How Aussie Banks Could Trigger a Property Crash

How Aussie Banks Could Trigger a Property Crash

The biggest lie in the Australian economy at the moment is that the next move in interest rates will be up.

Yet while the Big Four banks may move their interest rates higher, the Reserve Bank of Australia won’t.

There’s a consensus among analysts that the RBA has to move rates up soon because they can’t stay at 1.50% forever.

That’s true.

But the cash rate can go lower…and that’s exactly what the RBA is likely to do next.

I’ll explain why…

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The typical argument goes that if rates stay too low for too long, they’ll make property prices even more unaffordable. People will spend recklessly because low rates encourage borrowing. And they’ll ramp up debt-fuelled spending if rates stay low for much longer.

Well, that’s already happened.

Total household debt-to-income in Australia is at 199.7%. That’s one of the highest rates in the world, according to UBS, an investment bank.

Currently, Aussies owe $2.46 trillion in bank loans and credit facilities. Of that, $1.6 trillion is wrapped up in outstanding mortgage debt.

Yet, with debt at record levels, it appears we have exhausted growth in the form of credit-driven consumption.

As a result, it’s a risky time in the Aussie economy.

Consumption data is showing that Australians are tapped out. And retail spending in Australia is growing at a very slow rate — last seen during the financial crisis.

Furthermore, the inflation rate is at 1.9% — well under the RBA’s 2–3% target.

While I’m often highly suspect of official statistics, these figures go some way to show how little consumers are spending.

Any rate increase from the RBA would further slow consumer spending. Yet there’s zero chance that the RBA will want to hamper economic activity.

Which means that it’s all up to the big Aussie banks to change lending rates.

Aussie banks control the mortgage market now

Over the past four years, Aussie banks have set the lending rate in Australia, not the Reserve Bank.

This disconnect first appeared in July 2014 when the RBA cash rate was at 2.50%.

After two years of campaigning to distance itself from the RBA, ANZ finally announced it would hold a panel once a month to set its own interest rate regardless of what the RBA did.

People were furious.

Shortly after, HSBC chief economist Paul Bloxham told The Age this would allow ANZ to pass on rate hikes to customers faster, rather than waiting for the RBA to move. Bloxham added that he and other analysts were tipping that the next rate hike at the time would come in the first quarter of 2015. Which is interesting because, come February 2015, the RBA dropped the cash to 2.25%.

By December 2014, the three other major banks all quietly announced they would set their own interest rate policy regardless of the RBA’s decisions.

Since ANZ made its move in 2014, the official RBA cash rate has fallen to 1.50%.

Low wages, low savings, many problems

It was only a month ago that current RBA chief Philip Lowe told an audience in Perth that, for the cash rate to go higher, wages must grow.

Wage growth has been falling since 2014, and currently sits at 2.1% a year.

Not only that but Aussies have so much debt that a 0.25% increase today would have the equivalent impact of one three times higher.

Australians are so billed up that the RBA are handcuffed to the fact that a standard quarter-of-a-percent increase could cripple the market.

What’s more, amid this low-rate, low-wage growth environment, the savings rate has been falling.

The Australian household savings ratio — the ratio of income saved to household net disposable income — fell to 2.7% in January this year. In 2014, shortly before the ANZ changed its rate policy, the savings ratio was nearing 10%.

All told, the Aussie economy is in a precarious state. But it’s nonetheless functioning in spite of the low wage growth, the low cash rate and the complete absence of savings.

How long can this hold true?

In my view, it’s merely setting the stage for a spectacular meltdown.

What may bring Australia’s debt problems to a head may ultimately have nothing to do with the RBA…and everything to do with the Aussie banks…

Most major banks around the world care about one thing: expanding their balance sheets. They like making money. And in order to do that, they must lend money. So they whip up some zeroes on a computer and lend them out to ever-riskier borrowers, charging interest on top.

In days gone by, banks would lend out money based on deposits held. But banks can’t grow as quickly as they want using deposits alone, especially when the savings rate is shrinking.

In order to meet loan demand, banks will often seek offshore funding from institutional lenders overseas. This is a normal part of the banking industry. And banks, too, must pay back those loans with interest.

During the good times, this isn’t a problem. You just roll the debt over.

In the bad times, well, you’ve got a real problem on your hands. And all you need is one catalyst to make the whole system implode.

Savings are low. And wage growth is hindering people’s ability to increase how much they save.

But banks need to lend money to make money, not least because they owe around $750 billion in offshore debt.

Unfortunately, this debt is at the mercy of rising global interest rates.

How central banks could crash the Aussie property market

Major central banks around the world are increasing interest rates.

The Bank of England began raising rates last year. The Bank of Canada has raised rates four times in the past eight months. And the Federal Reserve Bank has jacked up the base rate six times in the past two-and-a-half years. The Fed now has the cash rate sitting at 1.50% (at parity with Australia), with a potential move to 2.25–3% by 2020.

All of these rate increases by central banks will increase the amount of interest Aussie banks have to pay back.

The banks’ loan costs are going up because their offshore debt is costing more as global interest rates go up while Aussie wages remain stagnant.

Regardless of what the RBA does, Aussie banks must meet their debt obligations, especially as those costs are rising.

To stay in the black, Aussie banks will pass on those costs to you and me.

In spite of assurances from the RBA and the Australian Prudential Regulation Authority that we have plenty in the kitty to survive as rates head higher locally, the low rate of consumption and falling savings rate suggests that Aussie households are under much more pressure than official data would have us believe.

Which makes the loud calls for the RBA to raise rates downright irresponsible.

The RBA barely affects house prices anymore. And the big banks now move their rates independent of the RBA.

What happens to the Aussie property market — and indeed the wider economy — from here all rests on decisions made by international central banks.

Kind regards,

Shae Russell Signature

Shae Russell,
Editor, The Daily Reckoning Australia