Month: June 2015

The real reasons negative gearing on housing should be phased out

From The Conversation. In recent weeks, there have been signs sentiment may be changing around the contentious policy of negative gearing.

There are well-rehearsed arguments on both sides. Critics argue that the deduction of property losses from other sources of income (such as wages) is a tax shelter that imposes an unfair burden on other taxpayers. Defenders of the policy suggest that it is used by prudent savers to “get ahead”, and by high income individuals to lower unduly high tax burdens that blunt work incentives.

However, these arguments are tax policy concerns since taxpayers can negatively gear other financial investments such as shares. There are housing policy specific issues that instead warrant a focus on housing; three deserve particular attention.

The first is a familiar refrain. Given a fixed supply of land, negative gearing advantages property investors who are better able to out-bid other land users. Part of the tax break gets shifted into higher land and housing prices; some other users of land – first home buyers, for example – are “crowded-out”.

But a second reason, related to so-called tax “clientele effects” has been rarely mentioned. It is a more nuanced influence, yet it is important to an understanding of the supply side effects of reform in this area.

The Australian private rental housing stock is relatively large by international standards and mostly held by “mum and dad” investors. There are not enough high tax bracket investors willing and able to hold all the housing in this tenure. Lower tax bracket investors must be enticed into the market. These investors are often retirees looking for secure, regular flows of income, and are attracted to those segments of the market where rental yields are relatively high.

On the other hand, the appeal of property investment to the high tax bracket investor is that they can negatively gear the asset’s acquisition, yet an important part of the returns (capital gains) are lightly taxed compared to other types of investment income. The consequence is that high tax bracket investors crowd into segments of the market offering high capital growth but low rental yields. Low tax bracket investors concentrate in segments offering high rental yields but lower capital growth.

The removal of negative gearing is then likely to have supply side impacts that are not as straightforward as has been suggested in some of the media commentary. To be sure some high tax bracket investors will withdraw and as price pressures ease and rental markets tighten, rental yields will rise.

But those higher rental yields will prompt some growth in the number of low tax bracket investors, and especially so in today’s low interest rate environment. As low tax bracket investors face tighter borrowing constraints, the overall supply side impact will be negative. But it will not be the collapse in supply that some fear.

The third reason for change with respect to negative gearing and housing is perhaps the most important in the current context. The share of investment property loans in total debt has tripled from one-tenth to three-tenths in a little over two decades. Investors now take up a higher share of the value of new loans than do first home buyers.

According to the Australian Bureau of Statistics, investment housing accounted for 40% of the total value of housing finance commitments in April 2015. Of the dwellings that secured housing finance commitments within the owner occupation sector, only 15% was attributable to first home buyers. The presence of housing investors on such a large scale is a potential source of instability, especially if highly geared.

In their seminal research, the late Professor John Quigley and his colleague Karl Case note that when markets slump home owner behaviour differs from that of other investors.

They can “consume” the housing they have bought – by enjoying the surroundings and the comforts of home – and provided mortgage payments are met, they are invariably willing to “sit out” the slump. This can be an important source of stability in housing markets.

But property investors have not bought a dwelling to live in it. When prices slump some if not many will cut their losses and seek a safe haven for their capital elsewhere, especially if they are highly geared. Our research finds that negatively geared investors are more likely to terminate rental leases than equity-oriented investors. The former are also prone to churn in and out of rental investments as they refinance to preserve tax shelter benefits.

When large numbers of indebted investors come to bank on continued house price gains, and low interest rates, the resilience of housing markets is undermined. Phasing out negative gearing should be a priority for a housing policy fit for the 21st century.

Authors: Gavin Wood, Professor of Housing at RMIT University and Rachel Ong, Principal Research Fellow, Bankwest Curtin Economics Centre at Curtin University

 

Tackling housing unaffordability: a 10-point national plan

From The Conversation. The widening cracks in Australia’s housing system can no longer be concealed. The extraordinary recent debate has laid bare both the depth of public concern and the vacuum of coherent policy to promote housing affordability. The community is clamouring for leadership and change.

Especially as it affects our major cities, housing unaffordability is not just a problem for those priced out of a decent place to live. It also damages the efficiency of the entire urban economy as lower paid workers are forced further from jobs, adding to costly traffic congestion and pushing up unemployment.

There have recently been some positive developments at the state level, such as Western Australia’s ten year commitment to supply 20,000 affordable homes for low and moderate income earners. Meanwhile, following South Australia’s lead, Victoria plans to mandate affordable housing targets for developments on public land. And in March the NSW State Premier announced a fund to generate $1bn in affordable housing investment.

But although welcome, these initiatives will not turn the affordability problem around while tax settings continue to support existing homeowners and investors at the expense of first time buyers and renters. Moreover, apart from a brief interruption 2008-2012, the Commonwealth has been steadily winding back its explicit housing role for more than 20 years.

The post of housing minister was deleted in 2013, and just last month Government senators dismissed calls for renewed Commonwealth housing policy leadership recommended by the Senate’s extensive (2013-2015) Affordable Housing Inquiry. This complacency cannot go unchallenged.

Challenging the “best left to the market” mantra

The mantra adopted by Australian governments since the 1980s that housing provision is “best left to the market” will not wash. Government intervention already influences the housing market on a huge scale, especially through tax concessions to existing property owners, such as negative gearing. Unfortunately, these interventions largely contribute to the housing unaffordability problem rather than its solution.

But first we need to define what exactly constitutes the housing affordability challenge. In reality, it’s not a single problem, but several interrelated issues and any strategic housing plan must specifically address each of these.

Firstly, there is the problem faced by aspiring first home buyers contending with house prices escalating ahead of income growth in hot urban housing markets. The intensification of this issue is clear from the reduced home ownership rate among young adults from 53% in 1990 to just 34% in 2011 – a decline only minimally offset by the entry of well-off young households into the housing market as first-time investors.

Secondly, there is the problem of unaffordability in the private rental market affecting tenants able to keep arrears at bay only by going without basic essentials, or by tolerating unacceptable conditions such as overcrowding or disrepair. Newly published research shows that, by 2011, more than half of Australia’s low income tenants – nearly 400,000 households – were in this way being pushed into poverty by unaffordable rents.

Thirdly, there is the long-term decline in public housing and the public finance affordability challenge posed by the need to tackle this. In NSW, for example, 30-40% of all public housing is officially sub-standard.

“Why the “build more houses” approach won’t work

A factor underlying all these issues is the long-running tendency of housing construction numbers to lag behind household growth. But while action to maximise supply is unquestionably part of the required strategy, it is a lazy fallacy to claim that the solution is simply to ‘build more homes’.

Even if you could somehow double new construction in (say) 2016, this would expand overall supply of properties being put up for sale in that year only very slightly. More importantly, the growing inequality in the way housing is occupied (more and more second homes and underutilised homes) blunts any potential impact of extra supply in moderating house prices. Re-balancing demand and supply must surely therefore involve countering inefficient housing occupancy by re-tuning tax and social security settings.

Where maximising housing supply can directly ease housing unaffordability is through expanding the stock of affordable rental housing for lower income earners. Not-for-profit community housing providers – the entities best placed to help here – have expanded fast in recent years. But their potential remains constrained by the cost and terms of loan finance and by their ability to secure development sites.

Housing is different to other investment assets

Fundamentally, one of the reasons we’ve ended up in our current predicament is that the prime function of housing has transitioned from “usable facility” to “tradeable commodity and investment asset”. Policies designed to promote home ownership and rental housing provision have morphed into subsidies expanding property asset values.

Along with pro-speculative tax settings, this changed perception about the primary purpose of housing has inflated the entire urban property market. The OECD rates Australia as the fourth or fifth most “over-valued” housing market in the developed world. Property values have become detached from economic fundamentals; a longer term problem exaggerated by the boom of the past three years. As well as pushing prices beyond the reach of first home buyers, this also undermines possible market-based solutions by swelling land values which damage rental yields, undermining the scope for affordable housing. Moreover, this places Australia among those economies which, in OECD-speak, are “most vulnerable to a price correction”.

While moderated property prices could benefit national welfare, no one wants to trigger a price crash. Rather, governments need to face up to the challenge of managing a “soft landing” by phasing out the tax system’s economically and socially unjustifiable market distortions and re-directing housing subsidies to progressive effect.

A 10-point plan for improved housing affordability

Underpinned by a decade’s research on fixing Australia’s housing problems, we therefore propose the following priority actions for Commonwealth, State and Territory governments acting in concert:

  • Moderate speculative investment in housing by a phased reduction of existing tax incentives favouring rental investors (concessional treatment of negative gearing and capital gains tax liability)
  • Redirect the additional tax receipts accruing from reduced concessions to support provision of affordable rental housing at a range of price points and to offer appropriate incentives for prospective home buyers with limited means.
  • By developing structured financing arrangements (such as housing supply bonds backed by a government guarantee), actively engage with the super funds and other institutional players who have shown interest in investing in rental housing
  • Replace stamp duty (an inefficient tax on mobility) with a broad-based property value tax (a healthy incentive to fully utilise property assets)
  • Expand availability of more affordable hybrid ‘partial ownership’ tenures such as shared equity – to provide ‘another rung on the ladder’
  • Implement the Henry Tax Review recommendations on enhancing Rent Assistance to improve affordability for low income tenants especially in the capital city housing markets where rising rents have far outstripped the value of RA payments.
  • Reduce urban land price gradients (compounding housing inequity and economic segregation) by improving mass transit infrastructure and encouraging targeted regional development to redirect growth
  • Continue to simplify landuse planning processes to facilitate housing supply while retaining scope for community involvement and proper controls on inappropriate development
  • Require local authorities to develop local housing needs assessments and equip them with the means to secure mandated affordable housing targets within private housing development projects over a certain size
  • Develop a costed and funded plan for existing public housing to see it upgraded to a decent standard and placed on a firm financial footing within 10 years.

While not every interest group would endorse all of our proposals, most are widely supported by policymakers, academics and advocacy communities, as well as throughout the affordable housing industry. As the Senate Inquiry demonstrated beyond doubt, an increasingly dysfunctional housing system is exacting a growing toll on national welfare. This a policy area crying out for responsible bipartisan reform.

Net Stable Funding Ratio Disclosure Standards – BIS

The Bank for International Settlements has released the template to be used by banks to report their Net Stable Funding Ratio (NSFR). This is a further layer of regulation designed to bolster financial stability.  Supervisors will give effect to the disclosure requirements set out in this standard by no later than 1 January 2018. Banks will be required to comply with these disclosure requirements from the date of the first reporting period after 1 January 2018. The disclosure requirements are applicable to all internationally active banks on a consolidated basis but may be used for other banks and on any subset of entities of internationally active banks to ensure greater consistency and a level playing field between domestic and cross-border banks. The disclosure of quantitative information about the NSFR should follow the common template developed by the Committee.

The fundamental role of banks in financial intermediation makes them inherently vulnerable to liquidity risk, of both an institution-specific and market nature. Financial market developments have increased the complexity of liquidity risk and its management. During the early “liquidity phase” of the financial crisis that began in 2007, many banks – despite meeting the capital requirements then in effect – experienced difficulties because they did not prudently manage their liquidity. The difficulties experienced by some banks arose from failures to observe the basic principles of liquidity risk measurement and management.

In 2008, the Basel Committee on Banking Supervision responded by publishing Principles for Sound Liquidity Risk Management and Supervision (the “Sound Principles”), which provide detailed guidance on the risk management and supervision of funding liquidity risk. The Committee has further strengthened its liquidity framework by developing two minimum standards for funding liquidity. These standards aim to achieve two separate but complementary objectives. The first objective is to promote the short-term resilience of a bank’s liquidity risk profile by ensuring that it has sufficient high-quality liquid assets (HQLA) to survive a significant stress scenario lasting for 30 days. To this end, the Committee published Basel III: The Liquidity Coverage Ratio and liquidity risk monitoring tools. The second objective is to reduce funding risk over a longer time horizon by requiring banks to fund their activities with sufficiently stable sources of funding in order to mitigate the risk of future funding stress. To achieve this objective, the Committee published Basel III: The Net Stable Funding Ratio. The NSFR will become a minimum standard by 1 January 2018. This ratio should be equal to at least 100% on an ongoing basis. These standards are an essential component of the set of reforms introduced by Basel III and together will increase banks’ resilience to liquidity shocks, promote a more stable funding profile and enhance overall liquidity risk management.

This disclosure framework is focused on disclosure requirements for the Net Stable Funding Ratio (NSFR). Similar to the LCR disclosure framework,4 this requirement will improve the transparency of regulatory funding requirements, reinforce the Sound Principles, enhance market discipline, and reduce uncertainty in the markets as the NSFR is implemented.

It is important that banks adopt a common public disclosure framework to help market participants consistently assess banks’ funding risk. To promote the consistency and usability of disclosures related to the NSFR, and to enhance market discipline, the Committee has agreed that internationally active banks across member jurisdictions will be required to publish their NSFRs according to a common template. There are, however, some challenges associated with disclosure of funding positions under certain circumstances, including the potential for undesirable dynamics during stress. The Committee has carefully considered this trade-off in formulating the disclosure framework contained in this document.

The disclosure requirements set out in this document are applicable to all internationally active banks on a consolidated basis but may be used for other banks and on any subset of entities of internationally active banks to ensure greater consistency and a level playing field between domestic and cross-border banks.

Banks must publish this disclosure with the same frequency as, and concurrently with, the publication of their financial statements (ie typically quarterly or semi-annually), irrespective of whether the financial statements are audited.

Banks must either include the disclosures required by this document in their published financial reports or, at a minimum, provide a direct and prominent link to the completed disclosure on their websites or in publicly available regulatory reports. Banks must also make available on their websites, or through publicly available regulatory reports, an archive (for a suitable retention period as determined by the relevant supervisors) of all templates relating to prior reporting periods. Irrespective of the location of the disclosure, the minimum disclosure requirements must be in the format required by this document (ie according to the requirements in Section 2).

Residential Property Now Worth A Record $5.5 Trillion

The ABS released their data on Residential Property Prices to March 2015. The total value of Australia’s 9.5 million residential dwellings increased to $5.5 trillion. The mean price of dwellings in Australia is now $576,100, an increase of $8,400 over the quarter. Sydney continues to drive residential property price increases with the Residential Property Price Index (RPPI) for Sydney rising 3.1 per cent in the March quarter 2015 and 13.1 per cent in the previous year. Established house prices for Sydney rose 3.8 per cent and attached dwelling prices rose 2.2 per cent.

The price index for residential properties for the weighted average of the eight capital cities rose 1.6% in the March quarter 2015. The index rose 6.9% through the year to the March quarter 2015. The capital city residential property price indexes rose in Sydney (+3.1%), Melbourne (+0.6%), Brisbane (+0.4%), Adelaide (+0.7%), Canberra (+1.1%) and Hobart (+0.5%) and fell in Darwin (-0.2%) and Perth (-0.1%). Annually, residential property prices rose in Sydney (+13.1%), Melbourne (+4.7%), Brisbane (+3.9%), Adelaide (+2.5%), Canberra (+3.0%) and Hobart (+1.9%) and fell in Darwin (-0.4%) and Perth (-0.3%).

House-Price-CHanges-to-March-2015-TrendWe see how Sydney steamed ahead of other states in the last quarter.

House-Price-Change-March-Q-2015We also see significant differences between the relative price of established houses and attached dwellings in Sydney compared with other centres, the rest of the states outside the capital cities.

Average-House-Prices-March-2015---Cities-and-Rest
A review of the Residential Property Price Indexes was undertaken in 2014 as a response to planned reductions to the ABS work program. The outcomes of the Review were released on the ABS website in a feature article in the September 2014 issue of Residential Property Price Indexes: Eight Capital Cities. The implementation of the review outcomes is occurring in this issue.

In summary, the changes in this issue are:

  • all Australian residential property sales data used to compile the price indexes and related statistics are now supplied to the ABS by CoreLogic RP Data;
  • from the March quarter 2015 the suite of residential property price indexes are considered final;
  • the method of calculating prices in the total value of the dwelling stock has been modified due to the change in timing of this release;
  • the unstratified median price and number of dwelling transfers series are now being published up to the current quarter.

Amazon shows Google tax can work, despite arguments against it

From the Conversation. In late May, Amazon announced it had started to pay tax on its sales in the UK rather than in Luxembourg. This came about after Amazon restructured its tax structure in Europe in response, at least in part, to the UK’s diverted profits tax (commonly known as the Google Tax) that came into effect in April.

Book publishing giant Amazon has responded to the UK’s Google tax by restructuring its European tax affairs. Image sourced from www.shutterstock.com

This development is important not only for the UK, but also for Australia. Treasurer Joe Hockey has announced that the government will introduce a similar Google Tax in 2016. It is especially important when some submissions to the draft legislation of our Google Tax have argued that it is not a good idea for Australia to introduce the tax.

The Law Council of Australia has argued in its submission that the proposed regime is:

…inconsistent with the design principle for a tax … system that tax rules should be applied to commerce in accordance with the structure and mechanisms by which commerce operates.

It basically argues that the tax law should respect the corporate structures of multinational enterprises even if they are tax driven. In other words, its submission does not support the idea that the Australian Taxation Office (ATO) should have the power to deem Google or Amazon to have a taxable presence in Australia.

That argument is questionable. The hard practical matter of fact is that multinationals at present are able to design their tax structures in such a way that substantial activities are being done in Australia but profits are booked in low or even no tax jurisdictions. And these structures are perfectly legal under the current tax law.

It is important to remember that the current international tax regime has been developed largely at a time when multinationals were much less integrated than today. The rules were designed primarily for a bilateral scenario in which, for example, a US company sells goods directly to Australia. None of these countries were tax havens.

However, the stories of Apple, Google and Microsoft have proved that the scenario is very different today. Multinational companies have been successfully converted this kind of bilateral transaction into multilateral transactions by inserting low-tax countries between Australia and the US.

If we believe that this outcome is not acceptable, the tax law has to be improved to address this issue. The general principle of “applying tax rules to commercial operations” should be premised on the assumption that the transactions are genuine with commercial substance. However, if a transaction is artificially created primarily for the purpose of generating low-taxed income, there is a good basis to argue that the tax law should empower the ATO to look through the legal form of the transaction and impose tax according to the economic substance. Therefore, a deeming provision is not only desirable but also necessary in these cases.

Some submissions have also argued that the proposed Google Tax should not apply to existing tax structures. For example, the Law Council suggested that the proposed rule “ought not to apply to existing, well understood and generally accepted business arrangements, particularly where many of the arrangements are longstanding … Existing arrangements ought to be quarantined from any application of the measure”.

If the government follows this suggestion, the proposed law will not apply to the existing tax avoidance structures of Google, Microsoft and Amazon. As most multinationals would presumably have been well served by their tax advisers and have their tax structures in place long before the government’s proposal, one would wonder whether this grandfather treatment will leave any major multinational subject to the proposed law at all.

To be fair, many submissions to the government have rightly pointed out that the draft legislation needs substantial improvements before the proposal can be effective as well as satisfying as far as possible the tax policy objectives of simplicity and fairness.

For example, the Law Council’s submission has highlighted the need to have clear definitions of some new concepts in the proposed law. The meaning of “no or low corporate tax jurisdiction” – which is one of the conditions before the proposed law will apply – should be stipulated explicitly in the legislation. This will not only provide certainty to both the ATO and multinational companies, but also serve more effectively as a clear signal of the level of tax that is not acceptable to the government.

The recent restructure of Amazon suggests that the government’s proposal to introduce a Google Tax in Australia is in the right direction. The experience of UK’s Google Tax shows that such a tax can change the behaviour of these large corporations.

Of course, more work has to be done to improve the drafting of the legislation before the tax can be an effective weapon to deal with aggressive tax avoidance structures used by multinationals.

Author: Antony Ting – Associate Professor at University of Sydney

Uber drivers stuck in legal limbo as US labor laws fail to keep up

From The Conversation. Uber’s arm’s-length relationship with its drivers just got a bit closer after the California Labor Commission ruled that one of the ride-hailing company’s motorists in San Francisco is an employee, not a contractor, as it contends.

re Uber drivers employees or just contractors? Reuters

This is a big deal because the rights of Uber drivers depend sharply on whether they are deemed employees or self-employed independent contractors hired for particular jobs. By extension, the success of Uber’s business model may hinge on the question as well, but that’s for another article.

If they are employees, a litany of rights and requirements go along with it. They have a right to form a union, they must be paid minimum wage, they must be paid extra for overtime hours, their federal taxes must be withheld, Uber is liable if they hit anyone or anything, and Uber may not discriminate among drivers on the basis of race, color, religion, sex, national origin, age or disability.

But if they are self-employed, Uber may owe them nothing, except what it explicitly promises in the contracts it drafts.

Courts have given mixed rulings on the issue as more workers have been labeled “self-employed contractors” by companies eager to cut costs, a trend accelerated by the rise of the on-demand economy of companies that quickly provide goods and services. Part of the problem is that independent contractors fall into a hole in labor laws, one that could be filled by taking a page from our northern neighbors and creating a new class of worker: dependent contractors.

Merely a facilitator

Uber maintains that it is merely a software company that facilitates deals between customers and drivers. While the courts have generally been skeptical on this point, if Uber manages to win this argument, it would not be an employer at all – at least as far as the drivers are concerned.

Uber would not have to recognize a drivers’ union. So-called unions in which independent contractors fix their compensation normally fall outside of current labor laws and violate antitrust laws. Nor, if drivers are self-employed, would Uber be liable for their accidents, or owe them any particular level of compensation.

Employers naturally like to claim that the individuals who perform services for them are self-employed. But courts have been pushing back against these claims.

Let a jury decide

In May, a judge refused to dismiss a class action by Uber and Lyft drivers in San Francisco complaining of Uber’s treatment of their tips, saying it should be up to a jury to determine whether the drivers were employees or self-employed.

A few weeks ago, a federal appeals court similarly argued the determination should be left to a jury when it reversed a lower court’s ruling that FedEx drivers are employees. The judges said it was unclear whether they were. Last year a different federal appeals court found instead that FedEx drivers are its employees.

Other courts have been more forceful in favor of certain classes of workers that have slipped between the cracks. A federal judge in New York found that production interns on the set of the movie Black Swan were actually employees of both the production company and of Fox Searchlight Pictures.

And most recently, the California Labor Commission ruled last week that an Uber driver was an employee, not a contractor. Uber, while insisting the ruling applied to only that individual driver, is appealing.

The commission found that Uber is “involved in every aspect of the operation,” a sharp turnaround from the same agency’s ruling in 2012 that deemed an Uber driver an independent contractor.

Who’s in control

Such rulings are normally highly fact-specific. The basic legal approach to the question of employee status looks to who controls the means and manner of work. There are some interesting variations among the states, but they all – including federal statutes – look mainly to this question of control.

This is not a very clear test, and it would be impossible to find any labor relations expert who would defend it as a general approach. The Supreme Court has noted that the line between employee and independent contractor “can be manipulated largely at the will of” the employer, and is often a “very poor proxy for the interests at stake.”

The two decisions that found that Uber is, or might be, its drivers’ employer, rested on the tech company’s control of hiring, rules of driver conduct, restrictions on drivers’ ability to solicit other work and ability to terminate drivers at will. In some other ways, however, Uber drivers do control their work; they own their own cars and pick their own hours, for example.

More legal wrangling ahead

The latest decisions are invitations for future litigation. They do not settle the legal question permanently.

If you were Uber, you would not immediately begin treating drivers as employees, withholding taxes, paying back taxes, purchasing employment practices liability insurance and filing W-2 forms. You would be more likely to relax your control of drivers in minor ways, and then invite them to litigate again.

Uber might, for example, drop its rules over which radio stations drivers can play in their cars, permit drivers to hand out business cards, and then insist that now the drivers were actually self-employed.

The labor laws of Canada, Sweden and some other countries recognize a category called “dependent contractors.” Such workers are self-employed for some purposes, say tax administration. But if their livelihood depends on the richer entity that hires them, then that entity is bound by labor laws when it administers tips, or compensation.

Creation of such a category by US state legislators, or by some future Congress capable of legislation, would be highly desirable. It has been reported that tech companies are enthusiastic about the idea of creating such a category, though there is much hard work ahead in working out the details.

It would recognize that Americans are committed both to the creation of new ways of working and, at the same time, to the proposition that the powerful must not be permitted to exploit people whose services are integral to their businesses.

Author: Alan Hyde, Distinguished Professor of Law and Sidney Reitman Scholar at Rutgers University Newark

Greece: why there can be no winners in the Grexit game

From The Conversation. Greece is on the brink. Even if a last-minute deal is found it is clear that the solutions proposed are little more than a way to delay the crisis. A more comprehensive resolution of the Greek tragedy needs to address the medium-term (non-)sustainability of the Greek debt position.

Economists know that negotiations usually break down when there is uncertainty in bargaining. When the two sides are uncertain as to what gains and losses the other side can make through any deal or by walking away. In this case, part of the uncertainty is political, because the Greek and other EU governments don’t fully know what might be acceptable to their electorates. But a good part of the uncertainty at this bargaining table is economic. Because we are in totally uncharted waters. Monetary unions can be, and have been, dissolved before in history but, except in the aftermath of wars, not usually in anger.

Uncharted waters

There are several sources of uncertainty for both sides in the dispute.

First, if Greece leaves the Eurozone, at one level it will have greater freedom to walk away from at least some its debt, or to restructure it in a way which suits its short-term economic need. It could plan a moderate primary surplus. The problem for the Greek government is that it will inherit a broken banking system and there will be great uncertainty on whether a devaluing new Drachma could benefit its net trade position, with an impaired financial system, and shut out from world capital markets. Greece is not Iceland, and there is less social consensus on how to share the short-run burden of economic adjustment in a Grexit scenario.

Second, the losses for the EU lenders are truly eye-watering. The two bail-out packages for Greece amount to €215.8 billion. Of these €183.8 billion came from other EU countries and the rest from the IMF. The biggest shares of the support through the European Financial Stability Facility came from Germany and France. None of this includes the cost of support given to the Greek banking system via the ECB. The IMF would suffer considerable losses too (the UK’s main exposure is through this channel). The impact of Grexit and a partial or full debt repudiation on the rest of the EU would be considerable. Paradoxically by triggering a Grexit rather than an orderly debt restructure, the EU lenders may lose more of their current bail-out. So why are they not more accommodating? Because if it stays in, Greece will need a further bail-out, as no-one believes the current plan is sustainable. It’s that uncertainty again.

Third, no-one can really estimate the contagion effect of a seemingly irreversible monetary union breaking up. A major jump in borrowing costs for countries like Italy and Spain would hit these countries hard, and potentially create a domino effect. If Grexit happens, the Eurozone needs rapid reform to ensure a guarantee of greater mutualisation of fiscal policy. Is that likely to be acceptable to northern EU members? Nobody knows for sure, but it seems unlikely.

The computer gets it

In the 1980s movie War Games, the computer in charge of the US nuclear arsenal realises, by constantly repeating the game of noughts and crosses (which cannot be won if both players play rationally), that nuclear war is unwinnable. The problem with all this uncertainty is that the various players in the Grexit game fail to properly understand the serious consequences of not reaching a rational deal. They still think they can win. That’s not to say that keeping Greece in the Euro is the best option in the long term. But a breakdown in negotiations and a disorderly exit doesn’t appear desirable.

Author: Anton Muscatelli, Principal and Vice Chancellor at University of Glasgow

Australian Job Mix In Rotation – Warning Signs Ahead

The recent ABS data on Labour Force in Australia which is a quarterly publication to May 2015 contained some interesting insights into the changes underway. Essentially, in sectors where there is strong international competition there has been a relative reduction in the number of jobs available in Australia, whilst in other sectors more shielded from the chill winds of direct international competition the relative proportion is rising. The chart below shows the change in the relative distribution of jobs on a 2 year, 5 year and 10 year horizon.

Industry-ShiftsThe most significant growth areas have been in Health Care and Social Assistance, Education and Training and Professional, Scientific and Technical Services. The most significant falls are in Manufacturing, Agriculture, Forestry and Fishing and Retail Trade. Mining highlights the long term growth, but short term fall in jobs as competition increases, and we move into the exploit phase. In marked contrast, Construction, which dipped in the 5 year horizon is now growing again. We also see modest falls in Financial Services due to greater efficiency and online channels, and a rise recently in Real Estate Services thanks to the property boom.

However, there is an important point to make. The rise in service related industries in general has lower wages relative to some other sectors, and it will only flourish whilst there are enough people able and willing to pay for said services. For example, the vast pool of superannuation savings will flow into the healthcare sector as households age. In essence these industries move money about the economy, but do not create things which in turn can create value. The worry is that those sectors which truly create wealth in the economy are under the most pressure. As a result, wages are flat, and the growth levers are not operating that strongly. This highlight the long-term issues we face.

Which industry sectors will be the next growth engines for the economy?

Fed Rate Hike Would Cause Modest US Corporate Discomfort – Fitch

A gradual hike in interest rates would increase the cost of borrowing for US companies, likely resulting in lower profits and slower growth, according to Fitch Ratings.

But while higher rates would cause some discomfort, Fitch continues to believe a gradual rise would have limited impact for U.S. corporate credits as a whole, given the offsetting backdrop of US economic growth and aggressive refinancing by most corporates over the last few years that has resulted in maturities being pushed out with low-coupon, long dated debt.

In contrast, under our stress case scenario, rapid interest rate increases by the Federal Reserve would put additional pressure on credit metrics and could prompt more rating changes. Our stress case scenario includes more rapid rate increases, a choking off of near-term credit, a flattening of the yield curve and a spike in inflation. Against a backdrop of increased M&A activity, interest rate pressure could also impair the financial flexibility of buyers as acquisitions become more expensive to finance.

The ability to handle interest rate increases varies by corporate sector. U.S. Corporate sectors with cost recovery mechanisms (utilities, master limited partnerships (MLPs)) or strong pricing power (aerospace and defense, engineering and construction) are generally among those best able to counter the challenges in the stress case stemming from faster rising inflation and interest rates, while sectors with limited pricing power(such as homebuilders) may encounter more issues.

The secondary effects of a stress scenario are also important, as rising rates in a stagnant economic environment are likely to dampen equity values. Sectors where ongoing access to capital markets is critical for funding growth (REITs and MLPs) are likely to be especially sensitive to the stress scenario, given their high distributions and limited ability to retain cash.

Macroprudential Case Studies

The IMF just released a working paper “Experiences with Macroprudential Policy—Five Case Studies” which discusses the implementation of macroprudential policies, mainly to attempt to manage the housing sector at a time of rising prices and high levels of bank lending.

The paper presents case studies of macroprudential policy in five jurisdictions (Hong Kong SAR, the Netherlands, New Zealand, Singapore, and Sweden). The case studies describe the institutional framework, its evolution, the use of macroprudential tools, and the circumstances under which the tools have been used. In all cases macroprudential tools have been used to address risks in the housing market. In addition, some of them have moved to enhance the resilience of their banks to more general cyclical and structural risks.

In all the cases reviewed, the macroprudential tools have been used primarily to address risks in the real estate sector. Partly for this reason, the loan-to-value (LTV) limit was the most popular macroprudential tool, used in the five cases. Some jurisdictions have used multiple tools to help the effectiveness of the measures. For instance, Hong Kong SAR and Singapore have used the debt service–to-income (DSTI) ratio and taxes applied to real estate transactions along with the LTV ratio. Sweden and Hong Kong SAR also have imposed additional capital requirements for mortgages.

To enhance the resilience of the banking system, some authorities in these five cases also have used, or plan to use, additional macroprudential tools to address risk in the time and structural dimensions. Most of these measures were adopted in response to the global financial crisis. New Zealand, for instance, moved quite quickly compared to other countries and imposed liquidity requirements to contain bank funding risks, and gradually increased the requirement. Sweden did the same in 2013. Banks in both countries rely heavily on wholesale funding. Countercyclical capital buffers will take effect in Sweden in the Fall of 2015 and in Hong Kong SAR in phases beginning 2016, while the Netherlands intends to impose them too. Furthermore, systemically important institutions will have to hold additional capital buffers starting in 2015 in Sweden and 2016 in Hong Kong SAR and the Netherlands.

It is too early to gauge the full impact of the measures that have been undertaken. In addition, some measures will only take effect in the future. Nevertheless, there is some early evidence that the implementation of macroprudential measures have enhanced banking system resilience and helped reduce the build-up of housing sector leverage in the cases reviewed. For instance, LTV ratios declined in Hong Kong SAR, New Zealand, and Singapore following the adoption of LTV limits. House prices growth was also affected. For example, the rate of growth of house prices peaked in New Zealand following the imposition of a cap on LTVs. House prices also leveled off in Hong Kong SAR under the combined weight of macroprudential tools and taxes, with the taxes appearing to have a more immediate impact.

CONCLUDING REMARKS
Increasing attention has been given to the field of macroprudential policy following the global financial crisis. This paper reviews the use of macroprudential policy in five economies (Hong Kong SAR, the Netherlands, New Zealand, Singapore, and Sweden). All these jurisdictions actively implemented macroprudential policy measures following the global financial crisis. The analysis shows that each jurisdiction reviewed adopted an institutional framework for macroprudential policy suited to their own circumstances. The evidence reviewed confirms that “one size does not fit all,” and that it is possible to conduct macroprudential policy with a heterogenous set of institutional frameworks. In all cases, most of the macroprudential tools used were directed at containing risks arising from a booming housing market (for e.g., LTV and DSTI ratio limits). Some of the cases studied also took steps to enhance the resilience of the banking system to more general cyclical and structural risks (for e.g., liquidity requirements and additional capital requirement for systemically important institutions). While there is some early evidence that the measures taken have enhanced banking system resilience, it is still early to determine their full impact.

Note: The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.