![Nellie Liang, former director of the Fed's Office of Financial Stability Policy and Research.](http://web.archive.org./web/20170814181222/http://www.afr.com/content/dam/images/g/x/v/1/m/4/image.related.afrArticleLead.620x350.gxv0i5.png/1502661833372.jpg)
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Soaring house prices are vulnerable to a sharp downturn that would damage the local economy if Chinese buyers retreat from residential property in Australia, a former top US Federal Reserve official has warned.
Nellie Liang, who recently visited Sydney and shared her thoughts on financial stability research with the Reserve Bank of Australia, told The Australian Financial Review policymakers were right to be "really concerned" about high house prices and household debt that was elevated by international standards.
Amid signs that Chinese businesses and people are being forced to move offshore money back home, the recently retired head of the Fed's financial stability division said a "trigger" for a real estate price collapse could be a reversal in international capital flows.
"The problem with high house prices and high household debt is it leads to unsustainable debt burdens if house prices fall," Dr Liang said in Washington.
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"Even without debt, when you have the outsiders buying properties, if the outside money pulls out and prices fall, there's innocent bystanders who took on debt and end up underwater, which could lead to defaults.
"Twenty per cent moves in house prices isn't crazy anymore."
Beijing's regulatory crackdown on capital outflows is starting to cause some Chinese money to exit Australia.
China's Wanda Group, under pressure from Beijing to crimp its offshore expansion and reduce debt, last week confirmed it was selling majority stakes in its Sydney apartments and hotel development and Gold Coast apartments project.
Other Chinse entities and individuals are facing demands to unwind and halt offshore investments in a bid to stop capital flight and bolster the value of the yuan.
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Reflecting this, China's foreign exchange reserves recorded their sixth straight monthly rise, increasing by $US24 billion ($30 billion) to $US3.08 trillion in July, figures published last week showed
National Australia Bank says property experts estimate foreign acquirers in the combined established and new property markets represented 17 per cent of all apartment buyers and 11 per cent of house buyers in the June quarter.
Anecdotally, Chinese represent the biggest share of foreign buyers.
Dr Liang visited Sydney in March where she spoke at a closed-door Reserve Bank research conference.
![Nellie Liang says the problem with high house prices and high household debt is it leads to unsustainable debt burdens ...](http://web.archive.org./web/20170814181222/http://www.afr.com/content/dam/images/g/x/v/1/l/r/image.imgtype.afrArticleInline.620x0.png/1502592200752.jpg)
A 30-year Fed veteran before retiring as the director of the financial stability division at the end of last year, she said "everyone is paying attention to China".
"China is such a big economy now, and they have links to other countries, including to Australia and Canada through the housing markets, that people need to be thinking about," said Dr Liang, now a senior fellow at the Brookings Institution and consultant to the International Monetary Fund in Washington.
"They've been growing and trying to reform their economy and financial system, but debt has been growing rapidly."
Sydney and Melbourne home prices are on track for their fifth straight year of double-digit price growth.
Surging residential real estate values in Sydney and Melbourne have been underpinned by record low interest rates, limited new land supply, high consumer debt levels and an influx of foreign buyers, particularly from China.
Sydney's median dwelling – a combination of houses and apartments – price has surged to $856,000, up 12 per cent over the past year, according to CoreLogic.
In Melbourne, the median dwelling price has jumped to $655,000, up 16 per cent over the 12 months.
Some property and China experts believe official figures underestimate the true extent of foreign money pouring into real estate because Chinese Australians and permanent resident holders act as conduits to buy property for friends and family back home who have discretely deployed their money into a perceived safe haven asset class.
That's despite China's crackdown on capital outflows and a raft of new local restrictions and taxes on foreign ownership imposed by federal and state governments.
Among buyers of new properties, foreigners accounted for 11.6 per cent in the June quarter, NAB said. Offshore investors in new dwellings were highest in Victoria (20.8 per cent) and NSW (12 per cent).
Foreign buyers of established property accounted for a more modest 5.6 per cent, the lowest in four years.
Other figures show foreign investors have been a driving force in the residential construction market.
Master Builders Australia calculates that foreign investors accounted for as much as one-third of the approximate 230,000 houses and apartments that began being built last year.
The Reserve Bank has anchored the cash rate at an historic low of 1.5 per cent since August 2016, helping drive up house prices.
In consultation with the RBA, the Australian Prudential Regulation Authority has implemented a series of measures to try to temper rapid house price growth and household debt that has spiked to 190 per cent of disposable income.
These so-called micro and macro prudential measures include higher bank capital, tighter lending restrictions for investors and limits on the number of interest-only loans that recently reached as high as 40 per cent of all new mortgages issued.
However, these measures appear to have had less success than regulators hope.
The Reserve Bank has resisted raising interest rates to raise the cost of credit, due to subdued inflation and concerns about an overvalued Australian dollar.
RBA governor Philip Lowe on Friday said the central bank's main priority is stoking growth and inflation in a way that doesn't trigger financial risks from an overheated household sector, which "we've done enough for the time being" to curb.
Dr Liang said Australia's high household debt-to-GDP ratio was now even higher than previous international leaders, Sweden and Norway, "countries that have been taking actions to reduce the risks associated with higher house prices and household debt for many years."
Globally, Dr Liang favours four financial stability policy steps.
First, Microprudential policies to ensure bank safety and soundness, such as boosting equity capital ratios, risk management, stress tests and living wills for banks to outline how they would wind down in the event of insolvency.
Second, policing the non-bank financial sector, such as monitoring short-term wholesale funding and reducing liquidity mismatches in open-end investment funds.
Third, macroprudential rules such as counter cyclical capital buffers for banks and potential targeting of loan-to-valuation restrictions.
"Household debt ratios and credit growth are indicators of increasing system-wide concerns that could call for macroprudential policy actions," she said.
Fourth, potentially adjusting monetary policy for financial stability purposes.
Dr Liang took over the Fed's division of financial stability soon after the 2008 global financial crisis and played a key role in shoring up the US financial system after failing banks were bailed out by the government.