High and rising household debt levels have long been a concern. Despite the housing slowdown, household debt in Australia is still growing faster than income.
Some worry Australians are unsustainably stretched and it is only a matter of time before they hit trouble. This issue is particularly pertinent at times of global economic uncertainty, like now. We last looked at the household debt issue 18 months ago and our conclusions haven’t changed.
Not just Australia
The chart below shows the level of household debt (mortgage, credit card and personal debt) relative to annual household disposable income for major countries.
While rising household debt is a global phenomenon, debt levels in Australia have gone from the bottom of the pack to near the top. In 1990, average household debt was equal to just half a year’s average household income after tax. Today, it is equal to one and a half years’ after tax income.
I am not my parents
The increase in debt reflects both economic and attitudinal changes. Memories of wars and economic depression have faded and recessions have been getting milder and further apart making debt seem less risky. Furthermore, modern society encourages instant gratification as opposed to saving for what you want. Lower interest rates have made debt seem more affordable and increased competition amongst financial providers has made it more available. So, Baby Boomers and particularly Generation Xers have been far more relaxed about taking on debt than earlier generations.
Not as bad as it looks
There are severalreasons why the rise in household debt may not be as bad as it looks:
· Firstly, household debt has been rising since credit was first invented. It is unclear what a “safe” level is.
· Secondly, higher debt partly reflects a rational adjustment to greater credit availability via competition and lower rates. This also led to the democratisation of credit – making it more widely available.
· Thirdly, the rise in debt levels has been matched by a rise in total household wealth. Thanks largely to a surge in the value of houses and a rise in financial wealth over the last three years, we are far richer. The value of average household wealth has gone from six times average annual after tax income in 1992 to 10 times today. So, while the average level of debt for each man, woman and child in Australia has increased from $11,900 ten years ago to $41,000 now, this has been swamped by an increase in average wealth per person from $108,900 to $277,900.
As a result Australians’ household balance sheets, as measured by net wealth (assets less liabilities), are very healthy. Despite a slight dip over the last year, as average house prices flattened, over the last decade net wealth relative to income has increased substantially, particularly against other countries.
· Fourthly, despite debt interest payments now eating up a record level of after tax income, Australians are not having major problems servicing their loans.
The Reserve Bank’s latest Financial Stability Review shows loan payments in arrears remains low.
· The distribution of debt doesn’t indicate a problem. Debt is concentrated in high-income households who have a high capacity to service it.[1]
· Much of the rise in debt levels before 2003 came via investment property loans. As servicing investment loans is helped by tax breaks the debt burden today is not as onerous as suggested by the previous chart.
· The rise in household debt over the last decade is matched by relatively stable business borrowing and public sector budget surpluses. Its not as if Australians have gone on a spending spree – consumer spending has been trending down relative to GDP. Rather, a low wages share/high profits share of GDP and relatively high tax payments have constrained growth in after tax income and contributed to a fall in household saving and rise in household debt. The flipside has been relatively stable corporate debt and falling public debt.
So what are the risks?
This is not to say the rise in household debt is without risk. It certainly increases households’ vulnerability to tougher economic conditions. There are several threats:
1. Higher interest rates – the rise in debt means moves in interest rates are three times as potent compared to 15 years ago. However, a sharp rise in interest rates remains unlikely. The RBA is well aware of the rise in sensitivities flowing from higher debt and so is likely to remain relatively cautious is raising rates.
2. Rising unemployment – high debt levels add to the risk that if the economy falls into recession, rising unemployment will create debt-servicing problems and thereby deepen the recession. However, it is hard to see unemployment rising sharply anytime soon.
3. Deflation in goods and services prices – high debt levels could become a problem if the global and local economies slip into deflation. Falling prices increase the real value of debt, which could cause debtors to cut back spending and try and sell assets, risking a vicious spiral. However, the risk of deflation is low.
4. A collapse in asset prices – a sharp collapse in house prices – by undermining the collateral for much household debt – could cause severe damage. Fortunately, the Australian housing bubble has deflated in a gradual fashion and it is hard to see the trigger for a major collapse in house prices.
5. Spontaneous de-leveraging – another risk is that households take fright at their high debt levels and cut them. But this seems unlikely without a trigger.
Conclusion
With household balance sheets in good shape and households not appearing to have much trouble in servicing their loans it is hard to see high household debt levels causing a problem on their own. High debt levels are not going to spontaneously cause consumers to cut their spending. While the surge in household debt has left Australian households vulnerable to anything which threatens their ability to service their debts or significantly undermines the value of houses, the trigger for major problems remains hard to see.
Dr Shane Oliver, head of investment strategy and chief economist with AMP Capital Investors.*
