15 February 2018
Australia – from the bottom to the top in debt stakes
The chart below shows the level of household debt (mortgage, credit card and personal debt) relative to annual household disposable income for major countries.
Why has debt gone up so much in Australia?
It’s not quite as bad as it looks
- Firstly, higher debt partly reflects a rational adjustment to lower rates and greater credit availability via competition.
- Secondly, household debt has been rising since credit was first invented. It is unclear what a “safe” level is. This is complicated because income is a flow and debt is a stock which is arguably best measured against the stock of assets or wealth.
- And on this front, the rise in the stock of debt levels has been matched by a rise in total household wealth in Australia. Thanks to a surge in the value of houses and a rise in financial wealth, we are far richer. Wealth rose 9.5% last year to a new record. The value of average household wealth has gone from five times average annual after tax household income in 1990 to 9.5 times today.
- Fourthly, Australians are not having major problems servicing their loans. According to the Reserve Bank’s Financial Stability Review non-performing loans are low and Census and Household Expenditure Survey data shows that mortgage stress has been falling. Of course, this may reflect low mortgage rates with interest costs as a share of income running a third below its 2008 high.
- Fifthly, debt is concentrated in higher income households who have a higher capacity to service it. This is particularly the case for investment property loans.
- Sixthly, a disproportionate share of the rise in housing debt over the last 20 years owes to investment property loans. As servicing investment loans is helped by tax breaks the debt burden is not even as onerous.
- Finally, lending standards have not deteriorated to the same degree in Australia as they did in the US prior to the GFC where loans were given to NINJAs – borrowers with no income, no job and no assets.
So what are the risks?
- Higher interest rates – the rise in debt means moves in interest rates are three times as potent compared to say 25 years ago. Just a 2% rise in interest rates will take interest payments as a share of household income back to where they were just prior to the GFC (and which led to a fall in consumer spending). However, the RBA is well aware of the rise in sensitivities flowing from higher debt and so knows that when the time comes to eventually start raising rates (maybe later this year) it simply won’t have to raise rates anywhere near as much as in the past to have a given impact in say controlling spending and inflation. And so, it’s likely to be very cautious in raising rates (and is very unlikely to need to raise rates by anything like 2%.)
- Rising unemployment – high debt levels add to the risk that if the economy falls into recession, rising unemployment will create debt-servicing problems. However, it is hard to see unemployment rising sharply anytime soon.
- Deflation – high debt levels could become a problem if the global and local economies slip into deflation. Falling prices increase the real value of debt, which could cause debtors to cut back spending and sell assets, risking a vicious spiral. However, the risk of deflation has been receding.
- A sharp collapse in home prices – by undermining the collateral for much household debt – could cause severe damage. Fortunately, it is hard to see the trigger for a major collapse in house prices, ie, much higher interest rates or unemployment. And full recourse loans provide a disincentive to just walk away from the home and mortgage unlike in parts of the US during the GFC.
- A change in attitudes against debt – households could take fright at their high debt levels (maybe after a bout of weakness in home prices or when rates start to rise) and seek to cut them by cutting their spending. Of course, if lots of people do this at same time it will just result in slower economic growth. At present the risk is low but its worth keeping an eye on with Sydney and Melbourne property prices now falling. But high household debt levels are likely to be a constraint on consumer spending.
While the surge in household debt has left Australian households vulnerable to anything which threatens their ability to service their debts or significantly undermines the value of houses, the trigger for major problems remains hard to see. However, household discomfort at their high debt levels poses a degree of uncertainty over the outlook for consumer spending should households decide to reduce their debt levels.
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