The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Tuesday, January 19, 2010

Excellent Saul Eslake op-ed

Updated: Saul Eslake eviscerates the popular argument that Australia has unsustainably high debt levels in this terrific op-ed (the RBA's Guy Debelle has made similar arguments):

"It is, of course, undeniable that household debt is at record levels in absolute terms, and relative to either household or national income. It is also true that, as a proportion of GDP, Australian household debt is high by international standards: the corresponding ratios for the United States and Britain at the end of September were 99 per cent and 108 per cent, respectively.

But the question to ask is, do these figures actually convey anything significant?

It's a question I was frequently asked when I was chief economist of one of Australia's four major banks. By way of response, I would often invite those with whom I was speaking to consider a hypothetical example of a potential customer walking into one of the bank's branches, having $100,000 in cash, an after-tax income of $100,000 per annum, and wanting to borrow $200,000 in order to buy a $300,000 house.

Putting to one side the fact that, these days, the branch manager would need to interrogate the customer as to how he or she had come by the $100,000 in cash, and report the results to Austrac, the manager would not reject the customer's request for a loan on the grounds that he or she would then have a debt-to-income ratio of 200 per cent.

Rather, the manager would look at the customer's debt-to-assets ratio, which in this hypothetical example would be 67 per cent. Banks will normally lend for owner-occupied housing up to 80 per cent of the value of the property (or up to 90 per cent with mortgage insurance). No problem there.

The manager would also consider the customer's capacity to service the loan out of his or her income. Assuming a mortgage rate of, say, 7 per cent, interest payments would be absorbing 14 per cent of his or her disposable income, plus a little more for principal repayment. Banks will typically lend amounts requiring up to 25 or even 30 per cent of a customer's disposable income before becoming seriously concerned about his or her capacity to service the mortgage.

So, I used to finish by saying, not only would the customer's request be approved more or less on the spot, but, mindful of the ''cross-selling'' targets the manager would have had, he or she would probably also have been offered a further $100,000 loan for a geared investment into the sharemarket.

...if a bank wouldn't judge the financial soundness of an individual customer on the basis of his or her debt-to-income ratio, why should we draw any conclusions about the stability of household finances as a whole from the aggregate household debt-to-income ratio, without having any regard to the level of household assets, or to the capacity of households to service their debt out of their income?

According to figures published by the Reserve Bank in its most recent monthly Statistical Bulletin, the debt-to-assets ratio of Australian households as a whole was 20.1 per cent at the end of June last year, while the ratio of interest paid to income for the June quarter was 10.3 per cent. Neither of these figures would raise any alarm bells with a bank manager if they pertained to an individual customer."