why are rates so high in rocky??

its a long one

August 20, 2003

THE BULLETIN
THE DEBT OFFENSIVE – MAX WALSH

The Reserve Bank has belatedly realised that the longer the credit bubble
continues, the greater will be the potential damage to the economy as a
whole.

Do not hold your breath waiting for another interest rate cut. The Reserve
Bank of Australia is at last becoming seriously worried about the country’s
credit bubble. Last week’s “Statement on Monetary Policy” was, by central
bank standards, almost blunt about the risks now posed by our national
descent into debt.

The statement came in the wake of Ian Macfarlane’s reappointment as RBA
governor for a final, limited term. Having decided that he will stick
around for only another three years, Macfarlane has increased his
“independence”. The importance of this rather depends on when and in what
manner the present credit bubble deflates. Unfortunately, it has probably
reached such proportions that it will pop with considerable adverse fallout
across the economy.

The RBA said as much in its statement when it noted: “Historically, credit
booms have tended to end only after a protracted period of
higher-than-average interest rates and/or a significant contraction in the
economy.”

The RBA calls it a credit boom. I call it a bubble both because of its
dimensions and the degree of irrationality now associated with its most
obvious manifestation: the scramble to buy residential investment
properties. Where I live in Sydney, the “For Lease” signs in apartment
windows now exceed the “For sale” signs and both are out there in strong
numbers.

Rents in some of the more popular areas are down by 25%. Yet investors are
still buying apartments off the plan. Of course, they are being given
“guaranteed” rental returns for a limited period. That return no surprise
has been capitalised into the price.

The accompanying table illustrates the way in which Australian investors
are still being seduced by the bubble. Since 1995, credit has grown at an
annual rate in Australia of 11.1%. In the latest year, the rate has been
12.7%. But the real driver has been household credit, which has charged
ahead in the latest year at an annual rate of 19.6%.

The RBA says simply: “The current pace of household credit growth in
Australia exceeds any reasonable benchmark by a large margin.” In fact, as
the table shows, credit has been growing way too fast for eight years now.
Between 1980 and 1995, household credit in Australia grew, on average, by
about 3.75 percentage points faster than nominal GDP. Had this differential
been maintained since 1995, the level of household credit outstanding would
be almost a third lower than is currently the case.

While Australia has a faster inflating ­bubble than anyone else, we are not
alone in the credit bubble business. That raises the prospect of multiple
hard landings.

While there is no magic single figure, which tells you how fast credit
should expand, the RBA suggests that Canada provides a useful benchmark
because it has a long history of a relatively deregulated financial system
that has avoided credit excesses and their painful consequences. There,
credit has grown on average by about 1.5 percentage points faster than
nominal GDP. None of the countries in the table have had inflation of more
than 3% on average since 1995. Using the Canadian benchmark, credit growth
should have averaged 4.5% or less.

The RBA, in its past observations about the growth of credit in Australia,
took comfort in the fact that debt, as a proportion of wealth, was not
increasing. Also, it was reassured by the stable nature of the
debt-to-household income ratio, despite the rapid growth in credit.

That was institutional self-delusion on both counts. The increase in
household wealth has been functionally related to a credit boom that has
been financed with an interest-rate structure below its long-term average:
unsustainable affordability.

Furthermore, wealth in the form of the family home is qualitatively
different from other forms of asset wealth. It is part of the family
life-support system. It is notoriously illiquid, especially in weak
markets. Transaction costs involved are extremely high.

Housing prices do fall after credit bubbles. Even when they fall
significantly, the extent of the price collapse is muted by the degree of
balance-sheet consolidation people are prepared to undertake rather than
take a heavy loss on their home.

In the present bubble, the extent of consolidation in household accounts is
likely to be severe because 40% of the value of all housing loans recently
has been for investment purposes.

These are negatively geared properties with deposits often financed by
shifting equity from the family home. Such investments are structured to be
financed by a combination of rental income and income from regular
employment.

If rental income is not forthcoming or is less than expected, that will
involve diverting consumption activity towards debt service. With
consumption spending the main source of national economic growth, such a
diversion can set in train a cascading downturn in economic activity. That
is what happened in Finland, Norway, Sweden, Japan and the United Kingdom
following the popping of asset bubbles at the end of the 1980s. Australia
itself went into recession, a number of our major financial institutions
struggled to survive and a couple of state banks effectively went under.

The institutional risks involved in credit bubbles have, I suspect, been
underrated by the RBA. The banking system appears to be in pretty good
condition because the banks have changed the way they do business.

Credit risk, especially in the form of housing mortgages, is transferred by
bundling and securitisation. Other credit risks are insured. That does not
mean risks have been eliminated. In fact, there is a strong suspicion that
securitisation has encouraged a far less rigorous approach to risk
assessment.

Central bankers believe that this spreading of risk across the financial
system, rather than confining it to the banks, reduces the risk of a call
for lender of last resort ­facilities to prevent a systemic crisis.

But one of the consequences of this risk divestment strategy is that the
authorities do not know where the cost of the collapse of the credit bubble
will hit. What is self-evident is that the longer the bubble continues, the
greater will be the potential damage to the economy as a whole. Ideally,
the RBA should now be edging rates up to reinforce its so-far ineffective
jawboning.

However, while there have been some encouraging signs of improvement in the
external environment, the global recovery is not yet guaranteed. The
resurgence of bond yields in the US on the basis of modest indications of a
pick-up in growth has raised concern that the recovery could be nipped in
the bud.

With an election due next year, Canberra would be looking for lower, not
higher, interest rates. Governor Macfarlane’s independence may be put to
the test.

hame – very insightful. bit of david suzuki in that

just noted the architechture.

a front and back staircase a little extravagant.

he he
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westan – secret (i havent read any either)

good you got a laugh though. im easily bored…

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no no no no no

i think i speak for all longer time forumites when i say that please lets put this topic to rest.

we had only just starting to get over it too[}]

please move on

interesting point

fyg just say i were to find a +ve geared property
returning 10.4 pct. good deal eh! meets the 11 second rule – ive done my due diligence no bikies next door etc etc.

is it a good deal however what if that same property returned 30 pct only 12 mos b4.

either the market ‘was’ underpriced. or the market is ‘now’ overpriced.

i might be wrong but it hink returns in the country areas have historically been alot more than 10 or 11 pct?? and these high returns would merely represent the premium for the risk of investing in the country areas.

from what i can tell the risk hasnt really changed but the price and the rent has

can anyone clarify what historically has been a good rural/country town return???

or is this a case of how long is a piece of string..

gee dee

take yr weekly rent / 2 x 1000

thats how much to pay for a +ve cashflow property
according to the rule

eg 200/2 x 1000 = 100,000

anything from max walker