2008 - the year of the credit crunch?

[MichaelW]

All,

And to complete the story, here's the latest instalment from Dr Oliver analysing the impact on the Fed's 0.5% rate cut recently.

His view is that the US will avoid recession but rates the chance at 40%. He also sees near term volatility remaining in the ASX but the market recovering momentum as the US tightening cycle plays out. He sees a year end position for the ASX around 6700.

http://www.amp.com.au/display/file/...?filename=US+interest+rates+-+OI+#31+2007.pdf

Cheers,
Michael.

 

[yieldmatters]

Yes, but if the value of those assets is held up by debt......

Exactly!

I'm very surprised Shane Oliver missed that very point. He talks about the household balance sheet being healthy (debt has increased but assets have increased more). And then he talks about an unusually high proportion of these assets being in housing. But he doesn't make the connection that these asset 'values' are dependent on debt?

If the number of houses in the country had increased to offset the debt then I would be less worried - more debt and genuinely more assets to offset it. But generally it is just the 'value' of existing houses going up.

 

[alexlee]

Exactly!

I'm very surprised Shane Oliver missed that very point. He talks about the household balance sheet being healthy (debt has increased but assets have increased more). And then he talks about an unusually high proportion of these assets being in housing. But he doesn't make the connection that these asset 'values' are dependent on debt?

If the number of houses in the country had increased to offset the debt then I would be less worried - more debt and genuinely more assets to offset it. But generally it is just the 'value' of existing houses going up.

The difference between you and me is that while both you and I expect property to come down, I'm going to keep buying, and I haven't sold anything.

Actually, if the number of houses had increased more I'd be MORE worried, because rents would stay low. As it is, my rents are shooting up 10% a year. Interest rate rises mean nothing to me.
Alex

 

[Kennethkohsg]

Both options are implemented in other countries, see singapore for option 1, see USA for option 2.

&&&&&&&&&&&&&&&&&&&&&&&&
Dear Trugoy,

However, please note that the housing markets and the taxation system as well as the prevailing taxable incomes/tax rates are fundamentally different in Australia and in Singapore, at this point in time.

Cheers,
Kenneth KOH

 

[Kennethkohsg]

Either way the credit crunch is over, or ignored, for now. Until the next one that is.

***************************
Dear Masterjunko,

....Or is the present USA sub-prime credit crunch , only a "prelude"/"symptomatic" of a more serious (hidden) currency/financial crisis to come such as the bursting of a global currency bubble, leading to a prolonged US recession, as suggested by Richard Duncan, in his book, "The Dollar Crisis"


Cheers,
Kenneth KOH

 

[miner]

I'd be less worried about the credit crunch impacting on the real economiy if the increase in debt had been utilised to increase capacity, rather than funding increased consumption (only approx 30% of finance for mortgages goes to investors) through more expensive existing houses (only approx 10% of finance for mortgages goes to new construction) .

In any credit crunch borrowed money becomes more expensive (unless on fixed rates) to allow less effective uses of the borrowed money to be made non-profitable. So borrowed funds will take more disposable income to fund, which means less money spent in the real economy, which leads down the lower growth possibly recession path. The same arguement could be made for increased rents, less money is available for other spending.

House values are not fixed and only reflect what someone is willing to pay, there is no inherent amount of value in a house. Debt, however, is a fixed amount. Therein lies the rub, if values are held up by debt, and I think they are, and less debt is available in a credit crunch to keep people purchasing at the prices that keep "value" inflated, the value must drop. The debt won't.

The real problem is that debt is now funded globally, so it doesn't matter if the Aust economy can keep going in the face of a US housing slump, we will have to pay for our debt in a market that is requiring higher prices to take on risk.

We are starting to see this with banks suggesting they will increase rates by larger amounts than the RBA increases, despite the best efforts of politicans to jawbone the banks.

It will be interesting times in which we live.

 

[trendsta]

I'd be less worried about the credit crunch impacting on the real economiy if the increase in debt had been utilised to increase capacity, rather than funding increased consumption (only approx 30% of finance for mortgages goes to investors) through more expensive existing houses (only approx 10% of finance for mortgages goes to new construction) .

In any credit crunch borrowed money becomes more expensive (unless on fixed rates) to allow less effective uses of the borrowed money to be made non-profitable. So borrowed funds will take more disposable income to fund, which means less money spent in the real economy, which leads down the lower growth possibly recession path. The same arguement could be made for increased rents, less money is available for other spending.

House values are not fixed and only reflect what someone is willing to pay, there is no inherent amount of value in a house. Debt, however, is a fixed amount. Therein lies the rub, if values are held up by debt, and I think they are, and less debt is available in a credit crunch to keep people purchasing at the prices that keep "value" inflated, the value must drop. The debt won't.

The real problem is that debt is now funded globally, so it doesn't matter if the Aust economy can keep going in the face of a US housing slump, we will have to pay for our debt in a market that is requiring higher prices to take on risk.

We are starting to see this with banks suggesting they will increase rates by larger amounts than the RBA increases, despite the best efforts of politicans to jawbone the banks.

It will be interesting times in which we live.

some excellent points miner ...

 

[Kennethkohsg]

I'd be less worried about the credit crunch impacting on the real economiy if the increase in debt had been utilised to increase capacity, rather than funding increased consumption (only approx 30% of finance for mortgages goes to investors) through more expensive existing houses (only approx 10% of finance for mortgages goes to new construction) .

Very well said indeed!

Cheers,
Kenneth KOH

 

[Kennethkohsg]

But generally it is just the 'value' of existing houses going up.

================
Similar effect is also achieved through the GST implementation in 2000s, when the costs of building a new house suddenly goes up by more than 10% overnight, post-GST period.

Cheers,
Kenneth KOH

 

[handyandy]

Actually, if the number of houses had increased more I'd be MORE worried, because rents would stay low. As it is, my rents are shooting up 10% a year. Interest rate rises mean nothing to me.
Alex

Hi Alex

One problem with rents is that they are inelastic.

When rents get to high people will generally start sharing, move back with parents etc.

My observation is that basic wages have moved over recent times (couple of years only ) from about 35k to about the 50k mark. I expect that rents can then move up as a portion of this wage increase but not beyond as simply people would go bankrupt renting so they find alternatives.

A further downside to this constriction in the rental market is higher wear and tear on your IP's. With the increase in rents the tenant will start renting out the spare room rathr than leaving it full of their junk.

Obviously for this to happen there has to be a change in expectations but necessity is the mother of invention.

Cheers

 

[MichaelW]

Hi guys,

Another great article from Shane Oliver at AMP Capital.

http://www.amp.com.au/display/file/...filename=Australian+economy+-+OI+#37+2007.pdf

Here's some interesting insight from that article that I wasn't aware of:

And perhaps most significantly, most of the rise in household debt has been amongst older higher households borrowing to buy investment properties, shares or to trade up to better houses. This means that the first chart showing a massive rise in household income payments relative to household income is less meaningful. The increase in the number of older, higher income households with housing debt has meant that of those households with housing debt, the median debt servicing ratio is not much different than a decade ago.

In other words, the rise in household debt levels largely reflects an increase in the number of households with debt rather than debt per household. Older higher income households tend to be relatively insensitive to interest rate increases. As a result, the rise in interest rates over the last few years has not been nearly as negative for the economy as might have been surmised from the rise in aggregate debt levels alone.

Finally, only about a third of households have mortgages and of these about 20% are fixed. So it’s only about 26% or so of households in total which are directly adversely affected by higher interest rates.

Maybe I should have posted this in the "Interest Rates Rise, ho hum" thread. Only 26% of households are directly impacted by rate rises on variable mortgage rates. 1 in 4 ain't going to spell the end of the world, nor is it going to spell a Global House Price Crash (GHPC). Sorry, couldn't help myself with that one...

Shane is still upbeat about the ASX and sees our current wobbles as just that, a small term glitch on an upwards trend. We're still in the fair value band and looking strong into 2008.

Cheers,
Michael

 

[trendsta]

Hi guys,

Another great article from Shane Oliver at AMP Capital.

http://www.amp.com.au/display/file/...filename=Australian+economy+-+OI+#37+2007.pdf

Here's some interesting insight from that article that I wasn't aware of:

Maybe I should have posted this in the "Interest Rates Rise, ho hum" thread. Only 26% of households are directly impacted by rate rises on variable mortgage rates. 1 in 4 ain't going to spell the end of the world, nor is it going to spell a Global House Price Crash (GHPC). Sorry, couldn't help myself with that one...

Shane is still upbeat about the ASX and sees our current wobbles as just that, a small term glitch on an upwards trend. We're still in the fair value band and looking strong into 2008.

Cheers,
Michael

Michael,

ok, fair enuf.. only 1 in 4 are affected by the rises..
do you know what percentage of owners were/are affected by IR and mortgage resets in the US? And have you recently seen the impact this had?

 

[Kennethkohsg]

Dear All,

1. I read from the Australian newspapers today that both Alan Greenspan and George Soros believe that the US housing slump and its related subprime credit crisis are likely to linger on further throughout the most part of 2008, with some 200,000 -300,000 excess housing units to clear. They are likely to further drive down the housing prices in the US property markets, and potentially leading to a US Recession during the 2008-2009 period.

2. The present credit crunch is likely to involve some US$900 Billion worth of sub-prime mortgages, which have been re-packaged up and sold off as collaterised bonds, previously.

http://www.theaustralian.news.com.au/story/0,25197,22720970-20142,00.html

3. for your kind update and further comments/discussion, please.

4. Thank you.

regards,
Kenneth KOH

 

[MichaelW]

and potentially leading to a US Recession during the 2008-2009 period.

Kenneth,

That's the only bit you need to worry about now. And its only potentially going to lead to a recession.

Have a read of that Shane Oliver report I linked. In that report, Dr Shane Oliver argues that the risk of a US recession is heightened, but in his opinion still unlikely to happen. Without a US recession, the global markets remain robust. Sure the cost of credit has gone up slightly, but it is only in the order of 0.25% and is already factored into future earnings downgrades and absorbed into market pricing. Bernanke said the other day it might be $150Bn instead of the $100Bn already absorbed so there might be a bit more tightening of profit outlooks to come, but that will mostly hurt the financial institutions and only slightly impact the cost of capital beyond the 0.25% current increase. We're still in the middle of fair value in Australia and likely to see fair value rise as China continues to drive up demand for what we produce.

So, in short, no US recession equals business as usual and lets keep riding the China boom to ongoing prosperity in Australia.

Looks like the Aussie banks are going to pass on that 0.25% increase in their cost of borrowings to their borrowers via a rate rise so that they can maintain their spreads at current levels. NAB and others are signalling a Christmas 0.25% rise so they can get their spreads back to where they were:

http://www.smh.com.au/news/business...-up-rates-again/2007/11/09/1194329464130.html

These rates were "still bobbling about", he said, with the price yesterday standing at 0.26 per cent above usual interest rates. "We're carrying that cost and we're not entirely comfortable with that," added Mr Stewart.

So the global credit crunch equals a quarter of one percent in the global cost of capital? That certainly isn't the end of the world. If $100Bn equals a quarter of one percent, then $150Bn worst case equals 0.375%. Not even half a percent...

Cheers,
Michael.

 

[yieldmatters]

Shane Oliver

That is interesting about who is carrying the debt - there may be some life left in this debt run up yet. Still can't go on forever though - it will hit a limit regardless of who is carrying it.

Shane Oliver also said (again) that "Australian house prices are extremely overvalued and hence vulnerable to an economic downturn or much higher interest rates".

I think anybody looking for medium term gains is in for a shock - it will take a long time to repeat what we have seen in the last 6 years (maybe never).

 

[Gremlin]

Shane Oliver also said (again) that "Australian house prices are extremely overvalued and hence vulnerable to an economic downturn or much higher interest rates".

I don't recall him saying that in anything I've read recently from him. Link please for context?

 

[yieldmatters]

I don't recall him saying that in anything I've read recently from him. Link please for context?

http://www.amp.com.au/display/file/0...337+2007%2Epdf

 

[Peter 14.7]

Giday All

Just come across this thread and yes I have seen the 4 Corners Program and it scared me as someone with some serious cash assets with Internet At Call Accounts.

I wonder who of the big banks overseas have bought these junk bonds and how may go under. First it was only small fry then BNP, now Merrill Lynch and now Citigroup. Are ING or Bankwest next? Mac Bank looks sick but denies any illness. All smells very much like 1990 again. Some of us could lose savings and that could flow to super and the overall economy.

But....

I don’t think Aus will tank if the US tanks as it appears to me the days of the US running the show is over. China will still find someone to buy their products (soon to include cars) if the US does not and that may mean a slowing in sales of minerals but it is booming anyway. We cannot keep up.

The US is in decline and divide. It not going to happen in 5 years but they have fundamental problems to get over.

What this does mean, IMO, and “blind freddie” can see this, the big 4 Aus Banks who have been screwed on margin by the non-bank lenders are going to get some back.

And it will not be in raising rates above the RBA target. No that too media focussed but it will be in reducing the discount they offer on wealth packages and deals which they can do to all these housing and margin loans at any time of their choosing. Increasing cost and hence inflation.

When the cash dries up for low docs and no docs and the small players are squeezed out then the natural law of supply and demand will come into play.

In short, the cost of money in Aus will rise.

Regards to all, Peter 14.7

 

[Kennethkohsg]

Kenneth,

That's the only bit you need to worry about now. And its only potentially going to lead to a recession.

Cheers,
Michael.

+++++++++++++++++++++++

Dear Michael,

1. Thanks for your feedback.

2. However it is further believed and said, " ... we have Learned from EXPERIENCE that (MARKET) SLOWDOWN OFTEN PRECEDES a PRICE COLLAPSE" - Robert Schiller - "The Next Bubble (or Bust)"

Cheers,
Kenneth KOH

 

[Peter 14.7]

Following on from my theory that how is holding these Junk Bonds i htought I would search Bankwest possible exposure.

Well Bank west is wholly owned by HBOS

http://en.wikipedia.org/wiki/HBOS_plc

And you search HBOS and sub prime you get

http://uk.biz.yahoo.com/05112007/32...bprime-contagion-fears-unnerve-investors.html

Which states as of the 5th Nov there are some concerns although other articles seem to say the losses will be acceptable. However, there will be losses. The bank has admitted that.

Does this effect Bankwest At call accounts? It should not but ...Tricontinental brought down the State Bank of VIC so who knows?

Time to read my disclosure statments on those at call accounts!

Peter