Last weekend's Sunday Telegraph pointed out a new record for Australia: our ratio of household debt to GDP is now higher than the USA's. I've written the following commentary on this dubious "gold medal" (or is it really lead?) for the ABC's The Drum.
In all the self-congratulations over how Australia has managed to sidestep the GFC, an inconvenient truth has been overlooked: the crisis was caused by too much debt, and Australian households have had a stronger and longer love affair with debt than even the Americans.
As of the latest RBA figures, Australian households now owe the equivalent of an entire year's GDP—3% more than Americans ever owed. We grew our debt pile much faster than Americans did. We are continuing to go deeper into debt, while American households have started to reduce theirs. And in one of the great travesties of our GFC sidestep, the most recent growth in household debt has been deliberately engineered by government policy.
Back in 1990, American households had twice our level of household debt—60% of GDP versus 30%. But after just 15 years, Australians had caught up: by 2005, both countries had household debt to GDP ratios of 86%. Just as the media started to focus on the Subprime Catastrophe in the USA, American household debt began to stabilise, while ours continued to grow—peaking at 99% of GDP in March of 2008, versus the USA's all-time high of just under 97% one year later.
We actually began to reduce our debt levels before America—with household debt falling from 99% to 96% of GDP in March 2009. but then the federal government's First Home Owners' Boost began to kick in (it was introduced in October 2008, and I railed against it at the time—see "Rescuing the Economy or the Bubble?”). This enticed new entrants into mortgage debt in record numbers: during the life of the Boost, over 1 percent of the Australian population took the government’s additional $7,000 bribe down to the bank, and levered it up five or more times with a mortgage. Even though households were reducing other forms of debt, total household debt rose until it cracked the mark of 100% of GDP in the last month.
The good news—for the rest of us—from this First Home Buyers debt binge was that their borrowing was one of three domestic contributors to Australia avoiding a technical recession in 2009 (China’s own stimulus package was an important fourth factor). The additional $40 billion of mortgage-backed money combined with the $30 billion impact of Rudd’s stimulus packages, and the close to $40 billion boost from the RBA’s rate cuts, to dramatically increase both household incomes and spending. Gerard Minack from Morgan Stanley, who estimated that the last two factors increased household disposable incomes by 9% last year, commented that “If that’s a recession, bring it on!”
The bad news is that spending boost from additional mortgage debt is, in the immortal words of Paul Keating, a souffle that is unlikely to rise twice. There just aren’t that many more First Home Buyers who can be enticed into the market in 2010, even if the Federal Government follows NSW’s lead and extends its Boost for another six months. Property spruikers may be confident that the Great Australian House Price Bubble is back, but the market is unlikely to fly in the absence of deliberate government manipulation of demand and a renewed reluctance by buyers to go into debt.
That’s not to say that the banks and the property lobby aren’t doing their best to keep the bubble flying. Thanks to Kris Sayce from Money Morning magazine for bringing the following to my attention some months back: many lenders are now offering loans of 110% of the value of a property, so long as there’s a guarantor. Needless to say, the following excerpt from Home Loan Experts is not a product endorsement:
Guarantor loans are now the only way to borrow 100% of the purchase price as no deposit home loans have been withdrawn from the market. Did you know that there are stark differences between the guarantor supported loans offered by different lenders?With the help of a guarantor you can borrow over 100% of the purchase price which will allow you to buy a home and consolidate debts or renovate the property at the same time.How much can you borrow?
- First home buyer guarantor loan: 110% of the property value.
- Second home buyer guarantor loan: 110% of the property value.
- Refinance guarantor loan: 100% of the property value.
- Debt consolidation & purchase guarantor loan: 110% of the property value.
- Investor guarantor loan: 105% of the property value.
- Construction guarantor loan: 100% of the property value & cost of construction.
- Low doc guarantor loan: Not available with a guarantor mortgage. See below for our 80/20 method of financing low doc loans with the help of a family member…
Shades of Japan’s “99 year mortgages” at the height of their Bubble Economy back in 1990! While this could surely help boost the bubble, practically I doubt that there will be many takers. So one of the four props that kept our economy up in 2009 is unlikely to work in 2010. The interest rate prop is now working in reverse, as the RBA resumes its eternal fight against the consumer price inflation dragon, leaving only fiscal stimulus and China to counteract the decline in credit-based spending.
This is the real folly of boosting the economy by enticing households to take our more debt. Since spending is the sum of income plus the change in debt, increasing debt levels provide a strong boost to the economy. But that same process can work in reverse if households decide that they’re carrying too much debt: then their attempts to reduce their debt—“deleveraging”—necessarily reduces their spending.
When debt levels are low—as they were back in the 1950s and 60s—this isn’t a major problem. But when debt is as high as it is now—literally 100% of GDP for households and another 60% for businesses—then deleveraging can cause a dramatic fall in demand.
This is the force that is driving the downturn in the rest of the OECD, and by adding to household debt, we have simply delayed its arrival here—we have not stopped it.