Social Trends – Page 167 – Digital Finance Analytics (DFA) Blog

Economic Implications of High and Rising Household Indebtedness

The Reserve Bank of New Zealand just published an interesting report on this important topic. High and rapidly rising levels of household debt can be risky. A high level of debt increases the sensitivity of households to any shock to their income or balance sheet. And during periods of financial stress, highly indebted households tend to cut their spending more than their less-indebted peers. This can amplify a downturn and helps to explain why many advanced economies since the 2008-09 crisis have had subdued recoveries. Financial institutions can suffer direct losses from lending to households, although these losses are rarely enough on their own to cause a systemic banking crisis. The sustainability of household debt can be assessed best by looking at data detailed enough to build a picture of how debt and debt servicing capacity is distributed across different types of borrowers.

Households, either individually, or in aggregate, can ‘over-borrow’, and financial institutions can ‘over-lend’ to them. A high level of household debt can affect both the financial system and the economy in several ways that are explained in this article.

Two sets of comparative data makes interesting reading. First, household debt-to-disposable income ratio – by country. Cross-country comparisons of debt levels need to be treated with caution, given a variety of measurement issues and different institutional features. That said, the rise in household debt in New Zealand over the last cycle was not exceptional compared to other countries, and Australia is higher.Second, Household debt-to-income ratios – selected countries. The Reserve Bank comments that “in quite a few countries there was no domestic financial crisis and little sustained fall in house prices. Policymakers in several of these economies, including New Zealand, have subsequently become concerned by household sector developments over the past several years – developments underpinned by low interest rates and an easing in lending standards. Household debt levels have started to increase from already high levels, while house prices are growing from a starting point of ‘over-valuation’.

The implementation of an LVR speed limit in New Zealand reflected emerging developments in the housing market that if left unchecked, could have threatened future macroeconomic stability. Some other jurisdictions have also used new macro-prudential tools, in combination with improving the existing underlying prudential framework. In addition to LVR restrictions, other measures include: maximum debt servicing-to-income limits, maximum debt to-income limits, higher risk weights on banks’ housing loans and prudent (or responsible) lending guidelines.

They conclude that:

“This article has focused on the various channels through which household debt can affect the financial system and broader economy. In this sense, households can ‘over-borrow’, although this is often not apparent in ‘real time’ and excess debt levels can lead to, or aggravate, economic downturns or periods of financial distress. The relationship between household indebtedness and consumption volatility is important for the macroeconomy, because it means that the behaviour of highly indebted households during periods of financial duress can amplify downturns. While historical evidence suggests losses on household lending are rarely the sole factor in systemic banking crises, housing-related credit booms and busts often occur alongside booms and busts in other sectors such as the (much riskier) construction and commercial property sector. It is also worth noting that, over time, housing loan portfolios have become a larger share of bank lending in many countries, including New Zealand, increasing their potential to play a larger part in future financial crises. Thus household debt is an important area of focus from a financial stability perspective.

Good micro-level household data provide an important window into how debt and debt servicing capacity is distributed across the household sector, and are also helpful for carrying out simple stress-tests of the sector using a range of large, but plausible shocks. New Zealand’s data in this area are improving. Data from the Household Economic Survey show a rise in the proportion of borrowers with a high LVR and high debt-to-income ratio, thereby supporting the view that LVR speed limits have been appropriate to curtail risks to financial stability. The Reserve Bank will continue to develop its framework for analysing household sector risk and vulnerabilities.”

Latest DFA Survey – Drilling Down On Overseas Investors

Over the next few days we will be posting the results of our latest household surveys. We are going to start with the hot investment segment, and look specifically at the vexed question of the proportion of overseas investors buying investment property for the first time. This is a tough data set to capture, because by definition such households are hard to contact, or prefer not to talk and they do not use an Australian mortgage. However, we devised a proxy set of questions focussing on funding sources, and as a result we now have a view of the proportion of first time investors in the market, and the overseas mix.

Taking the January data as a starting point, ABS tells us that there were 5,961 loans to owner occupied purchasers. In addition, we identified a further 3,661 first time buyers getting a mortgage for investment purposes. These amount to 35% of loans who are not identified as first time buyers in the ABS data, but are in the overall loan volume data. 8%, or 850, require no mortgage at all, and do not show in the mortgage statistics. We would need reliable purchase transfer records to get at the true picture, something not readily available.

From our surveys we teased out the funding options that first time buyers went with. 36% of deals used an interest only mortgage, 41% used a standard repayment mortgage, but the rest, 850 transactions (8%) did not require mortgage funding from an Australian bank but rather used other sources including parents, or were an overseas purchase.

We can dissect these purchases based on funding. About 125 were local purchasers without finance, over 200 were financed by parents and under 100 financed from other sources. However the most significant number was the 415 by overseas investors, using funding from offshore.

Looking at these 850 transactions through the lens of our surveys, we found that more than 550 were in NSW, more than 200 in VIC and a few sprinkled across the other states. This equates to about 4% of all first time buyers and 9.2% of investor first time buyers. Enough to more than move the dial, especially given the concentration in Sydney.

Next time we will look at investor motivations, and future plans. We think the investment housing boom is likely to continue to run, as more investors get the bug.

ASIC puts payday lending industry on notice to lift standards

ASIC today released a report Payday lenders and the new small amount lending provisions that found that payday lenders need to improve compliance with some of the key consumer protection laws operating in the industry. As at December 2014 there were approximately 1,136 Australian credit licensees that identified that they operate in the payday lending industry (out of a total of 5,842 Australian credit licensees). This figure has declined slightly (by about 6%) over the last 12 months.

Nine of the 13 payday lenders in the review have also diversified their business since the new cap-on-costs provisions commenced. Other business interests and products offered identified in the review include:

medium amount loans;
other credit contracts;
cheque cashing;
gold buying;
purchasing delinquent debts;
secured loans; and
pawnbroking.

ASIC’s review of 288 consumer files for 13 payday lenders – who are responsible for more than 75 per cent of payday loans made to consumers in Australia – found some lenders engaging in conduct that risks breaching responsible lending obligations. 187 recorded the consumer’s purpose for the loan.

While ASIC’s review found compliance with some rules was working, it also found that payday lenders are falling short in meeting important new obligations introduced as part of the small amount lending reforms in 2013.

ASIC’s review found particular compliance risks around the tests for loan suitability, which must be considered when the consumer has multiple other payday loans or is in default under a payday loan.

The review also identified concerns where payday lenders set their loan terms at 12 months or more, thereby charging the consumer more fees, in circumstances where a consumer had requested a shorter term and paid the loan back in that shorter time.

The report also found systemic weaknesses in documentation and record keeping, including around the issue of the consumer’s objectives and needs.

ASIC’s review found better levels of compliance with some regulations, including the requirement to provide a warning about alternative credit options and the income protection rules for Centrelink recipients.

ASIC’s review follows a series of enforcement actions against payday lenders, including the recent Cash Store decision which saw penalties of almost $19 million handed down by the Federal Court for irresponsible lending and unconscionable conduct.

Following the work and the conduct that has been uncovered ASIC has commenced investigations and further follow-up work in certain cases, and will consider enforcement action or other regulatory action.

ASIC became the national credit regulator in 2010. Tighter consumer credit rules for small amount lending were introduced in 2013.

ASIC has focused on three areas of misconduct in the payday lending sector:

irresponsible lending
avoidance through business models that attempt to circumvent the law, and
unfair fees and misleading advertising.

Since 2010, ASIC enforcement action has resulted in close to $2 million in refunds to more than 10,000 consumers who have been overcharged when taking out a payday loan. Payday lenders have also been issued with 13 infringement notices totalling approximately $120,000 in response to ASIC concerns about their compliance with the credit laws.

ASIC notes the 2013 small amount credit reforms will be independently reviewed after 1 July 2015. ASIC will continue its focus on enforcing the current provisions and raising industry standards.

Unemployment Stays at 6.3% (Trend) – ABS

The ABS released the Labour Force data for February, today. Australia’s estimated seasonally adjusted unemployment rate for February 2015 was 6.3 per cent, compared with 6.4 per cent for January 2015. In trend terms, the unemployment rate was unchanged at 6.3 per cent.

The seasonally adjusted labour force participation rate decreased to 64.6 per cent in February 2015 from 64.7 per cent in January 2015.

The ABS reported the number of people employed increased by 15,600 to 11,652,400 in February 2015 (seasonally adjusted). The increase in employment was driven by increases in both full-time (up 10,300) and part-time employment (up 5,300). Seasonally adjusted employment increased for both males (up 9,300) and females (up 6,300) in February 2015.

The ABS seasonally adjusted aggregate monthly hours worked series increased in February 2015, up 13.0 million hours (0.8%) to 1,620.8 million hours.

The seasonally adjusted number of people unemployed decreased by 15,800 to 777,300 in February 2015. The decrease was driven by those looking only for part-time work, down 18,600.

The seasonally adjusted underemployment rate was 8.6 per cent in February 2015, a decrease of 0.1 percentage points from November 2014 based on unrounded estimates. Combined with the unemployment rate of 6.3 per cent, the latest seasonally adjusted estimate of total labour force underutilisation was 14.9 per cent in February 2015, a decrease of 0.1 percentage points from November 2014.

Note that The February 2015 data incorporates estimates rebenchmarked to the latest population estimates and projections. Commencing from the May 2015 issue this will be a regular quarterly process which will ensure that the Labour Force series reflect the most up to date population benchmarks. So further tweaks to the data have been made, making series comparisons difficult.

Hot Sydney Market Distorts National Property Picture

The CoreLogic RP Data Market Summary to 8th March highlights the disparity between the Sydney market and other capital cities. For example, the monthly lift in prices was 1.3% in Sydney, compared with a combined capital city change of 0.2%. It should also sound a warning, if the London market is anything to go by.

Auction clearance rates in Sydney were at 83.3%, compared with a weighted average of 73%, and half of all properties sold were in Sydney (677 out of 1,227).

The average house price in Sydney has now broken above $800,000, compared with a combined average of $596,677. A word of warning, parallels have been drawn between Sydney and the London property markets in recent time. So, its worth reflecting on this commentary relating to the London market.

Further evidence is emerging that the central London housing market bubble has burst and price falls are spreading throughout the rest of Greater London, the latest index suggests. Prime central London prices are still falling as the supply of properties rises and confidence in property as an investment ebbs away,’ according to the data from Home.co.uk. Central London locations dominate the latest list of biggest house price falls across the UK, with Walworth in the London Borough of Southwark seeing a 15% fall in average house prices between January 2014 and January 2015.

House prices in Belgravia fell by 10.3% over the same period and Cromwell Road in Kensington saw a slump of 8.3%. Of the 20 UK areas with the biggest annual fall in sales prices, 11 are in London. Landlords’ return on investment on central London properties is also falling. Of the 15 UK locations recording negative real % yield, which occurs when the value of the property depreciates by more than the annual rent, 12 are in central London.

The index shows that in January 2015, landlords with a property in Walworth recorded a negative real % yield of 11.3%, while in Belgravia the negative real % yield stood at 7.1%.

Central London flat prices are among the hardest hit. On average, the price of a flat fell by 9% in central London between January 2014 and January 2015. Over the same time, the number of flats for sale in central London has increased by 64%.

Since November 2013, the price of a typical flat in Belgravia has fallen 20%, from £1,995,000 to £1,600,000. A similar price correction has already spread into Islington, where the typical asking price of a flat has dropped 11% since March 2014. This represents a loss of £85,000 for flat buyers in Islington over the last 10 months.

There is further evidence that price falls are rippling out to more remote areas of Greater London and look set to spread further into the South East. The spectre of negative equity is looming large for recent buyers.

Further out in Greater London, Holloway flat prices peaked in May 2014 but have since dropped by 13%, while the typical time on market for flats in the area has more than doubled. Meanwhile, Muswell Hill in North London has seen flat prices fall 4% since October last year.

‘Optimism in the UK housing market is still riding high in the rest of the country, but it comes as a shock to many to learn that prices are?crumbling in the most expensive streets in London,’ said Doug Shephard, Home.co.uk director.

‘These price movements may soon have a knock-on effect for the rest of Greater London and, later, the Home Counties,’ he added, pointing out that prices in central London went up too far, too fast during 2012 and 2013.

‘In a synthetic property boom and bust such as London has experienced, on account of ultra-low interest rates and other stimulus measures, it is hard to imagine any possible remedial action on the part of the government. Prices this time may simply have to fall back to a more natural equilibrium,’ he added.

It’s The Supply Side Stupid!

Housing is, no surprise, an issue in the NSW election, with Baird promising to facilitate a small number of extra homes (20,000 over 4 years) and Labor talking about deferring stamp duty for first time buyers.

Here is the thing. DFA modelling for NSW indicates we need an additional 150,000 homes in and around Sydney, each year, for the next three years, just to bring things back to equilibrium. Many of these should be starter homes in the inner suburban area, not on the urban fringe. We also need properties designed for older less mobile households. Our modelling takes account of net migration, demographic shifts, and household preferences. In particular we know there is demand for units and small houses in the inner suburban area, from both first time buyers and investors.

We do not believe that further “assistance” to first time buyers, whether via stamp duty, or access to super, per Hockey’s comments recently have any economic merit (more likely they should be seen as dog whistle politics).

Anything which eases the purchase price will simply lift the price, as for example in the now defunct first time buyer incentives.

The right question is how will policy be changed to release more land for development, and how will planning regulations be tweaked to allow the development of starter homes. How many will be built? If the answer is not in the 100,000’s we do not have the right answer. Such an inflection in supply would have a dampening effect on house price growth.

The root cause of the current issues in property in NSW goes back to pure Economics. Simply put, supply and demand are out of kilter.

On the supply side, not enough property is being constructed to meet increasing demand from local and overseas purchasers. Either space is a problem, land releases have not kept pace, or builders cannot get funding.

Demand is being stoked by demographic shifts, like more single households, older independents and young families. Also, investment purchasers see property as a good hedge against wider uncertainty, so are very active. Many can enjoy tax breaks. Plus Chinese investors have become a major force.

Thanks to the banks, purchasers can borrow more, and this lifts prices. First, low interest rates are making larger mortgages more affordable. Second, they have been able to increase the supply of home lending credit, thanks to lower capital rules, especially for those using the most sophisticated capital management. Next, they see risks in property lending much lower than commercial lending, so are happy to skew their portfolio. Finally, they have changed their lending criteria (although some regulators are pushing back), making larger loans possible, for some.

As a result, rising property prices are artificially lifting bank and household balance sheets. History shows that prices won’t necessarily defy gravity for ever. If they do correct there could be significant consequences for households, banks and the community.

We need proper supply-side strategies.

Limits To Low Interest Rate Policy

In a recent speech, “Low Inflation in a World of Monetary Stimulus” RBA Deputy Governor Philip Lowe highlighted the impact of low interest rates. Significantly he observes that low interest rates are not translating into buoyant consumer spending. As a result, such monetary policy will not necessarily deliver the desired economic outcomes.

One area where low interest rates do appear to be having the broadly expected effect is on asset prices: global equity markets have been strong; property prices are again recording solid gains in some countries; and bond prices have increased substantially. However, for these increases in asset prices to boost the global economy, households and businesses need to respond by increasing their spending. While in the United States there are now some signs that this is happening, on the whole the response of private spending to higher asset prices has been muted.

Overall, looking at this experience, I find it difficult to escape the conclusion that changes in interest rates are not affecting decisions about spending and saving in the way they might once have done. Undoubtedly, low interest rates are helping to repair balance sheets by lowering debt-servicing costs and by pushing up asset prices. In so doing, they are helping lay the foundations for future growth in consumption and investment. But, while this repair process is taking place, consumption is weaker than it otherwise would be. In turn, subdued consumption growth is feeding through to a more subdued business climate and weaker investment.

Arguably, a similar dynamic has been playing out in government finances in a number of countries. After the financial crisis, many governments found themselves with debt levels that were very high. Like many households, they have responded by tightening their belts. Given the high levels of debt and ongoing imbalances between recurrent revenue and expenditure, few governments have seen the very low interest rates as an opportunity to support long-term infrastructure investment at low cost. Rather, much as households have done, governments have taken advantage of the lower debt-servicing costs to help shore up their finances.

He concludes that low interest rate monetary policies are unlikely to succeed.

Finally, stepping back from the short term, the low interest rates we are seeing globally and in Australia are a direct consequence of an elevated appetite for saving and a muted appetite for real investment in many economies. Monetary policy globally has responded to this reality in a way that a decade or so ago would have hardly seemed imaginable. In doing so it has helped the global economy through a very difficult period. But, at the end of the day, the solution to the problems caused by the disconnect between the desire to save and the desire to invest cannot lie with monetary policy. Instead, it lies in measures to improve the investment environment so that once again there is strong productive demand for the use of our societies’ savings.