Webdiary - Founded and Inspired by Margo Kingston

Dr Russell Darroch has been a Webdiarist since the 2004 federal election. This is his debut piece. Of his background Russell writes:

"I have a varied background in psychology, psychometrics, survey research and methodology, environmental studies, and population psychology. I obtained degrees in psychology and linguistics/psycholinguistics from Carleton College and the University of Illinois. At the latter institution I worked on a social systems project with the Centre for Advanced Computation in the early days of ARPAnet (the precursor to the modern internet). From 1971 to 1986 I taught at the ANU and have since run a variety of businesses, mostly in IT, some in conjunction with other business partners. Since 2000 I've worked as an independent IT consultant and trainer specializing in data technologies as well as working on a number of books, including one on debt and bankruptcy in Australia and one on IT and terrorism."

By way of introduction to this piece Russell explains: 

"On Monday 6 June 2005 the website News.com.au published two articles that should, I believe, have caught Australians’ attention in a BIG way. Instead, no sooner had they appeared...than they disappeared off the front page altogether.

In the ensuing 2 weeks we’ve had many distractions, such as the 'Gang of Four' and Douglas Wood, which might be just as well for Treasurer Peter Costello given the sobering nature of the stories and what they implied about the state of the economy, present and future. Virtually no other sources picked them up as major stories, either, although Ross Gittins in 'Welcome to life after the housing boom' contributed some additional information, even if I think he missed the main points.

I've elected to embed the complete articles in mine (which obviously they helped inspire), because I believe that they merit both more attention and broader discussion as a part of any Webdiary debate that my own kicks off."

*

Housing, debt and the gathering storm

by Dr Russell Darroch

Chill Winds

During the last two years I have watched with increasing frustration as economists and various financial commentators skate across the surface of our complex economic system, failing to take account of the gathering storm – disintegrating job markets (the so-called casualised workforce, so dear to Costello and big business’s heart), rising housing costs, rising interest rates, rising health costs, rising education costs, rising food costs, rising petrol costs...the list goes on and on.

This isn’t a case of Chicken Little saying “the sky is falling” but rather of our needing to pay attention to the nature of dynamic systems and their processes of adjustment – an issue discussed previously in Webdiary under the broader topic of Limits to Growth.

Two recent online articles, reprinted in full below, while not couched in these systemic terms at least implicitly confronted the correction mechanisms which are getting set to 'roll' in Australia.

The Sky Isn't Falling - But House Prices Are

From: News.Com.au, Monday 6 June 2005:

"Home prices to fall 'for years'

by Nicki Bourlioufas

Downhill...growth in Brisbane has slowed to 2.5 per cent.

House prices are set to fall in real terms for several years to come, with the only benefit being steady interest rates, according to analysts.

House prices were broadly flat in the first quarter of 2005, edging up by just 0.2 per cent. Over the year to March 31, house values were similarly stagnant, rising 0.4 per cent, the lowest annual increase since the March quarter 1996. According to analysts at ABN AMRO, house prices will fall in real terms for several years, with inflation likely to erode any nominal gains.

"The adjustment is likely to be prolonged and painful for household balance sheets," said economists Felicity Emmett and Kieran Davies at ABN AMRO in a research note. "This adjustment should place downward pressure on both growth and interest rates," the economists said.

In the big cities, house prices are stumbling. In Sydney, house prices fell by 3.4 per cent over the year to March, while prices in Melbourne dropped 1.7 per cent. In Canberra, prices slipped 1.3 per cent. "This is a larger decline than seen in the early 1990s recession and is close to the post-World War II record fall of 5 per cent in the early 1980s recession," said Davies and Emmett. "As for where prices are heading, a long period of stagnation (implying declines in real terms) would be the most benign outcome," they said.

"With prices falling in real terms and housing accounting for two thirds of household wealth, we suspect that the slump in housing is a key factor behind the sharp slowdown in consumer spending over the past year," the ABN AMRO economists said.

"Other culprits include record high petrol prices and higher rates. That is, growth in spending has slowed from over 6 per cent per annum, the fastest rate since the early 1970s – to less than 3.5 per cent. with early indications pointing to a sharp deceleration in the second quarter of 2005, as growth in net household wealth has slowed."

In Adelaide and Perth, house prices bucked the national trend, rising 8 per cent and 9.9 per cent respectively over the year to March, while Darwin prices jumped 9.6 per cent. In Brisbane, growth was a little slower at 2.5 per cent, as that city also braces for a downturn.

"Perth remains a bastion of strength, with growth of 10 per cent over the past year, although this is down from the frenzied 20 per cent-plus peak of 2003," ABN AMRO said.

Economists at Westpac also expect house prices to remain under pressure. "We expect the March interest rate rise to dampen conditions over the near-term. However, the good news is that interest rates look to be on hold for the remainder of 2005," senior economist Andrew Hanlan said. "Prospects remain patchy over the near-term, with the Reserve Bank of Australia nudging interest rates higher by 0.25 per cent in March. "However, in places like Perth, the mining boom will act to offset the interest rate effect," Hanlan said.

The central bank lifted official interest rates to 5.50 per cent from 5.25 per cent in March, taking official rates to their highest level in four years."

Outrunning the Weather?

Also from News.Com.au, 6 June 2005

"Boomers must sell up: report

by Michael McKinnon

Sell-off...super changes mean post-boomers will be better off.

Secret Treasury documents reveal the Howard Government has been warned the nation's 4 million baby boomers will have to sell their homes or work longer to have enough savings for a comfortable retirement.

By comparison, the analysis found members of the post-baby boomer era will be much better off after paying compulsory superannuation for most of their working lives.

"Since the superannuation guarantee was only introduced in the early 1990s and only recently (on July 1, 2002) increased to 9 per cent, there are many Australians who will be retiring without having been in the fully matured superannuation system for their entire working life," the document says.

The Treasury analysis shows that "fully implemented" superannuation guarantee arrangements, combined with the aged pension, will make the "average person's financial independence in retirement more secure than at any other time in Australia's history". This means the generation that follows the boomers will be able to retire after 30 years of work with about 65 per cent of their pre-retirement income to live on. The documents show that while Treasury is concerned about claims the superannuation guarantee rate is inadequate for retirement, there are no plans to increase it from the current 9 per cent.

There are an estimated 4.1 million baby boomers - the post-World War II generation born between 1946 and 1961 - and the first boomers are due to retire aged 65 in 2011.

The information in the documents was obtained under Freedom of Information laws and released to The Australian after a successful appeal to the Administrative Appeals Tribunal.

Yesterday, the Association of Superannuation Funds of Australia, the peak superannuation body, reiterated its call for the Government to cut taxes on super. Association spokesman Ross Clare said the Government had introduced some positive measures in the recent budget but the superannuation guarantee would not be adequate for the retirement of many people.

The association argues that cutting or eliminating the 15 per cent tax on contributions would help low to middle-income earners, as would widening the co-contribution scheme that limits government's contributions to those earning up to $28,000 a year. ASFA research shows people on average earnings of $40,000 who work for 30 years, receiving 9 per cent in employer contributions, would end up with an annual income of only $19,000 in retirement.

The 2002 Treasury documents refer to a research paper from the National Centre for Social and Economic Modelling saying that "with the SG (superannuation guarantee) system not yet mature, over the shorter term many will find their retirement incomes well below expectation and early retirement unaffordable".

"To some extent this is true, particularly for individuals relying solely on the SG, but the solution lies with individuals saving more within a favourably taxed environment, working longer or using the capital tied up in their homes," Treasury documents state."

Other Forming Dark Clouds

In addition to the factors mentioned in these articles I would like to draw attention to four other factors which tend to get little more than lip service mention in the media (if any coverage at all). They are:

- the continual upward spiralling number of credit cards and the level of debt on those cards;
- the patterns recorded by the Insolvency Trust of Australia;
- the dynamics of Australia’s age distribution (often referred to as a Population Pyramid), and
- the First Home Owner Grant double-edged sword.

Credit Cards: Fun for all...but not forever!

Recently ABC’s Four Corners program ran a scathing PBS analysis of the credit card industry; how it came about, and how it works. The full transcript of the story can be found here, while one of the more useful links from that story lists Eight things a credit card user should know:.

In the case of the Australian love affair with plastic debt there has indeed been a great deal of commentary, but in my view precious little hard analysis which goes to the nub of the problem, since it usually comes from commentators who appear to have little personal experience with such debt themselves.

The RBA publishes data each month on many indicators, but those on credit card debt are particularly interesting. While there is detailed information available for each month, I’ll examine March 1995, 2000, and 2005, as those numbers are typical, reflect the more detailed trend and conveniently give us a 5 and a 10 year overview. Examining March figures also ensures that much of the distorting 'Christmas effect' has settled.

Using the RBA data we find the following (and it should be noted that in this same period the total population only grew by 2 million, from 18M to 20M, whereas the accounts nearly doubled and the amount owed grew six-fold):

In March 1995 there were:

- 6.6 million card accounts
- $348M in cash advances
- $1615M in purchases
- $1964M in total transactions
- $2106M in repayments
- $5570M in Balances owed

For March 2000 the comparable figures are:

- 9.0 million card accounts
- $762M in cash advances
- $5365M in purchases
- $6127M in total transactions
- $6278M in repayments
- $12941M in Balances owed

By March 2005 these have become:

- 11.8 million card accounts
- $962M in cash advances
- $12879M in purchases
- $13841M in total transactions
- $14193M in repayments
- $30270M in Balances owed

When you plot this you get a fairly striking graph, with virtually all indicators moving sharply upwards (the detailed plot shows minor variations but the overall pattern is the same).

Of even more interest, and one which most commentators choose to ignore, is a new series of data which the RBA has been collecting only since August 2002. This is the amount of accruing interest owed on credit cards.

The annual numbers are:

- August 2002 $15449M
- March 2003 $16957M
- March 2004 $19320M
- March 2005 $21552M

When you plot the details for 'repayments versus purchases' there are wild fluctuations but underlying patterns with the various trend lines show that generally people are buying more and paying off less in a steadily-declining trend (Repayments less Purchases).

When these patterns are coupled with the mortgage data then the overall debt levels of Australians are indeed cause for concern. These data are also available in detail on the RBA site. Not only are more and more Australians in debt but they are in deeper and deeper debt. They also appear not to be repaying as much as they used to proportionally speaking and the past 10 years reflect the relatively low interest period so cockily crowed about by Howard and Costello.

But the other side of this is that more and more people got into debt at supposedly “low” rates (compared to other OECD countries this isn’t true, but that topic has been discussed extensively elsewhere in Webdiary). With the recent rises in interest rates all the attention was on housing but the credit cards mostly rose by 0.3% to rates of around 16-17% (even though the RBA on-raised the base rate by .25%!), and they are the more insidious changes since many people “juggle” their lives with their credit cards, both personally and in their businesses.

Most banks have a list of their various cards and rates but one of the more readable ones is from The Commonwealth Bank.

The patterns with cards are worrying indeed and suggest that considerable numbers of users are probably marginal in their current ability to pay off their cards. Anyone who has done the exercise of paying minimum monthly payment calculations will know that you can effectively NEVER pay off the cards by doing monthly minimum payments.

Do the banks care? Not on your nelly!

One final note: there has been discussion (the RBA again) about the problems that EFTPOS is facing and there have even been suggestions that it will be killed off. It is no wonder - the banks would MUCH rather have you running up debt on credit cards than paying with EFTPOS.

ITSA and patterns of bankruptcy

The Insolvency and Trustee Service of Australia is the body which manages bankruptcy, debt agreements, and other arrangements. Part X agreements with creditors have decreased marked over the past 10 years (from 539 in 1995 to 175 in 2004), debt arrangements have generally increased (from 47 in 1997 to 5382 in 2004) and the total annual bankruptcies (Part IV and XI) show the following:

Tax Year
Ending  - - - -   Total National

1995    - - - - - -   14132
1996 - - - - - -   17324
1997 - - - - - -   21846
1998 - - - - - -   24408
1999 - - - - - -   26378
2000 - - - - - -   23373
2001 - - - - - -   23902
2002 - - - - - -   24114
2003 - - - - - -   22639
2004 - - - - - -   20497
2005 - - - - - -   14850 (first 3 qrtrs; annual proj. app. 20,000)

There are many factors which have contributed to the patterns over the years:

– various changes in tax legislation;
- more specifically introduction of the GST (related to many of the bankruptcies between 1999 and 2003 in the first wave of effects; the second phase is still 'happening' with penalties for those businesses which kept trading but could not keep up...there is precious little data on these so far);
- fluctuating market 'conditions' which have resulted in mini-crashes along the way, and so on.

In recent years about 20% of the total bankruptcies are 'business related' and the remaining 80% are 'non-business'. Many of the latter, when examined more closely, are related to personal debt issues of one type or another. One of the worrisome recent trends is a sharp increase in teen-age bankruptcies due to mobile phones and the inability of the users to pay their very large mobile bills, often also attached to high interest credit card schemes with rates around 25%.

Unfortunately, as is true of a number of agencies, ITSA is under-resourced – the ITSA staff do an excellent job within those constraints. However the availability of statistics for certain kinds of detail is less than might be ideal to inform our discussion here. In the most recent 'Profiles of debtors' (2003 data is the most recent available, published in 2004) several things are of interest:

Nearly 50% of 'business' bankruptcies are due to economic conditions and related cash flow or capital issues; of 'non business' bankruptcies 37% are due to unemployment (broadly defined), and 23% are due to 'excessive use of credit'. Not surprisingly males constitute 55% of the bankruptcy cases but women are not immune and account for a total of 45% in the 2003 data even though they constituted only 51% of the total population.

In terms of to whom money is owed at the time of bankruptcy the major categories are:

Other (a poorly-defined category) 44%
Banks 29%
Finance companies 15%
Tax 10%

This is slightly misleading as overall the finance and tax sector accounts for 54% of the creditors. Both banks and finance companies are generally secured loans (houses, goods – appliances and cars) while tax is unsecured and is usually due to a mixture of unpaid taxes and penalties (which generally run interest rates of around 12% - much like lower rate credit card rates).

The data here do not include company administrations under ASIC control but the footnote here is that the lack of a US-style Chapter 11 equivalent means many businesses that could trade out of difficulty cannot actually do so; the administration process does not facilitate it and despite Costello’s hollow promises of reform in the area for quite some time now nothing has been done to fix the situation. The particularly messy topic of how company administration actually works (as opposed to how it is supposed to) would be a separate Webdiary piece altogether.

Overall, the patterns suggest that there is a sustained level of bankruptcy in Australia and while it varies from year to year, overall it is not going down. In fact, what is more alarming, but harder to tell from the ITSA data is that (given that bankruptcies generally last 3 years) we have moved from about 30,000 people in bankruptcy in the early 90s in any one year to about 70,000 currently in any one year, more than doubling in the 10 years. A non-trivial figure in anyone’s book but more so when you look at the fall-out for those around the bankrupt person – spouses, children, close relatives, friends, business associates. In the 44% of 'Others' as creditors the most common categories are family and friends who have tried to assist. On the rough assumption that each person of the 70,000 affects 3 or 4 others the total impact on lives is more on the order of 200,000-300,000 lives.

The patterns are interesting in their own right; in the context of the articles under discussion here they serve as a further caution that Australian battlers (a term much abused by Howard and Costello who have absolutely no idea what that term actually means) should work actively and aggressively to reduce their financial risks.

Population Pyramid Dynamics

The Australian Bureau of Statistics has an excellent site for those who want to explore these scenarios in more detail, at Animated (Dynamic) Population Pyramid, and also at Australia’s Ageing Population.

Demographers wax lyrical about 'population dynamics' and 'population pyramids' but for our purposes here there is only one particular point I want to make.

Take a look at the ABS site and run the pyramid...slowly. Watch what happens to the 'buying' (or potential buying) age groups. As the baby boomers (who own much of the real estate now) move up the pyramid they are replaced by...guess what, FEWER people to buy the properties. We don’t just have an ageing population, we also have a somewhat distorted one (in population terms), a situation that is common to most Western developed countries.

And while it is a whole other topic this problem is unlikely to be 'fixed' by either baby bonuses or immigration policies, by the way.

This has many implications, particularly for taxation, support for older people, work and jobs issues (remember, Costello says you now have to work until you drop)...never mind super, medical costs and demands on health infrastructure, and so on.

In the end, as a realtor acquaintance of mine said last week, "the market is going to go down and down because there just are not going to be the people to buy the properties that will be coming on the market." Now of course part of the systemic correction to THAT problem is for prices to go down and down...and then the question is, where does that leave the present owners with the high mortgages?!

Unfortunately it will probably leave many in their own versions of the Sydney couple reported recently who bought a year ago at about 2.3M and are trying to sell (unsuccessfully) at 1.2M...not a good situation to be in.

It is worth also noting in regard to the second article that those baby boomers 'rushing into retirement' would do well to consider how their anticipated income translates into reality – a considerable number who retired during the past 5 or 6 years have already had to go back to work to maintain an adequate income/life style. (It is worth pointing out also that the ITSA data indicate that approximately 23% of those going into bankruptcy are OVER 50 years of age.)

First Home Buyers

The recent SMH story First home buyers struggling: report should set off further alarm bells about the irresponsible agendas of parties with vested interests, namely banks, real estate businesses, housing industry associations and the various real estate institutes. Try this:

"The report highlights the need to provide more assistance to first home buyers, the Real Estate Institute of Australia (REIA) said."

In fact that is probably the last thing that we need. Housing has become, through various mechanisms, market and otherwise, far too expensive for what it intrinsically is. While it is in the interest of banks, housing industry associations and the REI to try to drive demand up again, it is not in the interest of home buyers and particularly first home buyers. Affordability, although improving by a smidgen, is still out of sight and will remain so for some time, particularly if it is not distorted by extensions to the  First Home Owner Grant.

The scheme itself has produced 2 effects that most commentators magically manage to avoid even mentioning, let alone discussing.

First, it has brought forward a lot of buyers and brought them into the market effectively 'ahead of schedule', ahead of when they would normally have bought houses – the scheme did this at a time when prices were going up and mortgage rates were relatively low...seems a good start, BUT:

(a) if it took the scheme to get into a house, probably those for whom it made a significant difference are more likely to be marginal in their ability to pay increased mortgages, and

(b) it effectively siphoned off future buyers that the market would have had available 'down the track'.

The system effects of this are likely to be two-fold: first, when rates go up the marginal owners will have a tougher time, more are likely to end up either selling (in a downward market!) or get caught out and get into tight situations with banks or even have to go down the bankruptcy route to deal with the crunch.

Secondly, whenever buyers are brought forward in a (purchasing) system of this type there will at some point be a lull or even a depressed market – you can’t just go out and create buyers out of thin air, they are people in a population and in a particular age and family life-cycle bracket...there are only so many to go around! (And there are only so many investors to go around, too.)

Conveniently, Howard and Costello neglected to worry about this - as have the REI and other parties interested only in the short term bucks and with a lack of care about long term consequences. In marked contrast to the way many influential system 'players' have been publicly legislating and commercially operating, housing is simply not an ever-increasing market...unless you have an ever-increasing population which can afford the going market rates with (implicitly) ever-increasing wages.

All of these we just do not have in Australia.

Summary - Waiting for the First Drops

The chickens are beginning to come home to roost on the Howard government. The articles above and the additional factors and data I have cited together signal very clearly that the size and weight of the vulnerable 'flock' - in this case current home owners - is much larger than most observers have been willing to acknowledge, despite many a warning from cautious economists and others (including many here in Webdiary).

What also needs to be remembered is that in addition to the matters raised here the debt burden carried by Australian households generally is at record levels along with record numbers of credit cards and mortgages at all-time highs. When any downward movement happens it tends to happen on multiple 'fronts'. So much for 'economic management' by either the government or the RBA – the entire country will be paying the price for years to come.

But hey - the pollies are OK, at least! 'Politicians have their super so they're all right Jack'

A decade of irresponsible economic management - to help fuel the growth of the banks, big business and the real estate markets - eventually had to come to some end, whether a voluntary and controlled one or, as now seems inevitable, as the result of unavoidable system corrections. We are only in the early days of the 'adjustment we'll have to have', yet these are likely to be testing times for many households - even more so if Howard’s IR reform agendas succeed, as they are likely to force wages down, decrease the amount of 'real' full-time employment (not the statistical sleight-of-hand redefinition engineered by Howard and Costello), and generally make life more difficult for millions of households.

In the long run (a favourite phrase in statistics!) housing should become more affordable...but that in turn assumes there will be buyers left with the ability to buy. Don’t you just love complex systems? They do eventually drive themselves back towards their own equilibrium but it isn’t always a pretty destination, and certainly not for every passenger along the way.

And by the time you add such additional speed bumps as rising petrol prices, rising general costs of living and rising interest rates, the looming system correction will likely take its toll on many households with a surprisingly wide range of debt and income levels (never mind the lack of proper tax reform and the inequities which Peter Costello has allowed to persist under every term in office).

Conclusion - Battening Down

In preparation Australian Battlers - of all types - would do well to reassess:

a) their level of real exposure;
b) what they will do if the unexpected happens (loss of job, less income, accident, etc), and how exposed they will be then;
c) whether they should have insurance to cover (b);
d) how quickly they could and should reduce their current levels of debt and risk;
e) the immediate effect on them if mortagage rates rise (numerous available online tools), and the real costs of their credit cards (ditto);
f) how often they are paying one credit card with another (a common trap, usually 'masked' through cash advances);
g) whether they are exposed through any 'buy now, pay later' arrangements which usually carry horrendous interest rates of 25% or higher, usually kicking in if you're late with even a single payment;
h) exactly how they use their cards – for example, consider switching from using credit cards to EFTPOS (you can’t then spend what you can’t afford...or at least it is harder to do!).

More broadly, it's also well worth reflecting that while generally most of us have been brought up in a framework couched in banking terms of 'assets' and 'liabilities', this is a dated and simplistic perspective which, especially in our brave new deregulated world, will probably not serve to shield us reliably from the financial storms. It is important to remember the following these days:

- the banks don’t care about you;
- the RBA doesn’t care about you, and
- Peter Costello (ie Treasurers) don’t really care about you personally.

You have to look after yourself now, and to start with, your assets need to be frankly assessed (a house is not an asset to you if you owe lots of money on it, it is only an asset to the bank; for a franker discussion read 'Rich Dad, Poor Dad' by Robert Kiyosaki). You need to know your true financial situation, and you need to watch the wider (globalised) financial climate carefully for the earliest signs of locally forming storms.

Given the content of these articles, I'd suggest reducing your debt and your expenditure now, if you are a 'typical' Australian household.

Otherwise you might find yourself getting very wet, very cold...very soon.