Tag: household debt

How deep is the financial hardship well?

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How many weeks your savings will last without income – graph provided by The Grattan Institute

It is probably no comfort to anyone to reflect on the year when investors could get 14.95% on a bank term deposit. It was January 1991, the recession Paul Keating said we had to have. People with personal loans and credit card debt watched horrified as repayment rates went to 20% and beyond. The average variable mortgage rate rose to 17.5% at the same time. The gap between the haves and have-nots in that era was painfully obvious.

In the early 1990s, financial hardship forced many younger Australians, unable to service their mortgage repayments, to walk out of their mortgaged houses, leaving the house keys on the bank’s counter. Meanwhile, the lucky worker/investor with a lazy $100k to invest could earn $14, 950 in interest (the price of a new car), over 12 months with no risk whatsoever. Except, of course, if the deposit was with one of the eight financial institutions that went broke in that era.

In 2020, the COVCID-19 pandemic has certainly made it clear how many Australians are suffering financial hardship. At one end of the scale, you have self-funded retirees, on the pig’s back, really, but struggling with the collapse in the value of shares and difficulties finding safe places to store their cash for a return of more than 1.75%.

At the other end of the generational spectrum, while the official unemployment figure is an improbably low 6.2%, it does not reflect the one million casuals who not only lost their jobs, but did not qualify for the Federal Government’s safety net, Jobkeeper.

COVID-19 struck at a time when the Australian household savings rate had dropped to 3.6% (20% is the ideal), and is forecast to drop to 2% or lower in 2021-22. The rate is calculated as a percentage of the amount saved from disposable income.

Meanwhile household debt – most of it linked to mortgages –  is at a high of 119.60% of GDP. Economist Gerard Minack told the 7.30 Report in November that household debt at 200% of household income was a “massive macro risk”.

Then came COVID-19 and an economic shutdown the likes of which the country has not seen since the 1930s.

I’m running these confronting numbers past you because there is a lot of nonsense written about Poor Pensioners vs Irresponsible Millenials.  Also, some commentators, particularly in the housing sector, are ‘talking it up’ at a time when worst-case scenarios predict a 30% drop in prices.

Conversely, stock market analysts are talking the market down, even as it keeps (slowly) recovering. You have to wonder why.

In mid-April the share market was officially proclaimed a “bull market’’ by the Australian Financial Review (AFR), because share prices had jumped 20% since mid-March.

What’s amazing is that the market has rallied at the same time that Australian superannuation funds paid $9.4 billion in financial hardship paymentsto approximately 1.17 million fund members. Australian super funds have a large exposure to equities, so they have managed the payments so far by selling investments, including shares and holdings in managed funds.

They also asked for help. As the AFR’s exceptionally well-informed Chanticleer observed, The Australian Superannuation Fund Association (ASFA) put a proposal to Treasurer Josh Frydenberg to allow the Australian Taxation Office to cover the hardship withdrawal payments. The plan was super funds would repay the payments over a period of time. The industry also called on the Reserve bank of Australia to provide a liquidity buffer. None of this happened, but Australian funds are expecting a continuation of the rush to withdraw hardship payments.

Under the COVID-19 measures, individuals whose income has been affected can withdraw up to $10,000 of their superannuation balances prior to June 30. They can, if necessary, apply for a further $10,000 after June 30.

There are ordinarily a few hoops to jump through to apply for an early-release hardship payment. As we know, superannuation is meant to be locked away until you retire or reach an age when you can officially tap the fund for money. But in these dire times, super funds worked with the Australian Tax office and other government departments to expedite hardship payments.

By close of business on May 7, ASFA made around 1,175,000 individual payments, totalling around $9.4 billion in temporary financial support. ASFA estimated that 98% of applications were paid within five working days.

Applying for a super hardship payment is a risky business if you are under 35. According to AMP, the average super balance for people aged 25-29 is $23,371 for men and $19,107 for women. In the age group 30-34, the average balance for men is $43,583 and for women $33,748. So it does not take too many trips to the hardship well to run out of cash. I used those age groups deliberately, as most pollsters agree that so-called Millennials are people now aged between 22 and38.

But it is not just the young that have little in the way of savings. According to the Grattan Institute, 50% of working households have less than $7,000 in savings. This probably explains the rush of super fund hardship applications. The Institute admits the data is a few years old, but says the scenario is unlikely to have changed much.

“As you might expect, working households on lower incomes tend to have less in the bank. Among working households in the bottom fifth of household income, the median total bank account balance is just $1,350. 

“The meagre savings of many low-income workers are a big worry because they are most likely to be employed as casuals and therefore not have paid sick leave or annual leave.” 

The Grattan Institute makes the point that as the lockdown drags on, more people will start to run out of ready cash.

“Our analysis shows that half of working households have five to six weeks’ income or less in the bank. The bottom 40% of working households has about three weeks’ income or less in the bank. A quarter of all working households have less than one week’s income in the bank.”

This last figure may bring your head up, if you remember news stories from New York, which we found shocking, of people with less than $400 in the bank.

Sometimes I think about these matters when doing the weekly grocery shopping, where retail prices are clearly outpacing inflation. (Ed: We did score a large pumpkin from a roadside stall for $3, so you can get lucky).

Those with a job who have not had a pay increase in years can justifiably feel cheated. Admittedly, the Federal Government came to the National Cabinet table with an extraordinary rescue package. But while one of these measures temporarily doubled the unemployment payment overnight, it now seems to be flawed piece of legislation.

People may rightly point out that employers are obliged to pass on the Jobkeeper payment of $1,500 a fortnight, regardless of what the employee was being paid previously. At some stage, these payments will stop and we will revert to the status quo. Will recipients who were technically overpaid have to repay some of this money, or does it just go to the deficit?

Robodebt II, coming soon to a cinema near you.

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Taking An Interest In Recessionary Economics

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Australia’s savings rate, spending and disposable income on a downward trend

The end of financial year meeting of the Basil and Sybil Cheeseparer Superannuation Fund was going well until the Trustees (a) found that their investment strategy was out of sync with reality and (b) failed to find a fixed interest investment that would return more than 2.50% over five years.

“We should stick it under the mattress,” said Sybil.

“Your side or mine?” quipped Basil.

As you should know, even if economics is not your forte, the Reserve Bank of Australia this week cut official rates for the second month in a row to a new low of 1.0%. They could have heeded this warning from Sydney’s University of Technology Professor Warren Hogan, but the RBA is not often swayed by commentary.

The RBA continues to be driven by persistently low inflation (1.3% in the March 2019 quarter). The theory is that if the RBA cuts rates low enough, business and consumer confidence will return and inflation will resume its normal trajectory (2% to 3%).  This in itself should build a case to raise interest rates, albeit gradually.

This current cycle of record low economic growth, inflation and interest rates is best explained by the graph ‘household consumption’.

It clearly shows consumption/spending falling off, concurrent with a decline in disposable income. Note the 10-year decline in our savings habit. Not much point saving if you are only going to get 2% or less in a bank and then pay a fee for the privilege, eh? (a nod to Canada Day).

An official interest rate of 0.1% is not as dire as that of Japan, Switzerland, Sweden or Denmark which have negative interest rates. Actually, since the onset of the Global Financial Crisis in 2007, many countries drastically cut interest rates in an attempt to stimulate growth (production and jobs). A blog by the International Monetary Fund (IMF) reasoned that while, the global economy has been recovering, and future downturns are inevitable:

“Severe recessions have historically required 3–6 percentage points cut in policy rates,” authors Ruchir Agarwal and Signe Krogstrup observe.

“If another crisis happens, few countries would have that kind of room for monetary policy to respond.”

IMF staffers periodically write blogs where they test models and theories (the IMF disclaimer says they do not represent the IMF’s views).

In this context, Agarawai and Krogstrup construct an argument for countries to survive financial crises by using negative interest.

The authors posit that, in a cashless world, there would be no lower bound on interest rates.

“A central bank could reduce the policy rate from, say, 2% to minus 4% to counter a severe recession. The interest rate cut would transmit to bank deposits, loans, and bonds.”

“Depositors would have to pay the negative interest rate to keep their money with the bank, making consumption and investment more attractive. This would jolt lending, boost demand, and stimulate the economy.”

Yes, but how do retirees like Basil and Sybil, who have surplus cash to invest, fit into this system? When the B&S Cheeseparer Superannuation Fund was formed, the cash rate was still climbing to its peak of 7.25% in 2009. That made it possible to invest cash in term deposits paying 5% or more, an attractive option for older people who wanted a safe haven.  

Now, the return for risk-averse investors barely covers the cost of self-managed super fund administration. And to think that Labor were talking about taking away much-needed dividend credit refunds! (The fact that this would only affect a small number of wealthy individuals was a fact not well explained by Labor and gleefully misinterpreted by the government).

Continuing low inflation is the main reason Australia’s central bank keeps cutting interest rates. Inflation dropped to 1.3% in March – the cost of living as represented by the Consumer Price Index (CPI) minus ‘volatile items’ like home purchase costs. However, Commonwealth Bank senior economist Gareth Aird argues that adding housing costs could add 0.55 percentage points to the CPI, giving the RBA less reason to lower interest rates.

Warren Hogan writes that ‘Australia is in a new environment where tinkering with interest rates may not be as relevant as it once was.’ Inflation is subdued around the world, he notes, yet the global economy is growing and unemployment is low.

Likewise in Australia, unemployment is low, although wages growth has stalled. As Hogan says, it isn’t at all clear that even lower interest rates would have a meaningful effect on inflation.

Australia has not plunged into a recession for 28 years, yet some commentators have used the R word when talking about the latest round of retail closures. (I should point out that uttering the R word is regarded in some circles as akin to walking under a ladder, breaking a mirror, toppling a salt shaker or seeing a priest in the street).

Retail closures included Maggie, T, Roger David, The Gap, Esprit and Laura Ashley. National retailers planning to downsize include Big W, Target, Myer and David Jones.

While some retail closures involved inevitable job losses, there will be more jobs to go as the big national chains roll out their smaller formats.

For the benefit of those aged under 28, an ‘R’ sets in after two consecutive quarters of negative GDP growth.

As we can see, the GDP result over nine months (+0.3%, +0.4% and +0.4%), means we are in dangerous territory.

The Gross Domestic Product (GDP) number is the one that measures whether the economy is growing or retracting. Safe to say at this point that a 0.4% increase in the March 2019 quarter (published this week) is not what the market or the government was looking for. The annualised GDP is 1.8% − the lowest since the GFC. Some pundits are calling it a GDP-per-capita-R, that is, population growth is overtaking economic growth.

The low interest rate scenario (and the data implies more cuts to come), is good for young people buying houses, but has a detrimental impact on retirees. Most people in retirement mode take a conservative view, preserving their remaining capital as long as possible. Bucket-list advocates would say what the hell and head off to Antarctica while there are still icebergs, glaciers and penguins.

Retirees typically have 60% to 70% of their super fund/savings in fixed interest products, with the balance in income-producing shares. But when faced with returns of 2.45% and less, it is difficult to stick to this formula. Shares or investment housing offer riskier but more attractive returns, though not as risky as spending all your cash on travel adventures or stashing it under her side of the mattress.

What to do? I have no answers, nor, I suspect, does the central bank, or the government, which is seemingly obsessed with the notion of stimulating the economy via $158 billion in tax cuts over 10 years.

Everyone under 30 needs to be across this subject because, as Herbert Hoover once said: “Blessed are the young, for they will inherit the national debt.”

We’ll leave you with some insights from Clarke & Dawe about banks, the debt crisis and interest.

 PS- I’m offering a choice of home-made, gluten free cake to whomever can explain to me why inflation is a ‘good thing’ – Ed..