Australia’s next doozy of a recession

It appears MB is getting through to the brighter elements of Australian economics. Stephen Walters of JP Morgan has penned a nice note sketching the outlines of what will be an historic event for the Australian economy:

The Australian economy’s unprecedented golden era of growth without recession now stretches across more than two decades. We have reported 23 straight years of positive annual GDP growth, beginning immediately after what then- Federal Treasurer Paul Keating infamously called “the recession we had to have” in 1990-91. Only one economy in the modern era has managed to avoid recession for longer: the Netherlands, whose citizens managed a 27-year stretch of uninterrupted growth from the early 1980s (first chart). This impressive achievement, though, ended badly for the Dutch during the Great Recession and the subsequent Euro area crisis; after falling 4.2% during the great recession, real GDP in Europe’s seventh largest economy has fallen in nine of the last 12 quarters.


No such Dutch disease?
In Australia, there have been setbacks since the last recession, in which GDP has fallen in a discrete quarter, including during the global recession of 2008-09. There have not, however, been consecutive quarterly GDP declines to satisfythe accepted definition of recession. In fact, Australia’s economy has expanded in 87 of the 90 quarters since the end of the last recession. There have been three technical recessions in GNE, but never in GDP. Since the last downturn, Australia has managed the excesses and subsequentconsequences of a housing boom, China’s urban and industrial expansion, record-high commodity prices, and, recently, an unprecedented addition of capacity in mining.

Nimble policymakers can take much credit for this, particularly RBA Board members, who have been quick toadjust policy, most notably during the most recent global downturn. The RBA was the first central bank to slash official interest rates 100bp after Lehman Brothers collapsed in September 2008; others quickly followed. Fiscal policy’s automatic stabilizers played a role, too, both here and in China, in particular, which now takes one-third of Australia’s exports. AUD’s flexibility and the prevailing variable mortgage rate structure, which means the RBA gets a lot of bang for its policy rate buck, also have been helpful.

RBA: recession here has 100% probability
But this golden era can’t last for ever; Australia will suffer recession at some point. RBA governor Glenn Stevens told the Wall Street Journal last year that recession in Australia has a “more or less” 100% probability; only the timing is uncertain. Indeed, Australia’s economic history since federation in 1901 shows recessions occurring regularly, every seven years or so, on average. Deep economic downturns, in particular, have followed terms of trade bonanzas much like the one just experienced, albeit not since the abrupt end of the 1950s’ wool price boom. Indeed, Australia generally has not handled booms well; all previous commodity price-driven growth surges ended in busts.

We are, however, not forecasting recession this time around, nor are any of our competitors. Even the most pessimistic of forecasters expects only a period of sub-trend growth in Australia, as do we and forecasters at the Reserve Bank and Treasury. A crucial difference now is that AUD floats freely, and should fall to ease the economy’s transition as the terms of trade decline. AUD was pegged or managed until late  1983, meaning there was no timely pressure valve when trouble struck. Also, the base of the commodity price boom this time was broader—previously, it was all about wool.

Cause of next recession unpredictable
We do not pretend to predict the timing and cause of the next downturn. Will it be fueled by over-investment, as before the 1990-91 recession, or be triggered by a spike in interest rates, a policy error, or some other unexpected event here or offshore? We do not know, and nor should anyone guess. Policymakers don’t know either; if they did, they would adjust policy to help prevent recession, rather than merely jawbone and “lean into” emerging risks, as they are now. Instead, we have examined the economy’s apparent vulnerabilities and possible excesses, to gauge where the fallout from Australia’s inevitable recession most likely will be largest. These apparent pressure points will change over time, particularly if Australia manages to beat the growth record of the Dutch. For now, we find the household sectormost exposed, with leverage high, debt servicing costs elevated (despite record low interest rates), and house prices among the world’s most highest. This contrasts with the experience before the 1990-91 recession, which had its  epicenter in the corporate world. The corporate sector this time around has performed better, although, until recently,
productivity growth was lame.

The oft-ignored benefits of recession
The apparent exposure of households, which we examine in more detail below, is the most obvious downside of Australia having avoided recession for so long. The absence of an economic trigger for change means many households will carry into the next downturn excesses that have built up over more than two decades. These will make the fallout from the downturn worse. We are not pro-recession; they are painful and destructive, usually causing unemployment to spike and wealth and potential output to be destroyed. Recessions do, however, have the benefit, often recognized only in hindsight, of triggering the necessary adjustment, a “clean out” that sets the sails for subsequent expansion. With the last recession receding into the deep past, many Australians have not experienced such catharsis first hand.

The likely prominent role for households in any downturn probably argues against the onset of catastrophe when recession arrives; bank failures, for example, as nearly happened in 1990-91, probably are less likely. It could, though, extend the duration of the downturn by constraining household discretionary spending over an extended period.

Indeed, unlike corporates, households de-lever only slowly.

Corporate entities can raise capital from external sources more easily and/or pay down debt; also, bankruptcy protection can be a superficially attractive alternative. Households have fewer options. Most battle through toughtimes, continuing to make mortgage payments while cutting back on discretionary purchases. Household capitulation happens rarely. Even in the last recession in 1990-91, commercial bank loss rates (i.e., write offs) for home loans hardly budged at close to zero percent of outstanding borrowing (chart), but large corporate loan losses amounted to nearly 4% of all loans, and spiked to 3% for smaller businesses.

Last downturn fueled by over-investment
Australia’s recession of 1990-91 had its genesis in the heady days of the late 1980s, when a rapid rise in corporate leverage, encouraged by steadily falling interest rates in the wake of the 1987 share market crash, helped fuel an unsustainable binge in non-residential property investment, in particular (first chart above). Excluding mining-related engineering spending, non-residential construction ballooned from just 1% of GDP in the mid-1980s to almost 4% of GDP in 1989. As a result, corporate debt rose to a then-record 65% of GDP (chart, previous page). Subsequent increases in official interest rates as inflation approached 9% eventually ended the boom, triggering widespread bankruptcies and deleveraging— corporate debt tumbled to 50% of GDP by 1993.

Unfortunately, the onset of recession in some of the world’s major economies exacerbated the extended economic downturn in Australia back then. This inconvenience constrained the subsequent boost to Australia’s exports as AUD fell sharply. The local unit, in fact, fell from near 90 US cents in the late 1980s to below 70 cents by 1993 and nearly 21% in real trade-weighted terms. Australia’s export share,however, rose only modestly, from 15% of GDP in 1990 to 18% by 1993. Much of the lift in the relative export share wasdue itself to the extended weakness in domestic demand.


Corporate sector prudent this time …
The corporate sector has been much better behaved during the recent expansion. Corporate debt is elevated at 69% of GDP,comparable to the peak heading into the last recession 23 years ago, but down significantly from the record 78% reached in 2008, ahead of the global slump. Indeed, despite the Australian economy dodging a deep downturn back then when others did not, corporate entities managed down theirdebt in the aftermath. Local managers perhaps felt chastened by what was happening elsewhere, and acted accordingly.

Unlike the boom in commercial office space in the late 1980s, the recent boom in mining-related engineering construction was funded largely by offshore investors, limiting growth in domestic debt. Engineering construction surged from 1% of GDP in 2002 to a record 7% in 2012 as foreign equity investment via Australia’s open capital account swung from a net outflow of A$40 billion per year (2.7% of GDP) in the mid-noughties to a net inflow of A$60 billion (4% of GDP) in 2012. Also, corporates now are sitting on large piles of cash, which have been funding extensive share buybacks and other capital management activities. These most liquid of reserves could be diverted to other purposes if need be.

… but households carry excesses
The fallout from the corporate recession of 1990-91 extended to the household sector via a sharp rise in the jobless rate as businesses cut costs or failed, falling equity and house prices, which led to negative wealth effects, and the rise in debt servicing costs that squeezed disposable income. Back then,
unlike many corporates, households had been well behaved; household debt was just 50% of annual income, but they were not immune to the effects of the recession. Moreover, the rapid rise in interest official rates to 17% took households’ debt servicing costs to a then-record high relative to disposable income. The moderate debt ratio, though, meant that house prices equated to just 2.5 times household income, comparable to the global average.

Now, the household metrics are more worrying. Two decades of falling interest rates, steadily declining unemployment, and easing bank lending standards, alongside rising national income, have allowed household gearing to explode; the household debt to income ratio now is 1.5 times, three times higher than before the 1990-91 recession (first chart next page), and among the world’s highest. As a result, average house prices in Australia are more than five times gross household income, also among the world’s highest.

The housing market, then, would be vulnerable when recession strikes, although the full-recourse lending provisions here should limit the damage. Indeed, “jingle mail,” as unwanted house keys are returned to financiers, is an unfamiliar phenomenon for local banks. In fact, we forecast further gains in house prices, as there still is a shortfall of supply. That said, house prices can fall, as Governor Stevens recently reminded investors. Prices nationally dropped 7% from peak to trough during the 2008-09 global recession, when the real-economy impact of the global downturn were modest. The price falls were largest in the biggest cities, as was the case in the last recession in the early 1990s (chart).

Cross-border comparisons are untidy, as all markets are different, partly owing to differential tax treatment, but national house prices fell 33% peak to trough in the US after the great recession (second chart), 13% in the UK, 11% in New Zealand, 10% in Canada, and 35% in Spain, where they are still falling. Prices fell only 6% in the Netherlands.

Modest hikes will see debt servicing spike
High debt is a particular pressure point for households. The surge of borrowing over the last decade means it would take only modest mortgage rate rises to lift household debt servicing costs back to record highs seen in 2008. The forecast anticipates the RBA starting to normalize monetary policy from the current record-low cash rate of 2.5% in 3Q 2015. The first 150bp of official rate hikes, which we expect by the end of 2016, would take the household debt servicing ratio back above 10%, higher than before the early-1990s recession, assuming an unchanged household debt ratio. This also assumes the official rate hikes are passed through fully to bank mortgage rates, which seems likely.

A potential mitigating factor for the next recession, however, is that improved corporate fundamentals could limit the rise in the jobless rate. The forecast assumes only a modest rise in the jobless rate this year but that, of course, assumes no recession; the jobless rate reached almost 11% during the 1990-91 recession. Also, there is a large buffer of household mortgage pre-payments that the dominant variable interest rate structure allows; most households keep repayments thesame as variable interest rates fall. The mortgage buffer will be eroded quickly, however, as interest rates rise, and particularly so if unemployment later climbs rapidly.

Policy flexibility now more limited …
A complicating factor for when the next recession hits is that policymakers have less flexibility now than they did when recession last struck. The prevailing cash rate in 1990, for example, was 17%, providing policy makers (via the RBA, which was not formally made independent from government until 1996) with plenty of room to move when trouble struck.

Now, the cash rate already is at a record low, although it probably will be higher by the time recession arrives, whenever that is. By then, the RBA will have started to normalize policy. Even after adjusting for inflation, the comparison stands. In 1990, the real cash rate was 8% (chart previous page); the real cash rate now is negative, for the first time in the inflation-targeting era.


Similarly, the government’s fiscal response to recession will be constrained. The Commonwealth budget deficit was less than 1% of GDP in the late 1980s, leaving room for the fiscal shortfall to blow out to nearly 5% of GDP as the automatic stabilizers kicked in. Now, due partly to extravagant (and largely wasteful, in our view) stimulus that played a small role in staving off recession five years ago, the deficit already sits above 3% of GDP. Rating agencies that bestow upon Australia the coveted AAA credit rating have called on the government to implement measures to return the Budget to surplus over time, further constraining any policy response. The agencies also have drawn a line in the sand on the public debt ratio at 30% of GDP, above which the credit rating could be under threat; it currently stands close to 20%.

… but AUD could fall sharply
Perhaps the pressure valve, then, would be lower AUD, which still sits proudly above 92 US cents, despite the plunge in previously soaring bulk commodity prices that helped drive the local unit above parity with USD two years ago. The incongruence between commodity prices and AUD reflects Australia’s now more prominent standing in the global AAAratedsovereign club, whose membership has been shrinking since 2009. The “curse” of the triple-A rating is that central banks and sovereign wealth funds now find AUDdenominated assets increasingly attractive, preventing AUD from falling, despite deteriorating fundamentals. The onset of recession, though, could see even these “sticky” investors head for relatively safer havens, triggering a fall in AUD that could boost exports, helping to cushion the damage done by recession to domestic demand.

Very good. Could have written that myself. The only point at which I disagree is the timing. I do think it will come this time around, following the next external shock, which is much closer ahead than the GFC is behind.

Houses and Holes
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  1. I had a read through that yesterday and thought it a fine piece.

    Everything is there from over indebted private side to over indulgence in real estate.

    The thing that interested me was it it is the first time I have seen someone other than you guys clearly state that the next recession will be a long grind out of recession with higher rates

    ‘Now, the cash rate already is at a record low, although it probably will be higher by the time recession arrives, whenever that is. By then, the RBA will have started to normalize policy. Even after adjusting for inflation, the comparison stands. In 1990, the real cash rate was 8% (chart previous page); the real cash rate now is negative, for the first time in the inflation-targeting era.’

    …..which for mine will mean it is going to be a bloody long grind out of recession, or avoiding one in the first place really.

    Never ever been a better time to buy real estate though

    • I’ve got your picture, I’ve got your picture

      I’d like a million of you all ’round my cell

      I want a doctor to take your picture

      So I can look at you from inside as well

      You’ve got me turning up and turning down
      I’m turning in I’m turning ’round………..

      I’m turning Japanese
      I think I’m turning Japanese
      I really think so…….

      Turning Japanese
      I think I’m turning Japanese
      I really think so…………..

      Edit: Not saying we are a bunch of [email protected] or anything but with all that property pornography out there diverting our attention from the real problems facing us one just has to wonder…

    • Excellent @gunna there’s a lot of goodness (facts) in this article.

      @lorax I note there is mention of the benefits of recession, a necessary part if the cycle. The lack of rebalancing/stress has caused the extreme excesses and inequality of today/recent years.

  2. sydboy007MEMBER

    The more I read the more I’m glad i have no debt. I don’t know how people with 600k+ mortgages are able to sleep at night knowing they need a few thousand a month just to keep the monster happy.

    • The scary part is that they wouldn’t be able to cover the mortgage if they rented the property out to a tenant. Otherwise, it wouldn’t be so bad.

      Value an asset based on its cash flows. Not hard.

      • How do you know the tenant will continue to be able to pay their rent, especially at current prices? Rent prices aren’t as stratospheric as land prices, but they aren’t exactly cheap.

      • Value an asset based on its cash flows. Not hard.

        Like all the major texts on business valuation advise? Weird idea, treating a rental property as a business…

  3. Worth reiterating: “Back then…households had been well behaved; household debt was just 50% of annual income, but they were not immune to the effects of the recession….Now, the household metrics are more worrying. Two decades … have allowed household gearing to explode; the household debt to income ratio now is 1.5 times, three times higher than before the 1990-91 recession “
    And that, ladies and gentlemen, is now an inescapable problem that won’t be resolved without massive asset price deflation. It’s the ‘best’ way of getting income back into line with asset prices. Lower prices = less future debt to fund them.

    • migtronixMEMBER

      Yup that debt is inextinguishable, where will it go?

      However unlike the dotcrash it won’t free up lots of useful resources cheap, like all those SunSparc servers that suddenly went from $20k to $2k each and allowed the genesis of Cloudware, not to mention Google/Youtube/MySpace/Facebook.

      No, it will more like Detroit with just empty lots crumbling by the road side….

      • migtronixMEMBER

        @Alby ha ha indeed

        I love this specufestor burnt country,
        A blend of sickening greed,
        Of disputed bottles of Grange,
        Of drunks flooding into RE

    • Hi Janet.

      Two problems with that section you quoted that the article didn’t quite get right:

      1)in ’91-’92 the 50% was of DISPOSABLE income … not income.

      2)the author then sneakily uses 1.5 times income instead of sticking to percentages… 150% …and once again that is disposable income as per the graph on the RBA site:

      • I’ve missed your point….Could you elaborate pls?

        Are you saying they’ve used disposable in 91 and gross now?

        AND…if so, wouldn’t that make it worse (which is what the article is saying….it’s bad)?

        Is there a difference between 1.5 times and 150%?

    • I’d lay a serious wager that asset deflation is not coming, it may arrive as a shock, but it will soon be sorted out by debasing the currency as was done this time, and the systems are in place so it can be sorted out quickly.

      Asset deflation – banks go insolvent, politicians go insolvent, households go insolvent. There won’t be many central banks an politicians watching this from the sidelines.

      As an aside, the true Lords of Usury, don’t really care if there is an asset shock and deflation, they own the security on all the assets, this will merely mean they convert that security to ownership.

      The politicians, the wealthy and the executives do care however and they will move heaven and earth to ensure asset prices don’t fail, as they have done this time.

      • I’ll wait for the next shock i reckon. However unlock many poor b&stards f..d over by the usury machine i own my house and have no debt, so i can be patient.

        One things for sure, i got caught with my pants down without gold investments last time and that won’t happen again.

      • Have 45% assets in metal.
        Have 10% of assets in gold shares bought 3 months ago after the ASX’s XGD had fallen 80% since it’s top of 8,500 on the index in early 2011.

  4. migtronixMEMBER

    I’d like to see some of that AUD weakness everyone has been talking about since February…

    • February which year? Mr Holes has been banging on about the need for a lower AUD since he was over at Dad’s Army.

      • Peter, would there be further gains in house prices during a recession because of lack of supply as suggested?

      • If there was a lack of supply maybe, but we are currently in construction mode and it is just as likely that we will see an oversupply of housing which will either cause some falls in certain localities or hold the price steady in others. Probably more so in apartments than detached dwellings.

        As long as they keep rates low and don’t cut lending the chance of oversupply increases. If the RBA raise rates or lower LVR’s then maybe the undersupply will continue.

        You’re old enough to remember housing recessions from overbuilding before – the Gold Coast is a prime example. Others here don’t have that experience.

        It will get soaked up in a few years at current immigration rates, but it will be an opportunity for the bulls to buy for a short time. Most will avoid buying during that period. Probably vary a lot from area to area.

        Why do you ask, I didn’t think that you either wanted to buy or sell.

      • ….”current immigration rates”….

        Perhaps the idiot average voter will change their focus from My kitchen rules et al. during a recession and finally see the ridiculous negative impact immigration is having on all of us.

      • Peter, I’m not interested in buying or selling — transaction costs alone put me off housing investment, not to mention lack of transparent pricing mechanisms, liquidity issues etc etc — but given that we live in a houses and holes economy, house prices will always have a big impact on the broader economy.

        I find it curious that you place so much emphasis on the supply side. It seems to me that if there is a serious recession, high unemployment, and a crisis of confidence this would affect prices regardless of the supply situation.

        Mig, 10,000 posts a day etc.

      • migtronixMEMBER

        10k posts a day don’t make Peter Fraser any less myopic.

        Less is more indeed! It’s what this economy is crying out for…

      • @PF,

        If there is recession, net immigration will plummet, irrespective of government intervention, so don’t hold your breath for immigrants to soak up all that supply.

        By the end of the last recession, annual immigration got as low as 30,000 (1993), starting from 158,000 (1989).

        EDIT: Also, studies conducted through the GFC show that recessions also stop people breeding. Birth rates in the US went down considerably at the time of the GFC, and they went down most in the areas whose economies slowed down most.

      • @ Lorax – yes a recession will lead to lower prices regardless, but if we still have an undersupply and high immigration then it will quickly pass because the demand isn’t satisfied. Higher unemployment, rate rises, all negative for housing but none of those provide homes where they are needed.

        We only have a recession in housing because people stop buying. The minute they start buying again the recession is over, and if we still have an under supply it’s back to the races – nothing is solved long term.

        Idi Amin once ordered shopkeepers to reduce prices – it worked for about 5 minutes.

        Only more supply will stop house prices rising further. Everything else just makes it worse because the issue is masked so the government, the public, and the RBA think they have sorted out the problem, but they haven’t. They are just painting over rust.

        @ Stat – and what is it now? Why do people risk their lives coming here by boat – even in a recession this country is better than almost every other country. What conditions do you think people in 3rd world countries live in?

      • Only more supply will stop house prices rising further

        What about less demand? i.e. Slower immigration, larger households, fewer unoccupied homes etc all symptoms of recession all reduce demand.

        What about lack of access to credit? If the banks can’t/won’t lend silly amounts, surely that will dampen prices?

      • What, the countries sending us immigrants now were better places to live in in the early ’90s?

        Anyway, it’s called net because it takes into account the people who will leave. That figure is going to soar.

        Also, if no one’s hiring, there are no 457s, regardless of how loose the rules are.

      • @ Lorax – Only supply matters at this moment.

        Demand won’t fade while we have a rising population and despite statements above we are not going to go into reverse for the foreseeable future.

        Credit is an enabler not a driver. Everything else is a lesser issue.

      • @PF,

        Both the Keating recession and the Fraser recession saw very substantial falls in net overseas migration to Australia.

        Australia is still Australia, and apart from the Soviet bloc (which has never been a big contributor to Australian immigration) the other countries of the world remain the other countries of the world.

        What on earth will be different at the next recession that means that the trend is not repeated?

        The only difference I can see is that with a longer lead time, there is a bigger build up of debt, so the whole process will be longer and more painful, but that doesn’t seem like it would make Australia more attractive.

      • @stat sailor

        I know it is only marginally related to this thread but on the ex Soviet Union and migration to Australia there has been quite a few migrate to Australia through third nations (eg Israel and New Zealand)

        But more interestingly I was told just last night that there are advertisements in Ukraine right now touting how easy life is in Australia (indeed suggesting that people simply need to rock up and they will get assistance). I think Ukraine could easily be on the verge of a humanitarian disaster. I think that will affect the EU far more than here, but I did find it interesting/bizarre that Australia was being touted by the people smuggling types there.

      • @gunna,

        Well, I suspect that wrt Ukrainian refugees, refugees whose skin pigmentation and religious more closely resembles that of the LNP cabinet room than some of the people arriving by boat in recent years may indeed get a warmer welcome than many refugees have received in the last few years.

        Consider further the recent sudden re-purposing of part of the refugee quota to rescue Iraqi Christians.

        EDIT: General comment on small Soviet impact on Australian immigration based on 20,000 Russians by birth living in Australia, compared to 1 million UK born or several hundred thousand Chinese or Indian born.

      • @ statsailor – quote (Both the Keating recession and the Fraser recession saw very substantial falls in net overseas migration to Australia.)

        I would expect the same result, but migration will still be net positive unless something extraordinary occurs.
        The trend will be repeated, but that doesn’t mean we need less houses than we do at this minute.

        We had a savage recession in 1991 but if you look at the long term house price index it’s just a blip. Expect the same this time when it happens.

      • migtronixMEMBER

        And that’s why I do it, those 10k posts a day, because people like fraser obfuscate and run the same “nothing changes” line over and over and over, and you guys let him by “debating” in his sandpit. F#ck that kick sand in his face!

      • Similar proportional fall in NOM is a fall of around 180,000.

        A construction rate of 150,000 housing units p.a. is quite different when population increases by 200,000 compared to an increase of 380,000.

        EDIT: With about 27% of Australian residents having been born overseas, if 7% of them decide to piss off in any one year, our population growth is under water. Yes that’s very unlikely, but it could get a lot less unlikely if things get really ugly.

      • Mig, FWIW I find Peter far less annoying than 3d1k. He’s entitled to his opinion, I don’t think he’s paid to post here, and he’s posting under his real name. A quick google will find him.

      • @ Stat – mate I’m agreeing with you – the trend will be the same. If you are now saying that migration may reverse then you are disagreeing with yourself and historical trends. It could happen but it would be quite unexpected.

        During a recession the rate of building falls greatly, so don’t expect a catchup then.

        If you want house prices to fall we have an excellent opportunity now that construction has increased. What I’m saying is that only a few people will be able to take advantage of that because as soon as buyers rush in the recession is over. I don’t understand why that is an issue.

      • To be clear I am saying:

        Immigration and hence population growth will decrease at least as much if not more than the previous two recessions.

        When that happens house prices will fall – just as they did after Keating’s recession (admittedly a disappointing 14% in real terms from 1989 peak to 1997 trough in Melbourne, but you’ve got to take what you can get sometimes). You seemed to be saying this last did not happen last time and won’t happen again. That’s what I was taking issue with.

        I also think that between the recent significantly above trend immigration of the last few years and the long time between recessions both the dip in NOM and other consequences of recession inc unemployment and house price falls will be more severe than previous,

        House price source:

        Note several periods of negative real house price growth despite positive population growth in all years surveyed.
        (page 9)

      • Ah. Well I was talking in nominal terms. Yes I agree that in real terms prices may fall over a long period if we see supply arrive in enough quantity, and that is a real possibility over the next two or three years depending on which city you are in..


    • @migtronix. Probably not happening till China’s iron ore imports drop for a couple of months.

  5. They seem to put a lot of faith on the power of the floating dollar – that it will ‘fall’ and act as a pressure release valve – as if our currency exists in some kind of vacuum.

    Every other currency on earth is having downward pressure put on it and when the next ‘shock’ comes, don’t expect the AUD to fall, just because it should.

    • The problem is not that it doesn´t fall to fair value but that it will have to fall way below to make up for 6 wasted years when everybody else has been gaining in productivity and slashing waste. To attract any export industry (including financials) Australia will have to become a second Thailand but with a much bigger debt and nothing to show for it.

  6. Solid article and I agree with Gunna above.

    As an aside, wtf is the obsession with “Jingle Mail”. I realise it creates different incentives and consequences for banks/borrowers when the SHTF, but don’t these commentators realise we’ll all be rightly f***ed anyway by the time borrowers have cause to consider mailing keys to their bank – or realise that they can’t. (And hasn’t it been shown that the US states with recourse-lending went off a similar cliff to the rest anyway?)

    • A debt collection agency will give you about 3% to buy outstanding shortfalls owed on a previous mortgage loan which is indicative of the likelihood of recovery. Far too much store is put on full recourse mortgage lending. A bank will almost never get it back which both it and the debtor know.

      • The banks will eat your equity first.

        Know of a case from Sth Australia back in 2010 – family knocked back $1.1m only for the bank to foreclose and sell it for $750k

        Never ever think that a bank is your friend – they will protect their interests (excuse the pun) above all others.

      • @Stomper
        “Never ever think that a bank is your friend – they will protect their interests (excuse the pun) above all others.”

        If someone out there still believes this after the GFC, they deserve to be taken to the cleaners. Banks have always been thieves that enjoy police protection.

  7. They say:

    “Also, there is a large buffer of household mortgage pre-payments that the dominant variable interest rate structure allows; most households keep repayments thesame as variable interest rates fall. The mortgage buffer will be eroded quickly, however, as interest rates rise”…

    I have always wondered about this mysterious ‘buffer’ that gets wheeled out from time to time. It seems to me to be a bit of a false measure of portfolio quality because i don’t think that it’s a measure that can be ‘averaged’ across a portfolio. So I don’t think its a good measure of how insulated the housing market is from a downturn.

    Say I’m a bank and half of my loans have a 30% buffer (principal repayment ahead of schedule) and the other half have 0% buffer. On average it is 15% ‘buffer’.

    When things turn sour and people lose their jobs, say, the debtors who are ahead on their payments can just let interest capitalise, eating the buffer (maybe in practice they must redraw the available excess to pay the loan). Presumably no bad debt provisioning is required as the debtors have plenty of time to find another job, liquidate assets, being in boarders etc. That’s half my portfolio.

    But the other half of the portfolio is screwed. Immediately, as soon as any borrower falls upon hard times. The excess ‘buffer’ existing in respect of other loans can’t help. The mortgagee in possession sale is a few months away.

    Am I missing something?

    • “…Am I missing something?….”


      Make a list of all the reasons why we are different and see how many are never heard of again when things prove not to be different.

      But they serve a purpose. They allow lots of people to say nobody could have seen it coming.

      Humans have a very healthy survival instinct – it is called optimism. However, it can cause problems when it comes to predicting the risks of financial options.

      • migtronixMEMBER

        Correct we have been indoctrinated to repeat the “no one could have it coming” mantra, it’s psychological based trauma where you become afraid to think differently from the herd. It MUST be that no one saw it coming otherwise we have wolves in sheeps clothing in our midst.

        Sorta like saying “it was an accident, not weapons grade evil”…

      • “..Sorta like saying “it was an accident, not weapons grade evil”…”

        I know it must itch but you should stop scratching that rash!!

      • migtronixMEMBER

        Ha ha ha ha actually it doesn’t itch any more and I wasn’t scratching it, it just flowed with such clear consequence from the earlier thesis I felt compelled to restate it….

    • “But the other half of the portfolio is screwed. Immediately, as soon as any borrower falls upon hard times. The excess ‘buffer’ existing in respect of other loans can’t help. The mortgagee in possession sale is a few months away.”

      Exactly how it played out in 2008/09, but the banks didn’t want to start the flood – which might have then caused their 30% client to be in the sh*t – so they didn’t put them on the market, they sat on them.

      Find someone senior at ANZ and ask them how many properties in Melbourne’s inner east alone the bank had in it’s posession back then. In many cases the banks were renting to families that lived there before, in other cases there were empty houses. Thankfully the govt enacted policies which proved beneficial to the big donors’ interests and this near-implosive episode was quietly forgotten.

      • Yes, it is not hard to imagine a scenario where the government either supports the banks developing into massive landlord/housing suppliers on the back of their bad loans or ‘purchases’ the houses from the banks at a small haircut to book value and buries them in a large publicly owned housing corporation.

        No stone will be left unturned to protect the private banks and the sanctity of the private bank control of the money supply.

        After all that is what taxpayers and their elected representatives live for.

    • Hi Peachy, I think that is a very valid point you have raised there.
      You don’t need a large part of the community to fail with their housing debt.
      There will always be a large section of the community that acts responsibly, paying down their housing loan ahead of time, and not in a position of having to sell in a down market.
      But it only takes a small section of the community to fail, losing their jobs, unable to make payments.
      Then $1,000,000 dollar home units come onto the market at $600,000, and that sets the tone for the property market… It goes into reverse.
      Those responsible people that are keeping up with their mortgages will still only get $600,000 for their once worth $1,000,000 unit…
      The saving grace is that the $1,500,000 home on a quarter acre block that you wanted to trade up to now only costs $900,000.

    • Only that most mortgages have significant equity in play – average mortgages are $300k

      Only 3% of Australian property changes hands each year and many are investors and upsizers.

      The risk for the banks is more recent 95% mortgages – but with many backed by mortgage insurance and parent guarantees or superannuation portfolios.

      The banks will have plenty of your equity to draw on when it all blows up.

  8. This is a bit odd but fairly typical from a bankers perspective.

    “The housing market, then, would be vulnerable when recession strikes, although the full-recourse lending provisions here should limit the damage. Indeed, “jingle mail,” as unwanted house keys are returned to financiers, is an unfamiliar phenomenon for local banks. In fact, we forecast further gains in house prices, as there still is a shortfall of supply.”

    An economy where debtors are strapped into their ill considered and ponzi pumped debts (i.e. no jingle mail) is an economy facing a long and painful path.

    To make matters worse, they suggest that the blocks on supply will continue causing land and housing prices to remain high even as the economy grinds to a halt as households shut their wallets and purses.

    But at least the security held by the banks on their loans holds it value.


    Demented analysis that is so very typical of the FIRE sector.

    Throw the economy and households under the bus to protect the banks.

    • Yes, jingle mail would solve the problem overnight. Imagine if the banks carried the risk of their loans?? Nooooo….way too radical!!

      And on the supply side holding prices up even in recession?? Ha ha ha…..good luck with that.

      • “And on the supply side holding prices up even in recession?? Ha ha ha…..good luck with that.”

        Yeah that bit was particularly nutty considering that most of the state governments seem to have clued on to the fact that 30 years of milking the housing construction cow has its limits and the fat profits they make from being a land banker drip feeding the market and creaming fat stamp duty from inflated property prices may not offset a growing army of unemployed dudes polishing their pitchforks and pressing their Hi Vis vests.

        Rock meets hard place.

        Housing ponzi schemes contain the seeds of their own destruction.

        They stuff up every other sector of the economy until about the only work left available is building new homes and when that happens the rest is history.

        Mining gave us a chance to soften the bang but as usually those dopes in Canberra (both parties) missed the opportunity.

  9. Three things that caught my eye:

    1. Last recession corporate debt was then record 65% of GDP, now it is 69%, having come down from a high of 78%. No, the corporates are no less able to sail through a recession than last time.

    2. The corporate buildings space has not had the excess of last recession. Ah, NO!!!, Stockland reported yesterday and their worst sector was non residential building. Head Office Australia is going through a massive downsizing with fewer bodies due to automation, better management, and lack of need (See Rio sub leasing Brisbane offices at a 40% discount to what they are paying just to get something in the tin).

    3. Unemployment – this is the WOW moment. How high is it headed? With capex cliff, downsizing manufacturing management positions, it could get ugly. And, as Gunna said, it will be a slow grind recession, so even an 8% unemployment rate will feel a lot worse than imagined.

  10. Thanks UE, it’s interesting that most analysis don’t look at externalities in their workings, the economy was firing until the gfc hit, this time round it could be Chinese house prices as you state.

    While you might not be able to predict what it is, you can predict I would think that something unforeseen to the domestic economy could have a detrimental impact to a couple of gdp points.

  11. Not that great a piece if read closely….

    ‘The likely prominent role for households in any downturn probably argues against the onset of catastrophe when recession arrives; bank failures, for example, as nearly happened in 1990-91, probably are less likely. ‘


    • Yeah I’m with you MM.

      In Professor Ross Garnaut’s book on the 2008 debacle, he says that all the banks were insolvent in October 2008.

      Further to this, Kevin Rudd had to get special dispensation from the federal government to allude to the same thing at the inquiry into ‘ pink batts’.

      In the interim the banks are leveraged even more.

  12. “In 1990, the real cash rate was 8% (chart previous page); the real cash rate now is negative, for the first time in the inflation-targeting era.”

    And has been for the last 12 months.

    Recession? Quick we better cut interest rates to all time lows…..oh that’s right… we already did.

    • +100 I find it extraordinary that MSM doesn’t push home the point that the guns have been fired and there is nothing left!

      Rising unemployment, weakening China demand, increasing structural govt deficits, falling real wages and a dysfunctional Govt.

      When will the lights go on????

      • The lights are on but nobody’s home.

        These facts are so disgusting and simple, it’s pathetic the MSM don’t report them. I guess they don’t want to spook their “battler” readership with 3 IP’s each and who study The Block every night for renovation ideas.

      • Yeah, that’s garbage. You can do anything with fiat, it’s all about stopping a deflation shock, which is the worst place imaginable for the politicians both personally and in terms of their lobby.

        Assets are all there are now. That doesn’t mean you won’t be in the sh8t if you debt fund, it just means those assets have value independent of any fiat based analysis.

  13. “Households have fewer options. Most battle through toughtimes, continuing to make mortgage payments while cutting back on discretionary purchases. Household capitulation happens rarely”

    Wouldn’t bet on it being the same this time around with 50% of the property market (in NSW at least) being investors.This is untested as to how they will react in a recession. Are they really going to hang in there for years, making NG losses on cashflow, and with an asset falling in value steadily?

    • Mining BoganMEMBER

      We’ll find out how deep their religious convictions go. I’m guessing sacrilege within twelve months.

      • Anyone with any sense is already out. They sold-out to a new crop of devotees who will hang in there a lot longer than might be expected. Isn’t that human nature? “Oh, it WILL go back up – then, I’ll sell”. The smart money got out 10% ago. Many having made 100% of a small holding from 75-85; then 100% of a larger holding 85-95; then 90% of a BIG holding from 95-05. That ‘missing’ 10% on the last hurrah was the bait needed to get out. Now – it’s sit and watch time. It might take longer than I would imagine. But, then again, maybe it won’t. And those with the sense to have gotten out, will wait much longer than they want to, being sensible and all, if indeed they do want to get back in again…..

      • Don’t disagree that they might want to hang in there in some cases to avoid a loss but if unemployment soars in a recession they might not have the luxury of making that decision

  14. Are there any figures that shows offsetted mortgages? As in mortgages with offset accounts?
    Many people i know who invest in property have large debts on them but at the same time have large chunks of that debt offset by cash so really house hold debt figures can be a little misleading. Would be good to see figures on this!

    • That’s encompassed in the sentence “there is a large buffer of household mortgage pre-payments that the dominant variable interest rate structure allows; most households keep repayments the same as variable interest rates fall. The mortgage buffer will be eroded quickly, however, as interest rates rise…” The cash in offset accounts could evaporate very quickly when interest rates rise/ the exchange rate falls ( imported inflation and higher living costs etc). It’s not the relatively small number of people who have a 100% offset account that will determine the outcome of the property market. It’s the overwhelming majority that are in debt up to their necks….

      • nicely put Janet, and addressing that overwhelming majority will involve keeping them in gainful employment, presumably with some form of wages growth.

        which with the AUD where it is involves the economy becoming more autarkic on a resources umbilical chord to the rest of the world (and I dont think that is going to cut it) or nutting out some form of game plan to retain a globally exposed side with the AUD at nose bleed levels, or to get the AUD down with an AAA around its nexk and everyone else in print mode [and our banks having borrowed internationally to fund local mortgages)

  15. For me the most important question facing Australia is:
    What does the post recession Aussie economy really look like?

    Where will real productive growth occur?
    Which industries will experience massive growth?
    Which jobs will be handsomely rewarded and which jobs will simply disappear?

    About five years ago the US economy began its transition, its still very much a work in progress but the winners are slowly appearing and through a natural evolutionary process replacing the old with new. In the process they are revitalizing the whole US economy IMHO Australia’s transition will be at least ten times as difficult as the US’s yet we dont even have a starting date. In many ways our late start will only guarantee that the most attractive new business opportunities are already being actively mined by US/European multinationals with a truly global market focus.

    For me this is a sort of Cassandra moment, I can see dozens of opportunities that are ideally suited to Australia and Australians but I know better then to suggest that any can actually be developed into viable local businesses with global focus.

    • migtronixMEMBER

      Oh C’mon Cass I’m listening, promise!

      Seriously other than med/bio-med what is there??

      IT has long left these shores, Hi-Tek manufacturing requires investments the Australian banks don’t have an appetite for, rocks you can find just about anywhere on this planet and will require fewer and fewer hours of manual labour done.

      Houses?? Footy??

      Serious CB what is there?

      • Some manufacturing stands a chance of coming back, given after a recession we won’t be able to afford to buy anything made overseas.

        Real wages are falling now, imagine how low they’ll go once the real pain sets in.

      • Um, yes, I worked in manufacturing for 13 years and was project engineer for the largest individual investment my former employer made – all Australian money too.

      • To be fair – was kicking around.

        This was just before Aussie dollar took off.

        Suspect that there is a lot of manufacturing that makes sense when the Aussie is at US$0.85 or lower that doesn’t make sense above US$0.90. There was a big change of attitude when that line was crossed – from ‘we could sell more if we could stick another machine in’ to ‘we could sell more if we could teach some guys in Vietnam or China to make our stuff’. Despite, mind you, previous attempts where the O/S company couldn’t achieve the quality benchmarks until after we’d given up and they’d started their own relationship with our customers, and suddenly our customers’ expectations and supplier’s ability converged extremely rapidly.

      • @WW
        I’ve worked with enough Asian’s to know that they’re all to some degree addicted to gambling. So this is a massive growth industry…I’m just not sure its a growth Industry that Australia can leverage and really turn into Aussie jobs. Unfortunately Sydney is and will remain an 11 hour flight from Shanghai, so as much as we may think of ourselves as being part of Asia the US west coast is actually closer and they’ve got the tourist gambling junket market pretty much sewn-up. As for the whales there is still a great business opportunity BUT a very limited jobs opportunity.

    • Agree 100% Bob.

      I find myself wondering about the AUD in all this.

      It needs to come down for the sake of the economy, but you would assume that the AAA will keep it stronger for longer, and that the banks needing to roll over what they have borrowed internationally and lend locally would be in the stronger for longer camp too.

      That brings me round to the suspicion that if we have a genuine BoP issue then the AAA gets stripped and we crash (like I am talking 0.50-0.60USD). OR

      We dont get stripped (and there would be a fair bit of political imperative not to lose the AAA) and the AUD remains uber strong (and with the US Fed, ECB, BoE and BoJ all in print mode and the limited number of global AAAs that would have to be a chance) and that the thing that melts [further] is the globally exposed part of economy.

      I tend to figure that would only be remotely sustainable while resources export volumes are upped massively (or prices rebound from where they are). But if there was anything in that then the next critical link would be the political determination to fry the economy to sort the banks and FIRE sector, and I dont think there is any doubt about the extent to which the political side would in fact fry the real economy.

      And from there I find myself wondering at what point wages growth (or non growth) turns into unemployment, which in turn materialises as NPLs in bank balance sheets – and of course brings us back to real estate.

      But of course it has never ever anywhere been a better time to buy

      • Sorry Gunna wanted to reply earlier but just didnt have the time

        To he honest I’m not a fan of floating exchange rates because they create an uncertainty which is completely outside of your business execution control. they become this X factor that rewards the undeserving and punishes the deserving with nothing you can do about it, uncertainty is the real enemy of all longish range business plans and floating exchange rates just amplify this business uncertainty.

        In the Aussie ventures that I was investigating I gave up on local funding and instead chased US/Asian capital unfortunately the floating Aussie creates an accounting nightmare for any internationally focused company with internationally sourced capital that must abide by Australian accounting standards and realize profits/losses/ value in $AUD. You start to think: It’d be a whole lot easier if my accounts were in $USD….it’s a short trip from there to wondering, for what possible reason have we made the parent company Australia based?

        To be honest I’m not sure what a post floating exchange rate regime should look ik, maybe it’ll involve Tax accounting in SDR’s or similar, all I know for certain is that something has to give so that Aussie export business risk is adequately rewarded. I’m a strong believer that If you can do this(create the reward mechanism) then the free market will take care of the rest.

        EDIT: BTW if the above comment makes no sense its because it was written after consuming several bottles of Sake and while a very flexible oriental “hostess” attempted to entertain me.

    • We will be swamped by large US, Chinese and European companies and none of us will get a look in

    • Where will real productive growth occur?
      Which industries will experience massive growth?
      Which jobs will be handsomely rewarded and which jobs will simply disappear?

      Well lets see CB, the Prime Minister’s Science, Engineering and Innovation Council, a group existing for at least the last 3 PMs with meetings 3 times per year or more, has yet to meet with Mr. Abbott.

      Throw in a bit of sovereign risk (successive Government’s doing complete 180s on everything) with absolutely no representation of small business in cabinet and I think you can read between the lines here.

      Like I’ve said before, all the smart mobile labour is leaving Australia and it’ll only get worse when SHTF.

      • migtronixMEMBER

        Yup Jason I’ve started making preparations and plan by this time next year to be enjoying a Northern summer again! Aaaah sun in July how I’ve missed you…

    • Sorry there are a few too many responses for me to even attempt individual responses in the time available.

      So let me expand a little on the opportunities because I think the problems are there for all too see.

      PV/Solar and storage integration into the Gird.
      This is a huge looming problem because towns (especially in remote and coastal regions) are seeing huge shifts towards PV. I could name towns where 1/3 of the houses have upward of 3KW of solar capacity installed on their roofs. That’s an average generation capacity of 1Kw per house where aggregate mid day demand is typically less then half this figure (say 500W). So today we have 500W of excess local capacity that basically needs to flow backwards and be absorbed by the grid. National transmission grids were NEVER designed for this scenario and it actually creates all sorts of technical problems because the local PV source is synched to the local grid which lags the national grid…this phase lag can make local PV generators actually look like loads to the Grid the result is massive current spikes and increased transmission losses along with harmonic distortion at the national grid level. To put it mildly its a looming disaster. The good news is that Australia is one of the first countries to be seeing this phenomenon so we’re in the hot seat when it comes to finding solutions. These solutions could develop into massive new Aussie business with truly global reach OR we could find politically expedient ways to squash and contain PV (btw I know which response to expect form our elected officials aka betters)

      At a tradie / construction level Aussies are very inefficient, but this very inefficiency creates opportunities to be the first to introduce new labor reducing technologies. By being the first to adopt any technology you control the space and can grow your businesses as the rest of the world comes to the realization that a solution exists to their own looming problem. Yea this is my favorite robotics soap box again ….the initial value for robotics hardware will be reaped by the makers of the machines BUT the real long term value will be reaped by those that control the application space. In my mind there is absolutely no reason that our tradies cant transition to application developers and own the global construction automation space. If we adopt early we can create the rules own the IP and have the real world depth of experience needed when the rest-of-the-world wakes up to the opportunity.

      Above are two examples of creating businesses that leverage disruptive technologies AND can afford to pay the new-technology start-up premiums needed to locally displace the entrenched businesses. I have other examples but they’re all along the same lines of utilizing emerging technology to turning today’s Australian labor/regulatory cost disadvantages into tomorrows global business opportunities.

      • migtronixMEMBER

        BUT the real long term value will be reaped by those that control the application space

        Ding ding ding!! Just like s/w all the money is in consumer facing apps not flogging O/Ss any more

        EDIT: BTW CB I’ve been working on/designing RasPi driven industrial controllers, stuff that was done with PICs once upon a time but its cheaper and easier to use a full silicon stack.

        Couple that with robotics and you’ve got 24/7 repair crews for things like the Sydney Harbour Bridge.

        The applications will be IMMENSE and Australia will import it not export it…

      • House building robot seems quite doable – we are amongst the world leaders in mining technology, especially safety gear, so it kind of seems logical to extend into housing too.

      • @CB, thanks for your thoughts.

        @mig – that is very cool about the RasPi development, keep us posted on what you make!

        @ff – absolutely. Watching a 3D concrete printer construct a house is nearing soft-porn, can’t wait to see the automated pre-fab/onsite-fab outcomes in the not too distant future.

      • PV/Solar and storage integration into the Gird.

        Do you know any local companies already working along these lines ? My wife is an electrical Engineer with a bent towards renewable/sustainable energy and would likely be interested.

      • @drsmithy
        Do you know any local companies already working along these lines ?

        I’ve heard some rumors about projects within some of the PV installers but this is largely in support of the niche off-grid sector and its very installation focused, as in let me sell you my imported solution. No real IP being developed.certainly nothing targeted at export.

        There’s a lot going on in China, because interestingly China has many of the same Grid stability issues caused by small towns / communities in isolated valleys. The US Grid storage plays have a very different focus because the cyber security of grid control is a much bigger hot button issue then efficiently managing solar integration. I dont have any real contacts or insight into the European initiatives except to say that most are far more focused on profiting from the development process (euro grants etc) then on developing profitably exportable products.

        One of the Chinese projects that I’m involved with has received expressions of interest from a certain power grid focused European based company, they want to rebadge and sell it as their own product but were not really interested in this business model so we’ll see what happens.

      • @Mig
        I agree HUGE opportunities using these fully integrated ARM platforms, it doesn’t matter if you call it a cell phone controller or a Rasberry PI same basic functionality with SO many integrated peripheral comms/sense functions all for around $25 (hardware and OS) its huge absolutely Huge.

      • “Do you know any local companies already working along these lines ? My wife is an electrical Engineer with a bent towards renewable/sustainable energy and would likely be interested.”


        …and who knows, it might be pretty cheap moving to WA soon…

      • @CB

        The local PV idea is one that will need to happen and soon. I don’t know why more simpler system are not being integrated into houses. You could use bladders to store compressed air. gravity pumps for water etc etc

      • Maybe we can leverage those holes in the ground left by the mining industry …
        or reuse parts of the gravel waste :

        Or start investing in automation to lead the pack when comes the time when “Humans Need not apply: :

      • migtronixMEMBER

        Absolute Duno, you do know!

        Of course harnessing potential energy is a good idea, its what a capacitor is.

        Solenoids all sorts of sh#t is available to us, we just need to smash the fossil fuel cartels first, they control everything at the moment.

    • Don’t worry, China Bob.

      If the US slowly recovers, very high inflation or hyperinlfation will wipe out USD. The world will then scramble for gold.

      We will export our way out by digging more gold our of the ground!