Stevens fire second warning shot across ship’s bow

Reserve Bank Boss Glenn Stevens has today warned Australian households to reduce their debt levels and start saving. The warning stems from the European debt crisis, with Mr Stevens saying markets can ignore problems they know about for a long time before something triggers a sudden collapse. “Markets can happily tolerate something for an extended period without much reaction, then suddenly react very strongly as some trigger brings the issue into clearer focus”

Mr Stevens said “The big rise in debt in the past couple of decades has been in the household sector” and that it wouldn’t be wise for this to continue and build. Doing so would expose households to significant shocks in the future.

A report yesterday from Standard & Poor’s supported Mr Stevens view. ”We believe the larger debts and higher leverage expose some Australian mortgage holders, especially those with less equity in their houses, to potentially greater financial shock if high unemployment and interest rates, alongside a collapse of residential property values, were to occur,” said Standard & Poor’s credit analyst Vera Chaplin.

The warning today follows one in May this year when RBA Governor Glenn Stevens told Channel 7’s Sunrise viewers that leveraging up in property wasn’t a “riskless, easy, guaranteed way to prosperity.”

Extremely high levels of household debt has only been a problem over the last 15 years. For most of the ’80s household debt sat on an average of about 40 cents for every $1 a household earned. Today, the level is 4 times that amount at just under $1.60 of debt for every dollar the household earns.

In December 2009, figures from the Reserve Bank of Australia showed total household debt as a percentage of disposable income at 155.8%. Of that, 138.2% or the vast majority of it is housing debt due much in part of Australia’s huge housing bubble.

As Stevens rightly says markets have ignored this problem of household debt for a long time, about 15 years now, and the consequences could be severe if an external shock was to occur.

Just as worrying is the pace of household savings. As houses continued over the past decade to outstrip wages, extra money was required from household budgets to meet repayments on this high level of debt. The first thing to get soaked up was household savings.

But this does leave highly leveraged households extremely vulnerable if there were a short term loss or reduction in household income and they were unable to met the repayments on their debt, something a little bit of savings might help with. As more money is soaked up into housing, less money is left in household budgets to be spent in the domestic economy. Retailers and small businesses are already beginning to bear the brunt of these consequences and many have lost their jobs.

External shocks could be the collapse of the property bubble in China, which could dent Australia’s resource exports or a further liquidity crisis in global lending.

When the GFC first hit, it was a wake up call for many. Almost immediately households began to de-leverage and start saving. However with economists saying Australia escaped the GFC (has it really begun?), households are back to their old ways of spending more than they earn and piling up the debt. Europe should be a timely reminder. The debt is killing us.

» RBA’s Stevens Says Household Debt Must Remain Prudent (Update1) – Bloomberg, 9th June 2010.

» ‘Financial shock’ risk for borrowers – The Sydney Morning Herald, 9th June 2010.