Savings

We need to change direction - our housing credit bubble is leaving business behind

Interesting article by Christopher Joye in the AFR today - see below - calling out our policy makers for spurring on our consumer credit bubble. Businesses are left behind.

It really matters that credit should be available for business purposes to finance growth. But our system allows banks to leverage house loans 40 times compared to 'only' 10 times for an SME loan.

So small-medium sized businesses that employ must of us don't get a look in...unless they own some real estate of course.

BANK LENDING TO SMES IS IN LONG TERM DECLINE GLOBALLY AND IN AUSTRALIA – OUR BANKS HAVE TURNED INTO BUILDING SOCIETIES AND THIS IS HOLDING BACK OUR ECONOMY

Our banks only want to lend against houses. Since 2013, only 11% of new business lending in Australia has gone to small businesses with little growth:

  • Most of the $900bn of loans outstanding to businesses goes to the big end of town
  • $269bn lent to SMEs is swamped by over $1,500bn in residential mortgage lending
  • Banks see SMEs as a critical source of cheap deposits – SME deposits far outweigh SME loans
  • But SMEs employ the bulk of our workforce

Due to global regulatory capital rules (Basel III), mortgages are more than 3 times more profitable than SME loans:

  • Real estate carries a risk weighting of 25% but SME loans require 100% (75% if backed by real estate)
  • Banks have effectively withdrawn from their original purpose: facilitate commerce

Meanwhile SME growth and employment is constrained by lack of cashflow facilities:

  • Banks will only lend to SMEs with real estate security which is a problem in a service based economy
  • The ATO/taxpayer is forced to act as lender of last resort (ATO is owed $12.5bn in tax by SMEs and growing rapidly)
  • Tight cashflow holds back growth:

The RBA is blowing the mother of all bubbles

Can history be repeated? A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966". RICHARD DREW

Can history be repeated? A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966". RICHARD DREW

by Christopher Joye

With US employment growth again surprising forecasters and the jobless rate declining to a boom-time 4.7 per cent, below "full-employment", the question is whether central banks, and the Federal Reserve in particular, are "behind the curve".

In research this week Goldman Sachs assessed this using a framework previously advocated by Fed chair Janet Yellen. Goldman found "the Fed's current policy stance is about 1 percentage point easier than prescribed by a Taylor rule that uses a depressed neutral rate" and about 3 percentage points easier when adopting a more normal neutral cash rate of about 4 per cent. The latter assumption "implies that the current policy stance represents the largest dovish policy deviation since the 1970s", which coincided with an inflation break-out.

"The implication that current policy is somewhat 'too easy' is consistent with the fact the [US] financial conditions index remains easier than average and is still delivering a positive growth impulse at a time when the Fed is trying to impose deceleration," Goldmans said.

The investment bank warns "history counsels caution about falling behind" with the experience of the mid 1960s suggesting that inflation increases much more quickly at very low unemployment rates. Back then, years of benign inflation gave way to a sudden spike as the Fed wilted under political pressure not to aggressively tighten rates. A mistake was cutting rates after the Fed's initial rate hikes "led to a sharp downturn in the housing market in 1966".

Federal Reserve Chair Janet Yellen: The third rate hike since the 2007-2009 recession was well telegraphed. Andrew Harnik

Could history repeat itself? Much hinges on policymakers' humility. Central bankers are not fond of acknowledging errors, often rationalising ex post facto via the meme that "this time is different", which can be exacerbated by the desire to propagate an image of infallibility. Remember the once-lionised monetary maven Alan Greenspan?

These risks have certainly spooked interest rate investors, although the adjustment process has a way to run. After the second biggest fall in fixed-rate (as opposed to floating-rate) bond prices in modern history in the December quarter, the spectre of a Fed hike in March - duly delivered this week - has lifted long-term rates further. 

Will RBA ever lift again?

In Australia the 10-year government bond yield is nearing 3 per cent, significantly higher than the sub-2 per cent level traders—gripped by "cheap money forever" fever—priced in September 2016. Current 10-year yields are, however, still miles below the 5.5 per cent average since the Reserve Bank of Australia started targeting inflation in 1993.

Some of the best interest rate traders I know, almost all of whom have never experienced a proper inflation cycle, genuinely believe the RBA "will never hike again".

The problem with a supercilious central bank is the ensuing risk insouciance increases the probability of mistakes. A classic example was a speech given by the RBA's new head of financial stability this week.

According to this revisionist narrative the global financial crisis (GFC) "hasn't fundamentally changed the way we think about financial system stability". The RBA is evidently so sensitive to allegations it has failed to heed the lessons of the GFC—by blowing the mother of all bubbles with excessively cheap money—that it felt compelled to repeat the mantra the crisis had not altered its approach on five separate occasions in the speech. There are demonstrable flaws in this fiction.

First, the RBA never came close to anticipating the GFC. Its financial stability guru, Luci Ellis, published a paper in 2006 arguing"the most important lesson to draw from recent international experience is that a run-up in housing prices and debt need not be dangerous for the macroeconomy, was probably inevitable, and might even be desirable".

Ellis maintained that "the experience of Australia and the UK seems to suggest booms in housing price growth can subside without themselves bringing about a macroeconomic downturn". Two years later the 33 per cent drop in US house prices would trigger the deepest global recession since the great depression.

Second, the GFC necessitated a raft of policy responses that had never been seriously contemplated before, which have transformed the way we think about dealing with shocks and the unanticipated consequences. Contrary to the recommendations of the 1997 financial system inquiry, the Commonwealth guaranteed bank deposits and bank bonds for the first time. The RBA agreed to buy securitised mortgage-backed portfolios via its liquidity facilities, which it had never done, and Treasury independently acquired $16 billion of these loans in the first case of local "quantitative easing".

Banks borrowed more money on longer terms from the RBA than anyone previously envisioned, which led the RBA to create a new bail-out program called the committed liquidity facility. In emergencies banks can now tap over $200 billion of cash instantly at a cost of just 1.9 per cent that makes trading while insolvent an impossibility.

A central tenet of pre-GFC regulation--attributable to the 1997 Wallis Inquiry—was that taxpayers should never guarantee any private firm for fear of inducing "moral hazard". This is the "heads bankers win, tails taxpayers lose" dysfunction that emerges when governments insure downside risk. The RBA has since conceded that the crisis bail-outs unleashed unprecedented moral hazards, such as too-big-to-fail institutions, that require new mitigants.

The Australian Prudential Regulation Authority used to allow the major banks to leverage their equity 65 times when lending against housing because these assets were presumed to be nearly risk-free. Since the 2014 financial system inquiry APRA has been persuaded to deleverage the major banks' home loan books to merely (!) 40 times.

In 2013 the RBA was publicly dismissive of foreign regulators' efforts to contain credit growth via so-called macroprudential interventions to cool hot housing markets. One and a half years later APRA belatedly sought to cauterise the housing boom the RBA's 2012 and 2013 rate cuts precipitated with light-touch macroprudential jaw-boning.

Of course in 2017 the RBA has a different version of events. Apparently it has always seen "macroprudential policy as part and parcel of the financial stability framework". It turns out that "in 2014 the Australian regulators [presciently!] took the [rear-]view that risks were building in the residential housing market that warranted attention".

Actually, none of APRA's December 2014 announcements had any impact until well into 2015 (two years after the boom started) and they proved to be woefully inadequate. This column revealed, for example, that many banks had completely ignored APRA's minimum serviceability tests on home loans.

Good risk management requires intellectual honesty, which is missing in action among those overseeing the "wonder down under".


Read more: http://www.afr.com/personal-finance/the-rba-is-blowing-the-mother-of-all-bubbles-20170316-gv043y?&utm_source=social&utm_medium=twitter&utm_campaign=nc&eid=socialn:twi-14omn0055-optim-nnn:nonpaid-27/06/2014-social_traffic-all-organicpost-nnn-afr-o&campaign_code=nocode&promote_channel=social_twitter#ixzz4bXWSWyAu 
 

Interest rates: lower for longer. Time to look at P2P investing.

Interesting perspective in the Financial Times on the effects of Brexit. The hunt for yield is likely to intensify. Building a diversified portfolio of Peer-to-Peer loans is a sensible option to consider.


Watch the interest rate outlook shift following Brexit vote

Gillian Tett

Future historians may conclude this is one of the most important ripple effects of the poll

When the results of the UK’s EU referendum emerged last Friday morning, the share price of MetLife, the stolid American insurance group, tumbled. In the course of two days its stock fell 14 per cent, making it one of the worst performers on the American indices.

At first glance, that seems bizarre. MetLife does not sell policies in the UK and its exposure to Europe is small. So it should be shielded from the more obvious potential effects of the vote that are looming over UK companies, eurozone banks and Wall Street giants, such as a European recession or a loss of business and influence for the City of London.

But MetLife has a vulnerability that highlights one impact of Brexit that will have further-reaching consequences. Market actors have turned their attention to the wider outlook for interest rates. Most notably, in recent days, investors have sharply downgraded their expectations for inflation and interest rates, not just in the UK but across the west.

That has nasty implications for asset managers of all stripes, including insurance companies, which need to earn decent returns to pay policyholders. It is also painful for banks, since low rates typically hurt their earnings.

When future historians look back at the Brexit shock, they may conclude that this shifting rate outlook is one of the most important ripple effects of the Leave vote — even if the implications of a Brexit for bond prices look less thrilling than, say, the political soap opera around Boris Johnson, the leading Leave campaigner who has pulled out of the race to be UK prime minister.

To understand this, take a look at the numbers. A couple of years ago negative-yielding bonds — which, in nominal terms, pay less at maturity than investors initially paid — were rare. But this week, Fitch Ratings agency calculated that there is now $11.7tn worth of sovereign debt in the global market that carries negative nominal interest rates.

That is extraordinary. Furthermore, this pile has swelled by $1.3tn in the past month alone, and includes $2.6tn of long-term bonds (those with more than seven years of maturity). Meanwhile, the pile of bonds with a yield that investors used to consider normal — above 2 per cent — is barely worth $2tn.

Most of this negative debt sits in Japan and the eurozone. But rate expectations in the UK and US are sliding, too. The US Treasuries market, for example, now expects a mere 125 basis points of rate rises in the next decade, with barely any hikes in the next two years. Indeed, one of America’s largest hedge funds is now warning its clients that “markets in aggregate are discounting . . . effectively no monetary tightening for a decade across the developed world”.

Can this gloomy market prognosis be believed? Maybe not. After all, the global economy is still growing overall, with lacklustre expansion in the US. A dash to havens may also have influenced some of the recent bond price swings. If the political climate stabilises and the Remain camp’s prediction of economic disaster in Europe turns out to be overblown, the downbeat outlook of the markets could be reversed.

But, there again, it is also possible to draw an even gloomier conclusion: that Brexit has crystallised and intensified more fundamental investor fears that the west is slipping ever-deeper into economic stagnation. After all, that $11.7tn negative-yield bond pile did not just emerge after the referendum but has in fact been swelling for many months.

Either way, the one thing that is clear is that unless that pile suddenly and unexpectedly shrinks, investors and policymakers need to prepare for yet more ripple effects in the months ahead. For one thing, asset managers and insurance companies will see their earnings slide unless they start buying more risky debt — which will bring dangers of its own.

Second, the central banks’ policy dilemma will intensify since they will face pressure to engage in further loosening monetary experiments — even though it is unclear that these unprecedented measures are actually boosting growth.

And there is another nasty twist. Negative, or low, rates may exacerbate income inequality, too, since these typically raise the value of assets that wealthy people own, such as property and stocks. If so, that might create even more political populism, sparking more political uncertainty and economic gloom.

The real ripple effects of Brexit, in other words, may have barely been seen yet. All eyes are on the political polls and trade flows, and on those bond prices.

http://www.ft.com/cms/s/0/63e265c0-3ebd-11e6-9f2c-36b487ebd80a.html#ixzz4D7AZiu00