Analysing household risk in the SoMP

I have spoken previously a number of times about my concern that the RBA is mis-reading the risk presented by the high level of household debt that exists in the Australian economy at a time when debt growth is decelerating. The main crux of my concern is covered in the following paragraph in reference to the 2009 first home buyer cohort.

The issue I had with that analysis was that the RBA seemed to be saying that the cohort who took on “riskier loans” will not get into trouble because house prices will continue to rise. This may end up being the case in the long run, but what the RBA doesn’t seem to be taking into account is the “cause and effect” in their analysis. The reason house prices continued to rise was because of the demand of the first home buyers who took on those risky loans, that is, the risk mitigator mentioned by the RBA is intrinsically linked to the cause of that same risk

More recently while analysing a speech by the RBA’s Malcolm Edey I stated:

As we have discussed many time previously on MacroBusiness, one of the major reasons that asset prices grew was because of the available credit to drive those values upwards. Tighten that credit stream and the value of the asset that support the debt position is likely to fall. As the effects of the stimulatory environment wear off and , as mentioned in the speech, the economy re-adjusted to a less expansionary position, then the debt to asset ratio of the private sector has the potential to worsen. Given that Malcolm Edey himself is stating that the economy is about to enter a phase of lower credit expansion, I suggest therefore, that the true test of APRA’s prudence is ahead of us, not behind. A slower growth environment is very much the thing that is going to test whether the bank’s equity-to-asset ratios can actually support their loan books. As I have mentioned in a couple of my previous posts it is not until we see debt growth fall back to a more sustainable level, that is in line with wages, that we can really measure the stability of the economy.

Given we are already seeing falling housing prices with debt growth at 6% YoY, Mr Edey may have gotten a bit ahead of himself.

As H&H mentioned on Friday the RBA’s most recent statement of monetary policy has been released and as usual devotes quite a bit of time to household finances. I was therefore interested to have a bit of a look at the RBA’s analysis of the household sector to see if they had adjusted their position on any risks or issues.

Household net worth is estimated to have fallen slightly in the June quarter to be 1¾ per cent higher over the year, with recent weakness driven by a fall in dwelling prices (Graph 3.4). This is in contrast to average annual growth in household net worth of almost 9 per cent over the past decade. Survey measures of consumer confidence have also fallen recently and are now at below-average levels. The weak growth in net worth, higher utilities prices, and the uncertainties about the global economy, amongst other things, are weighing on expectations of both the general economic outlook and household finances.

Reflecting these developments, the household saving ratio is estimated to have increased further in the March quarter, reaching 11½ per cent of disposable income, back to levels recorded in the mid 1980s. Consistent with this increase, credit card repayments have risen sharply over recent months, and are now around the levels of late 2008 and early 2009 when government stimulus payments facilitated some paying down of credit card debt (Graph 3.5).

As I have mentioned previously, the household savings ratio is wrongly named because it is actually the household not-consuming ratio. As you can see from the credit card data an adjustment in the household saving ratio doesn’t always mean more money in savings accounts. The chart above shows that very recently households have been attempting to pay down credit cards over an above their normal interest payments. The same is happening across other sectors which is why monthly credit growth has suddenly become negative for the first time since the GFC.

Back to the SoMP.

The cautiousness of households is also reflected in slowing household credit growth and an increase in housing equity injection, which is estimated to have been the equivalent of around 4 per cent of household disposable income in the March quarter, compared to rates of equity withdrawal averaging 4 per cent over 2002 and 2003. Based on previous analysis showing that housing equity withdrawal tends to be associated with housing transactions, the increase in housing equity injection is likely to be partly related to the slowdown in housing market turnover (Graph 3.6).

As I have spoken about previously the housing market needs turnover to maintain prices. The bottom chart (red line) shows that the housing turnover rate is now at 30 year lows and it is no coincidence that household net worth is also falling. This is classic debt deflation dynamics, where the desire of an indebted cohort to save in unison leads to further indebtedness because as they pay down debt they are indirectly lowering their nominal income and asset values.

If the trend in credit issuance continues then it is to be expected the effects will become broader. There is already some evidence that the retail sector is shedding jobs and once unemployment starts to rise this trend tends to become self re-enforcing. Australia obviously has the mining investment boom that has the potential offset these effects, but disleveraging has only just begun so it is yet to be seen if that is the case.

More from the SoMP

Mortgage arrears rates – both for banks’ on-balance sheet loans and securitised loans – picked up in the early part of 2011, though by international standards they are still low. Arrears rates have risen in all states, but most noticeably in Queensland. The worst performing loans in recent years have generally been those extended towards the end of earlier periods of strong local housing price growth and easier lending standards. In Queensland and Western Australia, these are the loans that were extended between 2006 and 2008, while in New South Wales, it was the loans made between 2003 and 2005 (Graph 3.9).

Anyone who has been following the real estate market in Australia shouldn’t be too surprised by the chart above, and it is basically the crux of my overall concern. The worst real estate markets are seeing rapid rises in arrears. As I have stated previously:

There is no way banks were going to see large increases in defaults in a rising market, anyone in financial trouble has been able to sell their property for a higher price, pay down their debt and move on with their lives. Even those who have recently been in financial trouble have been able to access hardship assistance which would have given them time to sell their house if need be. It is when the market begins to fall that the potential for trouble begins.

I think it is fairly clear from the charts above that this statement holds true. Queensland and Western Australia are the worst performing real estate markets over the last year and the sharp rise of the green line in the bottom 2 charts is again no coincidence.

Back to the SoMP.

In contrast, borrowers that purchased their home in 2009, including many first-home buyers, appear to be performing better than some previous cohorts, despite the increases in interest rates since 2009. The arrears rate for this cohort is only half the long-run national average, and likely reflects an improvement in loan quality due to the tightening in lending standards in 2008.

I simply don’t understand this comment and I cannot verify it because the 2009 data isn’t presented in the report. However the RBA’s data on loan characteristics from their FSR clearly shows that early 2009 was the peak of high LVR mortgage issuance.

In early 2009 1 in 4 loans issued to owner occupiers was with an LVR above 90% and there are many documented cases of young first home buyers purchasing properties using only the first home buyers grant as a deposit. How in the world the RBA can claim that this was a period of “tightened” lending standards is totally beyond me. H&H has previously discussed this topic so I will not rehash it here, but a quick glance at UBS’s predictions for the 2009 cohort tells a very different story to the one presented by the RBA.

And finally from the SoMP

Indicators of dwelling investment have softened over the first half of 2011. The number of building approvals for detached houses fell by 8 1/2 per cent over the first half of 2011, to be well below decade-average levels. Apartment building activity remains relatively stronger, particularly in Victoria, reflecting work committed in 2010;  low reached in early 2007 but well below decade average levels of around 2½ per cent. The estimates suggest Sydney is the tightest market, with a vacancy rate of 1.2 per cent, and Brisbane tightened the most over the quarter, with the vacancy rate almost halving to 1.8 per cent as natural disasters reduced the stock of housing. Reflecting these developments, the pace of rental growth has increased slightly, although it remains well below rates reached in 2008.

Much of that paragraph has been covered recently by the Leith, specifically Melbourne’s building activity and the Australian rental markets.

So in conclusion, the RBA has once again failed to convince me that they are fully aware of the risks presented by the high levels of household debt in this country, and more specifically the risk presented by the first home buyers grant boost. This is particularly concerning to me given that it now looks as if Australia is heading for a period of deleveraging which will bring with it the additional risk of debt deflation. It will be very interesting to see how the RBA handles interest rates if the trends in credit issuance continue. With FutureBoom! on one side and Godzilla on the other I expect it to be a rough ride.

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  1. DE

    You’ve nailed the issue that the RBA is blind to the Godzilla in the room. Unfortunately Godzilla is much larger than FutureBoom!

  2. Australians are saving at a high rate as they require a higher deposit to buy. A flagging and schizoid stockmarket makes fixed interest term deposits attractive. When banks and the RBA reintroduce interest rate cuts and the govt does what ever it has to to encourage people to buy property , what will all those Australians with healthy deposits do, well they’ll go out and buy a property. And you guys will be scratching your heads again waiting for that 40% collapse.

    • And the sky is blue and the birds are singing…….

      No offence, but that’s an awfully optimistic view of things. I can’t see any stimulus coming this time around as the government has been wedged by the chorus of “stop the waste”. People may well go out and buy more houses, but I doubt it.

      Unless you need one genuinely as a roof over your head, you only buy property in Australia for capital gain and tax dodging, which is just not happening anymore, and not likely to pick up anytime soon.

      The market is looking more and more likely to head into black and crispy phase before too long

    • Fabian Aldersey

      For some of us, the price is too high no matter what. I won’t be rushing in to become a debt slave, even if my term deposits don’t give me much for a while.

    • – Australian’s aren’t “saving” in terms of actually putting money away, they’re paying down debt. Did you even read the article?

      – As Delraiser said, the govt would be hard pressed to push more stimulus through and if they did, the fact that we “need” more stimulus just prooves how unhealthy our economy/housing market is. And what happens when that stimulus runs out and we end back where we are now or in back in ’08? More stimulus, again and again and again?

      – Who here is predicting a 40% crash, hmm?

      • “- Who here is predicting a 40% crash, hmm?”
        Nobody, at least none of the bloggers themselves.

        Even Steve Keen’s often misrepresented prediction was for a drop of 40% in real terms over a maximum 10-15 year period. IIRC he made that prediction in late 2007 or early 2008. Even with the Stimulus and emergency level interest rates Brisbane is already nearing a 10% drop from peak in real terms. And that’s with over a decade left for the “long slow melt” to continue.

    • This is one guy with the cash to buy outright (sold up in 07). I wont be buying. I’m trying to talk the missus in to never owning again.

      • My experience suggests that convincing the missus is actually more difficult than understanding the bloody market in the first place!

      • Given my experience with rental agencies and “managers” (sic), I’d think twice about never buying again.

        If you can find your own house where the mortgage cost equates to the same cost as a rental, I’d prefer to buy. Even 10% above that level would be worth the hassle of being treated like scum.

        Its going to take a generation or two before renters are treated like humans again in this country.

        • >If you can find your own house where the mortgage cost equates to the same cost as a rental, I’d prefer to buy. Even 10% above that level would be worth the hassle of being treated like scum.

          This is an interesting one, that I have mused on previously because it is a very important question in terms of where a market bottom could be found if there was no government intervention.

          The question is what price would the average person pay above rent for the security of housing. ( obvious caveats apply ).

          So lets say you can get a house that costs $400/week to rent which is roughly equivalent to the repayments on a $240,000 loan ( 7% over 30 yrs ).

          What would be an acceptable price to pay as an owner occupier ? $240,000? $300,000 ? $340,000?

          I think I would accept a $50,000 premium over renting. I wonder what others think about that. Maybe I will post on it sometime.

        • I’d buy if my mortgage payment would be within 30% of my current rent. Unfortunately where I live (inner south-east Melbourne), I’d need to put down about a 60-70% deposit for that to be the case!

          Happily we rent from an older lady who inherited the house, owes no money on it, and is happy that we look after it and she hasn’t increased the rent in more than three years.

        • DE – the house we just purchased is approx. 15% overvalued, using an imputed rent calculation.

          For mind, this premium (plus as Cameron has rightly pointed out, the depreciation costs, maintenance etc) was worth it, considering we have a substantial deposit and thus a relatively small mortgage.

          We purchased for 4 reasons:

          1. the premium above renting was just within my acceptable boundary for home ownership
          2. I wanted the security of semi-agricultural land (its on acreage)
          3. was a mortgagee repossession, so was able to get a deal
          4. I’m just sick and tired of being treated like scum because I rent.

          FWIW, if I was to buy our current rental house (only one week to go, thank Dog), I’d only pay a 10% premium above the rental cost, which values the house at just over $200,000.

          But I would be mad – and anyone else too – as there are a few HUNDRED identical houses here for sale for $270-350K. And no buyers. And they’ve come down from $400K.

    • “And you guys will be scratching your heads again waiting for that 40% collapse.”
      Lucdeluc. Please point us to an article where any MacroBusiness contributor forecast a 40% collapse? I think you are confusing us with Professor Keen…

    • Who will buy?

      There just aren’t that many FHBs out there to enter the market as such a large number were induced into the market in 2009. The numbers are still down around 20% and going to stay that way for another 12-18mths. The last round of stimulus sucked a huge number of under-prepared FHBs into the market, and as mentioned above, that saving is paying down debt.

      I highly doubt there are many buyers (other than readers of MB) with a big deposit out there.

  3. Note that the RBA increased M1 by only about 4% in the total 2 years until May 2011 but they have increased M1 by about 4% in the last reported month of June 2011. This may be a real trend change and needs watching for a loosening of policy.

  4. I just believe our society is just way to biased toward landlords and property owners. We don’t have the same rent controls as Europe and we have govts which turn on stimulas or migration at the turn of a tap. Plus with the RBAs ability to slash interest rates the carrot exists to buy. Most people buy in Australia buy to live in not as an investment. I know very few people who bought a home for investment purposes.

  5. As an average wage earner I cannot comprehend how anyone can or should pay $400 a week in rent or in mortgage repayments. I could do it for a while and maybe even a long time AS LONG AS I don’t have to rear children.
    Surely the issue must be affordability over anything else – even loose credit has its limits.

  6. Thank you for mentioning cause and effect. I think that too many mainstream macro economists deal only in correlations and forget about causal factors. (Unfortunately logic is not taught in mainstream economics causes.) And one primary causal factors is consumers’ time preferences:

    Debt deflation in Australia? Yes.