Martin North – Page 1000 – Digital Finance Analytics (DFA) Blog

Effects of Income, Fiscal Policy, and Wealth on Private Consumption

An IMF working paper discusses an important issue, relating to what should have been the appropriate fiscal policy in the aftermath of the global financial crisis is very much open. There is considerable controversy over the impact of fiscal consolidation on economic activity and on why sluggish economic growth persists across many advanced economies several years after the onset of the financial crisis.

This paper looks at private consumption because, on average across countries, it is the component of GDP that accounts for the largest proportion of the overall changes to real GDP. Using econometric modelling the paper looks at the possible effects of fiscal policy on private consumption, but also explore the negative wealth effects stemming from the collapse of housing and financial assets in the context of high household debt. They argue that wealth effects played an important role weighing down consumption growth, suggesting that the effect of fiscal policy on economic activity may be overestimated if such factors are overlooked.

Two interesting data sets relating to the relative position of Australia and other countries in the analysis which shows the relative significance of private consumption in Australia since 2003. In the context of slowing income growth and very high household debt levels today, we cannot expect households to create significant GDP momentum in the next few years. Yet we have been very reliant on this for some time. In essence we have a structural economic problem.

More generally they find that consumption is impacted by wealth effects, in addition to fiscal policy. They find a significant long-term relation between consumption and the different components of income and wealth. Labor income remains the main driver of consumption. Personal income taxes and social security contributions are found to have a negative impact on consumption, while social benefits are found to have a larger positive impact. Financial assets and housing assets are found to have a positive coefficient, while household debt is found to have a negative coefficient. Furthermore, the results suggest that the contribution to consumption from an increase in financial or housing assets would be more than offset if financed fully through in increase in household debt.

Note that IMF Working Papers describe research in progress by the author(s) and are published to elicit comments and to encourage debate. The views expressed in IMF Working Papers are those of the author(s) and do not necessarily represent the views of the IMF, its Executive Board, or IMF management.

The Fed and the Global Economy

Stanley Fischer, Vice Chairman, Board of Governors of the Federal Reserve System gave a speech entitled “The Federal Reserve and the Global Economy“. He discusses aspects of our global connectedness, spillovers from the United States to foreign economies and the effect of foreign economies on the United States.

In a progressively integrating world economy and financial system, a central bank cannot ignore developments beyond its country’s borders, and the Fed is no exception. This is true even though the Fed’s statutory objectives are defined as specific goals for the U.S. economy. In particular, the Federal Reserve’s objectives are given by its dual mandate to pursue maximum sustainable employment and price stability, and our policy decisions are targeted to achieve these dual objectives. Hence, at first blush, it may seem that there is little need for Fed policymakers to pay attention to developments outside the United States.

But such an inference would be incorrect. The state of the U.S. economy is significantly affected by the state of the world economy. A wide range of foreign shocks affect U.S. domestic spending, production, prices, and financial conditions. To anticipate how these shocks affect the U.S. economy, the Federal Reserve devotes significant resources to monitoring developments in foreign economies, including emerging market economies (EMEs), which account for an increasingly important share of global growth. The most recent available data show 47 percent of total U.S. exports going to EME destinations. And of course, actions taken by the Federal Reserve influence economic conditions abroad. Because these international effects in turn spill back on the evolution of the U.S. economy, we cannot make sensible monetary policy choices without taking them into account.

The Fed’s statutory objectives are defined by its dual mandate to pursue maximum sustainable employment and price stability in the U.S. economy. But the U.S. economy and the economies of the rest of the world have important feedback effects on each other. To make coherent policy choices, we have to take these feedback effects into account. The most important contribution that U.S. policymakers can make to the health of the world economy is to keep our own house in order–and the same goes for all countries. Because the dollar is the primary international currency, we have, in the past, had to take action–particularly in times of global economic crisis–to maintain order in international capital markets, such as the central bank liquidity swap lines extended during the global financial crisis. In that case, we were acting in accordance with our dual mandate, in the interest of the U.S. economy, by taking actions that also benefit the world economy. Going forward, we will continue to be guided by those same principles.

The Future Shape of Banking Regulation

In a speech entitled “The fence and the pendulum“, by Martin Taylor, External Member of the Financial Policy Committee, Bank of England, he discusses the thorny problems of macroprudential policymaking, which very much include the bank capital and too-big-to-fail agenda. It is worth reading in full.

He concludes:

This is a crucial time for the new international order in bank regulation. We are close to agreement on new standards that the industry, in the UK at least, is not too far off meeting. Four years ago that would have seemed a highly desirable outcome but quite an unlikely one. It’s good for our economies, and it will turn out to be good for the financial industry over the next quarter-century. At the same time the emergence – well, they never went away – the increasingly shrill emergence of voices calling for a regulatory softening is both structurally wrong and conjuncturally wrong. It remains the ungrateful job of the supervisors to save the banks from themselves. The shortness of human memory span and the speed with which we forget the ghastly misjudgements of the recent past: these are the enemies, the unresting enemies, alas, of financial stability.

Banking: Australian Banks’ Moves to Curb Residential Investment Lending Are Credit-Positive – Moody’s

In a brief note, Moody’s acknowledged that the bank’s recent moves to adjust their residential loan criteria could be positive for their credit ratings, but also underscored a number of potential risks in the Australian housing sector including elevated and rising house prices, declining mortgage affordability, and record levels of household indebtedness. As a result, they believe more will need to be done to tackle the risks in the portfolio.

Moody’s says the recent initiatives are credit positive since they reduce the banks’ exposure to a higher-risk loan segment. At the same time, it is likely that further additional steps will be required because the growing imbalances in the Australian housing market pose a longer-term challenge to the Australian banks’ credit profiles, over and above the immediate concerns relating to investment lending.

Therefore they expect the banks first to curtail their exposure to high LTV loans and investment lending further over the coming months; and second, they will gradually improve the quantity and quality of their capital through a combination of upward revisions to mortgage risk weights and capital increases. This is likely to happen over the next 18 months or so.

Westpac’s Revised LMI Arrangements Are Credit Negative for Australian Mortgage Insurers – Moody’s

Moody’s says that according to media reports, last Monday, Westpac Banking Corporation advised its mortgage brokers that it had revised its mortgage insurance arrangements so that effective that day, 18 May, all new Westpac-originated loans with a loan-to-value ratio (LTV) above 90% would be insured with its captive mortgage insurer, Westpac Lenders Mortgage Insurance Limited and reinsured with Arch Capital Group Ltd.

Westpac’s decision to shift its mortgage insurance policies away from domestic third-party lenders’mortgage insurance (LMI) providers is credit negative forGenworth Financial Mortgage Insurance Pty Ltd and QBE Lenders’ Mortgage Insurance Limited. Westpac accounted for around 14% of Genworth Australia’s gross written premium during 2014, and potentially a meaningful, albeit undisclosed, proportion of QBE LMI’s business. At the same time, existing policies will not be affected and the effect o nthe insurers’ net earned premium should only become material beginning in 2016. LMI customer contractual relationships are long term in nature and any further erosion of the customer base, when and if it occurs, remains contingent on market and individual customer developments.

Westpac’s move follows its earlier disclosures and the Genworth Australia announcement in February 2015that Genworth’s contract for the provision of LMI to Westpac was being terminated. Our understanding from Westpac’s disclosures and media reports is that Westpac’s LMI arrangements with QBE LMI have also been affected. Moody’s says that Westpac’s move is indicative of a longer-run trend towards reduced usage of the domestic mortgage insurance product. Australia’s major banks are not currently deriving regulatory capital benefits from using LMI. Similarly, product innovation, such as the use of self-insured low-deposit mortgage products, will affect the need for third-party LMI. Diminished third-party LMI usage elevates the insurers’ risk of losing pricing power and reducing their customer base, putting downward pressure on the firms’ profitability and volumes.

ING DIRECT Introduces ‘One Swipe’ Banking And Apple Watch App

ING DIRECT has introduced true ‘one swipe’ banking, allowing customers using Apple devices to easily check their transaction account, savings, mortgage and superannuation balances with just one swipe.

The ‘Widget’ feature makes use of the Apple iOS 8 Notification Centre, meaning if customers choose, they no longer have to unlock their mobile device or even open their ING DIRECT app to check their balances, they can simply swipe down on their home screen and their ING DIRECT account balances will be available.

ING was one of the first Australian banks to provide the pre-login balance feature, which is used by more than 98 per cent of their mobile banking customers and which displays account balances by simply tapping the ING DIRECT app icon.

ING DIRECT on Apple Watch

ING DIRECT has also launched an app for the Apple Watch which can be configured to display a range of account balances, while the mobile banking app has recently been updated with a security feature allowing customers to place a ‘hold’ on their Visa debit card, preventing it’s use until the customer choose to release the ‘hold’.

ING DIRECT Introduces ‘One Swipe’ Banking And Apple Watch App

More than 70 per cent of ING DIRECT’s mobile interactions are by customers using Apple devices. The ‘one swipe’ banking feature is not activated by default and is only made available to customers who chose to configure it through their iOS 8 Notification Centre.

Westpac. St George and CBA, as well as Optus also have plans for banking/payments on the watch.

Loan Types By Lender

Completing the analysis of the residential APRA Property Exposure data, we look at selected loan type data across the different ADI lender categories. This analysis is based on relative numbers of transactions, not value.

First we see that the proportion of loans approved outside normal serviceability criteria has drifted lower, though Building Societies, Credit Unions and the Smaller Banks are still most likely to bend the rules to get a loan written. Perhaps they have tighter rules in place to begin with?

The proportion of low doc loans written is miniscule and now consistently low. Most low doc borrowers would now be knocking on the door of the non-ADI’s as they do not have the same heavy supervisory oversight and are tending to be more flexible – but there is little public data on this.

Turning to interest only loans, the Majors, and Other Banks are most likely to write this type of loan. However, we note the rising proportion of Credit Unions, Building Societies and Foreign Banks who will consider the proposition.

Finally, looking at the use of the broker channel, Foregin Banks originate the highest proportion this way, with the smaller Banks also in on the third party origination game. Credit Unions and Building Societies are less inclined to use Brokers, though there have been some increase in recent years.

LVR Data By Lender Type

Continuing our analysis of the latest APRA data, we are looking at the LVR mix by type of lender by analysis of the relative ratio of LVR over time, (understanding that some lender categories are relatively small). APRA splits out the ADI data into sub categories, including Major Banks, Other Banks (excludes the Majors), Building Societies, Credit Unions and Foreign Banks. There are some interesting trend variations across these.

In the above 90% LVR category, we see a general drift down, Credit Unions took a dive last year, whilst Building Societies have the highest share of new 90%+ LVR loans, though we see this falling a little now. The Major Banks sit in the middle of the pack. Note that in 2009, Other Banks were writing more than 30% of their loans in this category, today its below 10%.

In the 80-90% LVR range, the Foreign banks, and Other Banks (ie not the big four) showed an uptick, though this may now be reversing. Building Societies and Credit Unions are below the Major Banks.

In the 60-80% range, we see the Building Society mix rising in this band, whilst the others have been relatively static.

Finally, the loans below 60% LVR. Here the Building Society have drop a few points, as they move into the higher LVR bands, though that may be reversing a little now. Foreign Banks share in this band dropped recently, after a spike in 2009.

Home Loans Up, Mix Changing, APRA

The Australian Prudential Regulation Authority (APRA) today released Quarterly Authorised Deposit-taking Institution Property Exposures for the March 2015 quarter.

Quarterly ADI Property Exposures contains information on ADIs’ commercial property exposures, residential property exposures and new housing loan approvals. Detailed statistics on residential property exposures and new housing loan approvals are included for ADIs with greater than $1 billion in housing loans.

ADIs’ commercial property exposures were $234.2 billion, an increase of $15.1 billion (6.9 per cent) over the year. Commercial property exposures within Australia were $193.3 billion, equivalent to 82.5 per cent of all commercial property exposures.

ADIs’ total domestic housing loans were $1.3 trillion, an increase of $107.1 billion (9.0 per cent) over the year. There were 5.3 million housing loans outstanding with an average balance of $243,000.

ADIs with greater than $1 billion of residential term loans approved $82.3 billion of new loans, an increase of $8.5 billion (11.5 per cent) over the year. Of these new loan approvals, $51.9 billion (63.0 per cent) were owner-occupied loans and $30.4 billion (37.0 per cent) were investment loans.

Looking in more detail at the data, looking first at the portfolio data, we see the rise on the value of home lending across the ADI’s and the rise in the proportion of investment loans in the mix. High LVR’s fell a little.

The mix of loan type shows a continuing slow rise in interest-only loans (28.9% of all loans) and offset loans (32.3%), and a slight fall in loans with redraw (77.1% of loans).

Across the portfolio, the average balance on interest-only loans is the highest, at $315,000, whilst reverse mortgages sat at $94,000.

Turning to approvals by quarter, we see a steady rise in approval volumes, with 37% by number investment loans. Remember that earlier APRA showed that more than 50% of loans by value were for investment loans, so we again see evidence that investment loans are larger by value.

Looking at LVR bands, we see a slight fall in loans over 90% LVR (from 14% to 11%) a slight rise in the 80-90% band, (from 16% to 22%). So the regulators influence is showing though to some extent.

Finally, we see that third party loans by volume (not value) fell from 45% to 42% this quarter. Interest only loans accounted for 42% of approvals. Low doc and loans outside serviceability were low.

So overall, we see buoyant loan growth, supported by rises in investment lending and interest only loans. We will be watching the data next quarter as the Regulators tighten the screws. We think the property worm is about to turn.

Residential Property Prices Increased Significantly YOY in Real Terms 4Q14 – BIS

The Bank for International settlements released their latest cross-country house price database. They highlight the volatile nature of property, and longer term, contrasts the rise and rise we have seen in Australia, with very different stories elsewhere. Between 2007 and now, prices in real terms are still lower than they were then in US, UK and Japan. In Australia, and Canada, they are higher. Real residential property prices had almost doubled in Brazil and had risen by 80% in India; but they had declined by almost one third in Russia.

“In the fourth quarter of 2014, residential property prices increased significantly year on year in real terms (ie deflated by the CPI) in several advanced economies. They grew by 3–5% in Australia, Canada and the United States, and by around 10% in Sweden and the United Kingdom. Real prices increased by 1% in the euro area, although there were important disparities among member states: they rose by 16% in Ireland and more moderately in Germany and Spain, but continued to decline in France, Greece and Italy. Prices also fell in Japan. The picture was also mixed among major emerging market economies. Property price inflation remained strong in India, and to a lesser extent in South Africa and Turkey, but prices continued to fall in China and Russia.

From a longer-term perspective, residential property prices generally peaked in real terms in 2006–07 in most advanced economies. Since the end of 2007, they had decreased by 14% in the euro area, reflecting a fall of around 40% in Greece, Ireland and Spain, and by 23% in Italy, partly offset by a price increase in Germany. As of the fourth quarter of 2014, real prices were also still well below their 2007 levels in the United States (by 13%) and, to a lesser extent, Japan and the United Kingdom. Most other advanced economies, such as Australia, Canada, Norway, Sweden and Switzerland, had registered a significant rise in property prices over the previous seven years. Among major emerging market economies, real residential property prices had almost doubled in Brazil and had risen by 80% in India; but they had declined by almost one third in Russia.”