Is an Aussie debt crisis around the corner?

By Leith van Onselen

From Capital Economics comes an interesting note on Australia’s private debt position:

We can’t rule it out completely, but recent suggestions that Australia is the second most likely country in the world to suffer a debt crisis and recession in the next one to three years seem overblown. The level of household debt isn’t as high as it appears at first sight. And the latest data suggest that the danger posed by the high share of interest-only mortgages is starting to recede…

There are certainly reasons to be concerned. There’s a risk that at some point a major fall in house prices and/or a rise in interest rates will mean that some of the debt won’t be repaid. The latest data, however, suggest that the risk isn’t as big as it first appears and that it may even be shrinking.
To start with, Australia’s household debt to GDP ratio looks higher than it really is as it doesn’t take into account the cash that households have in offset accounts…

ScreenHunter_12453 Apr. 01 14.17

Admittedly, the real concern is that 40% of all mortgages are interest-only mortgages, which are more vulnerable as and when interest rates rise significantly from their current record lows. Make no mistake, this is the single, biggest risk to the housing market and the health of the banks. However, the tighter lending conditions and the recent small rises in banks’ mortgage rates mean that interest-only mortgages have started to account for a smaller share of all new loans…

ScreenHunter_12455 Apr. 01 14.19

Overall, we don’t want to sound complacent about the outlook for the Australian economy (we are actually more downbeat than most) and we can’t completely rule out a debt crisis triggered by problems in the mortgage market in a few years’ time. However, the real problem probably won’t emerge until the RBA starts to raise rates from record lows, which may not happen for a year or two yet. And the latest evidence suggests that by then, the foundations of the mortgage market may be looking a bit more solid.

For mine, the bigger risk lie on the liability side of the banks’ balance sheet, whereby they have borrowed obscene sums from offshore to pump housing (see next chart), in the process leaving the banking sector and economy exposed to the whims of global capital markets and the risks of a sudden liquidity shock:

ScreenHunter_12420 Apr. 01 06.42

It has also put constraints around the Federal Budget in that it must continually strive for surplus to maintain Australia’s AAA credit rating, otherwise any downgrade would automatically flow-on to Australia’s banks, raising their cost of funding.

Whether or not Australia is likely to experience some kind of financial crisis within the next three years is a moot point. But having one of the world’s most overvalued housing markets, combined with overly indebted households and an extreme reliance on offshore funding, is hardly a good situation to be in and the opposite of prudence.

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  1. “Overall, we don’t want to sound complacent” …but we can’t stop ourselves.

  2. Tassie TomMEMBER

    Are 40% of all outstanding loans really IO? F**K ME – I though it was more like 15% or so! We’re stuffed.

    • Because negative gearing rewards ‘interest only’ loans – i.e. the more debt in the negatively geared asset the better – it’s hard to tell if this is desperation or just tax planning. The level of interest only loans in the place of residence (non-deductible) is probably a better test of the stress.

      • Original John

        Have a look at Manders and My discussion a few weeks back the lack of stress seen in credit card and vehicle leases. Mander made the point the ombudsman is “forcing” banks to move troubled loans onto interest only payment plans if they seek assistance from him. The implication of this revelation was that the number of interest only loans currently is masking the real underlying mortgage distress as these loans are no longer classified as in arrears or non-performing…..

      • The distressed consumer loans are getting packaged up as IO residential loans? It makes sense, but that split between investment and residence would still probably tell the story then?

      • Original John

        Need to question why there was a large drop recently in IP loans and a corresponding jump in PPOR loans… problem is data granularity – the banks really don’t want you to know about this issue.

      • Tassie TomMEMBER

        Yes, perhaps I’m naive. I thought that a significant minority of investor loans and an insignificant minority of owner-occupied loans would be IO. 40% of total outstanding loans would equate to about 80% of investor loans and 15% of O-O loans.

        I was “arguing” with someone on this site a few weeks ago about negative gearing. Whoever I was arguing with was saying that “not many investors make a net income loss over the life of their investment – just in the first few years until their debt goes down and their income generated goes up”. These stats make a mockery of that argument.

        It also means that I massively under-appreciated the significance of NAB (and possibly others) increasing the interest rates on their IO loans.

      • Agree OJ, this information is kept opaque. Given the scale of the leverage etc, APRA should make it available as broad based financial data – ideally the banks should provide it to their shareholders.

    • Isn’t this only an issue if people have trouble paying this interest? Even if the house drops by 30% initially, if you can still pay the interest, and even principal if forced to, it won’t affect much.

      • But then that household stops sending on everything else and begins to pay down debt result in aggregate is that debts CANNOT BE PAID its just the math !

    • Issue with IO loan numbers is that we usually don’t know if there are any savings against that loan. I have an IO loan for example but it’s completely offsetted by an equal amount of savings…

      • Tassie TomMEMBER

        Why on Earth would you do that?! Even though the IO interest is tax deductible, your savings interest is still taxable, and unless your interest rate on your savings is greater than your interest on your debt then you’re losing money. (Unless it’s in a 100% offset account of course).

      • “Why on Earth would you do that?”

        I did it for three years until pricing on IO was adjusted to be higher than P&I so I switched. Having IO with a 100% offset account (I had ~35% of my mortgage in the offset account) gives you more flexibility if you ever want to take the balance and invest it elsewhere.

        I’m now paying off the mortgage over 30 years officially but will keep increasing the offset account and pay out the mortgage within ten (unless there’s a massive property or stockmarket crash and I decide to invest the money in whatever has crashed).

      • drsmithyMEMBER

        Why on Earth would you do that?!

        So at some point in the future, he can pull all that cash out to buy a PPoR, then negative gear his now “investment” loan. Because “normally” you wouldn’t be able to negatively gear your PPoR mortgage.

        Ie: it’s yet another tax-dodge.

      • I’m the same. Really only needed the loan as a bridging loan, but thought I’d hang on to it for tax purposes if I ever move out and want to rent the house out in the future. Loan is 100% offset with the offset account so effectively an interest only loan with no interest payments. A bit worried that it will some how bite me in a case of bank collapses though I’m not sure how. May lose my nerve and pay out the loan before it becomes useful.

    • I like their point that when including the net of offset accounts, housing debt was only ~125% of GDP rather than ~135%. See? Everything will be just fine…

      Seriously, what kind of Kool-Aid do you have to be drinking to write stuff like this?

    • If you plan on selling i guess then yes but if yo u plan on keeping the property to generate rental income than i guess it would be best to pay it off asap.

      • All those negatively geared investors would be interest only I’m guessing, while they pay their primary residence off.

      • Yes that’s the point. The cash that you would have otherwise used to pay down the principal on your investment loan instead goes to pay down your mortgage (for which you get no deduction) faster.

    • It never pays to pay the debt off on an IO loan with an investment property and you probably shouldnt get it even for your own PPOR if you think you might rent the property at some stage in the future under the current tax system. And it’s not because you shouldn’t be paying it down; you should be using offset accounts to do so achieving the same effect. It allows more flexibility tax wise to manage your money by a lot (can save 1000s of tax a year) and gives you a line of credit always approved in case of emergencies. Without an offset account many investors would not be saving/reducing their interest by as much as possible because they would be too scared that they put too much money into the loan too soon they would have to redraw and under current tax laws redrawing on your debt has significant tax implications.

    • Yes that’s correct Richard! To maximize negative gearing tax claims, investors take out interest only loans with offset accounts, instead of paying money down on the principal, all money goes into the offset account, if they empty the offset account to purchase another property, they can negative gear the entire original loan amount again.

      If they pay down on the principal and re-draw, the ATO will not allow them to negative gear the original loan amount again.

      It’s a good example of how Australian Tax laws may seem ‘kooky’ until you appreciate who is benefiting – in this case Big4 fractional-reserve banks balance sheets benefit in looks only.

  3. Old mate has got his cause and effect arse about, the aggregate mortgage bill is based on ToT figures linked to never ending China growth. A large percentage of those cannot be paid as a result of lower ToT then house price correction then bank correction then crisis.

  4. 3 more years….YAY!!

    Its time we all just admit (those who want a home) that we do not know what or when something will happen.

    Time to move on with our lives. I wish i had bought 5 years ago before stumbling on MB.

    I know MB are right, and it will happen, but how long can i keep my family in turmoil, pushed and shoved from rental to rental without a sense of belonging or community…

    • So you need a mortgage to develop a sense of belonging or community?

      Oooooonly in Straya.


      Long ago I considered that the consequences for my family of this atomic bubble bursting far outweigh any benefits of buying back in, with or without a mortgage.

      I feel light, nimble, primed, ready.


      • Mining BoganMEMBER

        Yeah, I’m with you. Fairly sure nobody ignored me at the local follies last night because I rent. The mob I’m going to the footy with tomorrow night don’t seem to care much either. Or the lot I ride with. And golf.

        The only subject that does come up is how lucky I am to have heaps of spare time and dollar to enjoy things. Free. Yes.

      • No, I don’t need a mortgage, but to be a part of a community i do need to be able to live in that community.

        My experience of renting is one of 5 years of turmoil. 4 houses in 3 suburbs in 5 years. Not exactly settled.

        We have children now, do they deserve some stability throughout their lives and education, will they develop strong friendships if we move all the time? Can we even get them into a school, there are plenty of schools that want your name down years in advance…..we don’t know what to do.

        We have struggled to make friends, due to constant moving, been a friendless adult is not a nice situation.

        Sorry if this is trivial to you, its not to me.

      • reusachtigeMEMBER

        I feel for the renter above with no friends. This is a consequence of not taking care of one’s looks and staying a renter. It’s a sad punishment for those that followed the evil advice from “don’t buy now”. Utter scum evil advice… those commies should be sued!!!

      • JayBone, not sure where you live but if it’s fucking with you, just buy. The Nuts have bought a nice 3 bedroom 2 bathroom free standing townhouse for $390k which is 3x’s our income in an area where the average price is $550k which is “cheap” for Canberra. End of the day we’re not moving, prices go up , prices go down; this is our long term home, I really don’t care. We did the sums around a bunch of scenarios and bought what we could afford. As for reusa I wouldn’t waste a bullet on them, costs money, starvation costs nothing.

    • Yeah well – what’s the phrase?
      ‘The market can remain irrational longer than you can remain solvent’.

      • Clever aphorism, sure. But look at any long term chart for anything and you’ll notice that the market turns ‘rational’ way more often than you think. Typically, the longer the bouts of ‘irrationality’, the more calamitous the eventual ‘rationality’.

        long in the tooth for straya. lol

        tick tock and all that

      • Ha ha ha ha! Look at all these bears capitulating, just as Australia’s private debt breaks all the records in the books, while the capex cliff continues, while TOT remains in the toilet, and just before the auto industry shuts. In 2017, housing will be all that’s left of the Oz economy. But by all means, go all in now. Ha ha ha ha ha!

      • It is hard to remain sane, when everyone else around you is insane. I know I’m tired of it all.. Just want to be able to buy a home without 600K of debt… That isn’t Canberra, Adelaide or some place I’ve never heard of in QLD.

  5. PrinceOfPersia

    crisis around the corner?! We are already in a financial crisis! You have to be stupid not to noticed. Interest rate at lowest in the history (a yet more cuts may be on the way), desperate property spruikers jumping at any negative commentary about property, pathetic and gutless state and federal governments for withholding any appropriate economic measures, should I go on?! Australians are living on lies, and majority are too innocent to know the truth!!!!

    • ‘too innocent’?
      too IGNORANT – that’s the word you’re looking for surely.

      • lol. No. Too clever by half. That’s what Ossies are. And thus, complicit. & Deserving.
        Hear that? Tick. Tock.

  6. BakuninMEMBER

    ‘The crisis takes a much longer time coming than you think, and then it happens much faster than you would have thought’. Rudiger Dornbusch

  7. notsofastMEMBER

    The only thing left to do now is party like its 1999. Because there will be nothing left worth cleaning up after this RBA and APRA led party has finished….

    • The only thing left is to get rid of debt ASAP before the market crashes, so you can limit your losses! Then buy after the crash if you still have a job.

  8. In 2008 house prices in Australia should have been clipped by 40% like the rest of the world.
    In 2016 house prices have continued to rise…now they’ll have to come down 60%.

    The big 4 banks will be insolvent as they were in October 2008.
    No wonder the Government Guarantee only covers these banks’ deposits to $20 billion per bank.

  9. The article doesn’t mention that the real risk is unemployment increasing when the velocity of money chart from the St Louis Fed keeps going down.
    Pretty hard to pay an interest only mortgage on one wage for several years.
    Perhaps that’s when the geniuses at the RBA will recommend Negative Interest Rate Policy.