SYDNEY, AUSTRALIA - APRIL 28: A view of streets in Southern Sydney from a blimp on April 28, 2016 in Sydney, Australia. The Appliances Online blimp is the only operational blimp in the Southern Hemisphere flying all over Australia. It is currently based in Sydney navigating a variety of routes across the city and down the Eastern coastline. (Photo by Cameron Spencer/Getty Images)
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By Lucinda Shen
May 23, 2016

In late February, a hedge fund manager and economist went undercover as a gay couple earning $125,000 per annum in Australia.

The goal for Bronte Capital’s John Hempton and Variant Perception’s Jonathan Tepper was to investigate Australia’s property market. But what they found while touring Sydney’s neighborhood was bad news.

“Australia now has one of the biggest housing bubbles in history,” Tepper wrote in a note to clients following the investigation, noting banks’ risky lending practices which include discounts to low-income consumers and failing to fact check applications. To prepare for the impending shock, he told investors to take on a famously perilous strategy: short Australia’s banks.

But now it seems, hedge funds are coming to the same conclusion in droves. According to the Wall Street Journal, short positions in Australia’s four largest banks, once hedge fund darlings, have risen 50% this year—worth about $6.5 billion. That list of lenders includes the Commonwealth Bank of Australia, Australia and New Zealand Banking Group, Westpac Banking, and National Australia Bank.

It’s not just the housing bubble that has set hedge funds and investors on edge. Australian banks have also taken on bad debts and returned weak earnings. Moreover, the country’s economic data reveals a larger imbalance. While the country’s GDP and income remains weak, mortgages have soared.

But shorting Australia’s bank stocks is a loaded choice.

While many critics have predicted the decay of the Australian economy or the end of its housing price boom over the years, Australia’s banks has remained resilient—resulting in losses for short sellers. The strategy’s track history is so riddled with losses that it has been called “the widowmaker.”

For the most part, Australian bank stocks have been beloved by investors. Banks on the continent are among the most profitable in the world, with a return on equity of 17.2% at Commonwealth Bank and 14.2% at Westpac. The average return on equity for all U.S. banks is 8.3%. Australia’s banks also offer a steady stream off dividends, with an average return of 78% for the four big lenders.

But the volume of short sellers on the stock now suggests that Australia and its banks are potentially headed for a bust.

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