RBA Concerns Over Spending Not Housing
Despite what the scare mongering newspaper headlines may suggest, Reserve Bank Governor Phil Lowe’s speech this week on house prices and household debt was more reassuring than alarming.
And once again, it should – but likely won’t – dampen some of the hytersical concerns about a “bubble” in house prices and the potential vulnerabiltiy of our banks.
Indeed, Lowe’s speech will not please the many hedge funds across the globe who continue to believe our banks are vulnerable given the apparently high level of local house prices. Along with shorting Japanese government bonds, shorting the banks out of house prices concerns has been a popular trade within the hedge fund community – but sadly for them, both trades are known as “widow makers” as they’ve so far failed miserably.
Lowe was fairly clear on this view of the risks that housing posed to the banks. Concerns over banks, or more eupamistically “financial stability”, “is not what lies behind the Reserve Bank's recent focus on household debt and housing prices in Australia” Lowe declared.
Indeed, according to Lowe “the Australian banks are resilient and they are soundly capitalised. A significant correction in the property market would, no doubt, affect their profitability. But the stress tests that have been done under APRA's eye confirm that the banks are resilient to large movements in the price of residential property.”
That should be of some comfort to bank investors.
Lowe also largely blames poor regional planning – not rampant tax-assisted speculation – for relatvely high house prices, particularly in Sydney. In short, we don’t build enough land intensive housing developments in the highly concentrated urban areas where we insist on locating most new jobs – or better transport links to those jobs for those prepared to live futher our of the city. That creates a huge premium on land and homes close to cities.
It is true that household debt relative to income has lurched further ahead in recent years to now stand at record highs. But unlike the case in in the United States during the financial crisis, most of this extra debt has been taken on by more financially secure older and higher income households - largely to fund investment properties or because they’ve decided to pay down their own mortgages more slowly before retirement.
That said, the percentage of households with relatively high debt – i.e. more than, say, 300% of income, has increased from 12% in 2002 to almost 20% more recently. It remains the case, however, that around 70% of households have debt to income ratios of less than 200% - though this is down from around 80% in 2002.
Another indicator mentioned is the fact that while around half of borrowers are at least 6 months ahead in their mortgage repayments, around one third have little or no mortgage buffer – meaning they are at risk of servicing diffulties if their income drops, such as through unemployment. But whether this share of households with little or no mortgage buffer compared is high relative to history is less clear – maybe this has always been the case?
Either way, rather than worrying about bank solvency, of greater concern to the RBA are the risks that clearly higher household debt levels pose to consumer spending, which after all accounts for almost 60% of national economic output. Lowe contends that higher debt means consumer spending is now more suspectible to shifts in household income – meaning the economy is thefore less resiliant to shocks. What we’ve particuarly seen in recent years is that low interest rates have not encouraged households to borrow (such as through home equity loans) and splurge on consumer goods as much as they used to do.
All up, this seems to imply that monetary policy will likely need to react even more quickly and aggressively to negative income shocks in the future – both because interest rates per se have less effect on spending decisions, but also because income shocks have potentially greater effects.
What’s more, Lowe also suggested that high debt potentially introduces a new element of asymetry into monetary policy responses – as while a greater policy response may be needed to deal with negative income shocks, households will also be more suspectible rising interest rates. So rates need to be cut quickly and aggressivley, but then returned to more normal levels carefully and gradually.
We are seeing an example of ths approach in the United States right now.
David is one of Australia's leading economic and financial market analysts. His is Chief Economist with BetaShares, and an Economic Advisor to the National Institute for Economic and Industry Research (NIEIR). His has held former roles as senior commentator with The Australian Financial Review, Macquarie Bank interest rate strategist and Federal Treasury economist. He is also author of the online e-book, TheAustralian ETF Guide.