Category: Economics and Banking

Foreign Investors Fees Still In The Air

Speaking on ABC Insiders this morning Josh Frydenberg, Assistant Treasurer made the point that the foreign investor regulations, recently announced were open for consultation, and that a number of issues had yet to be resolved. For example, should a foreign investor pay the fee each time they apply to purchase a property (so bidding on multiple properties would mean multiple fees)? Or should they pay one fee to cover multiple potential transactions? If they are not successful in purchasing the target property, is the fee refundable? He appeared to be advocating paying the fee before putting a bid in, one fee for multiple bids, and refundable if unsuccessful.

However to decide, we need to know if the fee is simply to cover the cost of appropriate agency administration, or whether it is designed to be a barrier to transact. It is not clear for the available material which is envisaged. Administration would be a combination of assessing the credential of the individual (so once per person), and also the property (so once per property). Also, if unsuccessful, is it appropriate to refund the entire fee? After all, the work needs to be done before allowing a bid (else if you only pay after a successful transaction, what happens if you were declined subsequently, once you have contracted to purchase?)

He also confirmed there had been no action taken on a residential purchase by a foreigner since 2006, adequate data was not being collected, and cross agency communication was not effective.

Clearly more work needs to be done to design this right. DFA suggests that a foreign investor should be able to make application for approval to purchase property in Australia. This should be a licence, which needs to be maintained and renewed from time to time. Then there would be a fee payable on each property application. This latter fee would be refundable in the case of an unsuccessful sale.  It would also reduce the red tape so some extent.

 

Mortgage Arrears Higher In Mining Post Codes – Fitch

Fitch Ratings says in a new report that a reduction in mining investment and slower mining industry employment has resulted in higher delinquency rates over the past 18 months in areas where a significant population is employed in the industry, compared with delinquencies in non-mining areas.

Only 0.8% of Australian mortgages are located in mining postcodes (defined by Fitch as postcodes in which more than 20% of residents worked in the mining industry – employment based on 2011 census data). As a result, mortgages in Australia performed well overall, thanks to the stable economy, steady unemployment rate and record-low mortgage rates.

While Fitch expects the rapid change in industry dynamics that has occurred in the mining sector to impact both mortgage delinquencies and local property markets, Australian RMBS transactions are typically well-diversified geographically. As a result, Fitch does not expect the fall in mining employment to have a material effect on securitised portfolios and does not expect it to affect RMBS ratings in the medium term.

 

The Reform Imperative

John Fraser, Secretary to the Treasury spoke today to the Committee for Economic Development of Australia (CEDA). The speech, “Australia’s Economic Policy Challenges” outlined some important priorities for economic reform, as well as setting out the background to the reform imperative.

Boosting productivity will require improvements across all markets – input markets such as the labour market, financial markets, and infrastructure markets as well as final goods and services markets. Failure to undertake necessary reforms in related markets will mean that the potential benefits of reform in any single market are not realised. The Government has commissioned a number of policy reviews that will recommend ways to enhance Australia’s economic prosperity. Making the most of these reform opportunities is essential, where three areas stand out as priorities for raising Australia’s productivity performance.

The first is tax reform.

Studies have consistently shown that tax reform offers one of the largest policy opportunities to increase incomes and living standards. And the fact is that the structure of our tax system today looks remarkably like it did back in the 1950s — but our economy looks very different. That may tell us something. Tax reform can promote strong investment and encourage workforce participation. Our company tax rate is high by international standards. In the context of far more mobile capital, high tax rates are dampening investment and productivity, while continuing personal income tax bracket creep would have negative impacts on workforce participation and incentives. An important criterion for a well-functioning tax system is fairness, where there are some contentious and important issues that need to be explored. For example, substantial tax assistance is provided to superannuation savings. We need to consider whether the level and distribution of these concessions remains appropriate. These are the types of issues that will be considered in the upcoming Tax White Paper.

A second priority is continuing to modernise the workplace relations system.

Workplace regulation has been progressively and substantially reformed in recent decades. Many of the fundamental reforms were undertaken in the 1980s and 1990s, in particular the shift from centralised wage fixing to enterprise bargaining. These reforms have delivered substantial benefits. But elements of our workplace relations system may need to change to fit the workplaces of our future. The Productivity Commission’s Inquiry into the Workplace Relations Framework to be delivered later this year will be an important opportunity to create a modern system that will support jobs, promote productivity and lift living standards. A more flexible workplace relations system that supports the economy will help Australia respond to the challenge of lifting productivity growth. The rise of Asia, the ageing of the population and the transition away from resource-led growth will require significant adjustment. It is especially important that workplace laws are not impeding workplace transformation.

A third priority area for structural reform is driving greater competition in goods and services markets.

Previous product market reforms, and those associated with the Hilmer review in the 1990s, pushed competition into non-tradable sectors like electricity, telecommunications and rail freight. These were important changes, contributing to a GDP increase of around 2½ percentage points over the course of that decade. The proposals in Ian Harper’s draft report released in late 2014 provide the opportunity to boost Australia’s productivity performance. The final report will be released in March. Ian Harper proposes that we apply competition law and a new set of competition principles to all purchasing activities of government such as health, education and aged care. Even small improvements here, where government has a large footprint and where Australia’s population will impose greater demands on health and aged care, can deliver big benefits over time. The importance of strengthening competition was also a theme of the Financial System Inquiry. The Inquiry concludes that competition and competitive markets are at the heart of the philosophy of the financial system and the primary means of supporting the system’s efficiency. We must ensure that our banking and financial system more generally are more competitive. The Inquiry also recognised that, as the financial system becomes increasingly sophisticated and innovative, the importance of receiving appropriate financial advice and access to appropriate and competitively priced products has increased.

These are challenging issues and will require the Commonwealth and the State governments to work together.

Home Lending Up To $1.43 Trillion

Latest data from the RBA shows that home lending is worth $1.43 trillion, to end January. In the month, lending rose $8.5 billion, or 0.6%. However, investment home lending grew at 0.8%, whilst owner occupied lending grew at 0.49%. Investment lending was at a record 34.3% of total housing.

HousingAggregatesJan2015More broadly, total lending was up 0.6% from last month, and 6.2% year on year. The share of lending to business continued to fall as a share of total lending, now down to one third of all funds borrowed. This needs to be lifted if sustainable growth is to be delivered. Banks are biased toward ever more home lending, thanks to lower losses and advantaged capital requirements.

CreditAggregatesJan2015

Groupthink Stems From The Council of Financial Regulators

Behind the scenes, it is the mysterious Council of Financial Regulators which is coordinating activity across the Reserve Bank, APRA, AISC and Treasury. This body, is the conductor of the regulatory orchestra, and although formed initially in 1998, it has only had an independent website since 2013.  It is the coordinating body for Australia’s main financial regulatory agencies. It is a non-statutory body whose role is to contribute to the efficiency and effectiveness of financial regulation and to promote stability of the Australian financial system. The Reserve Bank of Australia (RBA) chairs the Council and members include the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission (ASIC), and The Treasury. The Council of Financial Regulators (CFR) comprises two representatives – the chief executive and a senior representative – from each of these four member agencies.

The CFR meets in person quarterly or more often if circumstances require it. The meetings are chaired by the RBA Governor, with secretariat support provided by the RBA. In the CFR, members share information, discuss regulatory issues and, if the need arises, coordinate responses to potential threats to financial stability. The CFR also advises Government on the adequacy of Australia’s financial regulatory arrangements. A formal charter was only adopted on 13 January 2014.

The Council of Financial Regulators (CFR) aims to facilitate cooperation and collaboration between the Reserve Bank of Australia, the Australian Prudential Regulation Authority (APRA), the Australian Securities and Investments Commission and The Treasury. Its ultimate objectives are to contribute to the efficiency and effectiveness of regulation and to promote stability of the Australian financial system.

The CFR provides a forum for:

  • identifying important issues and trends in the financial system, including those that may impinge upon overall financial stability;
  • ensuring the existence of appropriate coordination arrangements for responding to actual or potential instances of financial instability, and helping to resolve any issues where members’ responsibilities overlap; and
  • harmonising regulatory and reporting requirements, paying close attention to the need to keep regulatory costs to a minimum.

So, given the intended independence of the RBA, from Government, there is an important question to consider. How can this be seen to be true? More likely, we think there is significant potential for groupthink. In addition, no minutes of discussions are made public. We think its time for greater transparency and openness.

“Sunlight is said to be the best of disinfectants; electric light the most efficient policeman” said U.S. Supreme Court Justice Louis Brandeis. We agree.

Capex On The Slide

The ABS data released today shows the continued fall in mining expenditure, and no counterbalancing movement in other sectors. Total new capital expenditure trend estimate was $37,693 m, down 3.9% YOY.

It does not bode well. Business confidence remains low, and given that household debt is still high, we do not expect housing, and households to fill the gap. We are effectively running out of runway as mining investment trails off. So, housing is the only game in town. Given the data now, it is much more likely we will see interest rates lower for longer than previously anticipated. However, the continued reliance on unproductive lending for housing in not a recipe to drive business investment. We need some new thinking on how to stimulate business investment. Our surveys suggest that it is not interest rates which is the problem, so cutting further wont help much. APRA needs to step up here, turn to tap down on housing lending, and make business lending more likely.  The details of the ABS data are summarised below.

  • The trend volume estimate for total new capital expenditure fell 0.8% in the December quarter 2014 while the seasonally adjusted estimate fell 2.2%.
  • The trend volume estimate for buildings and structures fell 1.5% in the December quarter 2014 while the seasonally adjusted estimate fell 2.6%.
  • The trend volume estimate for equipment, plant and machinery rose 0.9% in the December quarter 2014 while the seasonally adjusted estimate fell 1.3%.
  • This issue includes the fifth estimate (Estimate 5) for 2014-15 and the first estimate (Estimate 1) for 2015-16.
  • Estimate 5 for 2014-15 is $152,656m. This is 8.6% lower than Estimate 5 for 2013-14. Estimate 5 is 0.4% higher than Estimate 4 for 2014-15.
  • Estimate 1 for 2015-16 is $109,799m. This is 12.4% lower than Estimate 1 for 2014-15.

 

The Impact of Low Interest Rates

In the UK interest rates are artificially low, and in Australia, rates were cut last month. What are the potential implications of a low interest rate policy? Is it good strategy, or a gamble?

In a speech given by Kristin Forbes, External MPC Member, Bank of England, the various impacts of ultra-low interest rates are outlined. It is worth reflecting on the significant range of implications.

By way of background, the UK, recovery is now well in progress and self-sustaining – despite continual headwinds from abroad, unemployment has fallen rapidly, from 8.4% about 3 years ago to 5.7% today, and is expected to continue to fall to reach its equilibrium rate within two years. Wage growth appears to finally be picking up, so that when combined with lower oil prices, families will, at long last, see their real earnings increase. However, one piece of the economy that has not yet started this process of normalization, however, is interest rates. Bank Rate – the main interest rate set by the Bank of England – remains at its emergency level of 0.5%. This near-zero interest rate made sense during the crisis and early stages of the faltering recovery. It continues to make sense today. But at what point will it no longer make sense? Low interest rates provide a number of benefits. For example, they make it easier for individuals, companies and governments to pay down debt. They make it more attractive for businesses to invest – stimulating production and job creation. They have helped allow the financial system to heal. They have played a key role in supporting the UK’s recent recovery. Increases in interest rates – especially after being sustained at low levels for so long – can also involve risks.

But there are also costs and risks from keeping interest rates at emergency levels for a sustained period, especially as an economy returns to more normal functioning. Interest rates sustained at emergency levels could lead to significant issues. We summarise the main arguments.

(1) inflationary pressures
Low headline inflation and stable domestically-generated inflation are unlikely to persist if interest rates remain low. The output gap is closing and there is limited slack left in the economy. The rate of wage growth is increasing – with AWE total pay growth in the three months to December of 2.1% relative to a year earlier, but 5.4% (annualised) relative to 3-months earlier. Since wages are an important component of prices and their recent pick-up has not been matched with a corresponding increase in productivity, these wage increases will support a pickup in inflation. If this pickup is gradual, as expected, inflationary pressures should only build slowly over time, so that interest rates can be increased slowly and gradually as necessary.

(2) asset bubbles and financial vulnerabilities
As rates continue to be low, especially during a period of recovery, the risks to the financial system could grow. More specifically, when interest rates are low, investors may “search for yield” and shift funds to riskier investments that are expected to earn a higher return – from equity markets to high-yield debt markets to emerging markets. This could drive up prices in these other markets and potentially create “bubbles”. This can not only lead to an inefficient allocation of capital, but leave certain investors with more risk than they appreciate. An adjustment in asset prices can bring about losses that are difficult to manage, especially if investments were supported by higher leverage possible due to low rates. If these losses were widespread across an economy, or affected systemically-important institutions, they could create substantial economic disruption.

(3) limited tools to respond to future challenges
There is less “firepower” to respond to future contingencies. There is no shortage of events that could cause growth to slow and inflation to fall in the future – and the first response is normally to reduce interest rates. Reductions in interest rates can be an important tool for stabilizing an economy. If Bank Rate remains around its current level of 0.5%, however, there is obviously not room during the next recession to lower it to the degree that has typically occurred. Bank Rate could go a bit lower than 0.5%. But rates could not be lowered by the average 3.8 percentage points that occurred during past easing cycles without creating severe distortions to the financial system and functioning of the economy. Regulators could instead use other tools to loosen monetary policy – such as guidance on future rate changes or quantitative easing. These tools are certainly viable, but it is harder to predict their impact and harder to assess their effectiveness than for changes in interest rates.

(4) an inefficient allocation of resources and lower productivity
Is there a chance that a prolonged period of near-zero interest rates is allowing less efficient companies to survive and curtailing the “creative destruction” that is critical to support productivity growth? Or even within existing, profitable companies – could a prolonged period of low borrowing costs reduce their incentive to carefully assess and evaluate investment projects – leading to a less efficient allocation of capital within companies? Any of these effects of near zero-interest rates could play a role in explaining the UK’s unusually weak productivity growth since the crisis. These types of concerns gained attention in Japan during the 1990s after the collapse of the Japanese real estate and stock market bubbles. During this period, many banks followed a policy of “forbearance”, during which they continued to lend to companies that would otherwise have been insolvent. These unprofitable companies kept alive by lenient banks were often referred to by the colourful name of “zombies”.

(5) vulnerabilities in the structure of demand
A fifth possible cost of low interest rates is that it could shift the sources of demand in ways which make underlying growth less balanced, less resilient, and less sustainable. This could occur through increases in consumption and debt, and decreases in savings and possibly the current account. Some of these effects of low interest rates on the sources of demand are not surprising and are important channels by which low interest rates are expected to stimulate growth. But if these shifts are too large – or vulnerabilities related to over consumption, over borrowing, insufficient savings, or large current account deficits continue for too long – they could create economic challenges.

(6) higher inequality
A final concern related to an extended period of ultra-accommodative monetary policy is how it might affect inequality. Changes in monetary policy always have distributional implications, but these concerns have recently received renewed attention – possible due to increased concerns about inequality more generally, or possibly because quantitative easing has more immediate and apparent distributional implications. How a sustained period of low interest rates impacts inequality, however, is far from clear cut. There are some channels by which low interest rates – and especially quantitative easing – can aggravate inequality. As discussed above, lower interest rates tend to boost asset values. Recent episodes of quantitative easing have also appeared to increase asset prices – especially in equity markets – although the magnitude of this effect is hard to estimate precisely. Holdings of financial assets are heavily skewed by age and income group, with close to 80% of gross financial assets of the household sector held by those over 45 years old and 40% held by the top 5% of households. As discussed in a recent BoE report, these older and higher income groups will therefore see a bigger boost to their financial savings as a result of low interest rates and quantitative easing. But, counteracting these effects, are also powerful channels by which lower interest rates (and quantitative easing) can reduce inequality and disproportionately harm older income groups. More specifically, one powerful effect of low rates is to reduce pension annuity rates, interest on savings, and other fixed-income payments. This disproportionately affects the older population (who relies on pensions and fixed income as a larger share of their income) and people in the middle of the income distribution (who have some savings, but less exposure to more sophisticated investments that can increase in value from lower rates). In addition to affecting the asset and earnings side of individual’s balance sheets, there can also be distributional consequences on the liability and payment side. As interest rates and the cost of servicing debt fall, individuals with mortgages and other borrowing can benefit. These benefits tend to disproportionately fall on the middle class – for which mortgage and debt payments are a higher share of total income – but can also benefit the wealthy if they have high levels of borrowing.

The full PowerPoint presentation is available here.

APRA, Start Disclosing Better Data

Each quarter APRA publishes Property Exposure for ADI’s and at first blush it looks like useful data. However, it does not provide the right lens on the the data, so some critical dimensions are missing completely.

First, we get nothing at all about Loan to Income ratios, either at a portfolio or new written loan level, when this is regarded as an essential tool is assessing true risks.

Second, we need a split between the key characteristics of investment loans versus owner occupied loans. What share are interest only loans, and how does the LVR splits stand between the owner occupied and investment sector? How do loan sizes compare between the two types?

Third, DFA believes, in the interests of good disclosure, and also as part of macroprudential management, the data should be provided at the individual lender level. They already do this for the monthly banking statistics. We know that some banks are more exposed to investment lending (and potentially exceeding 10% growth), yet the whole situation is opaque.

It is really time for proper disclosure, rather than myopic slices of data (even if contained in multiple layered spreadsheets) which mask as much as they hide. Come on APRA, lets get to the true picture.

 

$40.1 Billion (43.0 per cent) Interest-only Loans Written In 4Q 2014

APRA released their quarterly Property Exposure data to December 2014 today. We see continued strong growth in interest only loans. From DFA research we know these are mostly investment loans, despite the fact that APRA does not split out loan characteristics by investment and owner occupation. We think they should.

At a portfolio level, as at 31 December 2014, the total of residential term loans to households held by all ADIs was $1.28 trillion. This is an increase of $28.3 billion (2.3 per cent) on 30 September 2014 and an increase of $105.4 billion (9.0 per cent) on 31 December 2013. Owner-occupied loans accounted for 65.7 per cent of residential term loans to households. Owner-occupied loans were $840 billion, an increase of $14.8 billion (1.8 per cent) on 30 September 2014 and $57.6 billion (7.4 per cent) on 31 December 2013. Investment loans accounted for 34.3 per cent of residential term loans. Investment loans were $438.9 billion, an increase of $13.6 billion (3.2 per cent) on 30 September 2014 and $47.8 billion (12.2 per cent) on 31 December 2013.

Looking across the various types of ADI:

  • major banks held $1,037.3 billion of residential term loans, an increase of $23.0 billion (2.3 per cent) on 30 September 2014 and $83.7 billion (8.8 per cent) on 31 December 2013;
  • other domestic banks held $142.6 billion, an increase of $7.2 billion (5.3 per cent) on 30 September 2014 and $20.5 billion (16.8 per cent) on 31 December 2013;
  • foreign subsidiary banks held $54.3 billion, a decrease of $0.6 billion (1.1 per cent) on 30 September 2014 and an increase of $1.3 billion (2.5 per cent) on 31 December 2013;
  • building societies held $16.6 billion, an increase of $0.0 billion (0.1 per cent) on 30 September 2014 and a decrease of $0.1 billion (0.6 per cent) on 31 December 2013; and
  • credit unions held $27.9 billion, a decrease of $1.3 billion (4.5 per cent) on 30 September 2014 and an increase of $0.0 billion (0.1 per cent) on 31 December 2013.

Note that the higher growth of other domestic banks and lower growth of building societies and credit unions is in part due to the conversion of eight credit unions and one building society to banks.

ADIs with greater than $1 billion of residential term loans held 98.4 per cent of all residential term loans as at 31 December 2014. These ADIs reported 5.2 million loans totalling $1.26 trillion. The average loan size was approximately $241,000, compared to $234,000 as at 31 December 2013; $463.8 billion (36.9 per cent) were interest-only loans; and $31.5 billion (2.5 per cent) were low-documentation loans.

APRA-ADILoanPortfolioDec2014ADIs with greater than $1 billion of residential term loans approved $93.2 billion of new loans in the quarter ending 31 December 2014. This is an increase of $7.8 billion (9.2 per cent) on the quarter ending 30 September 2014 and $9.1 billion (10.8 per cent) on the quarter ending 31 December 2013. $58.4 billion (62.7 per cent) were for owner-occupied loans, an increase of $4.9 billion (9.2 per cent) from the quarter ending 30 September 2014; $34.8 billion (37.3 per cent) were for investment loans, an increase of $2.9 billion (9.1 per cent) from the quarter ending 30 September 2014;

Brokers accounted for 44.7% of loans by value, a record, since 2008. They reached an all time high of 46.7% prior to the GFC. However, if you take loan size into account, brokers continue to have a field day at the moment, thanks to high volumes and high commissions.

APRA-ADILoanNewDec2014$10.6 billion (11.4 per cent) had a loan-to-valuation ratio greater than or equal to 90 per cent; and $0.6 billion (0.7 per cent) were low-documentation loans.

APRA-ADILoanNewLVRDec2014

 

 

 

 

 

 

How Does High-Frequency Trading Impact Market Efficiency?

The Bank of England just published a research paper examining how High-Frequency Trading impacts Market Efficiency. High-frequency trading (HFT), where automated computer traders interact at lightning-fast speed with electronic trading platforms, has become an important feature of many modern financial markets. The rapid growth, and increased prominence, of these ultrafast traders have given rise to concerns regarding their impact on market quality and market stability. These concerns have been fuelled by instances of severe and short-lived market crashes such as the 6 May 2010 ‘Flash Crash’ in the US markets. One concern about HFT is that owing to the high rate at which HFT firms submit orders and execute trades, the algorithms they use could interact with each other in unpredictable ways and, in particular, in ways that could momentarily cause price pressure and price dislocations in financial markets.

Interactions among high-frequency traders Evangelos Benos, James Brugler, Erik Hjalmarsson and Filip Zikes

Using a unique data set on the transactions of individual high-frequency traders (HFTs), we examine the interactions between different HFTs and the impact of such interactions on price discovery. Our main results show that for trading in a given stock, HFT firm order flows are positively correlated at high-frequencies. In contrast, when performing the same analysis on our control sample of investment banks, we find that their order flows are negatively correlated. Put differently, aggressive (market-“taking”) volume by an HFT will tend to lead to more aggressive volume, in the same direction of trade, by other HFTs over the next few minutes. For banks the opposite holds, and a bank’s aggressive volume will tend to lead to aggressive volume in the opposite direction by other banks. As far as activity across different stocks is concerned, HFTs also tend to trade in the same direction across different stocks to a significantly larger extent than banks.

We find that HFT order flow is more correlated over time than that of the investment banks, both within and across stocks. This means that HFT firms tend more than their peer investment banks to buy or sell aggressively the same stock at the same time. Also, a typical HFT firm tends to simultaneously aggressively buy and sell multiple stocks at the same time to a larger extent than a typical investment bank. What does that mean for market quality? A key element of a well-functioning market is price efficiency; this characterises the extent to which asset prices reflect fundamental values. Dislocations of market prices are clear violations of price efficiency as they happen in the absence of any news about fundamental values.

Given the apparent tendency to commonality in trading activity and trading direction among HFTs, we further examine whether periods of high HFT correlation are associated with price impacts that are subsequently reversed. Such reversals might be interpreted as evidence of high trade correlations leading to short-term price dislocations and excess volatility. However, we find that instances of correlated trading among HFTs are associated with a permanent price impact, whereas instances of correlated bank trad- ing are, in fact, associated with future price reversals. We view this as evidence that the commonality of order flows in the cross-section of HFTs is the result of HFTs’ trades being informed, and as such have the same sign at approximately the same time. In other words, HFTs appear to be collectively buying and selling at the “right” time. The results are also in agreement with the conclusions of Chaboud, Chiquoine, Hjalmarsson, and Vega (2014), who find evidence of commonality among the trading strategies of algorithmic trades in the foreign exchange market, but who also find no evidence that such commonality appears to be creating price pressures and excess volatility that would be detrimental to market quality.

A final caveat is in order. The time period we examine is one of relative calm in the UK equity market. This means that additional research on the behaviour of HFTs, particularly during times of severe stress in equity and other markets, would be necessary in order to fully understand their role and impact on price efficiency.

DFA’s perspective is a little different. The underlying assumption in the paper is that more transactions gives greater market efficiency, and therefore HFT is fine. We are not so sure, as first the market efficiency assumption should be questioned, second it appears those without HFT loose out, so are second class market participants – those with more money to invest in market systems can make differentially more profit. This actually undermines the concept of a fair and open market. We think HFC needs to be better controlled to avoid an HFC arms race in search of ever swifter transaction times. To an extent therefore, the paper missed the point.