Our second-class citizens – kids who can’t leave home

From The New Daily.

This year’s Household, Income and Labour Dynamics in Australia (HILDA) survey results confirm, with damning certainty, how Australia is spiralling back into inequality based around property ownership.

The Household, Income and Labour Dynamics in Australia survey, one of the most comprehensive studies of social and economic trends, shows the proportion of 18 to 39-year-olds owning their own home slumping from 36 per cent in 2002 to just 25 per cent today.

Within that figure, couples with dependent children went from an ownership rate of 55.5 per cent 15 years ago, to just 38.6 per cent.

That’s important, because it is parents passing wealth down to their children that are once again starting to define who gets into property and who doesn’t – we’re going back to a 1950s-style class division.

All in the numbers

To see how, consider the way assets grow in value over time, and the relationship between inflation-adjusted (‘real’) growth, and nominal growth.

Imagine a couple buying a home in Brisbane in 2002 at the age of 25. When they hit 40 this year, two things will have happened.

Firstly, for any given interest rate, the real value of their monthly mortgage payments will be lower thanks to the eroding effect of inflation.

Assuming their income had only just kept pace with inflation, their repayments after 15 years would be, for any given interest rate, only 70 per cent as large a chunk of their pay packets.

Secondly, the home would be worth about 1.9 times as much in inflation-adjusted terms, or 2.7 times as much in nominal dollars, based on ABS data.

Those left behind

By contrast, a 25-year-old couple who decided not to buy in 2002, but who at the age of 40 decided to do so today, faces two financial nasties – they’ll need a much larger deposit; and they’ll have to hand over a much larger chunk of their income each month if they want to pay off the home by retirement.

If this example were set in the 1980s and 1990s, you might say “it’s their own stupid fault”.

And you’d probably be right – the barriers to entering the housing market were much lower then.

Today, however, the HILDA numbers describe a housing market in which many young Australians have no choice about getting into the market.

Since the turn of the millennium, house prices across Australia have roughly doubled in inflation-adjusted terms, and a deposit for a home can’t just be ‘scraped together’ by maxing-out a few credit cards and smashing the piggy bank.

So young Australians have three options: stay at home for years more and save madly for a deposit; move out and rent, saving even more madly for a deposit; or receive a windfall gift or loan from the ‘bank of Mum and Dad’.

The HILDA data shows more young Aussies opting for the first option. In 2001, 43 per cent of men and 27 per cent of women aged 22 to 25 lived with their parents, but those numbers have now ballooned to 60 per cent for men and 48 per cent for women.

The old progression of moving out and renting, scraping together a deposit, and then moving into property ownership is almost impossible for many – unless the ‘bank of Mum and Dad’ is able to help.

A compounding problem

When Mum and Dad are unable to help with a deposit, the effects on wealth equality begin to compound.

Today’s 25-year-olds who do not have family money behind them will take much longer to get into the market, meaning they’ll have smaller capital gains behind them when their own children come asking for help.

Buying a home has never been a universal right, but as detailed last week, it’s something that at its peak was available to 71.4 per cent of Australian households.

As that number slides lower – or tumbles lower for younger groups – it’s time to face facts.

The new class divide in Australia is between those who have generous property-owning parents, and those who do not.

Home ownership falling, debts rising – it’s looking grim for the under 40s

From The Conversation.

Home ownership among young people is declining, as mortgage debt almost doubles for the same age group, results from the Household Income and Labour Dynamics in Australia (HILDA) survey show. It also shows young people are living with their parents longer.

The Melbourne Institute of Applied Economic and Social Research undertakes the survey every year. It’s Australia’s only nationally representative household longitudinal study, and has followed the same individuals and households since 2001.

The survey shows the rate of home ownership among 18 to 39 year olds declined from 36% in 2002 to 25% in 2014. In the same age group, the decline in home ownership has been largest for families with dependent children, falling from 56% to 39%.

Even for those in this group who manage to buy a home, mortgage debt has risen dramatically. In 2002, 89% of home owners in this age range had mortgage debt. By 2014 this had risen to 94%.

More significantly, the average home debt rose considerably. Expressed in December 2015 prices, average home debt grew from about A$169,000 in 2002 to about A$337,000 in 2014. Low interest rates since the global financial crisis have meant mortgage repayments for these home owners have remained manageable, but this group is very vulnerable to rate rises.

Detailed wealth data in the survey, collected every four years since 2002, show this increase in debt and decrease in ownership are part of a trend in the wider population. HILDA shows 65% of households were in owner-occupied dwellings in 2015, down from 69% in 2001.

In fact, the decline in home ownership has been greater than the decline in owner-occupied households. This is largely because adult children are living with their parents for longer.

For example, the HILDA data show that the proportion of women aged 22 to 25 living with their parents rose from 28% in 2001 to 48% in 2015. For men this proportion rose from 42% to 60%.

Among those who manage to access the housing market, the data shows that the growth in home debt is not simply because they are borrowing more to purchase their home. A surprisingly high proportion of young home owners (between 30% and 40%) actually increase their debt from one year to the next, despite most of them remaining in the same home. Even over a four-year period – for example, from 2010 to 2014 – at least 40% of young home owners with a mortgage increase their nominal home debt.

The proportion of people with home debt that exceeds the value of their home – that is, negative equity – has also risen. In 2002, 2.4% of people had negative equity in their home; in 2014, 3.9% had negative equity. This is a relatively small proportion, but this could change as even small decreases in house prices will result in substantial increases in the prevalence of negative equity.

How this changes with location, income and profession

In 2014, less than 20% of Sydneysiders aged 18 to 39 were home owners, compared with 36% or more in the ACT, urban Northern Territory and non-urban regions of Australia. To a significant extent this reflects differences across regions in house prices.

Sydney and Melbourne have particularly high house prices, while non-urban areas generally have comparatively low house prices. Regional differences in the incomes of 18 to 39 year olds also play a role.

Those with the highest home-ownership rates are professionals and, to a lesser extent, managers. They experienced relatively little decline in home ownership.

For workers in other occupations, home ownership has declined substantially. In 2014 home ownership was especially rare among community and personal services workers, sales workers and labourers.

This decline represents profound social change among this age group, where renting is increasingly becoming the dominant form of housing. In 2002, 61% of people aged 35 to 39 were home owners – a clear majority of their age group. By 2014, this proportion had fallen to 48%.

The changing housing situation of young adults is part of a broader change in the distribution of wealth in Australia. The HILDA Survey shows that differences in average wealth by age have grown since 2002. For example, in 2002, median net wealth of those aged 65 and over was 2.8 times that of people aged 25 to 34. In 2014, this ratio had increased to 4.5.

The decline in home ownership among young adults and this broader trend in wealth have implications for their long-term economic wellbeing and indeed for the retirement income system. Even if house price growth moderates and many of those currently aged under 40 ultimately enter the housing market, it’s likely that a rising proportion will not have paid off the mortgage by the time they retire. It may be that many will resort to drawing on superannuation balances to repay home loans, in turn increasing demands on the Age Pension.

Author: Roger Wilkins, Professorial Research Fellow and Deputy Director (Research), HILDA Survey, Melbourne Institute of Applied Economic and Social Research, University of Melbourne

Income divide between rich and poor Australians widening

From The New Daily.

Income inequality is worsening in Australia, according to comprehensive new research that finds renters, pensioners and students are feeling the pinch while high earners get pay rises.

ME bank’s twice-yearly survey of 1500 households, conducted in June and published on Monday, revealed bigger gaps in income, housing and financial worries across the nation.

In the last financial year, the overwhelming majority of Australian households (68 per cent) saw their incomes stagnate or fall. Only 32 per cent got pay rises – the lowest in three years.

Income inequality was apparent.

Almost half (45 per cent) of households earning less than $40,000 said their incomes went backwards, while almost half (46 per cent) of households on at least $100,000 saw pay rises. These high earners were least likely (17 per cent) to report income cuts.

Meanwhile, the incomes of 46 per cent of the middle class (households earning $75,000 to $100,000 a year) were stagnant in 2016-17, according to the survey.

If the results reflect the nation’s finances, then just over half of all Australians (51 per cent) are living pay cheque to pay cheque, spending all their income or more each month, with nothing leftover.

ME’s consulting economist Jeff Oughton, who co-authored the report, said the findings were relevant to the current debate over inequality because “this is how people feel”.

“The bill shock, the income cuts and the housing stress were quite loud signals,” he told The New Daily.

“There have been different winners and losers here, post the global financial crisis, and different winners and losers from low interest rates.”

The good news was that, overall, those who filled out the 17-page survey were feeling slightly less worried about their finances, perhaps because the global economy appears to be recovering.

ME’s financial comfort index − measured by combining reflections on debt, income, retirement, savings and long-term investments − is now at 5.51 out of 10, up from 5.39 in 2012.

However, vulnerable groups were doing it tough.

Renters were far less financially comfortable (4.52 out of 10) than those paying off a mortgage (5.47) and outright home owners (6.44).

Students were the most worried. Their financial confidence plummeted from just over five to 4.32 over the last year, the lowest since the survey began in 2011. This may have been a response to the government’s increase to university debt repayments.

Single parents improved but still ranked poorly (4.95 out of 10).

Self-funded retirees were the most comfortable (7.12 out of 10) while age pensioners were among the least (5.03).

Households earning over $200,000 recorded a staggering double-digit rise in financial comfort – up 10 per cent to 7.85 out of 10 – while those on $40,000 or less were stuck at 4.43.

Overall, Australians were more confident about their debt levels (6.31 out of 10), income (5.72), retirement (5.18), savings (5.07) and long-term investments (4.99).

The only key measure of financial comfort that worsened was when households were asked to imagine their finances in 2017-18: confidence on that measure fell three per cent to 5.31 out of 10, reflecting a general pessimism in the economy.

According to the report, a key reason many Australians fear the future is that, despite low inflation, the price of fuel, power, groceries and other necessities appear high and rising.

A growing number also expect their ability to manage debt to deteriorate if mortgage interest rates rise significantly.

One in five households said they spent more than half their disposable income on housing payments – with the majority renters.

A third (31 per cent) expected to be worse off financially if the Reserve Bank raised the official cash rate by 100 basis points, from 1.5 to 2.5 per cent, including half (47 per cent) of those with a mortgage.

However, 29 per cent said they would be better off – a reflection of those who own their homes and investors seeking better returns.

Generation X, those born between 1961 and 1981 (41 per cent), and single parents (36 per cent) were those most concerned about rising rates. And owner-occupiers (53 per cent ‘worse off’, 22 per cent ‘better off’) were far more concerned than property investors (35 per cent ‘worse off’, 29 per cent ‘better off’).

Households who expected to benefit from rising rates included outright home owners (38 per cent), those earning $100,000+ (36 per cent) and retirees (32 per cent).

Pleasingly, only three per cent of households said they were behind on their mortgage payments. But this was much higher among single parents (15 per cent) and Australians earning under $40,000 a year (9 per cent).

There was also a spike in those who expected to fail to meet minimum debt repayments in the next 6 to 12 months, up from 5 per cent to 9 per cent.

Further reflecting the divide, all groups of workers – full-timers, self-employed, part-timers and casuals – reported more financial confidence.

But the comfort levels of the unemployed plummeted from 4.5 to 3.12 out of 10, the lowest ever.

The divide was also seen across geographical regions. Metro areas rated their financial comfort 5.66 out of 10, while regional areas were 5.05.

The only state to worsen was South Australia, where financial comfort fell from 5.70 to 5.20 out of 10 over the last year.

Rental Stress, The Hidden Problem

There is much discussion of mortgage stress, some of which we highlight by our ongoing research into the growing numbers of households under financial pressure. The results for July will be out soon.

But rental stress is less discussed, but in our mind is equally significant, so today we explore some of the data in our Core Market Model to July 17. In fact there are more households in rental stress than in mortgage stress according to our analysis. We know their financial confidence on average is lower.

First, we need to define rental stress. Whilst some will use a “30% of income to pay the rent” as a benchmark, we do not think it is an adequate measure – not least because we see large numbers of households renting where more than 30% of income is paid away on rent, yet they are not in financial difficulty. Others pay less away, but are in stress. 30% is too arbitrary!

So we look at net cash flow. If households, once they pay their rent, tax and other outgoings have close to nothing left, or a small deficit, at the end of the month, they fall into our mild stressed category. Those with a severe cash deficit at the end of the month, are in serve stress.

We start by looking at the causes of rental stress. Using data from our surveys, we find that costs of living, under employment and flat incomes are the main causes of rental stress.

Those renting tend to hold less financial assets, so are more exposed, especially where they are also responsible for bills (electricity, council rates etc). Those in difficulty will be more likely to hold multiple credit cards, and also access short term loans to get by. Those in the stressed categories will be less likely to spend at the shops, and so are a brake on economic activity.  One strategy some use is to move to cheaper rented accommodation, with poorer facilities to reduce outgoings. The migratory nature of renters, especially those in stress are not well understood. The current tenancy regulations in Australia are pretty weak. Much of this movement is not reported, nor recorded.

So, lets look at some of the numbers, remembering one third of households are renting, in round numbers that is 3 million households.

Looking by state, more than half of renters in NSW are in rental stress (on our definition), and the highest proportion of any state here are in severe rental stress. The proportion of households in stress fades away as we look across the other states and territories. But the three most populous states have the highest rental stress levels.

Looking across our segments, we see that older households are more under stress, and a significant proportion in severe stress.  Whilst wealthy seniors may hold some savings, stressed seniors do not. Many are reliant on Government support.

Looking across the geographic zones (a series of concentric rings around our main urban hubs) we see significant levels of stress in the urban centres, as well as on the urban fringe. The former is being created by high rents – especially in the newly constructed high-rise blocks being thrown up across the eastern states, often occupied by young affluent households; whilst in the urban fringe, it is more about depressed incomes. We see stress rolling out into the regions, but is less apparent in the more rural and remote areas.

Finally, here is list of the regions across the country. Greater Sydney and the Central Coast have the highest representation of stressed renters as a proportion of all households renting.

All this highlights the issues we have due to the combination of flat incomes, and rising costs. It is also the obverse of the picture we revealed yesterday, where we showed rental growth is very low (causing more investors to have a net cash-flow problem).

Once again we see the outworking of poor public policy over a generation. With an internationally high proportion of property investors and a high proportion of people who are likely to never own their own property, rental stress provides another important perspective of the issues we face.

We have very granular data, down to post code, but that will get too detailed for this post.



Giving you more say in your super? Not likely with these changes

From The Conversation.

The government is introducing a raft of changes to the regulation of superannuation in a bid to give consumers more power over their retirement funds. But, in fact, consumers are unlikely to use these new powers and the changes might not improve super fund performance.

The headline change introduces annual general meetings (AGMs) for superannuation funds. Previously these weren’t commonplace, as they are with companies. The government proposes these meetings will help fund members hold superannuation fund trustees and executives to account.

But many of us barely glance at our own superannuation account balances when the six-monthly statement appears in our inbox, so it’s reasonable to predict that, of the 15 million or so superannuation fund members in Australia, only a tiny fraction are likely to go to an annual meeting.

And why would we? One reason shareholders attend listed company AGMs is so they can vote on appointments of directors and remuneration of managers. However, superannuation funds are trusts, not public companies, and members won’t have the same rights even if they attend.

These AGMs will instead offer members the chance to quiz the executives, auditor and actuary, but no votes on material decisions. So this is nothing new: superannuation fund members have virtually no influence over trustee appointments, executive remuneration or other decisions.

Even the industry fund trustees, who are representatives of member organisations in super funds (such as trade unions), are not usually elected by fund members but are appointed by their sponsoring organisations.

If members are consigned to tea and biscuits with the fund chairman, where is the consumer “power” in Financial Services Minister Kelly O’Dwyer’s reforms? It rests mainly with the regulator, the Australian Prudential Regulation Authority (APRA).

The key changes intend to give APRA more responsibility for protecting the interests of superannuation fund members. This is particularly in relation to MySuper – the standardised default superannuation product.

Because superannuation is mandatory for most employees, the system captures many people who don’t have the will or the skill to make active choices about what fund manages their retirement savings. This includes decisions on where their savings will be invested, and what level of life insurance cover they take. Passive members don’t “shop around” for efficient providers, to their own cost.

Following the paternalistic reasoning of the Cooper Review, successive governments have shepherded passive superannuation fund members into MySuper options. MySuper products must have a single diversified investment strategy, are allowed to charge only a limited range of fees and must offer a standard default cover for life and total and permanent disability.

MySuper funds also have to report their investment goals and performance on a dashboard that is supposed to help people make comparisons between similar products. Employers must choose a default fund for their employees from the list of MySuper products.

Even so, MySuper product fees and investment performance vary widely. APRA quarterly superannuation statistics (2017) report that, in 2015, after MySuper was “up and running”, annual fees and costs on a A$50,000 account balance in fixed-strategy MySuper products ranged from $265 per year to $1085 per year (with a median of A$520 per year).

The investment performance of MySuper products also varies considerably. In the same year, the mean annual investment return (gross of expenses) for single-strategy MySuper products was 8.45%, the bottom 10% receive less than a 5.5% return and the top 10% receive more than a 10.9%.

While some variation in returns is due to intentional differences in the design of default investment products, some is related to differences in manager skill or efficiency.

These latest reforms, if passed into law, will mean APRA can refuse or cancel a MySuper authority, at a much lower threshold than applies currently. If APRA has reason to think that a superannuation entity that offers a MySuper product may not meets its obligations, that is grounds to refuse or cancel an authority. Since the default superannuation sector is large, such a decision would be extremely costly to the fund in question.

Under this legislation, trustees of MySuper funds will be obliged to write their own annual report card. Each year, trustees will have to assess the “options, benefits and facilities” offered to their members and the investment strategy (target risk and return). Trustees will also be required to report on the insurance strategy for members, including whether (unnecessary) insurance fees are depleting balances; and to evaluate whether the fund is large enough to do all these at a reasonable cost.

In each case, trustees are required to show that they are promoting members’ financial interests. They will have to compare the performance of their MySuper product to that of other MySuper products.

Even though the trustees score their own card, APRA will also examine these, under the threat that the MySuper authority could be cancelled. It’s not clear how much discipline these rules can impose on trustees, but there are some obstacles to implementation and some possible unintended consequences.

Most superannuation funds know very little about their members. Usually these funds only collect a member’s age, gender, some indication of income, and sometimes their postcode. To show that a financial service, investment or insurance product promotes (or fails to promote) the financial interest of a member will be very difficult on this little information.

For example, two 25-year-old men in the same profession will have very different needs for life insurance if one is single and the other has a non-income-earning partner and a child. But they will look the same to the MySuper trustees.

Also, having an annual peer comparison of investment performance by MySuper trustees will focus on short-term results rather than the long-horizon outcomes needed for a secure retirement.

So the governments’ claim that these changes will “give consumers more power” and strengthen regulation of this large sector are stretching the truth.

Author: Susan Thorp, Professor of Finance, University of Sydney

‘Generation Rent’ and the ruinous rule of unfair and unjust laws

From The New Daily.

Shadow Treasurer Chris Bowen gave a good speech on Tuesday, promising to super-size Labor’s planned banking royal commission.

Originally intended to flush out illegal and deceptive activity in the banks, a royal commission should, he says, spring clean their legal activities too because that’s where the real damage to the economy is occurring.

Actually, Labor doesn’t need a royal commission to address the problem Mr Bowen described – namely, the hodge-podge of regulations being used to deal with the housing-credit bubble. A bit of well-written legislation would do the job just fine.

He is right, however, that we have a problem.

The key regulators who influence bank behaviour – the Reserve Bank, the Australian Prudential Regulatory Authority and the Australian Securities and Investment Commission – are discharging their duties admirably, but are still somehow allowing the banks to gobble up more and more of Australian life.

Australia’s growing private debt to GDP ratio, he points out, is second only to Switzerland’s, at 123 per cent.

Mr Bowen spoke about the need for banks to be “unquestionably strong”, complained about the “composition of the property market, investors versus owner-occupiers”, and repeated regulators’ concerns that household debt is making the economy less resilient.

Well that’s all true. But if he wants to sharpen his rhetoric, he’d should reframe those comments from the perspective of young Australians.

Intergenerational wipe-out

In the space of just 70 years Australians climbed a home ownership mountain, only to find themselves sliding down the other side.

After World War II, only half of private sector homes were owned, either with or without a mortgage, by their occupants.

That climbed rapidly to peak at 71.4 per cent in 1966 – a level that fluctuated a bit, but was essentially maintained until the turn of the millennium.

But as the housing-credit bubble inflated, and prices sky-rocketed, the home ownership rate started sliding – from 69.5 per cent in 2002, to 67 per cent at the 2011 census, and to 65.5 per cent last year.

This is a direct result of the debt bubble that Mr Bowen acknowledged in his speech, and which he rightly points out has been inflated by the property-investor tax breaks of negative gearing and the capital gains tax discount.

But wait, it gets worse. It is the younger generations – new entrants to the housing market – where all the damage is being done.

Twenty- and thirty-somethings are either being locked out of the market forever or taking on budget-crushing mortgage repayments.

Some among those age groups may eventually receive large inheritances from their property-owning parents – assuming, that is, that today’s sky-high valuations do not tumble in the years ahead.

But for those that do not, one of two dismal economic futures awaits.

Firstly, the members of ‘Generation Rent’, on present settings, will face an under-funded retirement.

That’s because Australia’s superannuation system, and the complementary state pension, were calibrated in the early 1990s for a nation in which most people did not have to pay rent in retirement.

Secondly, the young Australians ‘lucky’ enough to secure huge mortgages will wave goodbye to a proportionally larger chunk of their household budget each month over the next 25 or 30 years, if they wish to actually pay off their homes.

Low interest rates, remember, only reduce the interest bill. The principal repayments not only stay the same in nominal terms, but in a low interest-rate environment they are ‘eroded’ more slowly by inflation.

Get to the root of the problem

So the problem, as Mr Bowen defines it, is the overlap and confusion of “ad hoc” attempts by regulators to head off disaster – particularly APRA’s attempts to slow mortgage lending.

But surely it’s better to remove the cause of those policy contortions than to unscramble the omelette.

As it happens, Labor last year pledged to reduce the wealth-redistributing and bubble-inflating tax incentives of negative gearing and the capital gains tax discount.

That policy should go further, but at least it’s a good start.

So, yes, let’s have a royal commission into the illegal practices of the banks.

But as for ending the perfectly legal attack on the finances of young Australians, Labor only has to deliver what it’s already promised.

Understanding Banking from the Ground Up

From The St. Louis Fed On The Economy Blog.

Weak U.S. family balance sheets have driven more Americans to the “fringe” of the American banking system. But is this necessarily a bad thing?

The Federal Reserve’s Board of Governors recently released a shocking report showing that, if confronted with an unanticipated $400 expense, nearly half (44 percent) of Americans would have to sell something, borrow or simply not pay at all.1

Other surveys have been equally concerning:

This balance sheet fragility, especially illiquidity, is fueling the demand among Americans—and clearly, as the above data suggest, among middle-class Americans—for “alternative” financial services, including those from payday lenders, auto title lenders, check cashers and the like.

But should we be too critical of their financial choices? Is patronizing an alternative provider necessarily a poor or irrational choice? And do we ban payday lenders and the like because of annual percentage rates that are often in excess of 300 percent?

A Conversation with Lisa Servon on Unbanking

I wrestled with these questions following a recent St. Louis Fed event titled “The Banking and Unbanking of America”—featuring Lisa Servon, author of The Unbanking of America: How the New Middle Class Survives—and I think the answer to these questions is no.

Servon wondered: If these services are so bad, why have check-cashing transactions grown 30 percent between 1990 and 2010 while payday lending transactions tripled between 2000 and 2010?

According to Servon, it turns out that banks (with a growing number of encouraging exceptions) haven’t been serving these customers well, including charging more and higher fees for account opening, maintenance and overdrafts. Meanwhile, struggling consumers are turning to alternative providers (as well as to community development credit unions) because they value:

  • Greater transparency (with actual costs clearly displayed like signs in a fast-food restaurant)
  • Better service (including convenient hours, locations and friendly, multilingual staff)

What I really liked is that Servon—an East Coast, Ivy League academic—didn’t just arrive at these conclusions by only reading reports and talking to experts. She actually became a teller at both a payday lender in Oakland, Calif., and a check casher in the South Bronx, N.Y.

Mapping Financial Choices

I also like that several of my Community Development colleagues here at the St. Louis Fed have embraced this community-driven understanding of financial decision-making as well through a “system dynamics” research study, which maps the actual factors that influence the financial choices consumers make.

Like Servon’s work, the forthcoming version of this study will focus less on the narrow “banked/unbanked” framework and more on the broader, CFSI-inspired idea of “financial health.”

Other Areas to Address

Beyond adopting the financial health framework, Servon also suggests rethinking the government/banking relationship and supporting smart regulation so financial innovation or risk taking can thrive with some protections.

Most importantly, in my view, she recommends addressing the macro problems—for example, flat or declining real wages, less full-time and stable employment, and weaker unions—that underlie the demand for the immediate cash that alternative providers offer so well, albeit not so cheaply.

But it’s also true that weak balance sheets—the micro—contribute to the macro problem: Strapped consumers just don’t spend as much. So, we really must address both.

Notes and References

1Report on the Economic Well-Being of U.S. Households in 2016.” Board of Governors of the Federal Reserve System, May 19, 2017.

2 Gutman, Aliza; Garon, Thea; Hogarth, Jeanne; and Schneider, Rachel. “Understanding and Improving Consumer Financial Health in America.” Center for Financial Services Innovation, March 24, 2015.

3The Precarious State of Family Balance Sheets.” The Pew Charitable Trusts, January 2015.

Author: By Ray Boshara, Senior Adviser and Director, Center for Household Financial Stability

Mortgage Rate Warnings Get More Strident

More people are now saying that households need to brace for mortgage rate rises. Among the crowd is Malcolm Turnbull who warned households to prepare for interest rates to climb.

It is all a bit late given the level of debt which we have across Australia. As we discussed before, the debt quagmire will really hurt.

It is not that employment is too bad, but incomes are static, costs are rising, and underemployment is the spectre at the feast.

But lets be clear, it is not a financial stability problem, yet. It is highly unlikely the banks will see their mortgage defaults rise that much, because currently many households are still protected by lofty capital gains sufficient to repay the lender. They also have tremendous pricing power, as has been demonstrated in the past few months, with a litany of out of cycle rate hikes. Expect more to come. Their capital base is strong, and rising (and APRA has been light on them).  As a result, banks profits will rise – this explains recent stock market moves.

No, the real impact is among households. We think here are three groups of households who should be taking great care just now.

There are some amazing offers around for first time buyers, and lenders are falling over each other to try and attract them. This is because banks need new loans to fund their growth. But these buyers should beware. They are buying in at the top of the market, when rates are low. Banks have tightened their underwriting standards, but still they are too lax. Just because the bank says you can afford a loan does not mean it is the right thing to do. Any purchaser should run the numbers on a mortgage rate 3% (yes 3%) higher than the current rates on offer. If you can still afford the repayments, then go ahead. If not, and remember incomes are not growing very fast – best delay.

Second, there are people with mortgages in financial difficulty now. Well over 24% of households do not have sufficient cash-flow to pay the mortgage and other household expenses. The temptation is to use the credit card to fill the gap – but this is expensive, and only a short term fix. Households in strife need to build a budget (less than half have one) so they know what they are spending, and start to cut back. Talk to your lender also, as they have an obligation to assist in cases of hardship. And be very careful about refinancing your way out of trouble, it so often does not work.

Third there are property investors who are seeing rental incomes and mortgage repayments moving in opposite directions. As a result, despite tax breaks, the investment property looks a less good deal. Of course recent capital gains are there – and some savvy investors are selling down to lock in capital value – but be careful now. New property investors are in for a shock as mortgage rates rise further. And multiple investors, are most at risk. Should property values decline, then this will mark the real turning point; but we think the investment property party may be over.

This will play out over the next couple of years, but the bottom line is simply, mortgages will be more expensive, and households need to prepare now. Turnbull is right.

The banks and pollies have conned a generation

From The New Daily.

While a lot of things are ‘unknown knowns’ in finance, there’s an awful lot of ‘known knowns’ too – and one of those is about to hurt mortgage holders.

The Australian Prudential Regulatory Authority (APRA) has announced it will require big and small banks to hold more capital in reserve as a buffer against financial shocks.

That has forced the government to adopt APRA’s view that the effects of such a tightening are unknown, but probably benign.

Treasurer Scott Morrison said on Wednesday that the change “should not significantly impact loan pricing or consumers’ ability to access finance” and shouldn’t affect “business growth plans, dividends policies or [require the banks to undertake] equity capital raisings.”

Actually, the effects are more certain than that. Like a balloon squeezed at one end, the cost of holding extra capital has to bulge out somewhere else – either as lower profits and dividends, or higher borrowing costs charged to customers.

The other option is for banks to raise capital through new share issues, which effectively dilutes the earnings per share – analysts say the Commonwealth Bank is in the most likely to take this route.

The big four banks have a long tradition of passing on new costs to borrowers, and although not large in this case, the APRA change will be exacerbated by increases in the banks’ offshore borrowing costs plus changes to the way they are required to calculate the risk of their loan portfolios.

A double blow

The APRA move comes just a day after the RBA reminded borrowers that it considers its ‘neutral’ cash rate – the rate at which it is trying neither to slow nor stimulate the economy – to be 200 basis points higher than today over the longer term.

Mortgage rates are not determined solely by the short-term borrowing rates the RBA has control over, but as a rough proxy for future rates it is warning mortgage holders to add a ‘2’ to the first part of their home-loan rate.

Current standard variable rates – or, rather, the more accurate ‘comparison’ rate which includes all fees – are sitting at about 5.3 per cent, so households need to ask themselves if they can afford 7.3 per cent in a couple of years time.

This is an inevitable change that many lending managers have glossed over with customers in the past couple of years.

It’s also what former Treasurer Joe Hockey failed to mention when he said there had “never been a better time to borrow” in 2013.

In the midst of an expanding credit bubble, only a few voices were pointing out that when record-low interest rates normalised due to global forces, or if local macroprudential measures put the squeeze on home loan rates, our record private debt would become a problem.

Well we’re on a one-way trip to realising that problem now.

For a very long time Australian banks got away with soaking up too much of the nation’s working capital. The big four banks shares make up a monstrous 25 per cent of the value of the ASX200, while the nation’s biggest employers, Wesfarmers (owner of Coles) and Woolworths are worth just 5 per cent.

For too long the banks have lent at levels that could only be made ‘safe’ by an implicit government guarantee of their liabilities.

And for too long politicians in Canberra told voters to disregard the common-sense notion that huge debts were a problem.

The APRA tightening is just a small step towards returning banks a more traditional role – not stoking a credit bubble, but sensibly leveraging the savings of some households and businesses, to allow other households and businesses to expand.

That more subdued role should, eventually, start to ease Australia’s private debt problem.

But that’s little comfort for the generation that took on eye-watering debts at record low interest rates – the generation that will be hurt most by the ‘balloon bulge’ of rising bank costs.

The Household Debt Quagmire

We know that household debt has never been higher in Australia, but I do not think the true impact of this, especially in a rising interest, low income growth environment is truly understood.  We have to look beyond mortgage debt.

The latest RBA E2 – Households Finances – Selected Ratios shows that the ratio of household debt to annualised household disposable income , rose to 190.4, the ratio of housing debt to annualised household disposable income rose to 135, and worryingly the ratio of interest payments on housing debt to quarterly household disposable income has risen to 7.0, thanks to the out of cycle rate hikes and flat or falling incomes.  Of course failing cash rates helped households out, but the lending standards were not adjusted until too late.

But, here is the really scary picture of total debt value held mapped by debt to gross income ratio (DTI), aka Loan-to-Income (LTI). DTI or LTI is a good measure of potential risk in the system.

This first chart shows the distribution of debt value – of all types, including mortgagee, (owner occupied and investment), personal loans, credit cards, SACC borrowing, and all other loans – relative to gross income in debt-to-income bands.  We are using date from our household surveys.  It also shows the distribution of households, with more than half having low, or no debt, but with a long tail of highly indebted households.

Across Australia, more than 45% of all household debt (not just households with mortgages, but those mortgage free or renting) sit with households who have an LTI of more than 4.5 times annual income. I used 4.5 times because this is the ratio the Bank of England uses, and they say that higher LTI’s are more risky.

The second chart shows the relative distribution across the states and territories.

The third chart shows the proportion of households in each state and territory with a DTI of more than 4.5 times.  NSW holds the record, with more than half of all households above this, compared with 26% in ACT and 9% in NT.

This is a big deal, especially in a rising interest rate environment.  It means households have little wriggle room, and granted many will be holding paper profits in property which has risen significantly in recent years, this does not help with servicing ongoing debt repayments.

The effect of the debt burden is to reduce the ability of households to spend, and in effect it is a drag anchor on future economic growth.

The traditional argument that “most debt is held by those who can afford it” is partly true, but bigger debts require bigger incomes to service them, and the leveraged effect in a rising interest rate environment is profound.