Australia's own credit crisis
Australia's own credit crisis
The question is not if, but when, this country's own credit crisis is going to catch up with us. If you missed tonight's 'Debtland' episode of Four Corners, you can watch it here. Be warned, it's disturbing (if a little sensationalist).
It is a fact that we're in the midst of a debt binge of unprecedented proportions. The ratio of credit to disposable income in Australia is north of 180% - one of the highest of any country in the OECD (in the US, that ratio was 140% before the crunch).
The most common argument you'll hear professing we don't have a problem is that debt is high, yes, but so are household assets. If there are so many assets, where's the income those assets are producing? Houses yielding 3% net rental returns on their supposed value don't help service debt costing 10%, or 20% in the case of personal credit cards.
So how can this go on so long? I thought the most insightful comment from the program was this from JP Morgan banking analyst Brian Johnson (no relation):
Banks can do dumb lending year after year after year. But that isn't what creates the problem. It's when banks stop doing dumb lending.
I'd argue that it is the dumb lending that creates the problem, but you get the point. As long as the banks keep feeding their customers' addiction to debt, they don't have to worry about defaults. It's a Ponzi scheme of sorts – and one that might soon come tumbling down.
The global credit crisis is making it difficult and expensive for the banks to access funds. And that means they've got less funds to lend and will need to tighten their lending criteria. Is this the trigger that finally brings the party to an end?
Maybe, maybe not. But one day we will have to deal with the hangover this binge leaves us with. The banks will be at the forefront but the implications for the wider economy are worth some serious thought.
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The most common argument you’ll hear professing we don’t have a problem is that debt is high, yes, but so are household assets. If there are so many assets, where’s the income those assets are producing?
There's one more point- the valuation of these assets are not real. When everyone are forced to sell during a credit crisis, how much of these 'value' can be realised?
Can you believe it or not, our Aussie star economist, Shane Oliver of AMP is the one spreading this myth!!! See how this blogger criticised Shane Oliver at Aussie household debt not as bad as it seems?.
When those trusted experts themselves are spreading myths, it's time bloggers has to take up the slack left by those 'experts.' Good on you Steve!
It could be argued that an 'asset' is something which earns you more than you owe on it. Or it's REAL value (what someone is prepared to pay if you sell it) is more than you owe on it. Anything else is a 'liability'.
In the Rich Dad Poor Dad series, an Asset is defined as something that earns you money.
In this instance the family home is really the banks asset until you pay it off! I've read in other texts about calculating your personal net worth, that you should exclude the family home as this is really an illiquid thing (you need a place to live), but include the mortgage, as this is a real liability.
I must admit, this does make for an interesting Net Worth Figure.
Jason,
Agreed. A lot of these property 'investors' are just speculators. They buy liabilities (residential property) at high price, hoping to sell them at higher prices. Meanwhile, those properties are bleeding cash. When interest rates rise and/or property prices stop rising, these 'investments' are revealed as what they are- speculations.
While I agree that we have a debt problem, I don't know that using the ratio of overall credit to disposable income is appropriate. To truly understand the potential problems you would need to know the distribution of this ratio for individual households. If all households had a ratio of 180% we probably wouldn't have a problem, but if there are a third with a ration of 540% and two thirds with none, there is a serious problem. Personally my household has a mortgage that is 3x our after tax income, yet I do not consider myself in financial stress as our current repayments will pay the loan out in 10-11 years (interest rates would need to rise 4% for us to need to increase repayments), we save 10% of gross income on top of super and we have other assets we could liquidate to reduce the debt if required.
Hi Matt!
To truly understand the potential problems you would need to know the distribution of this ratio for individual households.
That's true. Someone referred your comment to UWS Professor Steve Keen about this (in his Debt Deflation blog), and this is what he has to say,
On the question, while it is true that the distribution of debt matters, so does the absolute magnitude. At its simplest level, debt and the financing obligations it generates are a monetary claim on the productivity of the physical, “real” economy.
The debt level we have now, combined with high real interest rates, translates into almost 15 percent of real output being required to meet interest payment commitments. That is an enormous burden, compared to the long term average of around 2-3%, and it’s a burden only ever experienced before during bouts of extreme deflation.
There is also a way in which a highly focused debt can be–but not necessarily is–less of a problem than widely distributed debt. The “chain reaction” effect of one bankruptcy precipitating another could be less if the debt was highly concentrated in just one fraction of the population. They would go bust, those with whom they had direct financial dealings might also go bust, but the contagion might not spread much further.
When debt is widespread however, the contagion can go a long way.
Firstly i must disclose that i am a financial planner.In my view the "four corners" programme only gave the viewers a gimpse of what is actually happening in our economy.Within 12-18 months Australia will experience a property mkt crash........unemployment will increase and hence Australia will be in a very deep long recession........................evryone should refer to Steven Keen's research about our current debt crisis....................................Don't make the mistake that the affluent and rich are not affected.................in fact these people have upgraded their homes with unstainable mortgages..............they appear to drive European cars but the problem is that all of these cars are leased including the holiday which is funded by their credit cards.......................it seems to be only a matter of time before we experience the same fate as the Americans ......................
When Ralph Norris bristled at a question put to him by the interviewer about unsustainable lending practices, I found this pretty hard to cop.
He then asserted that the banks interests are only served by lending to people who can afford to pay back the loans. This is of course correct, but how close does it resemble whats actually happening.
Any of these "long term" incentives these guys (& women) are practically gifted in the form of options do little to align real long term shareholders interests (who are stumping up their own cash for their shares out of their own pocket) to management. These incentives have to flow through to the banks lending policies.
To collect his freebies, surely he can at least cop a few tough questions on the chin from ABC journos.
I would agree with Sean on that. As Steve Johnson quoted Brian Johnson,
Banks can do dumb lending year after year after year. But that isn’t what creates the problem. It’s when banks stop doing dumb lending.
During the "year after year" of dumb lending, bank profits increase as more loans are made. More profits= higher stock price, stock options for the CEO and directors etc. By the time those banks are forced to stop doing these dumb lending, those original CEO and directors are long gone and cashing up their stock options and laughing all the way to the bank (no pun intended). The next batch of CEO/directors are the one who have to clean up the mess.
Good point Sean. The incentives for management, and more importantly the loans officers, are not necessarily aligned with long term shareholder interests. The Intelligent Investor folk just finished making the same point on their most recent podcast.
While I have not seen the program, I have a concern about the debt levels, especially given the stock market turmoil that was increased because of the highly leveraged positions some people were in, which generated margin calls, which just depressed the market, which forced more margin calls. The debt/asset ratio is a bit of a red herring, what is important is the cash flow - if there is enough cash coming in, you can weather a downturn. People who have extended themselves to buy rental property with a return of 3% when it is costing them 10% are in a fool's paradise if they think they can repay the mortgage by drawing down on the increased equity of a rising market - that is what is not sustainable.
The ratio of credit to disposable income may be an indicator of financial stress but wouldn't a better indicator be the ratio of the interest payable on that debt to disposable income?
Australians would seem to be suffering a double whammy compared to Americans - higher levels of debts at higher interest rates!
My wife and I recently moved to Brisbane. At the time we were thinking that house values would be around 20% less than prices in Sydney but we were disappointed to find that it is more like 10% and with a booming state economy the gap seems to be getting less. Can this market keep on increasing? Well the answer is a definite no, in the same way that it was a no at the end of the 80s. Did we buy? Yes and we have a small mortgage. I like Soul Pattinson's managing director who says that debt is for the birds. For most of us, we need debt to buy a house but the problem seems that we seem to need debt for lesser things instead of saving up for the goods. With large interest rates on consumer goods such as TVs, home cinemas and white goods should you choose the "easy" financing, it is inevitable that the financial pain will fall on less financially savvy people, who then pay well in excess of the item's original price. With must have items such as broadband, PayTV and mobile phones, the toll we pay for these each month is quite a large proportion of income, disposable or not on top of the debt. It can't be sustained and while we have watched household debt increase over the last 20 years, there comes a time when the lender will demand satisfaction.
I know this is sacreligious, but the simple fact is, the equity you have in your home is the only "asset" you own pertaining to it. The rest is simply debt and subject to the speculative and monetary influences attendant to all debt.
If , for whatever reason, you cannot service that debt- it must then be liquidated, somehow. In the case of a house of course, your liquidating a house to pay down that debt. The very big problem with this particular illiquid market now is the massive potential for herd effect. By it's very nature, and the relatively common income band within which the bulk of homeowners (and housing speculators) presently exist, the move to sell generated by economic or interest rate environments effects most participants simultaneously, triggering a herd response.
We are at that point now I feel.Speculators and others are starting to take profits already. Stock of available housing for sale is rising. And I suspect we will not be seeing interest rate relief anytime soon, which will only encourage the desire for more and faster housing sales. Something definately to watch.
Hi GSM!
You said,
We are at that point now I feel.Speculators and others are starting to take profits already. Stock of available housing for sale is rising. And I suspect we will not be seeing interest rate relief anytime soon, which will only encourage the desire for more and faster housing sales. Something definately to watch.
If you are right, then this means that the so called housing shortage is rubbish. If you take a read at Myths on the Australian housing/rental crisis & its implications, you will find that the number of vacant houses increases between 2001 and 2006. Some people must be hoarding to cause all these 'shortages'
I couldn't agree more. I think it is ridiculous that one generation is competing (for investment purposes) with the it's own kids for housing and creating a property bubble. Are we so lacking in imagination in this country that property is the default option for investment? The windfall that the mining boom has created needs to be steered into productive assets and capabilities for our future prosperity, with Gov taking a pro-active role.
If Governments (of all persuasions) had any sense there would be laws in place stating that no-one could borrow more than 70% of the value on a home they wished to purchase,as assessed by an independant Government licensed valuer. Heavy fines to be levied on any lending institution that broke the law. Credit card and store issued credit card debt is more difficult,but surely there could be some way found to prevent excessive borrowing.You may say that this would be an infringement of personal liberty, but it is plain that many need protection from their own financial incompetence
With a 3% return on investment property, which by the way is realistic, and interest on your loan of about 8%, you have no hope unless: you have a substantial deposit - which many buyers have, but few critics ever consider.
If your return is 3% on a house worth $400,000 say, that will be around $1,000 per month. Your payments to break even will need to be roughly $1,000 per month also. So to make that work you'll need to borrow no more than can be repaid with $1,000 per month - disregarding tax breaks etc. - which is about $165,000 x 30 years. Simple. Deposit needed is $235,000. If in a few years you can afford higher payments with higher rents coming in, it will be paid off quicker.
I have shares in several banks, all of which are announcing their "provison" for bad debts arising from the loans crisis.
I'd like to find out how many heads are rolling because their owners accepted the bad debts, presumably while in pursuit of their own "performance" bonuses.
However, each bank has so many "contact us" addresses it's hard to know who can provide this sort of information. Can anybody help?
Hi John,
I to hold financials in my portfolio but have only done so recently but mor so from a speculative view than an investment one!) I jut wanted to add that as far as bad debt provisions are concerned quite a large percentage of these are acctually corporate based debt not hoeshold (from memory) and at the end of the day they are jus provisions, so should the likes of say ANZ not have to utilise these providions come their net profit announcement I would dare say you'll see a tidy increase in the share price. However the days of 25% ROE year on year and gone for most of these lenders so if you purchased these stocks 2-3 years ago..... perhaps you should consider selling come the next random 3 day rally as if you had shares in any of the majors back then you should still be able to liquidate for an overall profit. If you bought them only 12 months ago........... then I guess thats not so easily fixed.
Something to think about anyway
Ok. Yes, the rate of consumer debt is worryingly high in Australia, and In my opinion the lending practices of the big four are certainly (partially) to blame, particularly for inflated house prices.
However, to equate this with the assumption that we're going to have our own 'credit crisis' is far-fetched. The credit crisis in America had very little to do with consumer debt, and everything to do with a lack of transparency in capital markets and corporate debt.
Yes, the flight from Mortgage Backed securities was caused by defaults, which was in turn caused by debt strain, but this was only in the sub-prime market, which is much better regulated in Australia.
Also, the comparing 3% rental gains to 10-20% credit card debt is obscene. Nobody borrows 300+k on credit cards...and 3% on a investment property of 300k (for example) could easily service a 20% credit card debt on 10k...
Your on the money JodaPo.
Australia is in a totally different situation than the US, our demand for housing is increasing and the cost of constructing a house is 25% more than what is costs to purchase an existing propoerty is, and now interest rates are high it is drivind demand as investors are shying away from the market so in the short term this is going to increase the deamnd for australian housing, i believe we are not going to see the same capital appreciation as previous years but onwards and upwards.
Remember Australia is a desireable place to live, no terrorism(to date), easy going people, beautiful country etc in comparison to some oversease countries so our immigration will continue demand for our housing. i believe America is the opposite, i don't really know many people who would want to live there, except mexicans.
I alos agree with Joda regarding comparing a rental return of 3% against credit card dept of 10-20%, the size of loans are not going to be comparable.
In my student days studying Economics, I remember (perhaps now vaguely :) ) in the National Accounts expenditure on housing was a Consumption item. I think it was during that moron Malcolm Faser's era (but I am open to correction on that - as to the time- not that the man is a moron) suddenly Housing became an investment item. I guess the need was to make the National Accounts look good to get elected at the next election.
Housing should be viewed both personally and nationally as a consumption item. We wouild then be less sanguine about our level of "Assets"
An examination of the Reserve Bank records on our Current Account Surplus / Deficit is also instructive. In just over 38 years we have run a surplus in just two calendar years and they were 35 years ago in 1972 and 1973. The total deficit for the 38 years is $684816000000 Now i'm not quite sure how to pronounce that but I think it is $685 BILLION dollars. In the last 12 m onths to December, in tne midst of the greatest resources boom of all time the deficit was $67 BILLION.
We have been forced to sell off most of our resources to pay for these deficits. For anyone who thinks deficits don't matter, wait till TSRHTF and then please explain to your children and grand children why foreign interests own nearly all of our country.
Right now we are busy trying to sell the small remainder of what we own to the Chinese so that we can all ignore reality, carry on doing what we are doing, and get Kevvy and Co elected again at the next election. (Don't get me wrong the previous bunch are at leat as guilty in this little saga)
What a bunch of morons have been ruling us these last 40 years!!!! What a bunch of clowns have been advising them! The MSM just goes along with it all out of commercial self interest and the genral population votes out of power anyone who interferes with its self-indulgence.
THIS COUNTRY HAS LOST THE DIGGERS CHARACTER HONESTY AND FIGHTING SPIRIT TO WIN FOR ALL TO HAVE A FAIR GO IN LIFE. THIS CULTURE OF OUR COUNTRY NOW RUNS ON PEOPLE WITH EGOES AND GREED STUFF ALL THE OTHERS I AM OK, I WILL JUST PUT OUT THERE I AM DOING THIS FOR AUSTRALIA. That is CRAP WE ARE SELLING OFF THE COUNTRIES WEALTH. WE HAVE STUFFED ESSENTIAL SERVICES THROUGH GREEDY EXPENSIVE CONSULTANTS RECOMMENDATIONS AND WE KEEP STUFFING IT UP FOR THE GRAND KDS OUR FUTURE IF THEY HAVE ONE WITH THIS COUNTRY NO LONGER ENDING UP HOURS having nothing left to sell!!
Our amounts of debt shows we are a people of chocholate lovers. Very few fruit lovers around. Soon we will all suffer from lack of vitamins.
[...] Australia’s banks are not immune. The lending practices of Australia’s banks may have been more restrained than their US and European peers but they’ve hardly been conservative. Margin lending fiascos, a leveraged infrastructure meltdown and the collapse of Centro and ABC Learning Centres represent the beginning of Australia’s own credit crisis. [...]
But its just bullcrap scare tactics media - "oh what a compelling story". Individual debt has decreased vastly since 2008 in australia. North Americas economy dynamic is different to ours, and so financial institutions have responded according;y. And yeah, it probably is because the housing boom. When someone gets their free Aussie Credit Card with their home loan, they'll throw 2 K on a couch, and another 3 k on a washer dryer & laundry combo
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