquidate in a distressed market), replace the bad debts in asset column of their balance sheets with homes with values that were artificially propped up (with the FHOG). We can imagine the Rudd government introducing some kind of scheme in which the banks rent the home back to the former home owner.

In addition, the government can implement another scheme to let the bank’s unemployed debtors to go on a repayment holiday (while interest payments get capitalised). That way, there wouldn’t be forced mortgagee sales to deflate house prices and coupled with FHOG to prop up the ‘value’ of homes, the accounting losses in the banks can perhaps be minimised?

Once the banking system goes down, the government will have to fork out up to AU$1 trillion in money (see Australian government?s contingent liability to exceed AU$1 trillion), which most likely mean Australia will have to print copious amount of money. Should that happen, the Australian dollar will be trashed and the government bonds will become junk bonds.

The question is, will this gamble succeed?