Australia | Sep 24 2007
By Greg Peel
Picture the scene. A couple sits in their back yard as two young offspring guzzle down red cordial before running maniacally around the garden without fear or favour. The exuberance soon comes to an abrupt end when the two children manage to clash heads and fall flat on their backs. Tears ensue, and parents offer superficial comfort. At least that’ll teach them a lesson, the parents muse. They may just be all the better for it and learn to exhibit some semblance of control as they get older. Might just back off the red cordial a bit though.
Somewhere across the Pacific a similar scene is played out, but this time the parents decide the only way to stop the crying is to offer more red cordial.
And so it was that the Reserve Bank of Australia released its September Financial Stability Report this morning. The RBA acknowledged the global credit crunch and its side effects, noting:
“Overall, market conditions have been characterised by considerable nervousness, and investor confidence – particularly in structured credit products – has been dented.”
But does it thus spell disaster ahead? Will the US economy, and subsequently the global economy, collapse into recession?
“These adjustments reflect, to a large extent, an increase in the compensation that investors require for holding risk as well as an increase in the perceived riskiness of some mortgage-related investments, rather than a fundamental reassessment of the risks to the global economy.”
So there you have it in a nutshell. The crisis that started with subprime mortgages spread through to more general mortgage-related investments, and the resultant uncertainty lead to a swing away from risky assets and into reliable government paper. But things will soon settle down, the RBA implies, and in the end we’ll all be better for it. And now that the problem has been nipped in the bud the global economy will be in a better position to grow more confidently:
“Viewed in a medium-term context, some adjustment in risk spreads is to be welcomed, increasing the likely durability of the current global expansion.”
Recession? What recession? The extent of the credit crunch has taken many by surprise, and the banks have been wearing a bit of short term pain, but things are already starting to get back to normal (See “Banking Sector: Tentative Steps Towards A Return To More Normal Programming”; today). This is also a “welcome development”, but the RBA warns there may still be a bit of turbulence ahead. At the end of the day however, things are actually pretty healthy:
“Underlying this improvement is the fact that the credit quality of corporate borrowers in most countries is sound and that the core financial institutions around the world typically have healthy balance sheets. Also, the outlook for the world economy remains positive, notwithstanding prospects for slower growth in the United States.”
All we’ll see is a return to more realistic credit spreads. And as far as Australia is concerned, well…we’ve had our share of the turmoil…but we are in a much better position some of our friends and allies:
“This reflects a number of factors, including the very limited exposure of Australian banks to the US sub-prime market and the very small size of the Australian non-conforming loan market (the closest equivalent to the US sub-prime market). In addition, arrears rates on Australian mortgages remain low by international standards. Australian financial institutions have been able to roll over maturing liabilities, albeit at higher interest rates than previously, and some have shifted their funding from offshore to domestic markets.
“Overall, the Australian banking system remains highly profitable and is well capitalised. Balance sheets have continued to grow strongly over the past year, bad loan expenses remain low, and banks have benefited from strong growth in income from their funds management operations.”
What the RBA expects to see is the return of traditional banking at the expense of the fly-by-night fringe players and opportunists. Loans will be funded more from balance sheets and less from spurious asset packaging. If the RBA was ever concerned about the dangerous rise of the non-bank credit market, we’ll probably never know. The default of a few dodgy mortgages in Miami have solved the problem quite sufficiently. As far as Australia’s overall debt situation is concerned, one which some economists and commentators regard as approaching perilous, it’s really all just a beat-up unless you happen to live in Campbelltown:
“More generally, the domestic economic and financial environment remains supportive of financial stability; the Australian economy is continuing to grow at a strong pace, with household and business balance sheets, overall, being in good shape. The share of households experiencing financial difficulties remains low, although it has increased over recent years, largely reflecting the much wider availability of credit over the past decade. Households are benefiting from strong income growth and low unemployment, with household wealth rising solidly recently. While there are some pockets of stress, particularly in western Sydney, most households are reasonably positive about their personal finances. Business balance sheets also remain in good shape overall, with debt-servicing ratios and arrears rates remaining low.”
Peter Costello must have read this document with some degree of trepidation. He could use it to once again espouse the virtues of the Howard government’s economic track record, and highlight how experienced economic managers can protect the Australian people from the folly of others across the globe. But he must also conclude that the shock and awe actions of the US Federal Reserve are going to have little impact on the local counterpart.
If the economy remains strong, unemployment low, investment booming and price pressures become apparent in the third quarter CPI data – November rate rise here we come.
The full RBA statement can be read at http://www.rba.gov.au/PublicationsAndResearch/FinancialStabilityReview/Sep2007/Html/financial_stability_review_0907.html