The Dark Side of Low Interest Rates
Today’s mortgage rates are cheaper than anything in living memory. Home buyers are taking out loans five to seven times their salaries to purchase properties that are 20% overvalued. The same cheap money is also pouring into the stock market inflating share prices that are over valuing companies.
In an interesting twist on economic guardianship, one might argue that by reducing interest rates, it is the Reserve Bank who is guilty of inter-generational theft. Governor Glen Stevens has disclosed that the most recent decision may not necessarily have the intended result; that low business confidence in the medium term may hold back expansion in the private sector.
That however, won’t stop home buyers from taking advantage of the historically low rates, buying into the market and inflating prices that will further exacerbate the growing housing bubble.
In the event the bubble bursts and prices crash, new home owners who have leveraged themselves beyond prudent limits, could well find themselves in a serious negative-equity position. By lowering rates the RBA is effectively exposing these buyers to a financial burden in the future, all in the name of stimulating the economy today.
While the RBA’s primary concern is the rebound of the dollar and the negative impact it would have on exports, the interest rate cut could also have a negative impact if the housing market suffers a rear guard case of nervous uncertainty.
It demonstrates all too clearly that we have learned nothing from the GFC. It was easy money prior to 2008 at quite low interest rates that set off a spider’s web of mortgage backed derivatives containing highly dubious and overvalued products that forced supposedly rock solid investment companies to close their doors when they found themselves insolvent.
Governments everywhere were willing partners along this disturbing trail toward wealth creation. Today, they still appear to have no concern for the level of debt the private sector carries. Their focus is transfixed on public debt (so called).
Not so long-ago John Howard and Peter Costello had no concern for private debt either. While Costello pumped out his surpluses the private sector had to offset them by borrowing. That’s how the nation’s balance sheet works. But let us not delude ourselves that the surplus was money in the bank. It wasn’t.
Surpluses are theft. Private debt is forced to offset them, but the onus of responsibilities shifts from a monopoly issuer, to a borrower with limited capacity. Sooner or later, that limited capacity (think of it as a balloon getting bigger and bigger), will explode.
This is what is coming.
The latest round of interest rate cuts will encourage private individuals to borrow. Some of these individuals will buy houses that cost more than they should. Others will take out margin loans and invest in shares.
Upward pressure will see those shares rise in value, eventually to a point where the automatic triggers that are programmed to issue sell orders, will activate. That will cause a crash. Banks will call in their margin loans and when the borrowers can’t recover their losses, those same banks will issue foreclosure orders against their mortgages.
To recovery their money, the banks will offload the properties at discount prices. That will cause a drop in house prices across the board. But the real estate market will have fewer buyers which will force prices down further.
All those who have mortgages will then be subject to an equity audit. Those who have borrowed upwards of 80% of valuation will find themselves in negative-equity territory and be subject to mortgage repayment demands they cannot meet.
They will lose their homes and look for rental properties. In the meantime, their employer, facing falling orders from reduced activity will begin staff layoffs. From there, it is all downhill for borrowers. And the government will suffer too.
Tax revenue will collapse as hundreds of thousands are made redundant. Welfare payments will soar. This will be Tony Abbott’s brief but damning legacy because he cannot see that his government’s inaction, their failure to respond correctly, will be the principal reason the economy will deteriorate so quickly.
Progressive macroeconomic theory has no problem with an increase in the deficit or the debt for that matter. It is a basic tenet that debt spent on projects that contribute to growth, that increase employment opportunities will stabilise and strengthen the economy.
This government is not doing that. They will never do that. They are paralysed by a fear of debt. Yet they have already wasted billions on border protection and failed to see revenue opportunities in a variety of tax expenditures. Meanwhile, inflated stock markets and housing bubbles do nothing to achieve growth in the long term.
Some free advice for the speculators: be careful out there.
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Yes exactly and anyone who thinks the capitalist world economy is doing ok just has to ask themselves why Japan the US and the Euro countries are /have printed trillionS of dollars/euros and yen. The system is buggered big time. The US dominated (ponzi scheme) system has failed and is in danger of falling over the cliff anytime soon. Sadly people will suffer big time when their super goes pop.
I hope you are both wrong, Mark and John. However, John Kelly, that horrible creature which resides within me, the Grammar Nazi, forces me to bring to your attention the word ‘Tenet’ which, in the closing paragraphs of your article you use the word ‘tenant’ […it is a basic tenant that debt spent on projects…]
A principle or belief, especially one of the main principles of a religion or philosophy.”the tenets of classical liberalism”
Otherwise, a good yet depressing article.
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Some good points, John and whenever I hear about the younger generation being locked out of a spiralling property market, much as I sympathise with their situation, I can’t help but reflecting on the experience of many of the older generation who struggled with 25 year mortgages at 12% and higher during the 1970/80’s.
Interest rates will never be lower than they are today but we live in a banking environment which, unlike the USA will only grant fixed rate loans for 3 to 5 years against up to 30 years in America.The prognosis, as you say, for those who borrow heavily on variable rates, is not a good one.
The other economic wave yet to reach our shores is the 20% depreciation of the Australian dollar against the $US in recent months : whilst a benefit for our export industries and inwards tourism we will soon see the impact on inflation as manufactured goods, including motor vehicles thanks to actions by the Abbott government, start to respond to a lower dollar.
Terry2 when interest rates were high (I was paying 16% at one stage) inflation was also high, wages increased accordingly and in a few years the percentage of wages required to service mortgage payments reduced significantly. Nowadays houses are already overpriced and inflation is low so the mortgage payments will be a burden for a much longer period of time. Low interest rates and poor economic growth are also adversely affecting superannuation returns, it will be interesting to see how many people actually derive any benefit in 10 years time. I don’t think the tail end of the baby boomers will enjoy retirement as much as the early ones have/are, financially anyhow.
John: Spot on as usual.
Mark Carney did the same in Canada and has now been exported to the UK where housing inflation and low interest rates a driving another ponzy scheme. Having survived the GFC we seem to be blindly walking into a similar disaster of our own making all because blind politicians want growth at any cost.
This government and the Reserve Bank are completely lost in a dystopian past that causes cycle after cycle of recession and depression with the subsequent suffering and hardship they impose, and yet they never learn.
You are right it is a fringing minefield.
This government is not doing that. They will never do that. They are paralysed by a fear of debt.
So true John. Paralysed by the irrational fear they have created and so unwilling to step out of the corner they have painted themselves into.
Another great article.
If Kaye Lee for PM. Then John Kelly for Treasurer.
BTW my nephew has just bought his first home. Well technically his parents have bought it for him.
His mother’s comment. “Forget first homes. The price of housing means you may as well skip to the second home.”
All so true John Kelly.
Our politicians are paralysed by a fear of debt and deficit.
If only we could have a summit to discuss progressive macroeconomic theory with the likes of Swan, Bowen and perhaps some of the ‘lefter’ lights of the ALP to thrash out a rational understanding and public educational response to these issues before they are elected to government in 2016.
I fear that after their re-election next year ALP will quickly be forced into political survival mode by hostile media and powerful vested interests – that will necessitate pandering to powerful vested interests by staying on the current business as usual economic merry-go-round.
A public conversion needs to take place to implement a bold deficit funded national investment program – let’s get all the media shock and outrage of abandonment of their religious like necessity to strive for a fed. ‘budget surplus’ out of the way before the election.
The public’s intuitive ‘accepted wisdom’ of ‘budget’ management that is so easily, effectively reinforced/exploited by neo-cons must be challenged and shown up to be the fraud that it truly is upon our nation.
Public understanding/acceptance of the entirely rational arguments for this essential change must start with education of the general public – to the fact that 77% of past fed. budgets have been in deficit – deficits were (and remain) an essential supply/demand management tool that should continue to be astutely used to build the nation’s future productive assets.
On a related subject:
I think that the word ‘budget’ is a misnomer when used in the federal financial management context – it should be replaced with other more accurate term that reflects the reality of the currency issuing capability and related economic activity regulation responsibilities of a sovereign government.
The term budget implies in/out balance is essential = “GOOD”, imbalance in deficit is therefore = “BAD”.
Public misunderstanding of proper federal budgetary management practice is purposefully exploited by neo-cons to advance their self serving goals of small government, reduced govt. ability to control or regulate and private acquirement of profitable state owned assets.
Is there a more appropriate term/word to use in place of ‘budget’ that reflects the governments full/proper responsibilities to manage a sovereign national economy in the pursuit of social equity, currency stability and constructing/enabling nation building assets and industries?
Ideally, I see the Federal Government’s responsibility is to plan, manage, protect and enable our ongoing equitable/egalitarian society for the common wealth of all Australians – ‘budget’ in the federal context does not convey that meaning to me, or in my opinion to the general public.
Perhaps a phrase that infers implementation of a strategic national management plan, without the negative connotation of ‘deficit’ or ‘spending’ now applied to govt. investments in long term nation building assets.
If the general population applied the same ‘debt and deficit’ logic to their own borrowings to acquire their home or other future income producing investment, no one but the ‘rich’ would possess a home to live in, no matter what the borrowing interest rate.
It’s almost as if the self serving populace live in an opposite parallel financial universe,
Yes and when all this happens Abbott will be long gone he will be horse riding in the Chilterns with Rebekah Brooks. Lucky he still has dual citizenship.
The only thing is Australian banks with 60% of their value in property wont be as eager to sell off as the US banks which didn’t enjoy a virtual monopoly/cartel like our banks do.
“Doing economics still largely means “sitting in a chair and making it up””
“The failure of mathematization to produce anything useful in economics has been blamed on mathematics itself”
“After the 2008 financial collapse the guilty were not punished, prosecuted nor reproached for their criminally destructive schemes to loot the American people and the world. Instead they were bailed out, allowed to retain their wealth and power, and rewarded for their misdeeds with further riches provided by their politician puppets in Washington D.C. Evil won.”
The Empire Of Debt: This Is A Sign Of The End.
Deanyz1, thank you for the Grammar Nazi. Always welcome.
My apologies John Kelly for addressing you as John Lord @February 23, 2015 at 2:31 pm.
Taken care of, JohnB
I have some money in Term deposit that is coming up for either renewal or investment.
I'm not interested in buying property, as you correctly state it is overpriced.
My shares are long term investments and it's unlikely I will be adding or selling any of those …. once again for the reasons you have outlined and they are currently giving me a good return.
So ……… "Some free advice for the speculators: be careful out there." …… care to expand on that ?
If you had money to invest where would it go.
With a Caveat emptor, naturally.
As someone who ‘invests’ in a whole variety of asset classes, can I ask you how you reached the conclusion:
20% overvalued? Are you sure? Compared to what? Perhaps a link? And I hope it’s not Steve Keen. (You know, the gambler who likes to go for long walks. And as a loser he does.) And yes people do buy houses and pay ‘too much’. While others pay too little.
Not sure how you arrive at those conclusions.
You go on:
While there’s ‘evidence’ that seems to be true re the Dow Jones, I am not sure that’s true re the ASX. My understanding is that the low returns on bonds, terms deposits and the like are ‘forcing’ ‘investors’, including retirees, to seek a better return via equities.
I am sure John you would know that returns of less than 3% means that you are slowly bleeding to death re retirement income, given inflation, rising cost of living and the like.
I could go on, but I suspect I’ve probably overstayed my welcome on this thread.
John since your last ‘doom and gloom’ prediction re the share market, sensible investors have reaped a bundle. I know I have.
And yes I could lose it in the ‘morrow. Just sayin …
John K – thanks for that fix.
I have been thinking further on how to get the message you have outlined above into the public/political arena for broad discussion.
Communicating policy suggestions to ALP Federal politicians seems to fall on selectively deaf ears – no one in the Federal parliamentary party is prepared to venture far from the prescribed party line these days, for fear of bringing down on themselves an avalanche of enthusiastically unfavourable media attention that will distract from the ever-giving LNP ‘Abbottastrophe’.
Perhaps seeking an informal discussion regarding MMT with some influential ALP ex politicians may reap some reward – someone who is sufficiently removed from party control to be not bound by party solidarity – and one who wouldn’t mind stirring the pot with some unfashionable/controversial economic analysis and home truths for the good of the nation.
People such as Paul Keating, John Faulkner, Julia Gillard, Greg Combet come to mind as persons with the credibility necessary to gain public/media attention. No doubt there are others I haven’t thought of.
Left unchallenged, if both major parties of potential 2016 government aspire to working towards ‘budget’ surpluses Australia is headed for certain recession, probably economic depression.
Is there anyone willing to ‘stick their neck’ out in the national interest to promote discussion outside the political process?
Matters Not, when one so called expert says there is a housing bubble, I would question his/her credentials. But when there is a consensus, I tend to listen. Three such opinions are listed below. There are more. Too often the word ‘bubble’ is appearing in respected news sources today. They may all be wrong but if they turn out to be right, what is the value in knowing that after the event?
John Fraser, right now and for the next 12 months, Term Deposit lets me sleep at night. Low return, yes, but how much is enough?
Perhaps I got a little sidetracked with Cockey's "productivity".
Sleep isn't a problem ….. plenty of time for that etc
Lending to responsible people @ 7% appeals.
I read something,somewhere about this happening with more frequency due to banks refusing small loans.
Can I be another English language Nazi for John B? I would use acquisition rather than acquirement. Some excellent if depressing arguments and ideas for which many thanks.
JohnB (yesterday 2.31pm)
Bill Mitchell shares your concerns about language…
“We noted that the term – budget deficit – has a negative connotation because it signifies a shortfall. In part, this relates to Proposition 1 – the household analogy. Using ‘budget’ with ‘deficit’ triggers this analogy immediately. We should thus only use the term ‘government deficit (surplus)’ and eschew the use of the accompanying qualifier ‘budget’”
John Fraser, I know someone who has done that. It seems to be working. Currently at 6%. You would want to make sure it is tied up with chains.
I remember the Article I read involved a young person with a good family background and support went to a bank for a loan for a car ($10k) and he was refused ……. something that happened to me way,way back when one had to make an appointment with the bank manager, wear a tie and hand over ones life history before begging.
You know John K. I would be inclined to look at helping refugees get set up because I saw just how good Vietnamese boat people made good.
If the banks are refusing them …. which I somehow doubt … I would look at taking up the slack, as well as getting a better return than Term deposit is offering.
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