FINANCE: by Patrick J. ByrneNews Weekly
Day of reckoning for Australia's debt binge?
, December 4, 2004
While the Australian economy has stayed buoyant from a borrowing and spending spree for housing, Reserve Bank governor Ian Macfarlane has warned that the bubble must eventually burst.
The Howard Government kept the economy bubbling along on the back of a booming housing market, helping it to win the recent federal election. Prosperity meant there was no reason to change government. The fear of higher interest rates under Labor made it doubly certain voters would not change government.
The extent of our spending spree was spelt out by The Age
newspaper's Tim Colebatch: "In 1980, Australian companies, governments and households owed the world just a net $8 billion, or 6 per cent of GDP. In 2004 we owe the world $393 billion, or 48 per cent of GDP. In the past five years, the value of our annual output has risen by $224 billion, yet our net debt has risen by $163 billion.
"Suppose we had not borrowed and spent all that money. Would Australia's growth look so impressive for the past five years, or the past 25?"
Much of our recent borrowings have gone into the property market.
Over the past year, net lending for housing soared to $200 billion, to about a quarter of our GDP. In 1986-87, it was only 15 per cent of GDP.
The huge investment in housing is reflected in the massive rise in household debt. In 1990 it was 50 per cent of household income, but now it is 150 per cent of household income.
Two weeks ago Reserve Bank of Australia governor, Ian Macfarlane, stepped up his warning of a housing market bubble.
He said, "There has been a step-by-step reduction in credit standards over recent years. A significant proportion of mortgages are now sold by brokers who are paid by commissions on volumes sold ...
"Intermediaries are now lending to individuals whose income is not substantiated. There has also been an upward drift in the maximum permissible debt-servicing ratio.
"When once a maximum of 30 per cent of gross income was the norm, now it is possible for borrowers on above-average income to go as high as 50 per cent of gross income ... The new lending models used by the banks ... seem to regard the bulk of income above subsistence as being available for debt-servicing."Reduced standards
Macfarlane was describing how mortgage-brokers have reduced their lending standards, in large part because they no longer carry the risk of home-buyers defaulting, as was once the case by the banks. They are able to bundle up a package of mortgages, say worth $100 million, sell these mortgages as bonds and then use the new revenue raised to finance another $100 million worth of property loans.
Mortgage-brokers have sold about $85 billion worth of mortgage bonds as securities since 2000, while regional banks, credit unions and building societies have sold about $47 billion in mortgage bonds securities.
Tony Boyd, of the Australian Financial Review
, recently reported how officials of the Australian Prudential Regulation Authority (APRA), the regulator of Australia's financial institutions, have criticised the banks for:
- Failing to independently verify customer data - particularly debt-servicing ability.
- The use of informal means of valuing properties.
- Inadequate information systems on vital loan information.
- Unsatisfactory error rates in compliance with the terms and conditions of lenders' mortgage insurance.
Macfarlane warns that, while lenders have tightened up on lending to some sectors like inner-city housing, "these have been small steps compared to the much bigger drift to lower credit standards ..."
Under federal legislation, the Reserve Bank's primary task is to keep inflation low, not manage the property market.
But any interest rate moves will have consequences on the mainstay of the apparent economic prosperity over which the Howard government presides.
If rates rise, it will prick the property bubble, leaving many homebuyers in heavy debt, and precipitate a recession.
If interest rates stay low, the property market will continue to boom.
Where Australian interest rates go now will most likely depend not on Mr Macfarlane but on his US counterpart, Alan Greenspan, who has been warning of the problems posed by the rising US foreign debt and rising US government debt. Together they are driving down the US dollar.
Like Australia, the US has maintained its prosperity by borrowing from the rest of the world.
Japan, China and other Asian nations have lent to the US the huge trade surpluses they have gained from booming exports to the US. They have been prepared to lend to the US, partly because the US dollar became the world's reserve currency when the British pound forfeited that role after World War II.
But Greenspan warns of a double whammy. Not only is US foreign debt unsustainable, but the EU euro is slowly becoming the world's second reserve currency. A loss of confidence in the US dollar and a shift by investors into euros could force a severe decline in the value of the US dollar.
This would see a sharp rise in the value of the Australian dollar. That means we would earn even less from our exports and suck in more, cheaper imports. This would push up Australia's foreign debt even faster.
When our creditors eventually put the brakes on our debt binge, either we will have to start repaying our foreign debt or our interest rates will have to rise sharply - at a time when Australians are burdened with record household debt.
Then there is a real risk that Australia's debt binge will collapse like a house of cards.