The great disleveraging

The RBA’s credit aggregates for December were out yesterday and as always make interesting reading. Owner-occupier mortgage debt expanded at an annualised rate  of 7.3% seasonally adjusted. Investor mortgages grew at 4.8%. Personal debt shrank at 4.2% annualised and business at 4.1%.

All four of these figures are showing slow declines or low growth plateaus.

Looking at the aggregates over a longer time frame, is also an interesting exercise:

The above image is year on year credit growth graphed monthly back to 1977. There are several obvious things of note. Firstly, there are the wild swings in credit growth rates of the seventies and eighties – the era of inflation. Then, of course, there is the epic bust in personal and business credit associated with the 1990s recession. Through which mortgage lending never dropped below 10%.

Then there is the period following, known amongst American economists as the Great Moderation, when inflation subsided and a seemingly endless expansion of credit was possible owing to lower interest rates.

As Hyman Minsky might say, however, stability of this kind always breeds instability in the financial system as risk premia are compressed and various stages of ponzi lending advance. It would have been no surprise to him to see the huge bust in personal and business credit at the end of it.

So, let’s take a closer look at where we are now. The below image is the same year on year credit growth rates graphed monthly but this time only since 2005:

Here we have a clear picture of the new normal for Australian business and assets. In terms of business, there is clear deleveraging. Let’s not forget that this is largely bank debt (with some securitisation thrown in) and does not include equity nor bond markets accessed offshore. Nonetheless, it shows a clear unwillingness to either lend or borrow at historic rates of growth.

One doesn’t want to jump to too many conclusions from such broad data, but we may find at least part of the answer for why in the personal debt trend. If we take this as a proxy for demand and the aspiration to consumption then it ain’t looking too good. And why would business take on debt to expand when demand is so insipid?

The truth is that this is what the RBA wants to see. They have engineered interest rates to produce just this result. Australia’s new normal is that it can no longer rely on the accumulation of offshore debt to boost asset prices and consumption. The GFC proved that international markets can and will shut down. To persist with a large external imbalance is imprudent.

In short, despite there being to date no bust in housing, Australia’s economy is in a post-bubble adjustment.

Normally, such adjustments are achieved through a long a painful process of deleveraging and growth out of the debt through increased competitiveness, generally via a falling currency (or, in Europe’s case, general deflation).

To date, Australia has rather been able to outgrow its bubble because of the income flows and business investment emanating from the iron ore, coal and LNG booms:

To describe this as lucky hardly seems to credit it.

Where the rubber really hits the road for the RBA, however, is in mortgages. The great experiment, of outgrowing a huge bubble without having to deleverage, hinges ultimately on the housing market.

There is never a stasis point for capital-growth asset markets. Or so they say. Such markets are either going up, as more people borrow ever more amounts, or they are going down as fewer people do so and price falls beget selling on capital loss capitulation.

The recent history of the aggregates appears to test this thesis.

We know that the current pace of mortgage expansion is insufficient to keep house prices growing. Indeed prices are falling in general, if only slowly at this point. The question is, what happens next?

Counter intuitively, this blogger has been of the view that a plateau in property prices is possible, for the reason that the bubble psychology in Australia is so entrenched that, supported by strong employment from the commodities boom, investors will look through weakness in the mistaken belief that they will make later gains.

There is evidence here that to date this is happening. In 34 years, mortgage credit growth only briefly dipped beneath 10% in the eighties. Yet it has now sat below that level for nearly three years without collapsing. Let’s call this disleveraging.

There is also evidence at the macro level that this disleveraging is working. At the conclusion of the 06/07 financial year Australia’s debt to GDP ratio was 164%. The next near it was 171%. The last two years it has shrunk first to 160% in June 08/09 and at the end of last financial year was 153%. You might choose a different data mix but the trend is clear.

Yet, the longer the RBA engineers these credit growth rates, the more likely the era of across-the-board property price rises is over.

An optimist would say that there will be local growth and falls, and those with the expertise to find the right one could benefit. Which is as it should be, is it not?

A realist, however, would say that there is no stasis in asset markets driven by capital growth. Either  credit growth and prices resume climbing or they keep falling.

A pessimist would say that these rates are unsustainable now.

For the time being, this blogger is still an optimist. On one condition. There is so little momentum in these disleveraging aggregates that the economy looks vulnerable to a shock  – an oil spike or China grabbing the handbrake or the RBA overdoing it – and disleveraging will become deleveraging, with a vengeance.

Comments

  1. The RBA posted M1 on their website today and have increased it by 4% in one month. This perhaps brings to an end one of the longest periods of static or near static M1 growth in recent history. In the 25 months from October 08 until November 10 M1 increased by ca.9%. This is in an economy wher there has been 3% inflation, immigration of 2% of population and growth of about 3%per annum. The only recent comparable period when M1 has been as low was in the 29 months from December 88 until May 91 when it was ca 10%. What followed this was the commercial property crash particularly in Melbourne and Sydney.

  2. Graphs are tiny and when I click the first two I get a message saying “Sorry, the page your requested could not be found, or no longer exists.”

  3. The following article from Deflationite gives a good insight into this phenomenon.

    http://www.deflationite.com/blog/?p=223#

    My position is that Australia is now effectively a mortgage driven economy underpinned by resources. As long as we keep taking on huge mortgages and can continue to do so thanks to our high terms of trade Australia should be alright.

    But in a world of potential external shocks this seems too much like a game of Russian Roulette for my liking.

    – Mortgage rates nearing 10%. *click*
    – GFC *click*
    – Ireland?
    – Greece?
    – Italy?
    – Spain?
    – A rise in worldwide interest rates?
    – RBA overdoing rate rises?
    – China hitting the brakes too hard?
    – Food inflation?
    – Something nobody has even noticed yet?
    – Something else nobody has even noticed yet?

    Surely one of these chambers has to be loaded?

  4. I’d really love to think that Australia was in for a decade (or more) of static house prices. Not least because my job requires people to borrow money (discretionary and investment). I just find it really hard to be optimisitic given the very nature of credit markets to bubble/bust sometimes violently.

    All the current situation needs is some spark that starts a general panic among real estate speculators and it’s game over. I defintely don’t see any real capital gains occuring over the next decade.

  5. Time: Time is unique to all phenomena and this includes nations and their socio-economies. We must consider (IMO) that time is actually ‘acceleration’ in the dynamic of your context and a higher acceleration increases demand and thus increases prices. There are real helpers to this, such as RMBS (and the like) where such exotic products were also in demand – once – by the markets where in Australia, the governments appears to being the buyer of last resort.

    Yes, Australian mortgages with full recourse and ARM terms gives the banks an almost 100% risk free sandpit, but it still needs rising prices as we can never forget our silent need of that ‘taxe tranquille’ ie inflation.

    And, again we have all our eggs in China which means as long as we dig holes for China all is well, but…

    And as well, do not forget the “leadership” fetish for creating new taxes for their total dedication to increase government spending… this will increase, a priori, no matter what happens: they just can’t help themselves in spending to increase longevity of office; its the very nature of the beast.

    Entropy is also an interesting phenomenon and its understanding (comprehension) along with its other accompanying Laws, is fundamental to an understanding not just of physics, but to all life.

    Or, I don’t see “economic theory” as a stand alone Maxim that can predict any much with a reasonably probability of successful outcome and therefore, economic theory as practiced today and commonly familiar, is not where one should look for house prices in future times.

    My guess is that they will fall eventually big-time somewhere during 2011 as the acceleration of consumer awareness is in growth as “For the first time in human history almost all of humanity is politically activated, politically conscious and politically interactive… The resulting global political activism is generating a surge in the quest for personal dignity, cultural respect and economic opportunity in a world painfully scarred by memories of centuries-long alien colonial or imperial domination… The worldwide yearning for human dignity is the central challenge inherent in the phenomenon of global political awakening… That awakening is socially massive and politically radicalizing… ”
    (Zbigniew Brzezinski).

    It will be this change in consciousness and awareness that will impact heavily on the future house prices in Australia. At the moment (IMO) the house prices are ludicrously over valued by about 50%. But if China stops buying our dirt, expect a crass and the government by holding all thum thar’ RMBS will not be in much of a position to help (never is really).

    Message: watch for the temporal signature ie, the speed(s) and direction of the long term trend; as the Bell Curve defines “time” (duration) of the phenomena.

    • Love that comment, not quite sure what it means but I know there is truth there if I can unravell the criptic (physics) clues.

      Ta!

  6. I’m not sure how you can say…

    “We know that the current pace of mortgage expansion is insufficient to keep house prices growing. Indeed prices are falling in general, if only slowly at this point.”

    The ABS data released today, along with the recent Residex and RPData results, show house prices still rising nationally, and in most cities.

    Housing credit is not falling. It is still growing, albeit more slowly than last year, at an annualised rate of over 7%

    The chart below shows the breakdown of financial aggregate growth into each category…

    RBA Financial Aggregates Chart (housing credit growing ‘normally’.

    The graph shows overall credit is still growing, albeit more slowly since the GFC.

    Although housing credit is still marching along, business and personal credit is really in the doldrums, which makes it hard for the RBA to increase rates even if they wanted to, to ‘kill the housing bubble’ as some bears insist they should.

    Back to your statement that…

    “the current pace of mortgage expansion is insufficient to keep house prices growing”

    As can be seen from the chart, annual housing credit is growing at close to the same rate it has been for the past few of years. Haven’t house prices been generally rising for the past few years?

    Furthermore, M3 growth and broad money is still accelerating. That doesn’t seem like deleveraging to me…

    Cheers,

    Shadow.

  7. Hi Shadow,

    Well, I guess some bulls are never satisfied.

    House prices are plateauing and falling pretty much across the nation and have been for a few months. Quarterly reporting is disguising it.

    Moreover, I didn’t say housing is deleveraging. I said it’s ‘disleverageing’, which was the whole point of writing the piece.

    D

  8. Shadow. You are obviously a property bull but seem to be having trouble interpreting your own data.

    David said

    “We know that the current pace of mortgage expansion is insufficient to keep house prices growing. Indeed prices are falling in general, if only slowly at this point.”

    He is talking about rate of change.

    You replied
    “Housing credit is not falling. It is still growing, albeit more slowly than last year, at an annualised rate of over 7%”

    You are talking about change, not rate of change.

    The graph you linked to on your interesting bull forum shows exactly what David said. The rate of change is falling.

    This is to say that the percentage of change in the credit money is slowing.

    This is significant.

    You also seem to conveniently neglecting the stock on market. To keep prices at the same level requires two things, assuming people are using a similar level of cash/equity. The same level of growth in credit ( real not percentage ) and the same level of stock on the market.

    If you are going to have an argument I suggest you compare apples with apples.

    Otherwise you just look silly. Like your name.

  9. H&H, how could quarterly data possibly hide falls that have been happening for ‘a few months’. That is a mathematical impossibility.

    ABS, Residex and RPData show national prices up for Q4. RPData show national prices up in December.

    Where is the data showing house prices “falling pretty much across the nation and have been for a few months”

    Can you link to this data?

    Cheers,

    Shadow.

  10. Bill, I know what my chart is showing. It shows housing credit growing, albeit at a slower rate than before, which is what I said. Neither the present rate of growth, nor the present change in that rate of growth, is evidence that house prices can’t continue to rise, as they have done in the past when the growth rate and change in growth rate was at similar levels. Prices are growing as we speak. The data shows house prices up for the month of December, and the December quarter as a whole.

    The forum that I linked to is not a ‘bull’ forum. In fact it is predominantly bearish as this poll illustrates…

    # 2010 Q4 ABS House Price Index — Predictions?

    As you can see, the vast majority of members expected the ABS data to show nationwide falls today. That sounds pretty bearish (and wrong).

    As to your comment that my name is ‘silly’… grow up. The fact that you resorted to an ad hominem response so quickly would suggest you have already lost the argument…

    Cheers,

    Shadow.

    • Hi,

      I think your graph is entirely consistent with the blogger’s central theme. Given the lag between when credit contracts and its effect on the price level of housing, I also think that the ABS data is neither surprising nor alarming.

      BTW, if you take at Leith’s most recent post on wholesale funding requirements, you might find that quite interesting.

      Cheers,
      Tan

  11. “Indeed prices are falling in general, if only slowly at this point.”
    This statement is simply not true. In the ABS data released yesterday, not only were prices in 7 of the 8 capitals up, but the rate of growth of prices in the 4th quarter actually exceeded the rate of growth in the 3rd quarter for 7 of the 8 capitals.
    On the money and credit aggregates, M3 and broad money have been accelerating with the annual rate of growth growing for the last 6 months. M3 growth is now 9.6%. Bill claimed that it is rate of change that matters. That is growing.
    Per capita M3 has shown extraordinary correlation with house prices since at least 1959 (as far back as the RBA records show). Check it out.

    • >M3 growth is now 9.6%. Bill claimed that it is rate of change that matters. That is growing.

      Actually Bill seemed to be talking about rate of change of credit which is falling. M3 is measure of deposits and currency, not credit.

      >Per capita M3 has shown extraordinary correlation with house prices since at least 1959 (as far back as the RBA records show). Check it out.

      Can you tell me where I would find such evidence ? Do you have a cahrt to back ths up.

      If I have a look at the rate of change of M3 I see little correlation to house price growth. The rate of change of M3 was down from early 2008 until August 2010. In that time the property market rose at bit, then stalled , went backwards and then rose sharply.

      If you look at credit data ( not M3 ) you can see the correlation. I would be interested if you can point out this correlation.

      • “Actually Bill seemed to be talking about rate of change of credit which is falling. M3 is measure of deposits and currency, not credit.

        >Per capita M3 has shown extraordinary correlation with house prices since at least 1959 (as far back as the RBA records show). Check it out.

        Can you tell me where I would find such evidence ? Do you have a cahrt to back ths up.”

        M3 effectively includes all private credit. If a bank lends me your deposit I give it to someone else who deposits it. There are now two deposits (part of M3) as a result of the credit where there was only one previously.

        A blogger called “Strindberg” put forward the correlation here and elsewhere:
        http://s4.zetaboards.com/Australian_Property/single/?p=8075777&t=8195174
        He claims, and provides the data, that the Australian house price has been within 14% of 10 times per capita M3 since 1959.

        • +/- 14.. Not exactly convincing was it.

          I could make the same correlation between my pant size over the last 40 years and get some similarly convincing data.

          >M3 effectively includes all private credit. If a bank lends me your deposit I give it to someone else who deposits it. There are now two deposits (part of M3) as a result of the credit where there was only one previously.

          Not so sure about this. I think I get your point, but there are a few issues with how you have phrased it.

          Australian banks don’t lend out deposits, they haven’t been required to do that since de-regulation, so the correlation between initial deposits and credit creation is not valid.

          Banks lend money at will and then issue equity and/or debt to cover their capital requirements if their current state requires it. Deposits play some part in this but they are not the whole story, and have certainly been less of the story lately.

          A loan can create a deposit, but it can also be used to pay down existing debt,so again increases in credit don’t always lead to deposits.

          I am yet to be convinced by either argument that an increase in M3 leads to house price growth as I said before

          “If I have a look at the rate of change of M3 I see little correlation to house price growth. The rate of change of M3 was down from early 2008 until August 2010. In that time the property market rose at bit, then stalled , went backwards and then rose sharply.”

          But thanks for the conversation.

          While I was writing this I saw this article

          http://macrobusiness.com.au/2011/01/guest-post-its-a-question-of-fundamentals/

          it could interest you.

          • Firstly, I happen to agree with what you say about the creation of credit and deposits. I was deliberately simplifying matters because I really didn’t wish to get into that debate – it can go on and on.
            However, to a large degree, M3 is reflective of private credit together with other factors.

            I see the plus or minus 14% over 50 years to be very significant. The correlation is much stronger than with say incomes or CPI or GDP. It is also a much stronger correlation than with credit alone. The RBA data for credit doesn’t go as far back as for M3 but it does go back to Sep 1976. The figures for total credit are in column H of RBA table D2. Per capita credit (ie col H/population) has risen much faster than house prices. Those figures show that credit per capita has risen about 33 fold since 1976. House prices have only risen about 15 fold. The correlation of house prices with M3 is much stronger. I don’t know why. But it’s interesting. I doubt it’s a nonsense correlation like the number of vicars and murders.
            Note: figures are rough – I didn’t spend time on them.

  12. Hi Freddie,

    House prices in general are soft, plateaued or falling. Nit-picking over the data doesn’t change it or advance the argument.

    Your point about M3 is interesting and you may be right.

    My only response is that if you’re right, the RBA will be on hold for five minutes.

    In my view, this is why it has dawned on a swath of former housing bulls that the market is stalled for the foreseeable future. The RBA is no longer on their team…

  13. When you say ‘soft’ do you mean rising? Plateau means flat, falling means down obviously, so soft must mean up?

    So you’re saying that house prices in general are going up, down, or sideways?

    That’s not terribly enlightening, but as Freddie mentioned, in most places they are going up slowly and sustainably (or behaving ‘softly’ if that’s what you want to call it…)

  14. Another point. You say…

    “Owner-occupier mortgage debt expanded at an annualised rate of 7.3% seasonally adjusted. Investor mortgages grew at 4.8%. Personal debt shrank at 4.2% annualised and business at 4.1%.”

    What you have done here is taken the figure for the month of December and annualised this forward 12 months. This is crazy. It is as silly as housing bears who take a one month fall in house prices and annualise it to come up with a huge crash. But then next month the data changes magnitude or direction and the annualisation exercise was pointless.

    Here are the correct 12-monthly figures, direct from the RBA report…

    OO Housing Credit: 7.1%
    Investor Housing Credit: 7.9%
    Personal Credit: 1.2%
    Business Credit: -2.3%

    To explain why it is pointless to annualise a monthly figure, look at the past few months of personal credit growth…

    Jul-2010 0.0
    Aug-2010 -0.3
    Sep-2010 0.4
    Oct-2010 0.3
    Nov-2010 0.5
    Dec-2010 -0.4

    You annualised the December figure to get -4.2%. If you had annualised the November figure you would get over +6%.

    By annualising monthly figures you are simply magnifying monthly noise and spikes. The result is meaningless.

    Cheers,

    Shadow.

  15. Hi Shadow,

    I don’t understand your referral to Residex and the RP Data/Rismark index as proof house prices are not falling.

    You pointed to the RP Data’s YoY value, where in fact even Chris Joye admits that “the market peaked in May”, and has been “soft” since. I suggest you take another look at RP Data’s rolling quarter to December results (raw) for the capital cities:
    Sydney -0.4%
    Melb -0.6%
    Brisbane -1.0%
    Adelaide 1.0%
    Perth -2.9%
    Canberra -1.3%
    National city values -0.8%

    Regarding credit growth, I am sceptical that a direct correlation can be drawn between particular levels of housing credit growth and prices rising or falling (primarily as there are other external factors also at play, and it is a broad and coarse index). However, that being said, analysis of the series makes it painfully obvious that housing credit growth is subdued, and that is definitely not a bullish indicator for house prices.

    As a firm believer that one of the biggest drivers in house prices has been cheap and available credit, I think that an extended period of subdued credit growth is actually a bearish indicator, providing there is no further stimulus (eg FHOG boost, relaxing FIRB restrictions – which will not show up in credit growth!, and so on).

    Also, it should be said that annualising a monthly figure (especially if the first half and second half of the rolling year have very different performance) can be just as bad as using a YoY figure. You’re better off looking at the last 3 – 6 months.

  16. Hi Booboo, yes the raw RPData figures were mostly down slightly but the headline figures (seasonally adjusted) were mostly up slightly in December.

    I rarely see the bears complaining about the headline SA figures when they show falls and the raw figures are showing rises.

    December is a generally a quiet month when prices rise less rapidly or fall, so it makes sense to look at seasonally adjusted figures. If a reduction in growth in December is a cyclical event, and this December the reduction in growth was less severe than normal for a December, then that is a positive sign, as the SA figures show.

    By the way, I’m not saying prices can’t or won’t fall. In fact I think prices will probably be lower in several cities by the end of this year. I just disagree with the comment on the blog that ‘prices are falling in general’ right now.

    Even if the non-SA prices did show a small fall in December, you would want to see at least a two full quarters of negative growth before claiming the trend is down. There have been a great many times in the past where house prices have fallen for a quarter (never mind a month) and then resumed their upwards trajectory.

    • I note that what you describe as the “headline figures” have only been reported for this data series 9 months ago in April 2010…. interestingly back then the SA reduced the magnitude of the price rises…. that first release was a couple of days after Glenn Stevens appeared on TV warning investors against blindly leveraging up on property… I imagine that was one time when “bulls” didn’t mind seeing a “headline figure” show a less positive result… shall be interesting to see whether upcoming March data have the same seasonal movements this year (i.e. downwards perhaps worsening already weak “raw” data)…..