RBA committing logical errors regarding Australian household finance

March 31st, 2009

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Ric Battellino, the deputy governor of the Reserve Bank of Australia (RBA) gave a speech today. Regarding Australia’s household finance, he said,

We continue to believe that the market here will hold up better than overseas. There are a number of reasons why this is likely to be so, but perhaps the most important is that we did not have the same deterioration in lending standards that occurred elsewhere. By and large, the great bulk of Australians who took out housing loans have been able to afford the repayments. Notwithstanding some rise over the past year, the 90?day arrears rate on housing loans is only 0.5 per cent, which is broadly in line with its long?run average and well below that in countries such as the US and UK.

As he said that, we imagine he was thinking somewhere along the line like this:

  1. US sub-prime loans resulted in bad debts
  2. Bad debts busted the US economy
  3. A busted US economy led to higher unemployment
  4. Higher unemployment led to more bad debts
  5. And so on…
  6. Because Australia has very little sub-prime debt
  7. Therefore Australia’s economy is not likely to be as busted as the US

If this is what he’s thinking, we think Ric Battellino has made a very grave error in logic. He’s mixing up cause and effect.

No doubt, in the US, it’s sub-prime (which by the way is yesterday’s story) that triggered the bust in the US economy in 2007. But for Australia, it’s the deterioration of  the global economy that will trigger the bust of the Australian economy. The effects of a bust will be rising unemployment, followed by bad debts, then debt deflation and then finally falling asset prices. In other words, the triggers are different, but the effects will be the same because Australia has the same debt disease as the US and UK.

Given Australia’s high household debt (see Aussie household debt not as bad as it seems?), prime debt can easily turn sub-prime when unemployment rises. As unemployment rises (which all mainstream economists in the government and private sector are forecasting), it will eventually reach a critical mass of prime debts turning sub-prime. Once this critical mass is reached, the deterioration in the Australian economy will accelerate (see what’s happening in the US and UK today). This is the point we made in March 2007 at Can Australia?s deflating property bubble deflate even further?,

In Australia?s case, with her towering levels of debt, any external shock can easily tip her over to a recession, which can lead to further asset (e.g. real estates and stocks) deflation.

By now, it should be clear that whatever the external shock is not the issue?the point is that Australia is highly vulnerable.

To make matters worse, the First Home Owners’ Grant (FHOG), while giving housing sector a temporary boost, are increasing the proportion of potential sub-prime loans in the financial system.

The fact that those at the helm of the RBA are committing such logical errors does not engender our confidence.

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  • Pete

    Nice article with good points Ed.

    Without starting another housing debate, I have some comments:

    1) Ric Battellino is a scumbag. He has said some horribly biased and untrue things about housing in the past. I am not sure exactly why he does it, whether it is him trying to ‘boost confidence’, whether he has speculative properties, whether he is told to, or whether he is just deluded.

    2) I totally agree they are looking at the wrong triggers. I am sick of hearing “look at our real estate market, its doing fine” when the reality is that it is a bomb just waiting to go off. So many factors point to it. It is like a mini-GFC itself, except we have the huge benefit of seeing the real estate markets of other countries go under first – and can plan ahead.

    3) This kind of thinking is exactly the same kind of thinking before the GFC stock market crashes. “Everything is fine, subprime mortgages are fine, lets make money”. Someone like Ric at a prominent(?) institution like the RBA should be ashamed of the bull$#!& that he is speaking, especially with the benefit of seeing what is going on elsewhere.

    4) With unemployment growing, and everywhere studies suggesting that it will grow even more (none show otherwise that I have heard of), how can unemployment be overlooked as a major factor to affect household balance sheets? Someone should put Ric out of a job.

    5) What saddens me is that I know these ‘experts’ providing this flawed advice will go completely unpunished for it when they are found to be completely wrong. It seems that when these crisis hit, people are too wrapped up in their own affairs that the people giving the bad advice are not held accountable. Unfortunately I don’t see a way to change that (not one that the Gov. would actually implement).

  • Pete

    Nice article with good points Ed.

    Without starting another housing debate, I have some comments:

    1) Ric Battellino is a scumbag. He has said some horribly biased and untrue things about housing in the past. I am not sure exactly why he does it, whether it is him trying to ‘boost confidence’, whether he has speculative properties, whether he is told to, or whether he is just deluded.

    2) I totally agree they are looking at the wrong triggers. I am sick of hearing “look at our real estate market, its doing fine” when the reality is that it is a bomb just waiting to go off. So many factors point to it. It is like a mini-GFC itself, except we have the huge benefit of seeing the real estate markets of other countries go under first – and can plan ahead.

    3) This kind of thinking is exactly the same kind of thinking before the GFC stock market crashes. “Everything is fine, subprime mortgages are fine, lets make money”. Someone like Ric at a prominent(?) institution like the RBA should be ashamed of the bull$#!& that he is speaking, especially with the benefit of seeing what is going on elsewhere.

    4) With unemployment growing, and everywhere studies suggesting that it will grow even more (none show otherwise that I have heard of), how can unemployment be overlooked as a major factor to affect household balance sheets? Someone should put Ric out of a job.

    5) What saddens me is that I know these ‘experts’ providing this flawed advice will go completely unpunished for it when they are found to be completely wrong. It seems that when these crisis hit, people are too wrapped up in their own affairs that the people giving the bad advice are not held accountable. Unfortunately I don’t see a way to change that (not one that the Gov. would actually implement).

  • Steve

    You are spot on re: point 5 Pete. Although we could always bring up these nonsensical statements later, people will be too busy bleating to be saved by that stage.

  • Steve

    You are spot on re: point 5 Pete. Although we could always bring up these nonsensical statements later, people will be too busy bleating to be saved by that stage.

  • Hi,
    Yes, quite. Excellent article & good points from Pete, the first of which made me laugh.
    Steve

  • Hi,
    Yes, quite. Excellent article & good points from Pete, the first of which made me laugh.
    Steve

  • Niko

    In the ‘political economy’ experts act as shepherds and herd the sheeple to the slaughter house.

  • Niko

    In the ‘political economy’ experts act as shepherds and herd the sheeple to the slaughter house.