The RBA Dynamic Duo Just Crashed into a Tree

australian real-estate development
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US markets ended the overnight session in the red, as investors worried about the thought of higher interest rates. The correction that I said was coming yesterday is still in its early stages.

Aussie stocks lost nearly 1% yesterday. They’re set for further falls today. The ASX 200 is on its way to 5,000 points again. Whether this level holds or not is an important consideration. A decent break below here will signal the onset of a much deeper and longer bear market than most people expect.

Driving this pessimistic stock market mood is a structurally weak Aussie economy. From today’s Financial Review:

Treasury is preparing a major downward revision of Australia’s trend economic growth rate because of faltering population growth in a major shift that implies an even greater blowout in the budget deficit over the next decade.

As I’ve often explained, population growth in Australia over the past decade has provided a huge boost to the economy. Thanks to Australia’s relatively strong economic performance, immigration levels have been very strong.

High levels of immigration help to increase demand and economic growth without politicians having to do anything. Instead, they spend their time desperately trying to stay in power, while ignoring the need for structural reforms.

Structural reforms lead to productivity growth, which is the main long term driver of economic growth and national prosperity. So when the economy turns down and people stop flooding into the country looking for work, as is happening now, increased productivity helps the economy to keep growing.

But as you know, for a long time now both sides of politics avoided difficult structural reforms. Instead, they sat back and gorged on the China driven boom. They opted for population growth to drive economic growth, and watched our infrastructure-depleted cities clog up with inefficiencies.

Now, Treasury realise that this poor long term governance will result in lower long term growth and a weaker budget position.

Treasury has no doubt known this for some time. But the new government under Malcolm Turnbull has probably given them the nod to build this scenario into their forecasts, and to publicly talk about it. It will help him sell the need for things like tax reform, which is currently on the agenda.

Unfortunately, the Aussie population has grown fat and stupid on the boom — first in mining and now, thanks to the RBA, the boom in residential property. Whether we’re ready for reform that chips away at the power of the rentier class remains to be seen. I have my doubts.

Speaking of the RBA, the Dynamic Duo was at it yesterday. That is, boss Glenn Stevens and his heir apparent, Phillip Lowe, both gave speeches at separate events.

Stevens delivered another great central banker speech containing a lot of words but not much substance.

He basically reiterated the points he’s made on plenty of occasions previously. That is, prosperity comes from productivity, and that comes from structural reforms.

While this has nothing to do with interest rates, Stevens did say that if anything, the next move in interest rates would be down.

I would add that with household debt levels already so high, lower interest rates actually work against the need for structural reform. Falling interest rates lead to an increase in debt and higher asset prices. It incentivises capital to chase speculative returns, rather than engage in productivity enhancing investment.

But don’t ever expect to hear this truth uttered by a central banker. They are the status quo and their job is to protect the status quo.

If you had any doubts about the banks’ incompetence, you only have to check out Phillip Lowe’s speech.

Unbelievably, he explained how the RBA was ‘surprised’ at the poor quality of housing loan data held by the big banks.

Umm, did they not see what happened to loan quality and documentation when interest rates fell dramatically in the US in 2005/06?

Even the most simple-minded drooling idiot knows that easy money causes banks to lower lending standards and give money to whoever asks for it. After all, if property secures the loan, it’s all good. Property never goes down!

Apparently this is news to the people at the centre of the banking system though. Which just goes to show why the banks always win. The commercial minds running these companies are so far in front of the regulators it’s not funny.

Anyway, here’s Lowe’s incredulity:

…over the past six months there have been very large upward revisions to the value of investor loans outstanding, with offsetting downward revisions to owner-occupier loans. Material revisions have been made by more than 10 institutions, including two of the largest lenders. The scale of these revisions can be seen in Graph 1, which shows the stock of investor credit outstanding as reported in each of May, June and September this year. The cumulative effect of the upward revisions has been to increase the stock of investor credit outstanding by around $50 billion, or 10 per cent. According to these new data, investor loans now account for 40 per cent of total housing loans outstanding, not the 35 per cent reported earlier in the year.

Source: RBA

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The second data issue has emerged over the past couple of months and has worked in the other direction, with lenders reporting that some loans that were previously recorded as investor loans were really loans to owner-occupiers. This is partly because, when faced with the higher interest rate on investor loans, some borrowers have indicated to their bank that they are not an investor, but rather an owner-occupier, and so should not have to pay the higher rate.

 The effect of these recent reclassifications on measured growth rates can be seen in Graph 2. Taken at face value, the data suggest a very sharp slowing in growth in investor credit and a sharp pick-up in owner-occupier credit (shown as the dotted lines). However, if we make adjustments for these reclassifications then the changes in growth rates are much less pronounced (the solid lines).

Source: RBA

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Lowe says it’s ‘disappointing’ that lenders haven’t been up to the task of reporting on home loans properly.

‘Disappointing’? They’re having a massive laugh at you!

This is what low interest rates do, fellas. We’ve seen it all before. Low interest rates cause individuals and banks to game the system. This relies on regulators who are asleep at the wheel.

Waking up after driving into a tree is a little too late. That’s exactly what’s happened here. The RBA and the banking regulator, APRA, dozed through the housing boom, so intent were they on achieving a rebalance of growth away from mining.

They only managed to cause greater problems, which we are just starting to experience now.

They should all be sacked for incompetence, of course. But who would replace them?

That’s the problem, isn’t it? The regulators are a part of the status quo too. The establishment works for each other, not for you and me.

Regards,

Greg Canavan

For The Daily Reckoning

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Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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