Because household debt is increasing faster than households. Between 1992 and 2012, household debt as a percentage of income increased 300%, household debt as a percentage of GDP increased 400%.As the population did not increase 300% in the same period, I assumed that leverage had increased. You seem to be implying that you can take on more debt on the same income without increasing leverage. Can you expand on how this is done?
Leverage = Assets/Equity. Unless you know what is happening to assets and equity, you know nothing about what is happening with leverage.
Income is irrelevant to leverage.
The truth will set you free. But first, it will piss you off. --Gloria Steinem AREPS™
You could make a reasonable case for that, but it is not the normal definition of assets. Nowhere on a financial balance sheet will you find an entry equal to NPV of income, and leverage is purely calculated from the balance sheet.
However, it is true that a reasonably widely accepted measure of the fair value of an asset is the NPV of all future dividends from that asset. On the other hand, leverage is calculated using the market value of assets, which can differ quite significantly from the fair value. (And is quite a bit more volatile.)
The truth will set you free. But first, it will piss you off. --Gloria Steinem AREPS™
Leverage = Assets/Equity. Unless you know what is happening to assets and equity, you know nothing about what is happening with leverage.
Income is irrelevant to leverage.
I know what is happening to assets, there is a measurement for that. And equity, in housing at least, is the initial deposit plus principal repaid plus increase in market value, if you mark the asset to market. The initial deposit is dependent on surplus income. For borrowers to have larger deposits relative to asset prices, their income would need to increase faster than asset prices. We know that hasn't happened.
Principal repaid, or offset in offset accounts, is also dependent on income, but to a lesser degree. Borrowers on variable rates do pay principal off faster when interest rates go down, but also have higher outgoings when inflation rises. Interest rates have been dropping faster than inflation has been rising, so it is possible that equity increased as a result, but many people also drew down on their equity to purchase consumables and depreciating assets, decreasing equity.
And then there is increases in market value, which do increase equity positions in assets marked to market, but are largely offset by borrowers upgrading to more expensive assets by relevering up their previous equity position. I believe this is reflected in the total debt outstanding.
So, I don't know exactly what is happening to equity, but I have an opinion that it hasn't increased all that much for the reasons above and others, and I do not agree with you that income is irrelevant to leverage. Income is relevant to starting equity. It is also relevant to the prevalence of equity draw downs as a way of supplementing income.
I know what is happening to assets, there is a measurement for that. And equity, in housing at least, is the initial deposit plus principal repaid plus increase in market value, if you mark the asset to market. The initial deposit is dependent on surplus income. For borrowers to have larger deposits relative to asset prices, their income would need to increase faster than asset prices. We know that hasn't happened.
Principal repaid, or offset in offset accounts, is also dependent on income, but to a lesser degree. Borrowers on variable rates do pay principal off faster when interest rates go down, but also have higher outgoings when inflation rises. Interest rates have been dropping faster than inflation has been rising, so it is possible that equity increased as a result, but many people also drew down on their equity to purchase consumables and depreciating assets, decreasing equity.
And then there is increases in market value, which do increase equity positions in assets marked to market, but are largely offset by borrowers upgrading to more expensive assets by relevering up their previous equity position. I believe this is reflected in the total debt outstanding.
So, I don't know exactly what is happening to equity, but I have an opinion that it hasn't increased all that much for the reasons above and others, and I do not agree with you that income is irrelevant to leverage. Income is relevant to starting equity. It is also relevant to the prevalence of equity draw downs as a way of supplementing income.
Well, in fact you didn't even mention equity. You said that debt had increased and then drew the conclusion from that, without any discussion of asset and equity, that leverage had increased. The conclusion is specious and suggests to me that you had no more than the haziest notion of what leverage actually is.
Getting back to your original assertion that I took issue with,
Quote:
Sorry, I wasn't clear on that. The point I was making is that if the seller of the asset is highly leveraged (and one would assume that as total household debt increases, the seller's leverage will also on average increase), that it becomes increasingly difficult to create new money in the economy through the creation of new credit. So as the total debt grows larger, the banking system finds it increasingly difficult to expand their balance sheet, so interest rates are sent lower to counteract this.
It's obviously a rubbish conclusion because:
a) It is not reasonable to assume that leverage of the seller has increased just because total household debt has increased. Leverage is more sensitive to asset values than it is to total debt.
b) The biggest contributor to increase in total debt is actually the increase in the value of assets against which money is borrowed, and since prudential standards have gotten, if anything, tougher over the last 20 years and asset values rose sharply over the first 10-15 of those and have been essentially flat during the rest of the them, there is nothing to suggest from that that alone that average leverage would have increased over the time. (I am not saying hasn't, only that you have not advanced any valid reason why it should have.)
c) The difficulty of creating extra money would stem only from the leverage level of the buyer and not the seller at any rate. As long as there are creditworthy borrowers who want to borrow available, money will be lent. The leverage level of the borrower is a key concern here, the seller not at all. In fact an expansion of overall debt points to an asset price expansion which would in turn point to a decrease in leverage of the seller and an increase in leverage of the buyer after the transaction. Except that prudential standards put a cap on the leverage level of the buyer anyhow.
Later on you make a lame attempt at deflection from the issue by claiming:
Quote:
Because household debt is increasing faster than households. Between 1992 and 2012, household debt as a percentage of income increased 300%, household debt as a percentage of GDP increased 400%.As the population did not increase 300% in the same period, I assumed that leverage had increased.
Which in itself is horseshit. Since 1992 private debt to GDP has increased from 80% to 160%, or 100%. Household debt to disposable income has increased from 50% to 150%, - an increase of 200%, and mortgage debt to GDP increased from a bit over 20% to a bit over 80% between 1992 and 2010 (i.e. 300%) and has been falling since. Meanwhile the value of an existing house has at least quadrupled (i.e. increased 300%) in most of the capital cities, so no joy for you there either.
And once again you show you were unaware of what leverage is by:
Quote:
You seem to be implying that you can take on more debt on the same income without increasing leverage. Can you expand on how this is done?
Of course your leverage changes independent of income at the same level of debt just through changes in asset values. Asset values increase -> leverage decreases. Asset values decrease -> leverage increases. So if your asset values increase then you can most definitely increase your debt without increasing your leverage, regardless of your income or lack thereof, especially if you are using that debt to purchase more assets. 1992-2007 saw a huge (and probably one-off) increase in housing asset values for a number of reasons that have been canvassed heavily in this forum. It is no surprise that the debt associated with those assets increased in-line.
The truth will set you free. But first, it will piss you off. --Gloria Steinem AREPS™
Well…this week, for me, we passed some kind of invisible tipping point. I no longer think that Australia has the resources to sustain the bubble into the future, nor does the politico-housing complex have the brains to pull off such a deft act indefinitely. Right now, the complex is marching the nation towards its doom.
The key event this week was the ratings agency Standard and Poors (S&P) putting a hard cap on Australia’s net debt levels at 30% of GDP to sustain the AAA rating. To understand why this is so vital you must first understand how the Australian economy works.
Our economy is a unique combination of the pre and post-modern, with no modern in between. We earn commodity income like cave men trading stones then borrow against it in offshore markets using hyper-real credit instruments, and tip that debt into houses. This asset inflation underpins the entire services and consumption economy, which barely exports anything and has terrible productivity and so can’t raise its own income. The kicker is that because commodity exports are capital not labour intensive, it is only through the second step of leveraging and asset inflation that domestic economic activity is produced.
It was not always thus. We used to have a much higher component of modern industries that were more labour intensive, tradable sectors that generated domestic economic activity and productivity growth without the need for debt. But after years of double Dutch disease and a radical over-concentration of ownership in all sectors, these are largely gone and in their place the credit and housing bubble has become the domestic economy.
You might ask why that matters. So long as we can keep borrowing overseas then we can keep on keeping on. We’re solvent so what’s the issue? That’s true, to a point.
But there are two problems with the system. Households are leveraged to the hilt and really can’t borrow any more, nor do they want to.
Second, our banks are also leveraged to the hilt. They’ve used every trick in the book to squeeze more mortgages out of astonishingly thin capital bases. Their first reckoning came in the GFC when they were bailed out by public guarantees to their debts and the banks have been trading on the public balance sheet for free ever since.
That bring us back to S&P. Its 30% of GDP cap for net public debt is very low in comparison to other AAA nations. But the reason it’s so low is that the Budget supports the banks’ enormous offshore debts via the guarantees. It is not the banks’ prudence or metrics that let’s them borrow at low enough rates in global markets to keep pumping up housing to keep the domestic economy ticking, it’s the clean public balance sheet, and S&P is exactly right to insist that it remains ship shape.
That’s the first reason why I see Australia running out of ammunition to support the credit and housing economic model.
Net public debt is currently at just above 20% of GDP (including Future Fund assets). More importantly, look at the 2009/10 parabola that took it from -5% to 15%. That’s what a recession does to public debt via stimulus and falling tax revenues, as well as automatic stabilisers like rising unemployment benefits. At all levels of government, in the past six years we have spent a net $320 billion just to keep the economy growing below trend, despite the greatest commodity boom in the nation’s history.
At a 30% ratio the AAA rating goes. I spoke with S&P sovereign analyst Craig Michaels yesterday and asked him how hard is the cap, especially in the circumstances of a recession. He said that they might offer some flexibility when the chips were down, to the extent that the ratio temporarily blew out to 31% or 32%, depending whether or not the external vulnerability was getting better or worse. In other words, it’s a hard cap. Very hard.
In the next few years the public debt to GDP ratio is going to get worse by a couple of percentage points as the terms of trade keep falling and government growth forecasts miss. As a result, we’re more likely than not going to enter the next recession with roughly half of the fiscal firepower used in 2009/10 to rescue the economy.
So, the downgrade is coming. And it’s going to hurt. The moment the AAA is lost, the guarantees ensure that bank’s ratings will be cut too and their cost of funds will rise at a time when fiscal policy is severely constrained and growth hard to come by. That unfortunate combination brings us to the second reason that the politico-housing complex passed a tipping point this week.
Well, in fact you didn't even mention equity. You said that debt had increased and then drew the conclusion from that, without any discussion of asset and equity, that leverage had increased. The conclusion is specious and suggests to me that you had no more than the haziest notion of what leverage actually is.
I am not sure if helps your argument.
Quote:
It's obviously a rubbish conclusion because:
a) It is not reasonable to assume that leverage of the seller has increased just because total household debt has increased. Leverage is more sensitive to asset values than it is to total debt.
So, when asset values increase, total debt declines?
Quote:
b) The biggest contributor to increase in total debt is actually the increase in the value of assets against which money is borrowed,
Don't disagree with that.
Quote:
and since prudential standards have gotten, if anything, tougher over the last 20 years
Quote:
and asset values rose sharply over the first 10-15 of those and have been essentially flat during the rest of the them, there is nothing to suggest from that that alone that average leverage would have increased over the time.
Nothing to suggest equity has increased either, but feel free to offer up such evidence.
Quote:
and mortgage debt to GDP increased from a bit over 20% to a bit over 80% between 1992 and 2010 (i.e. 300%) and has been falling since. Meanwhile the value of an existing house has at least quadrupled (i.e. increased 300%) in most of the capital cities, so no joy for you there either.
Okaayyyy .... so debt has increased at the same rate as asset values, but leverage is falling .....
Quote:
Of course your leverage changes independent of income at the same level of debt just through changes in asset values. Asset values increase -> leverage decreases. Asset values decrease -> leverage increases. So if your asset values increase then you can most definitely increase your debt without increasing your leverage, regardless of your income or lack thereof, especially if you are using that debt to purchase more assets. 1992-2007 saw a huge (and probably one-off) increase in housing asset values for a number of reasons that have been canvassed heavily in this forum. It is no surprise that the debt associated with those assets increased in-line.
Wha??
So if when dinosaurs roamed the earth, I took $20K and borrowed $80K, purchased a house for $100K, and then sold it when the mammals started to appear for $300K, took the $220K and borrowed $880K to purchase a $1M house, my leverage has decreased because asset values went up?
Well…this week, for me, we passed some kind of invisible tipping point. I no longer think that Australia has the resources to sustain the bubble into the future, nor does the politico-housing complex have the brains to pull off such a deft act indefinitely. Right now, the complex is marching the nation towards its doom.
The key event this week was the ratings agency Standard and Poors (S&P) putting a hard cap on Australia’s net debt levels at 30% of GDP to sustain the AAA rating. To understand why this is so vital you must first understand how the Australian economy works.
Our economy is a unique combination of the pre and post-modern, with no modern in between. We earn commodity income like cave men trading stones then borrow against it in offshore markets using hyper-real credit instruments, and tip that debt into houses. This asset inflation underpins the entire services and consumption economy, which barely exports anything and has terrible productivity and so can’t raise its own income. The kicker is that because commodity exports are capital not labour intensive, it is only through the second step of leveraging and asset inflation that domestic economic activity is produced.
It was not always thus. We used to have a much higher component of modern industries that were more labour intensive, tradable sectors that generated domestic economic activity and productivity growth without the need for debt. But after years of double Dutch disease and a radical over-concentration of ownership in all sectors, these are largely gone and in their place the credit and housing bubble has become the domestic economy.
You might ask why that matters. So long as we can keep borrowing overseas then we can keep on keeping on. We’re solvent so what’s the issue? That’s true, to a point.
But there are two problems with the system. Households are leveraged to the hilt and really can’t borrow any more, nor do they want to.
Second, our banks are also leveraged to the hilt. They’ve used every trick in the book to squeeze more mortgages out of astonishingly thin capital bases. Their first reckoning came in the GFC when they were bailed out by public guarantees to their debts and the banks have been trading on the public balance sheet for free ever since.
That bring us back to S&P. Its 30% of GDP cap for net public debt is very low in comparison to other AAA nations. But the reason it’s so low is that the Budget supports the banks’ enormous offshore debts via the guarantees. It is not the banks’ prudence or metrics that let’s them borrow at low enough rates in global markets to keep pumping up housing to keep the domestic economy ticking, it’s the clean public balance sheet, and S&P is exactly right to insist that it remains ship shape.
That’s the first reason why I see Australia running out of ammunition to support the credit and housing economic model.
Net public debt is currently at just above 20% of GDP (including Future Fund assets). More importantly, look at the 2009/10 parabola that took it from -5% to 15%. That’s what a recession does to public debt via stimulus and falling tax revenues, as well as automatic stabilisers like rising unemployment benefits. At all levels of government, in the past six years we have spent a net $320 billion just to keep the economy growing below trend, despite the greatest commodity boom in the nation’s history.
At a 30% ratio the AAA rating goes. I spoke with S&P sovereign analyst Craig Michaels yesterday and asked him how hard is the cap, especially in the circumstances of a recession. He said that they might offer some flexibility when the chips were down, to the extent that the ratio temporarily blew out to 31% or 32%, depending whether or not the external vulnerability was getting better or worse. In other words, it’s a hard cap. Very hard.
In the next few years the public debt to GDP ratio is going to get worse by a couple of percentage points as the terms of trade keep falling and government growth forecasts miss. As a result, we’re more likely than not going to enter the next recession with roughly half of the fiscal firepower used in 2009/10 to rescue the economy.
So, the downgrade is coming. And it’s going to hurt. The moment the AAA is lost, the guarantees ensure that bank’s ratings will be cut too and their cost of funds will rise at a time when fiscal policy is severely constrained and growth hard to come by. That unfortunate combination brings us to the second reason that the politico-housing complex passed a tipping point this week.
Probably the most interesting read so far on this forum. Where is part 2?
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