In a somewhat rare event, two bankers — one from the United States and one from Australia — made an extraordinary amount of sense yesterday. This appears to be an isolated instance, unlikely to be repeated.
The Financial Review reported that NAB’s head of business banking, Joseph Healy, warned of excessive lending to the residential housing sector, at the expense of businesses. Healy stated that “a banking system which allocated capital away from the most productive areas of the economy — business — is ultimately bad for growth, bad for competition, bad for jobs, bad for business and in the end, bad for Australia.”
Healy also noted that part of the reason for the bias towards mortgage lending over business finance was due Basel II requirements, which allegedly “create an economically unhealthy bias towards residential lending and distorts capital allocation from more entrepreneurial and productive sectors of the economy”.
Healy’s comments are so prescient he may find himself looking for a new job — such sense is usually not welcome in our banking oligopoly. While the media devotes most of its attention to variable home loan mortgage rates, it pays little attention to business lending rates, credit card rates or deposit returns. This obscures the fact that placing too much wealth in housing, as Healy noted, is a sure-fire path to financial ruin. Japan and the US are examples of that.
With the exception of providing shelter, housing provides minimal benefits to the economy (after the initial construction), unlike business and capital investment, which further technological improvement and create lasting employment. Lending money to fund an over-priced property sector is even worse, wasting previous capital on an asset that is far removed from its intrinsic value. That capital could, and should, be used on in its most efficient manner — over-paying for housing is certainly not efficient.
Meanwhile, over in the US, minutes released from a recent Federal Reserve meeting indicate that hawkish Kansas City Fed Chief Thomas Hoenig said what most US officials cannot bear to mention — that interest rates at zero percent are unsustainable and will lead to inflation.
Hoenig was the lone dissenting voice at the most recent Fed Open Markets meeting. Hoenig stated “it is a fact that the current outlook for fiscal policy poses a threat to the Federal Reserve’s ability to achieve the dual objectives of price stability and maximum sustainable long-term growth.” Hoenig’s views are hardly groundbreaking — widespread quantitative easing (also known as printing money), which is currently occurring in the US will almost certainly lead to inflation … eventually, it is just that no official has ever been brave enough to say as much.
Is there a link between Healy’s and Hoenig’s views? Quite possibly. Australian banks have profited recently from the increased lending to the residential sector. This was largely due to banks lending more as house prices rise. In the past five years, the ABS has found that median prices have risen by upwards of 60%, however, banks are willing to lend a similar (albeit slightly lower) percentage of the total purchase price. That means that banks are now lending substantially more (in a nominal sense) for the same property.
A substantial portion of this funding has come from overseas. If Hoenig is correct and US rates rise (as they must eventually), the cost of funding for banks will increase, and the cost to borrowers will rise. This will lead to higher local interest rates, which will cause a higher rate of delinquencies and reduce the buying power of those purchasing a property.
While politicians and the media laud Australia’s “world-beating” property market, the view of Joseph Healy is far more correct. Precious capital is being greedily soaked up by an asset class that confers minimal economic benefits. This capital distortion, which has been furthered by foolish government policies such as the first-home-owner’s grant and wholesale funding guarantees, may prove very costly in the years to come.
Don’t knock BASIL 2. The fact that Australian Banks implemented these standards (and been policed by APRA), ensured that our banks have remained solvent and been able to weather the financial storm over the past few years (as opposed to the US and UK)
Also business lending is a lot riskier than residential mortgage lending. (see just about every corporate collapse where the out of pocket creditors always include the big banks from hundreds of millions of dollars). Do we really want to encourage more of this?
And I like how you have casually dismissed housing as being economically irrelevant. Do you really think that is true? When house prices rise, households become more wealthy and more inclined to spend. As household consumption expenditure makes up around 52% of GDP in Australia, it is vitally important.
When is this going to cease Crikey? This continual woe-is-us-we’re-all-sinking housing comment from Adam Schwab?
……placing too much wealth in housing, as Healy noted, is a sure-fire path to financial ruin. Japan and the US are examples of that……
Wrong. Housing is one of the biggest contributors to Australia’s economy, it’s why we look out with baited breath for New Housing Starts every time they are released. Think about the goods and services that go into building a new home and then tell me that placing wealth in housing is a sure fire path to ruin. How about we simply stop lending for it and watch all the tradies and manufacturers go bankrupt?
Housing has been a solid place to store wealth since Feudalism. I understand what you’re trying to get at, but this is wrong.
………Lending money to fund an over-priced property sector is even worse, wasting previous capital on an asset that is far removed from its intrinsic value…….
Who says it’s overpriced? People are still buying it, we need it, there isn’t enough to go around in the areas that it’s needed, and there are plenty of people who think it’s about right. A good or a service is only worth what the market will pay for it – hell, I don’t think a Lady Gaga CD is worth $30 but yet there they are, selling away.
Adam, I’ll agree that yes business lending has suffered and this is detrimental, but our unemployment rate tends to dispel the myth that people can’t get hired because there are no businesses out there looking for workers, and can’t expand.
I know of a small business in Adelaide who advertised a position and only got 2 applications – for a high quality job which paid for all study and an above market rate of pay. We’re still struggling with a skills crisis, whether people admit that or not. The issue again is supply.
This is the reason banks have cut back on business lending, because things looked like they were going to nosedive a year or so ago. The economy looked like it would tank, no wonder banks cut back lending to businesses, it was a terrible time to start one.
A mate who is a liquidation administrator told me, people will let their business run into the ground and cut every corner there is before they don’t pay their mortgage. Debts simply don’t get repaid on business loans – mortgages do.
Curious comment to finish there, Scott.
Does that mean it is vital for the share market to rise consistently too? After all, more wealth = more spending = more GDP…?
Until a homeowner sells their property, any increased consumption based on perceived (ie. unrealised) increase in their personal wealth means that their CURRENT excess consumption relies upon them realising that entire expected gain in the FUTURE… Not necessarily a sustainable approach to managing one’s own finances.
If our economy must rely on ever-increasing property prices in order to justify ever-increasing consumption in order to maintain ever-increasing GDP then, frankly, I think we’re heading down the wrong track.
Which is exactly why the comment from NAB’s head of business banking hit the mark… A system which skews the allocation of resources away from fundamentally productive investment (ie. business lending) and towards less than productive investment (ie. residential property) has a problem.
Business loans; 3.5% non-performing. Mortgage loans;0.6% non-performing according to the RBA’s recent Financial Stability Report. Is it any wonder why banks skew their preference to mortgage loans? At least they are more likely to get their money back.
As for the share market, of course it is important for shareholder wealth to increase. Probably more so in the future as household wealth is increasingly tied up in superannuation.
In regards to the consumption issue; to use a business analogy, there is the balance sheet and the P&L. As the Net assets increase on the balance sheet (as house prices increase), people (and businesses) are more inclined to increase spending on the P&L as they know they can sell assets to pay debts if worse comes to worse. It is an entirely sustainable approach to managing finances.
I think the business banker is just having some issues with his loan book and letting off some steam.
@ Scott
((((When house prices rise, households become more wealthy and more inclined to spend. As household consumption expenditure makes up around 52% of GDP in Australia, it is vitally important.)))))
Yes, wedobe….but Scott, thats not real wealth at all. It’s artificial wealth based on a punters capactity to borrow, and more than likely that borrowing is against the equity in the family home.
The inherent risk is when property values fall, the owners can be left owing more than the property is worth….this is being witnessed more prevalent even as we speak under the disguise of mortgage stress. You call this productive?…the economy is actually being strangled two ways.
First it’s through short term come & go artifical wealth creation via inflated property values with all it’s detriment…and next it’s the cut-backs to business lending with has the direct negative effect on employment and consumer spending.
Joseph Healy must have had an epiphany of some kind, either that or someone slipped him a micky-finn truth serum….he should be applauded.