Posts Tagged ‘credit’

Australia’s money supply & credit growth in April 2008

Thursday, July 10th, 2008

Continuing from Australia?s money supply growth in March 2008, we will report on the growth of Australia?s money supply for April 2008. In that month, Australia?s broad and M3 money supply has reach yet another record high of AU$1089.4 billion and AU$1003 billion respectively (see What is money? on the explanations of the various measures of money). Between April 2007 and April 2008 (i.e. the year-to-date), Australia?s M3 money grew by 20.4%. The year-to-date growth for March 2008 and February 2008 was 21.1% and 21.6% respectively. No doubt, Australia’s money supply is still growing to record highs. But there seem to be some tentative indications that the growth is slowing since January 2008.

Credit growth is also exhibiting the same behaviour. While total credit reaches a record high of AU$1826.9 billion in April 2008, its year-to-date growth was slowing since January 2008.

The data for May and June 2008 is not out yet. If we see a sustained deceleration in both money supply and credit growth, this will mean that Australia is moving towards deflation, which is very bad for asset prices.

Can lower interest rates re-inflate the property price bubble?

Thursday, June 26th, 2008

Recently, those people at BIS Shrapnel are busy spreading misinformation in the mainstream media again (see this mainstream news article: House prices set to climb despite rates). Their first ‘analysis’ regarding house prices was first released in March this year. This month, their ‘analysis’ was again reported in the mainstream media. We had already criticised their flawed ‘analysis’ earlier in Another faulty analysis: BIS Shrapnel on house prices and would not repeat them again in this article.

But we would like to add one more point with regards to one of their flawed assumptions. When you read the mainstream news media, you will notice that one of their assumptions is that when the RBA eventually cut interest rates (insert: Mr Angie Zigomanis, the report author, said that “As credit conditions recover over the course of 2009…”), it will lead to the further re-inflation of property bubble. Judging from this flawed assumption of theirs, we wondered whether they are really that ignorant about economics.

To understand the flaw in their assumption, we have to first understand the RBA’s latest decision to hold interest rates in June. Currently, the RBA is still keeping an eye on price inflation. As BIS Shrapnel themselves acknowledged, the RBA is likely to raise interest rates again this year to combat price inflation. But the reason why the RBA kept interest rates on hold this month was that they expected the Australian economy to slow down in the coming months. In other words, the RBA is expecting the economy to slow down so that inflation will be kept at bay, which will reduce the necessity to raise interest rates.

When the economy slows down, what happens? You will see rising unemployment, falling profits, declining consumer confidence and so on. Given the astronomical levels of debt Australians owe, en economic slowdown will increase the debt servicing burden, which in turn (1) increases the likelihood of bad debts and thereby, (2) decreases the quality of the loans in the banking system. Effect (1) increases the likelihood of debt deflation (see Aussie household debt not as bad as it seems? for more detailed explanation). Effect (2) will lead to the contraction in the supply of money and credit (or at least a slowdown in its expansion) in the economy (see How money & credit can shrink (i.e. deflation)? for more detailed explanation).

As we said before in Australian property good investment? Part 3?prospects of capital appreciation (written more than a year ago),

Traditionally, it is the rising income levels that drive property prices upwards over the years. Naturally, as people?s general income level increases, the prices paid for property will increase as well. Recently, we have another phenomena that drive property prices upwards?the sudden availability of easy credit and low interest rates, which are manifestations of monetary inflation (?printing? of money). The result is a short-term property price bubble…

So, given that Australian house price inflation are driven mainly by credit (NOT income), shrinking supply of credit will at least put a brake on further price inflation. In fact, we can argue that for every same percentage increase in asset prices, the amount of credit required increases exponentially. Thus, we do not even need a shrinking amount of credit to induce asset price deflation- a slowdown in credit increase is enough to do that job. In Australia’s case, credit is the oxygen for the property market. Without it, no matter how much excess ‘demand’ for housing is out there, there will not be enough people who can afford them.

As we can see from this Bloomberg article, Australian House Prices Fall Most in Five Years on Higher Rates,

Australian house prices fell in the first quarter by the most in five years after the central bank raised interest rates at the fastest pace in more than a decade.

The median price for houses fell to A$458,488 ($439,644) in the March quarter, down 2.7 percent from the previous three months, the Real Estate Institute of Australia and Mortgage Choice Ltd. said. Apartments also fell 2.7 percent to A$355,297.

The statistics at RBA shows that credit growth in Australia is starting to slow due to interest rates rise. And at the same time, we see property price deflation in the first quarter of 2008.

Therefore, a slowing economy is NOT good for house price.

But what if the economy slows down too much for the RBA’s liking? In that case, given the high levels of debt of Australians, if the economy slows down too much, the Australian economy can tip into a dangerous downward deflationary spiral. That was what happened to Japan during the 1990s. Today, the Japanese are still trying to recover from that deflation. When that happens, the RBA will be cutting interest rates just like Ben Bernanke did recently. In short, while the RBA is looking at inflation, it will not cut interest rates unless deflation becomes a serious threat. By the time deflation becomes a serious threat, will cutting interest rates re-ignite the property price bubble?

Again, we doubt so. As we said before in What makes monetary policy ?loose? or ?tight??,

A common misperception is to assume that any rise in interest rates automatically implies a monetary tightening (and conversely for a fall in interest rates).

Underneath BIS Shrapnel’s assumption lies the erroneous misconception that the cutting of interest rates automatically result in a loose monetary policy (i.e. increase in the quantity of money and credit in the economy). If deflation gets serious enough, the cutting of interests will still result in a ‘tight’ monetary policy. Japan was an excellent case in point. Another excellent case in point is the United States today. Despite Ben Bernanke cutting interest rates desperately, did it re-inflate the property bubble over there (see this news magazine article, US Home Prices Tumble in April)?

In short, BIS Shrapnel has no credibility.

P.S. Temjin & David: We will continue to answer your questions (in What is a crack-up boom?) in the coming articles.

Is the credit crisis the end of the beginning?

Wednesday, May 14th, 2008

We will introduce another character today- Satyajit Das. He is a world-leading expert in derivatives and risk management and has a good inside knowledge of the murky world of derivatives. He is best known as the author of the fascinating book, Traders, Guns & Money.

Unlike the mainstream media and market, Satyajit Das is under no illusion that the credit crisis is over. In fact, as he wrote in Nuclear De-Leveraging,

An alternative and, arguably, better view of the current state of the financial crisis is that stated by Winston Churchill: ?… this is not the end. It is not even the beginning of the end. But it is, perhaps, the end of the beginning.?

Why is it so?  The short answer is de-leveraging. As we said before in Why are fantastic stocks sold off in a bear market?,

Today, there are so much leverage in the financial system and by extension, the market. Both retail and institutional market participants borrow and employ leveraged derivates (e.g. options, CFDs, futures, etc). The problem with leverage is that, when the market goes against you, your losses are magnified and you find that you are suddenly short of cash (to repay the debts, obligation, margin calls, collateral, etc). Sometimes, the only way to increase your cash level is to liquidate whatever you have- the good investments along with the bad. If enough people are in the same situation as you, this will result in widespread indiscriminate selling in the market.

As long as the de-leveraging process is confined to only the financial markets, the sell-off in stocks presents an excellent buying opportunity. Unfortunately, according to Satyajit Das’s opinion, the de-leveraging process in the financial market is only the first phase of a much larger process. He believes that this process will spread to the real side of the economy (see Analysing recent falls in oil prices?real vs investment demand on the difference between the financial and real sides of the economy), which means that the person on the street will eventually feel the impact. As we said before in The Great Crash of 1929,

Also contrary to popular impressions, that Great Crash was not a one-day event. It was a series of events that marked the beginning of an even more devastating consequence?the Great Depression. In fact, it took a year after the Great Crash for the average person on the street to feel the effects of the ensuing Great Depression.

If Satyajit Das is right, then in the future, we will look back at the credit crunch as just the beginning events of a greater scheme of things.  Currently, from the looks of things, the first phase is over. The effect is that money has become more expensive (see Rising price of money through the demise of ?shadow? banking system).

Next, another process is currently under way- the returning of bad quality assets into the bank’s balance sheet. As we explained before in What is SIV?,

The recent deterioration in the credit market is severely disrupting the SIV funds because of the high cost of obtaining short-term funding. As a result, many of the lenders have to buy back the mortgage assets from the SIV, resulting re-loading those mortgage asset into its balance sheet.

As Satyajit Das said,

High inter-bank rates and the deceleration in bank lending reflect, in part, banks husbanding their cash resources to accommodate the involuntary increase in assets.

In addition to this return of bad assets to their balance sheet, the banks also have to contend with losses incurred by the write-down of bad debts. What will happen then? As we said before in Banking for dummies,

As you can see by now, the banking business is a balancing act of managing a portfolio of assets and liabilities. Since the banking industry is a highly regulated one, there are rules for them to follow in this balancing act.

Now that the banks’ balance between assets and liabilities are out of equilibrium, what will happen? To restore balance, banks will have to raise capital (i.e. issue shares for cash) and/or cut down on lending and/or sell assets. Indeed, central bankers and foreign sovereign wealth funds have been very ‘helpful’ in this balance restoration process (see Central banks & pawnshops and Why did the foreigners bail out cash-starved financial institutions?).

As Satyajit Das continues,

The new capital noted above will merely restore bank balance sheets. Growth in lending and assets will require additional capital. The banking system?s ability to supply credit is significantly impaired and will remain so for the foreseeable future. Credit is clearly being rationed in the global financial system. If the banks are not able to re-capitalise, then the contraction in credit supply will be sharper.

Guess what will happen when the supply of money and credit contracts sharply? This is what we call “deflation” (see What is inflation and deflation?). During deflation, businesses and individuals have to de-leverage. Already, this process is already under way in Australia. When reading the mainstream newspapers, you will get to read numerous reports that credit is tightening. For example, take a read at Debt down as rates hurt in the Sydney Morning Herald,

The value of debt taken on by consumers and businesses slumped in March as higher interest rates continued to bite, according to figures published yesterday.

An economist at Lehman Brothers, Stephen Roberts, said the decrease in credit use was further evidence of the global credit crunch rippling through the broader economy as companies and consumers wind back their exposure to debt.

In Australia, with total private debt to GDP ratio of around 170%,  you can be sure that there will be more de-leveraging in the private sector to go.

This is the beginning of the next phase where the real economy is affected. In the next article, we will show you how this phase will unfold.

Banking for dummies

Wednesday, April 23rd, 2008

One of the most lucrative business in the world is banking. This is especially true in a world of fiat money and fractional reserve banking system, where money that is backed by nothing can be created from thin air. As we have seen previously in Reserve Bank of Australia entering the landlord business, the central bank can always prevent or prempt a shorter term financial meltdown by pumping liquidity into the system (that is,’printing’ money and then followed by lending them or buying up bad debts or some other tricks- see Recipe for hyperinflation) and introducing moral hazard. But in the longer term, the people have to pay for these moral hazards via inflation.

Today, we will take an introductory look at the business of banking.

At its very core, a bank borrows money at lower interest rates and lends them out at higher interest rates. Its borrowings are its liabilities while its lendings are its assets. When you deposit your money into the bank, your money is the bank’s liability but your asset. In accounting technicalities, your money goes into the bank’s balance sheet as an asset with a corresponding liability.

Currently, today’s banking system is a fractional reserve banking system. That means banks do not have to keep all your deposit money in its ‘vault.’ Since it is unlikely that you will recall most of your deposit money at any one time, it can lend out the vast majority of your deposit money while simultaneously maintaining the full balance in your bank statements. Legally, banks have to keep a minimum ratio of deposit money in its ‘vault’ to deposit money. This ratio is the reserve ratio, which is 10% in the US. Countries like Australia do not have formal reserve ratio requirement. The implication is that if every bank customer decides to recall all their deposit money simultaneously, the bank is insolvent instantaneously. That is, there is a run on the bank.

As we said earlier, a bank profits by taking a cut between its borrowing and lending interest rates. If it keeps too much deposit money in the ‘vault,’ it is money that is not put in productive use and thus, have a negative impact on its profits. On the other hand, lending money out entails risks of debt default. Side note: With the rise of securitisation (see Collateral Debt Obligation?turning rotten meat into delicious beef steak), banks (and non-banks as well) are able to lend and re-lend money many times over, spewing out massive amount of credit into the financial system.

As you can see by now, the banking business is a balancing act of managing a portfolio of assets and liabilities. Since the banking industry is a highly regulated one, there are rules for them to follow in this balancing act. For example, there are government regulations that require banks to keep a certain ratio between risky assets (loans and bonds) and equity capital (excess of assets over its liabilities). The upcoming Basel II accord is another such example.

The global credit crisis has thrown many spanners in the works of many banks’ portfolio and by extension, the global financial system. As you can see, bad debts is causing the mayhem in banks’ portfolio (see Is this sub-prime or solvency crisis?). When the financial system realised that the price of money was too low for too long (see Prepare for asset repricing, warns Trichet, which is written back in January last year), banks (as well as non-bank) become very much risk averse and hoarded money as a result. In other words, money suddenly becomes scarce (which implies its price, the interest rates has risen).

So, as we asked before in Reserve Bank of Australia entering the landlord business, what might be the “possible repercussions if the RBA had not [got into the landord business]?” When money becomes scarce and banks (as well as non-banks) become more scared, lending seizes up and credit standards become tighter (see Rising price of money through the demise of ?shadow? banking system). For economies that are drugged up by credit (e.g. Australia, UK and the US), this can cause the economic activity to seize up. The fact that the RBA is temporarily swapping risky assets (mortgage bonds) for thin air money at a bargain price is a very telling sign. And it is not only the RBA that is doing this- it looks that other central bankers are coordinating their efforts in pumping liquidity into the financial system. At least this is the official reason. Since the RBA did not reveal who they get their mortgage bonds from, other conspiracy theorists believe that the RBA are bailing out some financial institutions (which include banks and the non-bank lenders).

For bankers, there is such a thing as free lunch.

What lies ahead for the Australian economy in the coming years?

Sunday, April 6th, 2008

As we can see, over the past several months, there had been a lot of volatility in the global financial markets. As we said before in Why is the market so easily tossed and turned by dribs and drabs of data?, without the proper framework of sound economic theory, the outcome is that the lack of deductive reasoning and insights brought about the situation where the

… market gets tossed and turned by every minute variations of statistical information from economic reports. The end result is confusion and volatility.

Clearly, this shows that the media, pundits, investors, traders and other market participants do not know what is going on.

Today, we will present to you what we believe to be the long-term big picture. Our opinion is by no means a prediction in the forecasting sense- rather, it is just our feeling, intuition and guesses (maybe one day in the future, this opinion will be famously known as ‘insight’ or ‘foresight’?). Therefore, do NOT take our opinion as financial advice- we are not financial advisers and our conviction is that one should be ultimately responsible for one’s own investment and financial decisions.

Okay, here comes the meat…

Firstly, our belief is that the US economy is heading for a hard landing. Currently, Ben Bernanke’s forecast is that economic growth will pick up in 2009 after a possible mild recession. This is also the belief of the market, as it tentatively believes that the credit crunch is abating. We are sceptical of this view. After all, years of accumulation of bad debts, over-leverage, mal-investments and structural damage of the US economy cannot be simply brushed away with the turning of interest rate levers, money ‘printing,’ bailouts and sweet talks. As we explained 13 months ago in Marc Faber on why further correction is coming- Part 2, the liquidity contraction that started in the US is resulting in the process of global asset price deflation, especially house prices in the US. As asset prices deflate, this will bring about further bad debts, which in turn will bring about further deflation in a vicious cycle.

Next, as it especially applies to the Western developed world, the financial side of the economy has grown to be a major intertwined component of the overall economy. As we said before in Analysing recent falls in oil prices- real vs investment demand, the difference between the real and financial side of the economy is that the

.. real side [is] where you find the physical market for goods, services and labour. The financial side is where you find the flow of financial capital, assets and payments.

It can be argued that today, the financial side of the economy had grown beyond its original supporting role of efficiently and flexibly allocating capital for the real-side of the economy, to the point of playing one of the primary roles in the economy. In any case, both sides are interlocked hand-in-hand with each other, which means any shocks to the financial system will affect the real economy and vice versa. To illustrate this point, take the case of Australia. With the vast majority of working Australians parking their retirement savings through the superannuation system, which in turn distributes the savings into financial products (e.g. managed funds), which in turn further distribute these savings into the financial asset markets (e.g. stock market). Furthermore, even ownership of physical assets (e.g. property) requires credit, which in turn is sourced from the financial system. And when it comes to credit, developed Western economies like Australia have been gorging on them to fund anything from credit card debts, personal loans, car loans, stock investment through margin lending, store cards, etc. Therefore, you can see that any breakdown in the financial system will have serious and dire consequences on the rest of the real economy.

For Australia, it seems to be at a sweet spot. The voracious Chinese demand for commodities have been a windfall for Australia, which has vast reserves of resources to supply the Chinese economy. That, along with a highly advanced financial system helps spread the prosperity to the rest of the nation to some degree. But the dark side of this prosperity is the build up of leverage (debts) to a dangerously high level (see Aussie household debt not as bad as it seems? and Australia has no sub-prime debt? Think again!).

Now, there are dark clouds in the horizon. The global financial system had never been as interconnected as before in the history of capitalism. You can be sure that any trouble that begins in the US financial system will spread to the rest of the world. As of today, there are murmurs about the credit crunch being the most serious crisis since the Great Depression. As the financial system rot in the US economy spreads into its real side, you can be sure that Australia’s financial system will be severely affected as well. The Australian economy (along with other Western economies with advanced financial system like the US and UK economies) are highly leveraged (i.e. burdened with far too high levels of debt) both at the retail household level and at the institutional level. Already, we are hearing about bankruptcies, blow-ups and traumatic losses in the global corporate sector (e.g. Allco, MFS, Fincorp, Centro, Basis Capital, ABC Learning Centre, Tricom, Opes, Bear Stearns, UBS, Citigroup and too many more to list). The Australian household sector is feeling the debt stress (e.g. mortgage stress, housing affordability and rental crisis, soaring personal debt levels, etc). As we said before in Rising price of money through the demise of ?shadow? banking system),

Australians love their debt too much. From the large current account deficit (see Understanding the Balance of Payments), much of Australia?s debts are sourced from overseas. With the demise of the global ?shadow? banking system, the price of money in Australia has to rise too.

A highly indebted nation cannot afford to have the price of its credit rise without acute consequences. Thus, University of Western Sydney (UWS) Professor Steve Keen believes that a severe recession induced by debt deflation will arrive at Australia within 2 years.

The question is, will China save Australia from this?

For one, the rot in the global financial system may not affect the real side of the Chinese economy directly. This is because the Chinese financial system is still rather primitive compared to the advanced Wester economies. For example, there are still hundreds of millions of peasants toiling in the countryside. Those who migrated to the cities to toil under the factories are still not plugged into the developing Chinese financial system. Therefore, unlike the Western world, a bearish Chinese stock market does not necessarily forecast doom for the wider Chinese economy. As a result, the credit crunch that started in the US will have a limited impact on the real side of the Chinese economy. So far, this is good news for Australia (but Australia is not out of the woods yet).

Therefore, our opinion is that when the inevitable severe recession hits the Australian economy soon, the Australian mining (and related) sector will probably be the only bright spot in the darkness. In fact, we can argue that a recession may perhaps even be beneficial for the mining sector as much of the idle resources (caused by the recession) in the economy can be re-allocated to the mining sector (see How is Australia?s mining boom sucking resources out of the economy?).

But here comes the bad news.

Firstly, in a hard landing of the US economy, the real side of their economy will be crunched as well. Our theory is that this may lead to a more than proportionate contraction in the investment activities that dominates the Chinese economy, which will trigger a hard landing in the Chinese economy. Even if this theory turns out unfounded, there is another worry- the Chinese economy may not have enough resources supplied to it fast enough to maintain the trajectory of its economic growth. When that happens, the risk is that the trajectory may be shot down, resulting in the forced liquidation of all these mal-investments. The outcome is a big Chinese bust. Our article, Can China really ?de-couple? from a US recession? has the full explanation of our theory. When that happens, the last leg supporting the Australian economy will be kicked off. This is the worst-case scenario for the global economy (and by extension, Australia). Our feeling is that the coming Chinese bust may come with a time-lag after the US hard landing. If our theory about the more than proportionate contraction in Chinese investment holds true, then the time-lag may be shorter.

But yet again, this may not be all bad news in the longer run. If China’s rise is a secular event (see Example of a secular trend- commodities and the upcoming rise of a potential superpower) of the 21st century, then Australia can still climb out of this worst-case scenario.

Please note that we are not making any predictions here. Our vision is very far out into the future. Generally, the further one ventures into the future, the more likely unforeseen Black Swans will sneak in to turn one’s vision into fantasy. But as the old adage says, prepare for the worst but hope for the best.

Support mortgage lenders to keep borrowers in indentured servitude?

Thursday, April 3rd, 2008

Last week, there was an article in the mainstream news media, Call to support mortgage lenders,

THE global credit crunch is destroying competition in the home-lending market, leading to the threat of permanently higher mortgage rates.

The warning comes from two leading economists, who are calling on the Rudd Government to establish a scheme similar to those operating in the US and Canada, under which it would use its AAA credit rating to bolster the funds available for home lending, helping to keep small operators in business.

So, these ‘leading’ economists are asking the government to get into the landlord business? By reviving the shadow banking system that way (see Rising price of money through the demise of ?shadow? banking system), they hope to re-introduce ‘competition’ into the mortgage industry to lower mortgage rates.

These economists do not understand the concept of competition. In the real economy, competition means utilising scarce resources in a more efficient way to produce more, create new products or make better products. But for the mortgage industry where the product is credit, how can the idea of ‘competition’ be applied when the product (money and credit) can be created limitlessly out of thin air by the government (central bank) and financial system?

Mortgage rates have to rise for a good reason. Money had been too cheap for too long, and this is the primary reason why there are so many bad debts in the global financial system as far too many gorged on debt that they cannot really repay. Rising mortgage rates is just a reversion to what should have been long time ago. Supporting mortgage lenders will not solve the problems of scarcity in the real world- it will merely lead more people into indentured servitude.

Australia has no sub-prime debt? Think again!

Monday, March 31st, 2008

There is a widespread belief that the sub-prime debt problems in the US is something that can never happen to Australia. The idea that Australian lending is more ‘prudent’ and ‘responsible’ than their US brethren is quite popular. That, along with record low unemployment and the strong resource boom powered by the eternally booming Chinese economy gives the impression that the Australian economy is very strong and that no harm shall befall it forever and ever. Add the mob-pleasing cheerleading ‘research’ by institutions such as BIS Shrapnel (see Another faulty analysis: BIS Shrapnel on house prices) into the mix and we get further incitement into debt overindulgence. Indeed, Australia’s love affair with debt is no different from drug addiction. Eventually, when the drug wears off, painful cold turkey treatment will follow. As we have warned before in Aussie household debt not as bad as it seems?, we will sound our warning again.

Today, we will refer you to a sobering documentary from the ABC- Debtland. This documentary is highly recommended, especially for those who are (1) thinking of ‘investing’ in residential property (see our guide, Are Australian residential properties good investments?), (2) owning huge amounts of debt and (3) thinking of getting deeper into debt. Here, we will quote some important points and add some of our own comments from the transcript of this documentary:

Brian Johnson, a Banking Analyst from JP Morgan said,

The Banks are just handing out money on credit cards like there is no tomorrow. For me it’s quite terrifying to think that the average household in Australia, so the average, now has three months of their monthly disposable income on a credit card balance.

In addition to their burdensome mortgage debts, Australians are taking up even more debts from multiple credit cards, store cards, personal loans, car loans, etc. As Brain Johnson said,

It strikes me that it’s nonsensical, the amount of total debt out there. And no-one seems to know how much debt because a borrower can borrow money across multiple providers of credit.

Thus, each provider of credit does not know the true picture of a borrower’s financial position. While each credit may be sound on its own, how sound will all these combined credit be when concentrated on a borrower? If we do not really know how much debt a person has, how can we really know what the effect of rising interest rates be on that person?

Now, what about those families who are under severe mortgage stress? ABC reporter, asked,

So do you think we’re seeing a situation where people are really under stress on their mortgages and are getting credit cards and basically living off credit on the plastic?

Brian Johnson answered,

There’s no other way that you, there’s no other conclusion you can really draw from the data. And in fact when you speak to the banks about that quantum level of credit card debt there’s a noticeable silence.

Does Australia’s lender practice prudent lending practices? Here are some of the shocking cases…

Kim White, former National Australia Bank (NAB) said,

We would see people come through and we’d estimate how much it cost to lend them all their payments, everything else like that. At the end of the month they’d have $100 left over, but sometimes the system would still say, lend them the money and that person is living on a razor edge.

And you know that they’re not going to be able to afford it. They’re going to live on their credit card for their basic living expenses and get themselves into worse debt. But the system would say do it, the bank would say do it or else you’re going to be under the gun, you’re going to be performance managed out. So we’re in the situation where we lent to whoever we could and as much money as they wanted.

ABC’s Four Corners said

If Kim White wouldn’t rev up the credit limits, someone else would.

In another case, Commonwealth Bank of Australia (CBA) provided credit to a refugee family:

Deng Gatluak and his family fled to Melbourne from war torn Sudan. A refugee with no English, no job, and no concept of finance – yet the Commonwealth Bank gave him a $20,000 car loan. The repayments left this large family with next to nothing to live on.

His wife Nyatut still speaks virtually no English and has no assets, yet she was made the guarantor on the car loan.

Is this just some isolated cases? Good question. As Gary Rothman from Uniting Care said,

If we’re seeing people on low incomes and on Centrelink benefits being lent money that they have no way of repaying, then what are they doing to people who are on even higher incomes and how are they burdening them with debt that they can’t repay?

Good question.

What if an economic recession hits Australia? As we said before in Aussie household debt not as bad as it seems?

A severe downturn to the Australian economy may or may not be statistically likely, but given the level of unprecedented leverage, you can be sure the impact will not be small.

Professor Terry Burke from Swinburne University would agree with us,

What we found was that almost 50 per cent of all households were relying on either overtime or a second job of the main income earner to sustain the mortgage. Now that’s fine so long as the economy is still steaming along at full speed but any slow down in the economy, that’s what will go, the part-time job, the casual payments, overtime, and then you’re in trouble.

In a Sydney suburb of Kellyville,

Out here houses bought for $900,000 a few years ago have sold for not much more than half that. The staggering decline raises questions about the valuations the banks and the buyers relied on.

Brendon Hulcombe, CEO of Herron Todd White said,

The valuer should be able to act without fear or favour but unfortunately we’re getting a lot of pressure from lenders who want to get high valuations to get their deals through.

I don’t know how many are being over-valued but I can tell you that every hour of every day, pressure is put on valuers to write higher figures.

Furthermore, ABC reported that,

Just as banks have become freer with their lending they’ve become looser when it comes to assessing what a property is worth.

Often they don’t even bother to send a valuer through the front door and they’re not always aware of the backdoor deals being done to get the sales though.

As it turns out, valuations are subjected to corruption too as Matt Ganter, a valuer from Herron Todd White said,

There’s a bit of an issue out here where developers rebate to the tune of up to around about 15,000 on a block for 160,000, which brings the true value of what people are paying down to the 145,000 mark.

[Banks are getting false valuation] if they’re relying on the automated valuation models and there’s rebates involved, absolutely.

Now, in addition to mortgage loans and credit card, there are other kinds of loans including margin lending for shares, store cards, and so on. One of them, GE Money was singled out for irresponsible lending with exorbitant with high interest rates.

We wonder how much sub-prime debt does Australia have.

Another faulty analysis: BIS Shrapnel on house prices

Sunday, March 30th, 2008

As reported in this news media article, BIS Shrapnel just released an report,

Australia’s housing affordability crisis is expected to dramatically worsen during the next five years, with property prices forecast to rise by as much as 40 per cent.

Economic forecaster BIS Shrapnel says housing affordability, already at record lows, will decline even further in the years ahead as demand continues to outstrip supply.

This is an example of misinformation and ‘analysis’ by those who should know better.

Firstly, this is an example of turkey thinking (see Example of a financial turkey: Australian Property Monitors), as the article said:

The figures quoted by Mr Gelber are largely in line with Australian Bureau of Statistics (ABS) data.

Calculations, based on the ABS established house price index, show that during the 10 years to December 2007, house prices rose an average of 9.9 per cent a year. The index rose 12.3 per cent in 2007.

In the 10 years before that, house prices rose an average six per cent a year.

In the past 20 years they have risen an average 7.9 per cent a year.

The journalist who wrote that article was implying that since property prices had been rising so many percent over the past so many years, therefore what happened in the past is consistent to what will happen in the future as ‘predicted’ by BIS Shrapnel. Turkey thinking is the primary reason why the majority is always wrong (see our guide Why are the majority so wrong at the same time and in the same ways?).

Secondly, this type of analysis is too simplistic. Basically, it is simplistically saying that since demand is greater than supply, then prices will rise. It looks to us that BIS Shrapnel is looking at the Australian property market as a monolithic whole. In reality, as we said before in Myths on the Australian housing/rental crisis & its implications, the problem is not really simplistically due to outright shortage. Rather, the real problem is the mismatch between demand and supply. In Sydney alone, there are some areas suffering from over-demand and others suffering from over-supply. Blindly increasing the supply alone will not solve the problem.

Can Australia’s already excessive debt levels increase further to feed further property price boom? This is another flaw in BIS Shrapnel’s analysis. The only way for house price to rise further is for debt levels to increase. If Australia’s high levels of debts are already strangling the average Australians with excessive debt stress (e.g. mortgage debts) at a time of record low unemployment, how can debt levels increase any further to feed the further substantial increase in house prices? As the business cycle turns, unemployment will increase, which will result in de-leveraging of the highly leveraged households. The higher the leverage, the more painful the de-leveraging will be. The more painful de-leveraging is, the greater pressure will be on asset prices (see What can tip Australia into a downward property price spiral?).

Where is the housing ‘demand’ going to come from as credit becomes more expensive? The only way for most people to buy a property is to borrow money. If credit becomes more expensive (i.e. harder to borrow money), obviously the ‘demand’ for properties will fall as well. As we said before in Rising price of money through the demise of ?shadow? banking system, the global financial system is undergoing a credit crunch whereby money is getting more and more expensive. Along with that, the ‘demand’ for houses will slowly disappear as well.

BIS Shrapnel had also shown itself to be economically challenged. As the article said,

Mr Gelber says the current environment of rising interest rates has compounded the problem, with people choosing to wait before buying or building property.

This also meant that when interest rates stopped rising or eventually started to fall, there would likely be a surge in demand for housing which could result in another price explosion.

If it ever comes a day when the Reserve Bank of Australia (RBA) has to cut interest rates, it will be a day when the Australian economy is in deep trouble, when debt deflation grips the nation. That will NOT be good for property prices. In fact, this is currently happening in the US right now when money-printer Ben Bernanke (see Peering into the soul of Ben Bernanke) is busy trying to fight asset price deflation (see Recipe for hyperinflation).

We are astounded that even a leading industry research organisation can produce such nonsense.

Liquidity?Global Markets Face `Severe Correction,’ Faber Says

Tuesday, January 16th, 2007

Marc Faber, the legendary contrarian, predicted the 1987 stock market crash, had this to say. He singled out emerging markets for a correction, especially Russia, followed by China (see China is tightening liquidity) and India. In that correction, all asset markets will be affected.

What is the rationale behind Faber?s prediction?

First, we have to understand the concept of ?liquidity.? What is ?liquidity?? There are other meanings for the word ?liquidity?, but for the purpose of this article, we will stick to the quick and dirty definition of ?liquidity? being ?money? in the financial system. Now, how do we define what is the ?money? in liquidity? Traditionally, ?money? is just what it is?cash and deposits. But today, with the advances in finance, ?money? is no longer as easily and clearly defined as before. As a result, money substitutes are becoming proxies for money and playing a much more important role in global liquidity than before. Examples of money substitutes include credit (e.g. mortgage-backed securities) and derivatives.

Now, what has liquidity got to do with the asset markets?

As you may have noticed, stock markets around the world are in record high territories. What is driving the stock markets is liquidity?the sheer weight of money and money substitutes chasing after a limited supply of assets (bonds, stocks, art, etc), resulting in skyrocketing prices. Therefore, any crunch in liquidity will result in collapsing asset prices.

How is it possible for liquidity to be crunched?

The problem with liquidity is that most of the ?money? in it is made up of money substitutes, most notably derivatives. Today?s modern financial system is such that when the central bank ?creates? money, money substitutes get spawned multiple times. The outcome is a pyramid of ?money,? with hard cash at the apex and derivatives at the bottom. The financial assets between the apex and bottom include cash deposits (spawned and multiplied from hard cash through the fractional reserve banking system) and credit (e.g. securitised debt). In such a liquidity pyramid, the values of financial assets at the lower part of the pyramid are derived from and backed up by the financial assets above it. Since much more of global liquidity are composed of ?money? in the lower part of the pyramid, any contraction in the upper parts of the pyramid will result in a multiplied contraction in the lower parts. If the liquidity contraction is severe enough, asset prices will fall precipitously, which in turn may trigger even more contraction in liquidity. This is called a ?market crash.?

Thus, as long as the central bank can influence the increase in liquidity into the financial system, asset prices will rise. If for whatever reason, liquidity contract severely enough, asset prices will collapse.

The question is, are we now ripe for a contraction in liquidity?

One potential trouble-maker to watch out for in 2007

Wednesday, January 3rd, 2007

As 2006 closed with stock markets around the world in record high with an eerie calm in terms of volatility, it is very tempting to assume that 2007 will bring more of the same. From the news report, many fund managers have such optimistic view. With the supply of money and credit still expanding, it is indeed very much possible for the good times to continue in 2007. But this does not mean there are no dangers. Hence, today, we will look at a possible danger scenario: the sustained downtrend of the US dollar. As we said in Will the US dollar collapse?, it is only a matter of time before this scenario will happen. The question is, will it happen in 2007?

At this point in time, both the US bond and stock market (especially the bond market) are expecting interest rates to decline in 2007. We said before in Are you prepared for the coming storm?, the ?market seems to be spell-bound by some kind perfect wonderland myth?it ?thinks? that the economy is so weak that the Federal Reserve will cut interest rates next year (which is good for stock prices) and so strong that a recession will be avoided.? If events turn out to contradict the markets? expectation, we can be sure that the results will be very unfavourable.

As we elaborated in What can we expect in a US dollar decline?, a sustained decline in the US dollar will show up as inflation in the US domestic front, which will force the Federal Reserve to raise interest rates. With the US economy already faltering, this will lead to a recession. When that happens, the bull run of 2006 will turn into a bear, as it happened before in May 2006 when talk of raising interest rates spooked the stock and commodity markets. Thus, we will be faced with a hard-landing scenario of declining US dollar and rising interest rates. At this point in time, it will be much harder to foresee what will happen next. As such, what follow will be merely our gloomy guesses.

It is possible for a sustained decline of the US dollar to descend into a nightmare rout in the US dollar through a circuitous route of cause and effects (though it is unclear how likely it would be). If that happens, the results will be unpredictably ugly. Though Asian and Middle-Eastern central bankers certainly have the means to set off a disorderly collapse of the US dollar (see Awash with cash?what to do with it?), it is unlikely that they will have the motivation to do so unless some unpredictably drastic developments took place in their domestic front. It is more likely that they will not sell their US dollar reserves out of their own accord?that is, if they should do so, it would likely be because the US dollar is already falling. But whatever the initial cause, if should we see foreign central bankers dumping their US dollars, it will be the sign of the beginning of great global upheaval as there will be great implications on the Middle East and oil (we will talk about that in the future). Since much of the world?s financial assets are denominated in US dollars, there will be a rush to shift from those assets into safe havens?that can only mean old trusty gold, which is humanity?s choice since ancient history.

So, for 2007, watch out for the US dollar!