Can falling interest rates and rising mortgage rate come together?

July 21st, 2008

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Yesterday, in Too eager for an interest rate cut?, we said that

Fourth, an interest rate cut by the RBA need not necessary mean a cut in the mortgage rate. In fact, the opposite can occur.

Today, we will elaborate on that.

A large fraction of Australia’s borrowed money is sourced from overseas through the ‘shadow’ banking system. In other words, there are not enough domestic deposits to fund all the needed credit (e.g. home loans) in this country. As we explained before in Rising price of money through the demise of ?shadow? banking system, with the fall of the ‘shadow’ banking system, the supply of credit shrinks. This resulted in a rise in the price of money.

That is why non-bank mortgage lenders (e.g. RAMS) found their business in trouble. Because they are not banks, they do not have access to deposits to fund their lending. Their only source of funding is through the ‘shadow’ banking system. When money from that system dried up (i.e. credit crisis), they could no longer lend money as cheaply as before.

The banks, on the other hand, are not left off the hook. Because of their deposit base, they are in a better to weather the credit crisis storm. But overall, there is still a shortfall of deposits to provide for all the demand for lending. As the de-leveraging of the global financial system continues, the price of money will continue to increase. This left the banks with two choices:

  1. Increase the cost of loans (e.g. mortgage rate).
  2. Attract more deposits with higher interest rates- that’s where all the attractive term deposit interest rates from the banks come from.

For Australia to be completely free from the ‘shadow’ banking system, two things must happen:

  1. Borrowing must decrease.
  2. Savings must increase.

This is the only way to bridge the gap left by the credit crisis in the absence of any central bank intervention. We believe that the credit crisis will worsen (see Is the credit crisis the end of the beginning?), which means the gap will widen, which in turn implies even higher lending rate. Since the Australian economy is very much addicted to credit to keep going, any dramatic fall in its supply will have serious repercussions. What to do if such a day eventuate?

Not to worry, because Australia has a central bank (note: sarcasm here)! Since the Reserve Bank of Australia (RBA) is the only institution that can create credit out of thin air, we can be sure they will cut interest rates and be the lender of last resort when the day of reckoning comes. But that does not necessarily mean that mortgage rate will come down too, as reported in this news article, RBA rate cuts may fail to ease mortgage pain,

National Australia Bank chief economist Alan Oster, just back from a month in Europe, said a reprise of the British experience, where banks failed to ease the burden on borrowers despite official rates falling 75 basis points over six months, was not out of the question.

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  • Stephen Johnston

    There’s a question want ask you for a long time how strong really are our banks?
    In the 1990s Westpac and ANZ nearly went under and the strongest bank was the NAB through very conservative investing thanks to Nobby Clark.
    But this time around who is the most conservative Bank and I don’t think it’s the NAB?
    Banks have such short memories of pass disasters.
    Northern Rock had a deposit to debt ratio of 350% which is every one dollar deposit $3.50 is borrow to someone.
    In Australian Banks it’s more conservative the average for the banks every one dollar deposit $1.30 is borrow to someone.
    Thanks to higher interest rates our banks have more margin of safety.

  • Stephen Johnston

    There’s a question want ask you for a long time how strong really are our banks?
    In the 1990s Westpac and ANZ nearly went under and the strongest bank was the NAB through very conservative investing thanks to Nobby Clark.
    But this time around who is the most conservative Bank and I don’t think it’s the NAB?
    Banks have such short memories of pass disasters.
    Northern Rock had a deposit to debt ratio of 350% which is every one dollar deposit $3.50 is borrow to someone.
    In Australian Banks it’s more conservative the average for the banks every one dollar deposit $1.30 is borrow to someone.
    Thanks to higher interest rates our banks have more margin of safety.

  • Hi Stephen!

    In Australian Banks it’s more conservative the average for the banks every one dollar deposit $1.30 is borrow to someone.
    Thanks to higher interest rates our banks have more margin of safety.

    Our feeling is that, Australian banks are vulnerable ways that are different from the US counterparts. Some articles that you may be interested in:

    ANZ is the big local bank most at risk
    Fast rise of round robin lenders
    Banks to feel more pain: analysts:

    “Mr Johnson believes that Australia’s banks are failing to envisage the possibility of a loan-loss cycle where asset prices [such as housing] fall, and banks struggle to recover loans from defaulters and forced sales.”

    “Mr Johnson said Australian banks are actually more vulnerable to the credit crunch than many of their global counterparts because of their high levels of gearing, or loan to capital ratios.

    “We’re talking banks geared 25-30 times, whereas the global peers may be geared 15-20 times… even a moderate loan-loss cycle creates negative earnings,” he said.”

    We will post an article about Australian banks tomorrow night.

  • Hi Stephen!

    In Australian Banks it’s more conservative the average for the banks every one dollar deposit $1.30 is borrow to someone.
    Thanks to higher interest rates our banks have more margin of safety.

    Our feeling is that, Australian banks are vulnerable ways that are different from the US counterparts. Some articles that you may be interested in:

    ANZ is the big local bank most at risk
    Fast rise of round robin lenders
    Banks to feel more pain: analysts:

    “Mr Johnson believes that Australia’s banks are failing to envisage the possibility of a loan-loss cycle where asset prices [such as housing] fall, and banks struggle to recover loans from defaulters and forced sales.”

    “Mr Johnson said Australian banks are actually more vulnerable to the credit crunch than many of their global counterparts because of their high levels of gearing, or loan to capital ratios.

    “We’re talking banks geared 25-30 times, whereas the global peers may be geared 15-20 times… even a moderate loan-loss cycle creates negative earnings,” he said.”

    We will post an article about Australian banks tomorrow night.

  • Jackie

    Hi Editor,

    This is a thought provoking article; the banks that we are told to be safe may not be so in reality. When the banks are increasing lending rates out of step with the official cash rate, I feel that their funding difficulty may be more serious than it appears.

    I would like to ask 2 questions: In the case of bank failure in Australia,

    1. Are depositors really guaranteed of $20,000? Is this guarantee really passed by law or is it still under review? Who insure this deposit? Insurance company or the government? what if the insurance company collapse as well?

    2. For the articles stored in a safe deposit box in a bank, would it remain the owner’s property in a bank failure? Or would it be liquidated to pay for the bank’s debts as well? In other words, what is the counterparty risk of the valuables that we put in a safe deposit box, in the event of bank failure?

    Thanks.

  • Jackie

    Hi Editor,

    This is a thought provoking article; the banks that we are told to be safe may not be so in reality. When the banks are increasing lending rates out of step with the official cash rate, I feel that their funding difficulty may be more serious than it appears.

    I would like to ask 2 questions: In the case of bank failure in Australia,

    1. Are depositors really guaranteed of $20,000? Is this guarantee really passed by law or is it still under review? Who insure this deposit? Insurance company or the government? what if the insurance company collapse as well?

    2. For the articles stored in a safe deposit box in a bank, would it remain the owner’s property in a bank failure? Or would it be liquidated to pay for the bank’s debts as well? In other words, what is the counterparty risk of the valuables that we put in a safe deposit box, in the event of bank failure?

    Thanks.

  • Stephen Johnston

    If our banks are staying healthy by high interest rates.
    What would the government prefer masses complaining about another interest rate increase and cut back maybe on your new car or holiday.
    Or masses of people waiting to withdrawn their money out of a Bank?
    Think the government would prefer confidence in our banking system.
    The central planners are terrified of a run on a bank like in America.
    Atleast keep the central planners away for a while they cause this mess with their low interest rates.
    Central banking is gone done stick a fork it the central planners have not realise the reality of this situation it’s over.

  • Stephen Johnston

    If our banks are staying healthy by high interest rates.
    What would the government prefer masses complaining about another interest rate increase and cut back maybe on your new car or holiday.
    Or masses of people waiting to withdrawn their money out of a Bank?
    Think the government would prefer confidence in our banking system.
    The central planners are terrified of a run on a bank like in America.
    Atleast keep the central planners away for a while they cause this mess with their low interest rates.
    Central banking is gone done stick a fork it the central planners have not realise the reality of this situation it’s over.

  • Hi Jackie!

    When the banks are increasing lending rates out of step with the official cash rate, I feel that their funding difficulty may be more serious than it appears.

    You have a very good point here. It is very popular to point the finger at the “greedy” banks but this may be a symptom of the current banking weakness.

    Are depositors really guaranteed of $20,000? Is this guarantee really passed by law or is it still under review? Who insure this deposit? Insurance company or the government? what if the insurance company collapse as well?

    As far as we know, we believe it is still under review. Our guess is that the government is going to insure this deposit i.e. the same way the UK government bailed out Northern Rock.

    For the articles stored in a safe deposit box in a bank, would it remain the owner’s property in a bank failure? Or would it be liquidated to pay for the bank’s debts as well? In other words, what is the counterparty risk of the valuables that we put in a safe deposit box, in the event of bank failure?

    We are not legal experts here, so our opinion for this is unqualified. Our belief is that it will remain the owner’s property. We would suggest that you check the fine print and conduct due diligence on that.

  • Hi Jackie!

    When the banks are increasing lending rates out of step with the official cash rate, I feel that their funding difficulty may be more serious than it appears.

    You have a very good point here. It is very popular to point the finger at the “greedy” banks but this may be a symptom of the current banking weakness.

    Are depositors really guaranteed of $20,000? Is this guarantee really passed by law or is it still under review? Who insure this deposit? Insurance company or the government? what if the insurance company collapse as well?

    As far as we know, we believe it is still under review. Our guess is that the government is going to insure this deposit i.e. the same way the UK government bailed out Northern Rock.

    For the articles stored in a safe deposit box in a bank, would it remain the owner’s property in a bank failure? Or would it be liquidated to pay for the bank’s debts as well? In other words, what is the counterparty risk of the valuables that we put in a safe deposit box, in the event of bank failure?

    We are not legal experts here, so our opinion for this is unqualified. Our belief is that it will remain the owner’s property. We would suggest that you check the fine print and conduct due diligence on that.

  • Jackie

    Hi Editor,

    Thanks for that. I read some comments on the $20,000 deposit guarantee, which seem to treat it as a solid promise. I’m sure many Australians would be shocked to find that their deposits has no guarantee whatsoever. (though the government would bail out banks generally)

    Marc Faber recommends storing physical gold in a safe deposit box outside US. (not paper gold due to the counterparty risk) I am just wondering what the counterparty risk may be in this strategy. He also suggest investment in rural farmland. But it would be very difficult to action on this advice unless you have a large sum of money to purchase land. In your opinion, how can a small investor in Australia utilize this piece of advice?

    Thanks.

  • Jackie

    Hi Editor,

    Thanks for that. I read some comments on the $20,000 deposit guarantee, which seem to treat it as a solid promise. I’m sure many Australians would be shocked to find that their deposits has no guarantee whatsoever. (though the government would bail out banks generally)

    Marc Faber recommends storing physical gold in a safe deposit box outside US. (not paper gold due to the counterparty risk) I am just wondering what the counterparty risk may be in this strategy. He also suggest investment in rural farmland. But it would be very difficult to action on this advice unless you have a large sum of money to purchase land. In your opinion, how can a small investor in Australia utilize this piece of advice?

    Thanks.

  • jack

    Hi, Editor,

    Does that mean, in an extreme case, that you can have a RBA rate @ 2%, but a mortgage rate of 10%? Sounds weird.

    Reading your defalation/inflation arguments, you seem to suggest people should get away from the banks. It’s dangerous to borrow a large sum for the mortgage, but it’s also unsafe to put your money in the bank.

    Looks like the only solution is to hold physical gold?

    In a deflation situation, shouldn’t i hold some cash in the safe deposit box?

    Maybe one should hold a portfolio of cash/gold in the safe deposit box and buy some gold shares too?

    At the moment, I am still renting. I see no sign of relief in rent. I am not talking about making money thru investment, but these days, you have to put much effort to think just to preserve your own wealth. GEE…

  • jack

    Hi, Editor,

    Does that mean, in an extreme case, that you can have a RBA rate @ 2%, but a mortgage rate of 10%? Sounds weird.

    Reading your defalation/inflation arguments, you seem to suggest people should get away from the banks. It’s dangerous to borrow a large sum for the mortgage, but it’s also unsafe to put your money in the bank.

    Looks like the only solution is to hold physical gold?

    In a deflation situation, shouldn’t i hold some cash in the safe deposit box?

    Maybe one should hold a portfolio of cash/gold in the safe deposit box and buy some gold shares too?

    At the moment, I am still renting. I see no sign of relief in rent. I am not talking about making money thru investment, but these days, you have to put much effort to think just to preserve your own wealth. GEE…

  • Hi Jackie & Jack!

    Marc Faber recommends storing physical gold in a safe deposit box outside US. (not paper gold due to the counterparty risk) I am just

    wondering what the counterparty risk may be in this strategy.

    The idea of a physical gold is to eliminate counter-party risk. That is, if you own physical gold, you own a physical asset which is not a liability of another party. For example, cash in the bank is your asset but a liability to the bank. Paper gold on the other hand, may still have counter-party risk. For example, if the company (that holds your gold and gives you a gold certificate) collapses, creditors will demand that all the assets (including its gold) be sold. In that case, paper gold is your asset but a liability to that company.

    He also suggest investment in rural farmland. But it would be very difficult to action on this advice unless you have a large sum of money

    to purchase land. In your opinion, how can a small investor in Australia utilize this piece of advice?

    This advice is a bit vague, in our opinion. Does he mean buying farmland as in buying the land to hoard? Or buying productive farmland for its produce? If it’s the latter, the risks includes climate change, drought, water rights, disease, farm management etc.

    This advice is not feasible for small investors. Unless you set up some kind of investment company/trust, pool the money of many small investors together and invest in the farm and distribute the earnings back to the samll investors. In a sense, such investment product (e.g. agri-business investments) already exists in the retail market. Who knows, perhaps we may one day see Macquarie creating more of such a products.

    Does that mean, in an extreme case, that you can have a RBA rate @ 2%, but a mortgage rate of 10%? Sounds weird.

    To be honest, we are not sure about the possibility of such an extreme situation. The basic point to understand is that mortgage rates may not necessarily follow the interest rates downward. In fact, as overseas experience has shown, they can move in opposite direction.

    Reading your defalation/inflation arguments, you seem to suggest people should get away from the banks. It’s dangerous to borrow a large sum

    for the mortgage, but it’s also unsafe to put your money in the bank.

    Looks like the only solution is to hold physical gold?

    Before we can answer this question, please take care to understand that we are not predicting banking collapse and hyperinflation. As we said before in Failure to understand Black Swan leads to fallacious thinking,


    First, as contrarians, we are not in the business of prediction. Rather, we prepare for Black Swans. To give yourself an idea why such preparation is important, ask yourself this question: Why do parachutists pack a second reserve parachute? Since the statistical probability of a parachute failure is extremely low, does that mean we should completely ignore such a possibility (of the primary parachute not opening)? Therefore, those people who fallaciously believe that preparing for Black Swans is ?predicting? is like believing that the parachutist who packs a reserve parachute is ?predicting? that his/her primary parachute will fail.

    Now, back to the answer of your question: Yes, gold is a hedge against the two extremes of hyperinflation and deflation.

    In a deflation situation, shouldn’t i hold some cash in the safe deposit box?

    This is the first time we heard of this idea. But there are some pitfalls: The danger is, the government is most likely to resort to fighting deflation with inflation (i.e. printing money). Also, inflation is the norm, which means your cash is most certainly to lose purchasing power over time.

    Maybe one should hold a portfolio of cash/gold in the safe deposit box and buy some gold shares too?

    We can’t advice you on the specifics. Therefore, this is something that you have to decide for yourself. We don’t have all the answers ourselves too.

  • Hi Jackie & Jack!

    Marc Faber recommends storing physical gold in a safe deposit box outside US. (not paper gold due to the counterparty risk) I am just

    wondering what the counterparty risk may be in this strategy.

    The idea of a physical gold is to eliminate counter-party risk. That is, if you own physical gold, you own a physical asset which is not a liability of another party. For example, cash in the bank is your asset but a liability to the bank. Paper gold on the other hand, may still have counter-party risk. For example, if the company (that holds your gold and gives you a gold certificate) collapses, creditors will demand that all the assets (including its gold) be sold. In that case, paper gold is your asset but a liability to that company.

    He also suggest investment in rural farmland. But it would be very difficult to action on this advice unless you have a large sum of money

    to purchase land. In your opinion, how can a small investor in Australia utilize this piece of advice?

    This advice is a bit vague, in our opinion. Does he mean buying farmland as in buying the land to hoard? Or buying productive farmland for its produce? If it’s the latter, the risks includes climate change, drought, water rights, disease, farm management etc.

    This advice is not feasible for small investors. Unless you set up some kind of investment company/trust, pool the money of many small investors together and invest in the farm and distribute the earnings back to the samll investors. In a sense, such investment product (e.g. agri-business investments) already exists in the retail market. Who knows, perhaps we may one day see Macquarie creating more of such a products.

    Does that mean, in an extreme case, that you can have a RBA rate @ 2%, but a mortgage rate of 10%? Sounds weird.

    To be honest, we are not sure about the possibility of such an extreme situation. The basic point to understand is that mortgage rates may not necessarily follow the interest rates downward. In fact, as overseas experience has shown, they can move in opposite direction.

    Reading your defalation/inflation arguments, you seem to suggest people should get away from the banks. It’s dangerous to borrow a large sum

    for the mortgage, but it’s also unsafe to put your money in the bank.

    Looks like the only solution is to hold physical gold?

    Before we can answer this question, please take care to understand that we are not predicting banking collapse and hyperinflation. As we said before in Failure to understand Black Swan leads to fallacious thinking,


    First, as contrarians, we are not in the business of prediction. Rather, we prepare for Black Swans. To give yourself an idea why such preparation is important, ask yourself this question: Why do parachutists pack a second reserve parachute? Since the statistical probability of a parachute failure is extremely low, does that mean we should completely ignore such a possibility (of the primary parachute not opening)? Therefore, those people who fallaciously believe that preparing for Black Swans is ?predicting? is like believing that the parachutist who packs a reserve parachute is ?predicting? that his/her primary parachute will fail.

    Now, back to the answer of your question: Yes, gold is a hedge against the two extremes of hyperinflation and deflation.

    In a deflation situation, shouldn’t i hold some cash in the safe deposit box?

    This is the first time we heard of this idea. But there are some pitfalls: The danger is, the government is most likely to resort to fighting deflation with inflation (i.e. printing money). Also, inflation is the norm, which means your cash is most certainly to lose purchasing power over time.

    Maybe one should hold a portfolio of cash/gold in the safe deposit box and buy some gold shares too?

    We can’t advice you on the specifics. Therefore, this is something that you have to decide for yourself. We don’t have all the answers ourselves too.

  • Stephen Johnston

    Thank CIJ for the information on Banks.
    So the overseas investors are selling out of australian banks maybe they know something us local dump aussies don’t know?
    I guess it’s large losses on overseas operations and the people who would know that are the overseas investors?
    Australian has the most overvalued houses in the western world when take into consideration well over 6 times average wage to buy a house.
    America average was about 4 times earning.
    So you can imagine the fall out in Australian if America is only 4 times earning.
    Question is it’s unbelievable that our houses will not fall big time and what is going to cause the collapse.
    A slow down in china?
    Banks finally start to bite the bullet call in the bad loans?
    Why has Australian housing market been slower to fall than America and Britian?
    International media is far more honest with the public about falling house prices.
    Everytime someone reports about falling house prices in Australian next day you get another media report saying houses are only going to increase in value.Because rental demand ,lack of land and immigration.
    I don’t think the average man in this country even realises how much property has fallen and will fall in the future it shows you the power of the close media in this country.
    Property will always go up are the famous words and can be very misleading property does not always go up.

  • Stephen Johnston

    Thank CIJ for the information on Banks.
    So the overseas investors are selling out of australian banks maybe they know something us local dump aussies don’t know?
    I guess it’s large losses on overseas operations and the people who would know that are the overseas investors?
    Australian has the most overvalued houses in the western world when take into consideration well over 6 times average wage to buy a house.
    America average was about 4 times earning.
    So you can imagine the fall out in Australian if America is only 4 times earning.
    Question is it’s unbelievable that our houses will not fall big time and what is going to cause the collapse.
    A slow down in china?
    Banks finally start to bite the bullet call in the bad loans?
    Why has Australian housing market been slower to fall than America and Britian?
    International media is far more honest with the public about falling house prices.
    Everytime someone reports about falling house prices in Australian next day you get another media report saying houses are only going to increase in value.Because rental demand ,lack of land and immigration.
    I don’t think the average man in this country even realises how much property has fallen and will fall in the future it shows you the power of the close media in this country.
    Property will always go up are the famous words and can be very misleading property does not always go up.

  • Hi Stephen!

    That may explain why Australian banking stocks have been falling so much recently. It could be foreign shareholders pulling out of Australian bank shares.

  • Hi Stephen!

    That may explain why Australian banking stocks have been falling so much recently. It could be foreign shareholders pulling out of Australian bank shares.

  • Pete

    I wonder where they get ‘average’ earnings from when they state 6 times average earnings, 4 times average earnings, etc. And I wonder if it is by locale, or nationwide?

    Anyway, great article. I especially like the parachutist analogy in your comments. The topic of ‘shadow banking’ has helped me to understand the current situation very well.

    In the comments somewhere someone mentioned that Australia’s banks were leveraged 1.30 for every dollar deposited? So I take it that was completely false…? I was under the impression that it was much more like 4 or 5 dollars deposited to every 100 dollars lent.

    Personally, being my nasty self, I eagerly await the fall of some big banks. Sadly this would do more harm than good (at least in the short term), but I guess I take comfort in the notion that people who make money, from meddling with money and selling people future money ‘now’, will stop benefiting so much from such a parasitic trade. There’s producers and consumers…and they seem to fit neither.

    Actually something that just occurred to me: Does deflation widen the gap between rich and poor? I would assume that it does. But, then again, our nasty housing bubble seems to have done a pretty good job of it too.
    The reason I ask whether deflation widens the rich/poor divide is because if credit is not readily available, wouldn’t that stifle the creation of small business, public company takeovers, farming(borrowing for seed/fertiliser?), construction (and other things I cant think of now).

    I guess the high unemployment thing would widen the rich/poor gap a bit too…

    Me thinks I should take a Deflation 101 class. ๐Ÿ™‚

  • Pete

    I wonder where they get ‘average’ earnings from when they state 6 times average earnings, 4 times average earnings, etc. And I wonder if it is by locale, or nationwide?

    Anyway, great article. I especially like the parachutist analogy in your comments. The topic of ‘shadow banking’ has helped me to understand the current situation very well.

    In the comments somewhere someone mentioned that Australia’s banks were leveraged 1.30 for every dollar deposited? So I take it that was completely false…? I was under the impression that it was much more like 4 or 5 dollars deposited to every 100 dollars lent.

    Personally, being my nasty self, I eagerly await the fall of some big banks. Sadly this would do more harm than good (at least in the short term), but I guess I take comfort in the notion that people who make money, from meddling with money and selling people future money ‘now’, will stop benefiting so much from such a parasitic trade. There’s producers and consumers…and they seem to fit neither.

    Actually something that just occurred to me: Does deflation widen the gap between rich and poor? I would assume that it does. But, then again, our nasty housing bubble seems to have done a pretty good job of it too.
    The reason I ask whether deflation widens the rich/poor divide is because if credit is not readily available, wouldn’t that stifle the creation of small business, public company takeovers, farming(borrowing for seed/fertiliser?), construction (and other things I cant think of now).

    I guess the high unemployment thing would widen the rich/poor gap a bit too…

    Me thinks I should take a Deflation 101 class. ๐Ÿ™‚

  • Hi Pete!

    In the comments somewhere someone mentioned that Australia’s banks were leveraged 1.30 for every dollar deposited? So I take it that was completely false…? I was under the impression that it was much more like 4 or 5 dollars deposited to every 100 dollars lent.

    We are not sure where this 1.30 thingy come from. But according to Brian Johnson, a banking analyst from JP Morgan, Australian banks are, on average, leveraged 250-30 times whereas in overseas, they are leveraged 15-20 times. It probably means that for every $1 of equity (=asset-liability) in the bank balance sheet, there is $30 worth of assets. To fully understand this, we have to go into corporate accounting.

    I eagerly await the fall of some big banks.

    Be careful with what you hope for because your cash in the bank may be in danger. ๐Ÿ˜‰

    Does deflation widen the gap between rich and poor?

    We guess deflation is more indiscriminate in its wealth destruction. Deflation is primarily concentrated in the collapse of asset prices. Since the poor do not have much assets to begin with, they do not much to lose anyway, other than their jobs. The ‘rich’ (note the quotation around the word ‘rich’) has far more assets and if their assets is largely balanced by their liabilities (i.e. high leverage), deflation can turn their net worth to a large negative. For the poor, if they already have some debt, their net worth may turn negative. But it may be a much smaller negative. Or if the poor has no assets, no liabilities (and only their jobs), it may even be a mildly positive.

    In other words, when deflation is serious enough, the ‘rich’ may well turn out to be bankrupts with massive large negative net worth.

  • Hi Pete!

    In the comments somewhere someone mentioned that Australia’s banks were leveraged 1.30 for every dollar deposited? So I take it that was completely false…? I was under the impression that it was much more like 4 or 5 dollars deposited to every 100 dollars lent.

    We are not sure where this 1.30 thingy come from. But according to Brian Johnson, a banking analyst from JP Morgan, Australian banks are, on average, leveraged 250-30 times whereas in overseas, they are leveraged 15-20 times. It probably means that for every $1 of equity (=asset-liability) in the bank balance sheet, there is $30 worth of assets. To fully understand this, we have to go into corporate accounting.

    I eagerly await the fall of some big banks.

    Be careful with what you hope for because your cash in the bank may be in danger. ๐Ÿ˜‰

    Does deflation widen the gap between rich and poor?

    We guess deflation is more indiscriminate in its wealth destruction. Deflation is primarily concentrated in the collapse of asset prices. Since the poor do not have much assets to begin with, they do not much to lose anyway, other than their jobs. The ‘rich’ (note the quotation around the word ‘rich’) has far more assets and if their assets is largely balanced by their liabilities (i.e. high leverage), deflation can turn their net worth to a large negative. For the poor, if they already have some debt, their net worth may turn negative. But it may be a much smaller negative. Or if the poor has no assets, no liabilities (and only their jobs), it may even be a mildly positive.

    In other words, when deflation is serious enough, the ‘rich’ may well turn out to be bankrupts with massive large negative net worth.

  • Stephen Johnston

    Hi Pete
    How did I get the figure of $1.30 go to all the banks annual reports at the balance sheet give an example last year 2007 St George Bank had retail deposits of over 70 billion dollars liability on the asset side Loans of nearly 90 billion.
    Divided the 90 billion loan by 70 billion deposits get a dept to deposit ratio of 128%
    In this extreme envirnoment maybe the retail deposits are the asset not the liability.
    Discount the intangible assets to nothing on all the banks.
    I’m very curious how you got your figure of 4 or 5 dollars please give me real figures from a Banks annual report and if you are right then we may have a northern rock situation on our hands.
    You are right some parts of Australain the earning ratio to buying houses is lower however I’m talking about in the big cities you can find some solid research on earning wage ratio that does clearly show Australian is the most expensive place in the world.
    Cointrarian investor will beable to give you that information.

  • Stephen Johnston

    Hi Pete
    How did I get the figure of $1.30 go to all the banks annual reports at the balance sheet give an example last year 2007 St George Bank had retail deposits of over 70 billion dollars liability on the asset side Loans of nearly 90 billion.
    Divided the 90 billion loan by 70 billion deposits get a dept to deposit ratio of 128%
    In this extreme envirnoment maybe the retail deposits are the asset not the liability.
    Discount the intangible assets to nothing on all the banks.
    I’m very curious how you got your figure of 4 or 5 dollars please give me real figures from a Banks annual report and if you are right then we may have a northern rock situation on our hands.
    You are right some parts of Australain the earning ratio to buying houses is lower however I’m talking about in the big cities you can find some solid research on earning wage ratio that does clearly show Australian is the most expensive place in the world.
    Cointrarian investor will beable to give you that information.

  • Stephen Johnston

    Hi CIj
    Brian Johnson figures are close
    Example St George annual report again 2007
    St George Bank has equity of $5884 million minus the intangible assets of $1323 million we have real equity of $4561 million
    Cash is king and intangible assets are worth nothing in a falling market.
    Divided the total assets of $125800 by the equity of $4561 million
    Get a leverage figure of nearly 28 now a small mistake with such high leverage can cause major problems.
    However this is where I disagree with the experts about St George the Bank is probably the safest Why?
    It has very little exposure overseas and this is where the big losses may come in the future.
    It’s a regional bank that is basically all in real estate in Australain and even if 10 percent of it’s loan go pear shape and the real estate market goes down there is a margin of safety.
    The Australain culture will paid it’s mortgage come hell water.
    IF I had to make a choice between assets here in Australian or overseas with all that toxic stuff.
    I will take a Australian assets.

  • Stephen Johnston

    Hi CIj
    Brian Johnson figures are close
    Example St George annual report again 2007
    St George Bank has equity of $5884 million minus the intangible assets of $1323 million we have real equity of $4561 million
    Cash is king and intangible assets are worth nothing in a falling market.
    Divided the total assets of $125800 by the equity of $4561 million
    Get a leverage figure of nearly 28 now a small mistake with such high leverage can cause major problems.
    However this is where I disagree with the experts about St George the Bank is probably the safest Why?
    It has very little exposure overseas and this is where the big losses may come in the future.
    It’s a regional bank that is basically all in real estate in Australain and even if 10 percent of it’s loan go pear shape and the real estate market goes down there is a margin of safety.
    The Australain culture will paid it’s mortgage come hell water.
    IF I had to make a choice between assets here in Australian or overseas with all that toxic stuff.
    I will take a Australian assets.

  • Pete

    Good point about the banks and my savings Ed. Fortunately for me I have no ‘savings’ in any of the big 5. Some short term savings in an ING account (who knows what would happen to that), and the rest in our lovely bullish (kidding) stock market. I am almost certain to feel financial pain in the future, but we’ll see. At least I don’t have a mortgage (!).

    I agree with Stephen – I like St George. But they grow more into a big 4 bank everyday (especially if they merge with one?).

  • Pete

    Good point about the banks and my savings Ed. Fortunately for me I have no ‘savings’ in any of the big 5. Some short term savings in an ING account (who knows what would happen to that), and the rest in our lovely bullish (kidding) stock market. I am almost certain to feel financial pain in the future, but we’ll see. At least I don’t have a mortgage (!).

    I agree with Stephen – I like St George. But they grow more into a big 4 bank everyday (especially if they merge with one?).

  • Stephen Johnston

    Hi Pete
    You are right about St George growing into a big four everyday thanks to Westpac takeover.
    That’s why it’s the safest bank because takeover as well thus good capital injection at the moment.
    However I’m very suspicious about Westpac no real bad news to the market about loans overseas and currency transactions.
    Every other bank has report bad news overseas ANZ NAB and Commonwealth I notice that Westpac has been very quiet.
    Most transparent bank so far has been the ANZ which is actually a good sign atleast they know they have a problem.
    However do not take my assessment as right if we have a major property crash ST George will be effected badly, but probably by that time it will be Westpac problem.
    Again Pete check information yourself even if you hear it 20 times from anyone.
    Still wait for the Australian Competition watch dog to say yes or no to the takeover.

  • Stephen Johnston

    Hi Pete
    You are right about St George growing into a big four everyday thanks to Westpac takeover.
    That’s why it’s the safest bank because takeover as well thus good capital injection at the moment.
    However I’m very suspicious about Westpac no real bad news to the market about loans overseas and currency transactions.
    Every other bank has report bad news overseas ANZ NAB and Commonwealth I notice that Westpac has been very quiet.
    Most transparent bank so far has been the ANZ which is actually a good sign atleast they know they have a problem.
    However do not take my assessment as right if we have a major property crash ST George will be effected badly, but probably by that time it will be Westpac problem.
    Again Pete check information yourself even if you hear it 20 times from anyone.
    Still wait for the Australian Competition watch dog to say yes or no to the takeover.