Our Debt Situation and How It Affects You!


Mortgage debt is by far the largest component of debt in Australia today – government debt, which is the focus of political debate, is trivial by comparison. A quick caveat though – finance sector debt may be larger again than mortgage debt, if a claim sourced from Morgan Stanley, which shows Australia’s aggregate private debt ratio as almost equal to that in the US, is accurate.

Please read this article that was published in the Business Spectator this week written by Steven Keen. 

Steve Keen is a Professor of Economics & Finance at the University of Western Sydney and author of Debunking Economics and the blog Debtwatch.

The household debt-to-income ratio may have topped out now, after growing fivefold in the last two decades. Figure 2 shows the ratio of household debt to disposable income, which peaked at 149 per cent of disposable income back in late 2008. Despite the enticement into debt given by the First Home Vendors Boost, aggregate household debt never exceeded this pre-boost peak as a percentage of disposable income, since the fall in personal debt outweighed the rise in mortgage debt.

Figure 2

This huge rise in household debt compared to income has more than offset the falls in interest rates that occurred since the 1990s. The perennial argument from property spruikers that the rise in debt has simply been a rational reaction to the fall in interest rates is pure bunkum – especially when you take a less-than-myopic look at the data, and consider mortgage rates back in the 1960s, which were well below today’s rates (see figure 3).

Figure 3

This comparison stands even when inflation is taken into account. The average real mortgage rate in the relatively low-inflation 1960s was 3 per cent – a full per cent below the low inflation level of the last decade (see figure 4). Why wasn’t mortgage debt higher back then, if the increase since the 1990s was a “rational response to lower interest rates”?

Figure 4

I date the Australian house price bubble from 1988, when it was spiked by the reintroduction of the First Home Owners Scheme by the Hawke government in reaction to the stockmarket crash of 1987 (the scheme works by encouraging would-be buyers to take on mortgage debt, and then hand the leveraged sum over to the vendors – which is why I prefer to call it the First Home Vendors Scheme). It then really took off in 2001, when Howard doubled the grant in response to a feared recession (see figure 5, which combines Nigel Stapledon’s long-term index with the ABS data from 1976 on; Hawke and Howard respectively mark the re-introduction of the grant in 1988 and Howard’s doubling of it in 2001). However, it had already been running hot again from 1997 when – without any additional help from the government – the financial sector had enticed Australians to go from a 50 per cent to a 70 per cent mortgage debt to GDP ratio (at a time of rising interest rates).

Figure 5

The combination of higher rates and much higher debt levels means that paying the mortgage is taking far more out of the family purse than it used to do back in the pre-housing bubble years. Readily available data from the Reserve Bank of Australia shows that interest payments on household debt are five times as high as they were back in the 1970s.

The RBA data for mortgage debt only start in 1976; in the spirit of countering spruiker myopia, I’ve estimated pre-1976 mortgage debt as 30 per cent of total debt, from the RBA’s long-term data (the average from 1977-1980 was 31 per cent). Interest payments on mortgage debt are as much as ten times as high now as they were in the 1960s (see figure 6).

Figure 6

Spruikers also prefer to ignore the fact that debt has to be repaid, and focus on the interest payments alone. In the past mortgages have often been paid off after five to seven years via the resale of the property, but that will be a lot more difficult in future as house prices fall. Figure 7 shows household debt service as a percentage of disposable income, with mortgage debt being repaid over 25 years and personal debt over 10 years. On this basis, there has been a twelve-fold increase in the proportion of family income that has to be devoted to servicing mortgages since 1970. Even compared to the high interest days of 1990, mortgage debt service is now 2.5 times as burdensome.

Figure 7

There is clearly no capacity for debt service to take a larger slice of the family income pie, which in turn is taking the wind out of the housing market (A new age of deleveraging, December 19, 2011). Spruikers happily make a ‘supply and demand’ argument about why house prices have risen, but obsess about regulation-impaired supply and equate demand with population growth. In fact, demand for housing doesn’t come from population growth: it comes from the growth in the number and value of mortgages. That growth rate in fact peaked back in 2004, and it has been trending down ever since: the First Home Vendors Boost merely delayed this process without stopping it.

Figure 8

That in turn is the main factor driving house prices down – just as rising mortgage debt drove prices up, falling mortgage debt is driving them down. As I’ve explained elsewhere, the causal factor behind asset prices is not just rising but accelerating debt. This is an extension of my basic proposition that macroeconomic analysis must include the role of credit – which is ignored by conventional neoclassical economics. In a credit-driven economy, aggregate demand is the sum of incomes plus the change in debt, and this monetary demand is expended buying commodities and claims on existing assets – basically, shares and property.

Part of demand for housing thus comes from income (the focus of the property spruikers) and part comes from the increase in mortgage debt – which they ignore.

Figure 9

For prices to rise, demand must also be rising, and this requires not merely rising mortgage debt but accelerating debt. Of course variations in income (and variations in supply too) can play a role, but in the overwhelmingly speculative, overly-leveraged market that Australian housing has become, accelerating mortgage debt trumps the lot (see figure 10).

Figure 10

This is especially so since such a large percentage of buyers are so-called investors – ‘so-called’ because a better description is speculators. Actual investors aim to make a profit out of the income flow generated by an investment. Australia’s property “investors” instead lose money on their rental income, and hope to recoup the loss as capital gains via a later sale. With the days of house prices rising faster than incomes well and truly over, this percentage of the market could drop back to pre-1990s levels.

Figure 11

Both sources of demand are now falling strongly from the artificial boost given by Rudd’s spin of the FHVS sauce bottle.

Figure 12

One of the world’s last and greatest house price bubbles is thus finally ending.

Figure 13

Steve Keen is a Professor of Economics & Finance at the University of Western Sydney and author of Debunking Economics and the blog Debtwatch.

Posted in