The RBA governor is not worried by house prices. He’s worried about households who may cut back on spending in an attempt to get their debt levels under control.
Much recent discussion in financial circles has focussed on how mortgage defaults would damage banks’ balance sheets and place the Australian financial system at risk in the same manner as the U.S. banking sector was jeopardised in 2007/2008. House owners defaulted, banks lost money on loans which were not repaid in full and the result was banks had no funds to lend to business or credit-worthy borrowers. Recession ensued.
However, at a speech to the Economic Society of Australia in Queensland, Philip Lowe said this was not the scenario the RBA envisaged. As far as he and the RBA is concerned, Australian banks have enough capital. “The Australian banks are resilient and they are soundly capitalised. A significant correction in the property market would, no doubt, affect their profitability. But the stress tests that have been done under APRA’s eye confirm that the banks are resilient to large movements in the price of residential property.”
The problem as the RBA sees it, is households may begin to see their debt levels as a problem and try to do something about it. Not by selling assets and using the proceeds to repay debt but by spending less of their incomes, saving more and applying those savings to reduce debt. “Instead, the issue we have focused on is the possibility of future sharp cuts in household spending because of stretched balance sheets. Given the high levels of debt and housing prices, relative to incomes, it is likely that some households respond to a future shock to income or housing prices by deciding that they have borrowed too much.”
As consumer spending accounts for around two thirds of GDP, growth in Australia’s economy is largely tied to consumer behaviour. Any reduction in consumption patterns may lead to a contraction and a recession. As the RBA chief puts it, “This could prompt a sharp contraction in their spending, as they try to get their balance sheets back into better shape. An otherwise manageable downturn could be turned into something more serious.”
At this point Philip Lowe and the RBA are uncertain as to where Australia is heading. “History does not provide a particularly good guide, given that housing prices and debt relative to income are at levels that we have not seen before, and the distribution of debt across the population is changing.” Their recent research suggests “the higher is indebtedness, the greater is the sensitivity of spending…”