It’s not so easy to get a loan in Australia these days. For the first time in years, the cost of borrowing is going significantly up. That’s not good news if you are trying to buy or sell a house. It’s not good news for Australian banks heavily invested in the housing market, and it is not good news for the economy.

When credit markets tighten and the cost of borrowing goes up, those who rely on debt to function end up struggling to keep their heads above water. But what happens when a whole nation relies on ever-increasing levels of borrowing and debt to operate?

Australia may be about to find out.

Financial conditions are certainly “tightening,” says Australian bank abn amro chief economist Kieran Davies. Official and unofficial interest rates are rising, and lax lending standards are being toughened. Others are a little more pragmatic. “We are in the process of bringing the curtain down on what has been a super cycle for the Western world’s financial institutions, which was built on the willingness of consumers to increase their leverage [debt] at fantastic prices,” says investment bank Morgan Stanley’s chief economist Gerard Minack.

“The escalation in leverage over the past 20 years is completely off the scale. It is bigger than the 1890s property boom and bigger than the 1920s. It is bigger than anything we’ve ever seen, and I think we’ve reached the limit of how far these trends can go. The unraveling will be extremely painful.”

Why are financial conditions tightening? Just as in America, Australians have spent too much, and their debt is backed by grossly inflated assets. The difference is that the Aussie crisis could be much worse.

Australians may be the most indebted people in the world.

As ludicrous as it sounds, according to the Australian, Australians have been compounding their debt at an average rate of 15 percent for the past 20 years. In 1988, the average household had debts totaling 32 percent of its income. Now the average is a massive 160 percent of household income. As a percent of gross domestic product, household debt has reached 177 percent, almost a world record. Meanwhile, wages have grown at less than a third that rate.

Even with the recent tightening—which included the lowest level of bank lending in 25 years in June—Aussie households have $95 billion more debt now than they did a year ago. That equates to an additional $4,611 of new debt on average for each man woman and child in the country—in just one year.

“It’s like a debt tsunami out there,” says Sandra Saker, who manages a Salvation Army Service for families in Sydney suffering financial problems. “Five years ago, the maximum debt people came in with was about A$200,000. Now we see people coming in with over A$1 million.” But all this shouldn’t be too surprising for Australians. Home prices have been going through the roof.

Housing Bubble: Soft Underbelly of the Economy

Australian homes are arguably the most expensive in the world by some measures—no small achievement considering the massive run-up in home prices in the U.S., the UK and elsewhere. Since 1999, the median house price has soared an amazing 140 percent.

Several indicators show how extreme home prices have become. The house price to average income ratio in Australia is approximately 6. That means that Australians on average are paying more than twice as much for homes as Americans were before their housing bubble burst (in the U.S., the ratio peaked at about 3). The Washington-based International Monetary Fund says Australian house prices are overvalued by almost 25 percent when compared with the homeowner’s ability to pay the mortgage.

Assessed as an investment, Australian houses are also very pricey. On average, rents earn about 3 percent, versus the standard mortgage rate of 9 percent—which means that if the house prices do not appreciate, investors go in the hole about 6 percent a year.

“By every metric I can think of, Australian houses are too expensive,” confirms Gerard Minack. He is predicting that prices will fall by 30 percent over the next two years.

If Minack is correct, and home prices are not sustainable, the economy could be in for a big shock. Rising property prices was the catalyst that encouraged consumers to increase spending and keep Australia’s economy expanding despite the “Asian Flu” in the late 1990s and dotcom bust in the 2000s. And the housing and related industries are what is largely powering the economy today.

Approaching Tsunami

Unfortunately, it is increasingly evident that Australia will not escape the housing bubble meltdown plaguing the Anglo-sphere’s two largest economies, the United States and the United Kingdom. The same factors that popped these economies—rising default rates, rising borrowing costs, and slowing economic growth—are in play in the island nation.

The wave is already breaking. House prices in every major city in Australia fell last month—the first time such an event has occurred since just before the Great Depression. Sydney, Melbourne, Brisbane, Perth, Adelaide, Darwin, Hobart, Canberra—all the big boys went down.

“I panicked” upon seeing the data, said John Edwards, chief executive of Residex Ltd., a company that tracks property prices. “We’ve been doing this for 20 years and have data that goes as far back as 1865, and it’s really abnormal.”

“Australia is headed for a once-in-100-year real-estate slump,” he says. “I have never seen the convergence of so many negatives.”

And when the housing market goes, the economy will really feel it.

At first it will be real-estate agents and loan brokers that lose their jobs as sales slow. Construction workers will soon follow, as property developers find that new homes are not selling either. Next it will be the employees at home improvement stores like Bunnings and others.

But that is only the beginning. Once the average home owner on the street finds out that his house is worth only three quarters or half of what it was last year, then things will really start to deteriorate.

People are not so free with their money when they think they are poor, and especially when they think they are going to get poorer. In fact, they do the opposite: They begin to squirrel money away. Once consumer spending begins to contract, then the housing contagion will spread into the general economy. People won’t be spending on flat screens, cars and vacations. Business profitability will fall, and then the job losses will really get under way. Those already announced by Qantas and Starbucks are a harbinger of many more to come.

The resource boom won’t save the economy either. As a percentage of gdp, the mining and related resource industries originate approximately 8 percent of the total economy. Consumer and government spending account for 74.6 percent of Australia’s economic activity (as of 2006) and absolutely dwarf the real wealth-producing parts of the economy.

“It is amazing that in the midst of the biggest commodity boom ever seen [Australia has] still been unable to get a current account surplus,” says Gabriel Stein from Lombard Street Research. “They have been living beyond their means for 10 years.” Even houses in resource-rich Western Australia are falling in value.

And don’t forget what a collapsing housing bubble could do to Australia’s biggest banks.

Sydney research company Fujitsu Consulting estimates that 923,000 households will face “mortgage stress” by September. That is up from last year’s survey that found only 171,000 that were having trouble repaying loans. Since there are 6.9 million Australian households with mortgages, an astounding 13 percent of the total market could be in serious trouble. Any guesses what those kinds of default rates could do to Australia’s leading banks? They could quickly resemble the Bear Stearns and Northern Rocks of America and Britain. The share prices of Australia’s biggest banks are already plummeting.

Surf’s up: A massive wave of debt-induced economic problems is about to break on Australian shores. And Australia is about to pay the consequences of years of too much “easy money.” As investment bank bnp Paribas currency chief Hans Redeker says, referring to Australia’s currency: “The Aussie is going down, big time.”

TheTrumpet.com readers are warned to head for high ground. Australia is in the same position that America was in about a year and a half ago—just before its housing problems set off the global credit crunch that has since rippled through the global economy. Begin by reading “Ending Your Financial Worries” and Australia—Where to Now?