Myth Busting: Australia’s Economic Superheroes – Part II

The data keeps coming and the news is not good.

Myth Busting: Australia’s Economic Superheroes.

Household debt has exploded during the past 20 years, rising from about 40 per cent of disposable income in 1990 to 156 per cent of net income today.

Bankruptcies hit record high

THE proportion of Australians who are bankrupt or insolvent has hit an all-time high, latest figures show.

Data released on Friday by the Insolvency and Trustee Service Australia (ITSA) revealed 6649 new bankruptcies during the December quarter of 2008, an increase of 6.03 per cent over the corresponding period in 2007.

The number of people making debt agreements with their creditors also jumped by 37.12 per cent from December, 2007.

And, according to credit agency Veda Advantage, the number of people insolvent is 25 per cent higher than in 1992, when insolvency peaked during the last recession.

Veda Advantage uses the ITSA data to compile an “insolvency ratio”, which measures the number of debt agreements and bankruptcies as a percentage of the total population.

It reached a peak of 0.15 per cent in 1992, but now stands at a record 0.2 per cent.

“It’s at an all-time high and is going to get worse,” Veda Advantage head of external affairs Chris Gration said.

“We’ve analysed data going back to 1988, and this is the highest ratio yet.”

Household debt has exploded during the past 20 years, rising from about 40 per cent of disposable income in 1990 to 156 per cent of net income today.

“Increasing debt is fine when the economy is OK, but during a downturn it can be disastrous,” said AMP Capital chief economist Shane Oliver said.

“The figures are likely to get worse before they get better.”

According to the Consumer Credit Law Centre, until about 10 years ago most bankruptcies were business-related, but that changed during the mid-1990s.

“We then saw personal debt problems overtake business debt issues,” Carolyn Bond, of the Consumer Action Law Centre, said.

“Now most bankruptcies arise from personal debts such as mortgages, credit cards and personal loans.”

Although assets such as property and shares have risen in value, the economic downturn has placed extra strain on household budgets.

“Our figures show around 1.3 million Australians living in households where more than 50 per cent of income goes on paying debts,” Mr Gration said.

“For most people, that just isn’t sustainable.”

Mr Gration said credit laws made it too easy for people to get too deeply into debt.

“Very often, when people get into financial difficulty they try to borrow their way out of trouble, and this is usually a mistake,” he said.

Veda recently looked at 224 statements of affairs provided by ITSA to get a picture of how people behaved when they hit financial troubles.

One of the questions ITSA asked is when bankrupts realised they were insolvent.

A staggering 95 per cent of bankrupts said they had applied for more credit after the point at which they knew they were insolvent.

“People become desperate,” Mr Gration said.

In an effort to prevent more people drowning in debt, the Federal Government is considering legislation that will allow potential creditors to view all the debts held by an applicant, together with relevant credit limits, and see a borrower’s repayment history for the previous 24 months.

Over to you

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12 Responses

  1. I’m arguing, like I have been for some time: ‘SLUMP’. The level of personal debt in this country cannot support an increase in the housing market and given the the level of bankruptcies, it’s my opinion that the only way is down to more sane and sustainable price levels.

    Property prices: bargain or slump?
    http://www.news.com.au/dailytelegraph/money/story/0,26860,24896398-5015795,00.html
    “Is it the best or worst of times for real estate? Andrew Carswell sifts the evidence.

    MANY property fanatics are proclaiming 2009 as the best year in decades to buy a new home. But others vehemently disagree, arguing that house prices are due for a sharp correction. “

  2. And if unemployment continues to increase a decline in housing prices along with increased bankruptcy claims will no doubt accelerate

  3. I reckon it’s a good time to buy if you are reasonably confident of keeping your job.

    I also think that the 3nd and 3rd quarters of this year will see blood in the streets, but then the economy will begin to recover thereafter.

    Steve Keen’s predictions of a 30% drop in prices is a load of bollocks. Shane Oliver has a helluva lot more credibility than Steve Keen so I reckon his prediction of a 10% drop is more realistic.

  4. Soon it will be standing room only down at the Bankruptcy Court.

  5. Here’s something of interest, but what happens when housing has been overpriced and unemployment and job insecurity run counter to the market:
    “Both Treasury and the Reserve Bank have been counting on the lack of housing supply in Australia to stop prices from plunging as they have in the US and Britain.”
    Layoffs loom in building industry
    http://www.theaustralian.news.com.au/story/0,25197,24889988-601,00.html
    MASS lay-offs are looming in the home building and building supplies industries as orders for new homes evaporate in the face of the financial crisis.
    There was a shock 12.8 per cent fall in the number of plans for new dwellings approved by local councils in November.
    The number of new apartment developments on the drawing boards fell 21.9 per cent in the month and is only half the level of a year ago.
    The severity of the fall, which followed three months of big interest rate cuts and the tripling of the grant for first-home buyers purchasing newly built homes, has raised concern about a much sharper downturn in the housing market and sparked calls for the Reserve Bank board to cut interest rates further when it meets next month.
    The slump in building approvals came as new Organisation for Economic Co-operation and Development research showed Australians had more of their wealth tied up in housing than people in other major developed nations.
    Non-financial assets, principally housing, represent 75.8 per cent of Australian household wealth compared with 64.8 per cent in Britain and 43.1 per cent in the US.

  6. Reb@3 I think you’ve got your blinkers on.

  7. Time to face the facts reb the Howard Government failed us all very badly.

    I came across a very insightful article written by SMH’s Ross Gittins that I find simplifies the current crisis and how we got into this mess in the first place. Nothing new here, however, time and again people forget.

    A world of pain when debt gets the better of us
    Ross Gittins
    November 5, 2008

    In the recession of the early 1990s it was called “balance sheet repair”. This time it’s being called “deleveraging”. But whatever mystifying name it’s called by, it’s simply what you do when you realise you’ve borrowed far more than you should have: cut back your spending and try to reduce your debts.
    Trouble is, when a lot of businesses – or a lot of families – do this at the same time, it hurts like hell. When too many people cut back their spending, they make things tougher for everyone.
    The cut-backs feed on themselves: my reduced spending reduces your income, which prompts you to reduce your spending, which reduces my income. I respond by reducing my spending and round we go again. In the process, people get laid off, businesses collapse and the economy gets smaller – which is the definition of recession.
    Trying to understand the whys and wherefores of how the US subprime mortgage debacle of August last year became the global credit crunch which then, in late September this year, morphed into the global financial crisis that now looks likely to precipitate a global recession, is almost impossible for people outside the finance industry.
    You have to get your head around such exotic financial contracts as collateralised debt obligations, credit default swaps, structured products and many more. It’s clear that the innovative ways financiers have sought to use “derivatives” (synthetic contracts) to manage risk have, in fact, led financial institutions to take on risks they didn’t understand.
    But it’s important to understand that the greatest single cause of all the trouble – which will dog us for years to come – isn’t the least bit new or complicated. It’s businesses and households yielding to the temptation to borrow too much. A common way to seek to get rich is to “gear up” (or, as the Americans say, “leverage up”): rather than simply using your own savings to buy income-producing assets (such as property, shares, whole businesses or financial contracts) you borrow a lot of money, which allows you to buy a lot more.
    One advantage of gearing up is that interest paid on money borrowed to buy income-producing assets is tax deductible. But the big advantage is that, when you sell the asset at a profit, all the capital gain belongs to you and none to the lenders who picked up most of the cost.
    This, of course, is the logic behind the instance of financial leverage you’re familiar with: negatively geared investment in rental properties. It’s a tried and true method of getting rich quick.
    That is, it works a treat as long as asset prices keep rising. The big drawback is that when prices start falling your losses multiply as fast as profits mounted on the way up.
    If you don’t manage to sell before prices start falling you can soon find yourself in deep trouble, paying interest on a debt that now exceeds the value of the asset. Your balance sheet is now in disrepair and you have to deleverage by paying down your debt – if necessary, by selling the asset at a loss.
    If you’ve heard all this before – of course you have. That’s my point. It’s an old, old story. This sort of behaviour happens frequently in economic booms and always during booms in share and property prices.
    It’s borrowing that fuels the boom and the consequences of excessive borrowing that make the bust so painful.
    Everywhere you look in the global financial crisis you find individuals and businesses that borrowed too heavily and are causing great problems for themselves and the rest of us now the music’s stopped.
    Whatever exotic games they were playing, the risks were magnified by gearing up.
    Start with the subprime problem itself. Many people borrowed to buy homes they couldn’t afford. They’ve defaulted on their debts and the homes they’ve lost are a drag on the market. (Of course, the lenders are as much to blame as the borrowers, but that’s part of the same old story: in debt-fuelled booms the lenders get carried away and drop their credit standards.)
    The five big Wall Street investment banks that have now disappeared were all highly geared, with debts far in excess of their share capital. Most of the hedge funds were highly geared, which left them vulnerable when prices started falling and losses mounting.
    Next, the “private equity” craze, where a private firm borrows heavily to buy out all the other shareholders in a big company like Qantas then loads all the debt on to the company’s own books. This has left many American and European businesses terribly overstretched and vulnerable. It’s a mercy for us this craze hardly got going here before the start of the subprime crisis last year stopped the madness in its tracks. Had the Qantas deal gone ahead it would now be in deep trouble.
    Neither our banks nor our corporate sector are highly geared at present. Unfortunately, the same can’t be said for our households. In the past decade the housing boom – including the welter of negative gearing – has seen their total debt double relative to their disposable income from 80 per cent to almost 160 per cent.
    That’s our great vulnerability. If Australia succumbs to the global recession, excessive household borrowing will be the greatest reason.
    You may say, rather, that the root cause of the global crisis is greed and its ultimate transformation into fear. But it’s borrowing that facilitates greed and excessive levels of debt that generate so much fear when boom turns to bust.
    The point is not that all debt is evil. It’s that the ready availability of credit – itself the product of financial deregulation – is a two-edged sword.
    It’s like fire: useful for many purposes, but also dangerous and capable of great destruction.
    That’s hardly a new discovery. But in the heat of our optimism and greed we mere mortals keep forgetting it. Which is why financial markets need to be regulated by older and wiser heads.
    Their job is to protect us from our folly. But with their excessive faith in deregulation and their assumption that we’re all rational, they’ve allowed themselves to believe that all credit is good credit and so let us down badly

  8. By the way reb, I’m only having a friendly dig

  9. “I think you’ve got your blinkers on.”

    I can’t help it. It’s the medication. It makes me feel positive about everything 🙂

    yes I know you’re having a friendly dig. Give me some time to think up one to throw one back at you.

    Excellent article by Ross Gittins, although it’s kind of stating the obvious.

    One thing I have realised is that economists are very good at explaining why things have happened, but are absolutely useless at predicting the future. Remember the predictions of the Aussie dollar reaching parity with the US dollar by now, back in July?

    I agree that things are going to get worse. While the pain may be severe for many, the end result is what needs to happen.

    The housing ‘boom’ is well and truly over. However people still need a roof over their heads whether it be rented or mortgaged.

    I do have sympathy for people who are heavily geared and/or find themselves paying off loans for property or shares that have declined in value. That would be a truly awful situation to be in, and I suspect this predicament is far more widespread than we think.

    As has been reported, the number of people going bankrupt in Australia is at record highs, it’s bound to get worse.

    I suspect the “unravelling” will happen quite quickly say six to 12 months..

    But at the end of the day, people still need to buy stuff and still need somewhere to live.

    Things will eventually recover albeit slowly…

  10. Reb “I can’t help it. It’s the medication. It makes me feel positive about everything”
    Lol, I’d like what your having

    Yes, Gittins is stating the obvious and that’s what I appreciate most about the article. Plain english and the fact that regulators and the Federal Government ignored the madness.

  11. Bankruptcies is an interesting topic. When working in the Bank we received a list of all those who were granted bankruptcy each week and had to do a search of your files to see if any were our customers so the system could be noted.

    Despite statistics there are many reasons for bankruptcies that is not just a reflection of the econmy with many falling into the following categories.

    1) New management of a company destroy the business through greed or pooor customer relations. SDaw this many a time in restaurants and motels and other accommodation.

    2) People who obtain as much credit as possible and declare bankruptcy simply to avoid paying debts knowing that they can restart again in 3 years, despote bankruptcy staying on the system for 7 years most are discahrged after 3 years.

    3) One partner goes bankrupt after assets have been distributed to family memebers and also friends ( very strong loyal friends) to ensure creditors and shareholders lose out. *** Want to see an example look at Madoff in the US, caught with cheques for over $150 million to give to family to suck the final monies and then give himself up***.

    4) Of course numbers will grow because businesses and our population has grown.

    5) The numbers need to be broken down completely to make any sense.

    6) Many people are advised by lawyers to go bankrupt rather than try to negotiate they way out of it. Experienced this many times as well.

    The thing is, yes the state of the economoy may have some bearing but unless the real reason is obtained statistice are a wild stab in the dark just like the economist prediciotns of the past few years.

  12. Shane@11 – Interesting insights, thanks.

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