September 2015 – Page 9 – Digital Finance Analytics (DFA) Blog

Tapping super not the answer to home ownership decline

“All Australians should be able to retire with dignity and decent living standards.”

So states the recently released superannuation report of the Committee for Economic Development of Australia (CEDA).

CEDA’s report is commendable. And although I agree with most of its recommendations, including what the purpose of super should be, how retirement income products dealing with longevity risk should be developed and how super tax laws should be made more equitable, I have one serious misgiving: I do not believe active employees should be able to use their super funds to invest in owner-occupied housing.

The American 401(k) system (also a defined contribution model like Australian super) provides a cautionary tale on the damage caused by what’s known as pre-retirement leakage. Unlike Australia, it is fairly easy for US workers to access their 401(k) retirement accounts during active employment. Even prior to preservation age, which is 59½ in the US, individuals are able to use their workplace retirement accounts for a number of purposes, both with and without tax consequences.

For instance, the US tax code allows individuals under specified circumstances to take loans against the value of their retirement funds without tax penalty. Although such funds are required to be secured and paid back like any other commercial loan, studies show many employees are never able to restore the money to their 401(k) accounts. Not only does this lead to diminished pension pots, it also means there will be less money upon which interest or investment returns can build on in the long-term.

The US 401(k) system also permits employees to take hardship distributions for a number of reasons, including purchasing of a first home, university education and medical expenses. In these circumstances, not only does the individual not face any tax penalties for the withdrawal (except for having to pay ordinary income tax), they are also not required to pay back the money to their account.

Finally, employees can take money out of their 401(k) accounts if they “really” want. What I mean is, absent even an authorised loan or hardship distribution, employees before preservation age can withdraw funds from their retirement accounts. We call this “expensive money” because both a 10% excise tax and 20% employer withholding of funds apply. In the end, these employees receive 70 cents in the dollar for withdrawing money prematurely from their retirement account.

Such leakage in the US causes a significant erosion of assets in retirement – approximately 1.5% of retirement plan assets “leak” out every year. This can potentially lead to a reduction in total retirement assets of 20% to 25% over an employee’s working years, according to experts.

Remember the role of super

I do not disagree with the CEDA report that housing makes a critical contribution to sustaining living standards and helping to address elderly poverty. Needless to say, there should be a multipronged federal government response to the spectre of increasing poverty in old age because of the lack of home ownership. Many useful suggestions are made in the CEDA report in this regard.

But using super, even if only for first-time home buyers, should not be the answer. Indeed, CEDA agrees with much of the recent Financial System Inquiry report (the Murray report), which concludes that super legislation should state explicitly and clearly that its purpose is to provide retirement income.

While increasing home ownership for younger workers is an admirable policy prescription, it is not consistent with the retirement income focus of super. Allowing workers to use their super funds to buy homes means there will be much less money in the pension pot to grow over time to provide the necessary retirement income.

And the harm is ongoing. Making such a change would lead to a further constrained supply of housing, meaning more money chasing the increasingly limited stock of property, tending to drive home prices up even further.

Of course, when, not if, the housing market crashes, much of the super savings tied into such property will also be lost. This problem stems from a lack of diversification in one’s retirement portfolio through an over-investment in the family home. The consequent lack of investment diversification among asset classes means super is less likely to be able to survive future shocks to the Australian economic system.

The lesson from the United States is clear: pre-retirement leakage from super should be permitted only under the most exceptional of circumstances. Even for the very best of reasons, like first-time home ownership, Canberra should prevent super fund leakage during active employment to ensure the primary objective of super: retirement income adequacy.

Author: Paul Secunda, Senior Fulbright Scholar in Law (Labour and Super) at University of Melbourne

Bank Deposit Levy Dropped

The Government announced that the bank deposit levy will not proceed. The decision will amount to a $1.5 billion hit on the budget.

Labor announced the proposed levy from 2016 two years back, and included the potential savings in its budget figuring. The FSI made a recommendation focussing on raising required capital ratios to best international standards rather than a bank deposit tax.

The levy was perceived as a revenue grab, rather than good policy.

Mr Abbott said it was very important Australia’s banks were safe and secure and the best way to ensure that was through a good prudential regulatory system.

RBA Cash Rate Unchanged

At its meeting today, the Board decided to leave the cash rate unchanged at 2.0 per cent.

The global economy is expanding at a moderate pace, with some further softening in conditions in China and east Asia of late, but stronger US growth. Key commodity prices are much lower than a year ago, in part reflecting increased supply, including from Australia. Australia’s terms of trade are falling.

The Federal Reserve is expected to start increasing its policy rate over the period ahead, but some other major central banks are continuing to ease policy. Equity markets have been considerably more volatile of late, associated with developments in China, though other financial markets have been relatively stable. Long-term borrowing rates for most sovereigns and creditworthy private borrowers remain remarkably low. Overall, global financial conditions remain very accommodative.

In Australia, most of the available information suggests that moderate expansion in the economy continues. While growth has been somewhat below longer-term averages for some time, it has been accompanied with somewhat stronger growth of employment and a steady rate of unemployment over the past year. Overall, the economy is likely to be operating with a degree of spare capacity for some time yet, with domestic inflationary pressures contained. Inflation is thus forecast to remain consistent with the target over the next one to two years, even with a lower exchange rate.

In such circumstances, monetary policy needs to be accommodative. Low interest rates are acting to support borrowing and spending. Credit is recording moderate growth overall, with growth in lending to the housing market broadly steady over recent months. Dwelling prices continue to rise strongly in Sydney, though trends have been more varied in a number of other cities. The Bank is working with other regulators to assess and contain risks that may arise from the housing market. In other asset markets, prices for commercial property have been supported by lower long-term interest rates, while equity prices have moved lower and been more volatile recently, in parallel with developments in global markets. The Australian dollar is adjusting to the significant declines in key commodity prices.

The Board today judged that leaving the cash rate unchanged was appropriate at this meeting. Further information on economic and financial conditions to be received over the period ahead will inform the Board’s ongoing assessment of the outlook and hence whether the current stance of policy will most effectively foster sustainable growth and inflation consistent with the target.

Capital Gains Up, But Rental Yields Down – CoreLogic RP Data

According to the CoreLogic RP Data August 2015 Home Value Index, capital city dwelling values continued to rise over the month whilst growth in weekly rental rates shifted to a new record low for annual growth over the month of August.

The headline results show that dwelling values were 0.3 per cent higher over the month across the eight capital city index. The highest month-on-month movement was in Sydney, where dwelling values were 1.1 per cent higher, while dwelling values also moved higher across Adelaide (0.7 per cent) and Darwin (0.3 per cent), and were flat over the month in Melbourne and Brisbane. The remaining capital cities recorded a month-on month fall in dwelling values.

While the August results indicate a slowdown in the rate of appreciation in dwelling values, the quarterly figures highlight just how strong the housing market has been over the past three months; combined capital city dwelling values are 5.3 per cent higher over the three months to the end of August this year.

Sydney dwelling values are 17.6 per cent higher over the past year, and since the beginning of 2009, Australia’s largest capital city housing market has recorded a cumulative capital gain of 76 per cent. Using the median house price from January 2009 as a base, the typical Sydney home owner has seen the value of their home increase by approximately $309,000 since the beginning of 2009.

The only cities where dwelling values declined over the past twelve months have been Darwin (-4.6 per cent), Perth (-1.8 per cent) and Canberra (-0.9%).

Growth in weekly rental rates shifted to a new record low for annual growth over the month of August. Across the combined capital cities, the median weekly rental rate rose
by just 0.7 per cent over the past twelve months, with house rents up 0.5 per cent and unit rents up a higher 1.6 per cent.

Since May 2013, dwelling values have risen at a faster pace than weekly rents. “The result of the disparity between dwelling values and dwelling rents has been a consistent downwards trend in gross rental yields.

Gross yields are at record lows in both Sydney and Melbourne. A typical dwelling is attracting a gross yield of just 3.3 per cent and 3.1 per cent respectively across Australia’s two largest cities. Mr Lawless said that the low yield scenario has largely been overlooked by investors who appear to be more focused on chasing future anticipated capital gains rather than aiming for cash flow.

Building Approvals Fell 0.7% In July

The Australian Bureau of Statistics (ABS) Building Approvals show that the number of dwellings approved fell 0.7 per cent in July 2015, in trend terms, and has fallen for five months.

Dwelling approvals decreased in July in Tasmania (5.6 per cent), Victoria (3.1 per cent), South Australia (2.1 per cent), Western Australia (1.8 per cent) and Queensland (0.8 per cent) but increased in the Northern Territory (7.3 per cent), Australian Capital Territory (4.4 per cent) and New South Wales (1.9 per cent) in trend terms.

In trend terms, approvals for private sector houses fell 0.5 per cent in July. Private sector house approvals fell in Western Australia (2.3 per cent), Victoria (1.5 per cent) and South Australia (1.4 per cent) but rose in Queensland (1.2 per cent) and New South Wales (0.8 per cent).

The value of total building approved rose 0.6 per cent in July, in trend terms, and has risen for three months. The value of residential building fell 0.4 per cent while non-residential building rose 2.9 per cent in trend terms.

CEDA Super Report, A Curate’s Egg

A CEDA report released today is calling for an overhaul of retirement policy, including options such as pre-tax mortgage repayments and superannuation being available for owner-occupied home purchases, to be considered. We think, like the curate’s egg, it is good in parts!

Whilst we agree that a root and branch review of retirement income provisions should be undertaken (superannuation, SMSF, and government pensions holistically), we do not agree with the option of allowing savers to access superannuation for house purchase, nor a tax offset against mortgage interest payments. Both of these extend the ability of people to pay more for property, and will simply lift prices further above their long term norms. It also reinforces the view that property is about savings, not somewhere to live, as we discussed recently. We need a focus on the supply side of property, to meet demand, and reduce the price to income disparity. Extending yet more ability to purchase simply moves the problem on another generation and make ever larger mortgages worse, creating yet more risk in the banking sector. At some point the music has to stop.

“Two key trends, our ageing population and decreasing housing affordability, mean Australia’s retirement system structure needs a significant rethink,” CEDA Chief Executive Professor the Hon. Stephen Martin said when releasing The super challenge of retirement income policy.

“Talk about our ageing population and the impact on retirement policy has been part of national debate for many years but the impact of sustained housing affordability issues is only just beginning to be recognised as a significant issue for retirement policy.

“However, if it is not addressed the long term consequences could be significant with an increasing number of people living in poverty in retirement and unsustainable fiscal pressure on the Federal Budget.

“We already know from CEDA’s report Addressing entrenched disadvantage in Australia, released in April this year, that between 1 and 1.5 million Australians live in poverty and the elderly, particularly those who do not own their home, are an at-risk group. In fact, the overall poverty rate of older people in Australia is three times the OECD average, and one of the highest.

“Without a significant policy overhaul, that number is likely to significantly rise over the next 40 years.

“There has been a lot of talk and tweaking of retirement policy aimed at reducing the burden on government, but what Australia needs is a robust discussion on all the options to ensure long term Australians can retire comfortably.

“We strongly agree with the sentiments at last week’s National Reform Summit that tinkering at the edges is no longer an option and that discussion needs to broaden on this important issue.

“The system needs to be reviewed in its entirety. Ensuring retirement policies are not too onerous on the Federal Budget should be an outcome, but the focus must be on ensuring a sustainable system that delivers an adequate living standard for retirees.”

Professor Martin said the other priority must be a national conversation to confirm the objectives of the system, which would go a long way to alleviating confusion among the public, industry and government.

“Our retirement system should ensure Australians can retire with dignity and an adequate living standard, while providing a social safety net for those cannot afford to save enough for retirement,” he said.

Professor Martin said CEDA’s position is that there are a number of options that could help radically reshape retirement policy in Australia to improve its effectiveness in the long term and they need to all be put on the table and reviewed for their merits given the current environment.

“Obviously taxation arrangements need review because currently concessions are benefiting the rich and are being used as tax mitigation measures rather than to encourage retirement savings. However, the other area that needs review is the treatment of the family home,” he said.

“One option would be make the family home part of the assets test for the Age Pension and change superannuation payments to an after income tax payment, with all other super tax concessions removed.

“Alternatively, mortgage payments on the family home could be allowed to be made pre-tax.

“Implementing one of these options would allow for two important components of retirement savings – superannuation and the family home – to be treated the same.”

In addition Professor Martin said to further recognise the role of housing in alleviating poverty in retirement, first home buyers could be allowed to access superannuation funds to purchase owner-occupied housing.

“How policy impacts women should also be part of any review with women currently the most disadvantaged by the current system,” he said.

“We recognise that each of these policy recommendations come with their own issues, for example making mortgage repayments pre-tax could contribute to pushing house prices up. However, with the right combination of policy levers and checks and balances they are genuine options that should be explored given the trends we are now facing.”

The CEDA research report The super challenge of retirement income policy can be downloaded here.

Yellow Brick Road Reports Strong Growth

The latest results from YBR, in their 2015 annual report shows a 42% increase in loan settlements over the year to June. They grew their loan book to more than $30 billion or about 4% of Australia’s total home loan settlements. The mortgage and wealth franchise business includes Vow Financial and Resi Mortgage Corporation.

Yellow Brick Road’s own branded product, Empower, showed a 42% rise in settlements in the six months to June to $2 billion in loans over the 2015 financial year, whilst Vow Financial increased its annual settlements 46% to $10.38 billion and Vow Financial grew its advisor base by 29.7% and its broker agreements by 25.1%.

YBR has been expanding their franchise network which is now 255 branches across the country, the increase thanks partly to the addition of Resi’s 19 branches. Vow now has 891 independent mortgage and finance brokers as members of its network.

Economic Growth in Five Australian States Remains Below Average – ANZ

ANZ’s Stateometer, a new economic measure of Australia’s states and territories, showed economic growth in five Australian states was below trend in the year to June as Australian resource investment continues to decline. On the other hand, NSW and Victoria as the country’s top economic performers over the past year, led by strong residential investment, improving business and labour market conditions and pockets of strength in commercial property. Tasmania is close to its trend rate.

Tasmania and Queensland share similar characteristics to the stronger states including solid housing and private consumption and are also benefiting from the depreciating Australian dollar. ANZ says they expect their below-trend lower momentum position on the ANZ Stateometer will change as these drivers lead to recovery rather than further deterioration.

Western Australia (WA) and SA are experiencing downward momentum caused by WA’s ongoing mining consolidation and SA’s weakening industrial sector.

Economic activity increased in the Northern Territory due to recent improvements in its labour market. However it is expected to remain well below its growth trend rate due to a likely ongoing decline in overall business investment.

The ACT increased its momentum significantly but its performance has been well below its trend rate since Commonwealth budget tightening began around 2011.

They conclude that with strong inter-linkages between NSW and Victoria and the rest of the country, the weight of the resources downturn does present a downside risks to these economies. The backdrop of falling commodity prices and unsettled financial markets are also downside risks.

Trouble looms, so rates should hold

From The Conversation.

Wild swings in global stock markets have made investors edgy, the economic news coming out of China is not favourable and domestic private investment has plummeted. On the other hand, US growth surged to 3.7% annually and fears of a debt crisis in the Euro zone have abated. Latest estimates still put inflation at 1.5%, below the Reserve Bank of Australia’s target band of 2-3%.

The Shadow Board’s confidence that the cash rate should remain at its current level of 2% equals 77% (up from 68% in August). The confidence that a rate cut is appropriate has edged up three percentage points, to 9%; conversely, the confidence that a rate increase, to 2.25% or higher, is called for, has decreased considerably for the third time in a row, from 35% in July and 25% in August to 14%.

Latest figures show that Australia’s unemployment rate increased to 6.3% in July, according to the Australian Bureau of Statistics, even though total employment rose by nearly 40,000 in July. Nominal wage growth remains muted at 2.3% and is forecast to remain low in the next quarter.

The Aussie dollar depreciated further against major currencies. It now fetches less than 72 US¢. Yields on Australian 10-year government bonds remain low at 2.71%.

As already pointed out in last month’s statement, the Australian property market appears to be cooling and the local sharemarket is retreating further from its highs earlier this year.

The elephant about to enter the room is the dramatic fall in new private capital expenditure, equalling a sizable 4.0% in the June quarter, bringing the annual decline to 10.5%, the largest drop since the last recession in 1992. The large drop is largely attributable to the contraction of the mining sector; however, firms in other sectors are also planning to cut spending, posing a serious threat to the Australian economy.

The recent gyrations in worldwide stock markets have highlighted the frothiness in global asset prices. To what extent volatility and uncertainty in asset markets spills over into the real economy is, of course, unclear. However, few economists doubt that asset markets are relying on ultra-low interest rates to persist. Concerns about any debt crisis in the Euro zone have waned since the recent 80 billion Euro credit extended to Greece.

As in previous months, the deteriorating outlook for the Chinese economy pose the biggest immediate threat to Australia’s export markets and thus to Australia’s GDP. US growth, on the other hand, has been revised up to 3.7% (annualized) for the second quarter 2015, presenting a dilemma for the Federal Reserve Bank: the strong economic performance suggests an increase in the federal funds rate is around the corner but if volatility in stock markets persists, signalling heightened uncertainty about the future, the Fed may be tempted to postpone the interest rate increase. Commodity prices have continued to fall, with crude oil dipping below $40 a barrel.

Also of concern is the sizable contraction of world trade in the first half of this year. The volume of global trade shrank by 0.5% in the June quarter, while the figures for the March quarter were revised to a 1.5% contraction, indicating that world trade recorded its largest contraction since the 2008 global financial crisis.

Consumer and producer sentiment measures paint a motley picture. The Westpac/Melbourne Institute Consumer Sentiment Index jumped from 92.3 in July to 99.5 in August. Business confidence, according to the NAB business survey slumped from 10 in July to 4 in August, at the same time as the AIG manufacturing and services indices, both considered leading economic indicators, recorded notable improvements.

What the Shadow Board believes

The probabilities at longer horizons are as follows: 6 months out, the estimated probability that the cash rate should remain at 2% equals 27% (23% in August). The estimated need for an interest rate increase lies at 65% (73% in August), while the need for a rate decrease is estimated at 8% (4% in August).

A year out, the Shadow Board members’ confidence in a required cash rate increase equals 72% (six percentage down from August), in a required cash rate decrease 9% (7% in August) and in a required hold of the cash rate 18% (up from 15% in August).

Comments from Shadow Reserve bank members

Mark Crosby, Associate Professor, Melbourne Business School:

“The longer term outlook is still uncertain.”

Recent global gyrations should make the RBA hold rates this month, and with a recovery in equity markets outside of China there seems little reason to cut rates. The longer term outlook is still uncertain, with global trade falls the most recent worrying data in the global economy and far more consequential than falls in Chinese equity markets.

Guay Lim, Professorial Fellow, Deputy Director, Melbourne Institute:

“International interest rates are likely to rise.”

International interest rates are likely to rise, as growth and employment in the US appear to be stabilising at normal rates. While Australian asset markets are expected to continue to be volatile, the exchange rate is expected to remain low. Keeping the official rate steady at 2% would help offset some of the negative effects of uncertainty in the international environment on the domestic economy – as well keep the policy rate well above the zero lower bound.

James Morley, Professor of Economics and Associate Dean (Research) at UNSW Australia Business School:

“The RBA should not provide a ‘Greenspan put’.”

Given the recent turbulence in financial markets and underlying inflation being at the low end of the target range, the RBA should hold its policy rate steady rather than raise it. But with a stable real economy, an overheated housing market, and a low dollar stimulating the foreign sector, the RBA should not provide a “Greenspan put” by cutting rates in response to the stock market. Instead, it should carefully monitor conditions to determine when it will need to start raising the policy rate back towards its neutral level.

Jeffrey Sheen, Professor and Head of Department of Economics, Macquarie University, Editor, The Economic Record, CAMA:

“Monetary policy needs to avoid reversing recent currency falls.”

The current fragility in global stock markets appears to be more of a dash to liquidity than to value. It is likely an over-reaction to expected future interest rate increases, beginning with the federal funds rate perhaps this year. Nevertheless some downward adjustment was probably necessary because the boom in global stock prices generally did not mirror the sluggish recovery in the global real economy.

The trade-weighted Australian dollar has fallen about 15% in the last year, and fortunately has not risen with the recent competitive depreciations across Asia. Monetary policy needs to avoid reversing this contributor to Australia’s improved export competitiveness. In the current volatile financial environment, the RBA should maintain the current cash rate in September, though I have modestly increased the probability of a desirable cut.

Author: Timo Henckel, Research Associate, Centre for Applied Macroeconomic Analysis at Australian National University