Does private debt matter?

This discussion was started as a continuation from another:

I've seen property booms before and I think we will see them again . We bought our first PPOR at the peak of the late 80's boom which saw prices double in close to one year . There have been booms in the 60's and 70's .

I think there's skill to picking the right locations for each cycle, but it's unlikely the next 50 years will replicate the last 50 (as far as property price growth goes).

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Unless property investors expect private debt to double relative to GDP (300%)?

Is that gross debt or net debt? Doesn't sound right to me also. Our public net debt to GDP is a lot lower than that. I'm surprised private debt is that high


Net of savings. Common sense no? I may have a lot of outstanding debt, but maybe my debt is entirely offset by cash in offset account. Everything comes back down to the most basic, fundamental things.

Given that private debt is issued through a bank who creates both the deposit and the loan together, then by your measure net debt would be 0 (as there is private savings in the system to match all debt)?

I think that private debt relative to the size of the economy is a pretty important measure to keep an eye on. There has to be a limit at which point the burden becomes too much and it tops out... whether we are there or not is another question?!
 
Debt of what grade, AA? And is it all serviceable? And secured against something with some fat in the deals?

If yes to all of the above, whats the issue?
 
Is it all serviceable?
That's the question I'm asking. They are not exactly comparable, but if we consider GDP is the country's income, how high can private debt get relative to that before it is no longer serviceable? As it is we've had to drop rates down to record lows to sustain economic growth under the current burden... how much higher can it get?
 
Does private debt matter?

Does it matter to the individual? Yes, sure - until such time as it is repaid or written off.

To Australia as a whole? No. Well, assuming a heap of people don't bunk out on their debt at the same time such as the sub-prime mortgage crisis in the US.

Subprime_mortgage_originations%2C_1996-2008.GIF

Mortgage_delinquencies_by_loan_type_-_1998-2010.GIF


Given that private debt is issued through a bank who creates both the deposit and the loan together, then by your measure net debt would be 0 (as there is private savings in the system to match all debt)?

Yeah, see we have fractional reserve banking.

If we didn't have FRB, then you would be correct.

$1 in deposits = $1 in loans.

But in a FRB scenario $1 in deposit can equal much more than $1 in loans.

I think that private debt relative to the size of the economy is a pretty important measure to keep an eye on. There has to be a limit at which point the burden becomes too much and it tops out...

Sure... if incomes grow (be it GDP or Household Income) and debt grows to match it (at which time interest rates are likely increasing).... potentially you could end up with an economy on a knife edge, where an economic shock (an unforeseen negative event) just stalled the economy enough that....


whether we are there or not is another question?!

As it stands, probably not for a while yet.

But these things can change relatively quick.
 
Yeah, see we have fractional reserve banking.

If we didn't have FRB, then you would be correct.

$1 in deposits = $1 in loans.

But in a FRB scenario $1 in deposit can equal much more than $1 in loans.

While I am almost certain many really dont care, I love talking about this so here goes;

Frb still requires one dollar of deposits to make one dollar of loans unless the banks capital itself is loaned out.

The multiplier effect is about the money written in loans often coming back in further deposits allowing further loans. The lower the fractional reserve the higher the potential multiplier.

There is still either funding from deposits or initial capital that finances a banks loan assets.

Not saying its a rock solid financial system we are sitting on as decreasing propensity to either save or borrow can bring it crashing down. Only saying that on the face of it you need a dollar deposited (deposit liability) to loan a portion up to a full dollar out (create a loan asset).

It's often an economies propensity to save or borrow changing which can reduce money supply that can have devastating impacts on the wider economy.
 
In summary to te op: does private debt matter?

Yes it does and while serviceability is a part of the reason why equally important is the effect private debt has on the money supply.

Without a thirst for debt asset values would be far lower than they are. Inflation has been subdued in Australia mostly because our thirst for assets has outstripped our increasing debt levels.

What is interesting but no doubt tough for those in business as things have become tighter lower interest rates has only fueled our appetite further for assets having negligible impact on aggregate demand in the consumer parts of our economy.

I think monetary policy is now a broken instrument to be honest. It has lost it's impact on business and only serves to take money out or put money into families pockets rather than fuel or quell capital investment in the business community as it once did.
 
$1 in deposits = $1 in loans.
But in a FRB scenario $1 in deposit can equal much more than $1 in loans.
I think FRB models published on the internet can be misleading.

When a private bank issues a loan, it creates both a new deposit and loan account in equal amounts.

I think monetary policy is now a broken instrument to be honest. It has lost it's impact on business and only serves to take money out or put money into families pockets rather than fuel or quell capital investment in the business community as it once did.
Agree. There is only so long that enticing borrowers with lower and lower interest rates can support productive debt growing faster than income.
 
Frb still requires one dollar of deposits to make one dollar of loans unless the banks capital itself is loaned out.

The multiplier effect is about the money written in loans often coming back in further deposits allowing further loans. The lower the fractional reserve the higher the potential multiplier.

True.

My post was only half the story.

As this little fable (which I actually forgot I had posted on another forum) demonstrates -


It all started with my friend John. He had $100, and I had a nice big safe, so he asked me to store it for him.

Next thing I know, my friend Bob asked me if he could borrow $90. I'm a kind person, so of course I said yes, and took the $90 out of the safe.

Of course Bob being Bob, he spent the lot down the pub that very night

Bob wasn't so happy, but my friend Ken the landlord was, and he came by the next morning and asked me to keep it safely for him in my safe.

Well word must have been getting round that I'm a soft touch, so blow me down if another friend Mick didn't ask for a loan. This time he only wanted $81, so I open the safe again.

I knew that was a mistake. He's had this long-term gambling problem, and guess where the money went. Yep that's right, right into Dave the bookies pocket.

He's a careful chap, and asked me to keep it safe for him.

Then Pete asked for a loan. Only $72.90. I'm obviously too soft, but I give it to him from the money in the safe.

He's got quite a big family, and spent the lot at the local grocers. Ted the grocer came round that evening and asked me to put it in my safe.


At this point I thought I'd better start keeping some notes of all this. I'm starting to forget who borrowed what

Now, lets see, I started with $100 from John.

I've lent out:
$90 to my friend Bob.
$81 to Mick.
$72.90 to Pete.

So altogether I've lent out $243.90. And that's the total debt owed.

Hmmm, that's odd, because I only started with $100.

But what do my various friends think they have now?

Well John thinks he has that original $100.
And Ken the landlord has $90.
And Dave the bookie has $81.
And finally, Ted the grocer has $72.90.

So all up, that's $343.90.

And they say you can't make money for nothing

I just hope my friends don't all turn up at once asking for their money back, or I'm going to get beaten up. I've just looked, and I still only have $100 in the safe

Does anyone want to borrow some money ?


But here's the punchline that was somehow omitted from the joke....

I've lent out:
$90 to my friend Bob.
$81 to Mick.
$72.90 to Pete.

Yes, but in return I owe:

$100 to John
$90 to Ken
$81 to Dave, and
$72.90 to Ted.

They cancel each other out except for the $100 I owe John, which still happens to be sitting in my safe.

Not saying its a rock solid financial system we are sitting on as decreasing propensity to either save or borrow can bring it crashing down.

Or, a downturn in the economy combined with falling asset values.


I think monetary policy is now a broken instrument to be honest. It has lost it's impact on business and only serves to take money out or put money into families pockets rather than fuel or quell capital investment in the business community as it once did.

In defence of MP, it could be argued that is actually a good thing.

One of the criticisms of MP (interest rates) in the past has always been how blunt it is and that it does not discriminate between "bad debt" that funds consumer purchases (new TVs, cars, holidays) and, otoh, "good debt" which supports the capital investment decisions of business.

Businesses are motivated by profits (ergo some semblance of economic rationality in the traditional sense).

A lot of consumers are not "rational" in the same sense and if it takes a few interest rate hikes to make them think twice, then that's a good thing imo.
 
Yes those examples are very helpfull to see how with a small amount of cash we can have a gigantic broad money supply. Ie deposits can be far larger than cash. These deposits are considered bank liabilities like each of the deposits into your safe above are all liabilities to you.

To a bank however each time someone deposits money in your safe it is considered a deposit liability both the original $100 and the subsequent deposits. It does show however how with $100.00 cash you am end up with a large amount of deposits.

Interestingly Australia's primary tool for maintaining financial stability is capital ratios rather than fractional reserve banking. The banks must have capital over and above the value of their deposit liabilities, the quality determining the ratio of capital to deposits.

What worries me about this is that a write back of say 5percent of a banks capital has a proportionate affect on their allowable deposit liabilities and hence loan assets. So it can be the case they have to stop loaning more money, then the whole economy is in trouble.

Why sometimes I think if there was a super profits tax it should be on banks. The government has to be at the ready to bail them out so might as well make a few quid of them in the good times.
 
Why sometimes I think if there was a super profits tax it should be on banks. The government has to be at the ready to bail them out so might as well make a few quid of them in the good times.

Haha i've had long long debates about this with a number of economists. Its a pretty good idea. From memory, Swans last budget had some tool to do exactly this (albeit, small). I dont know much in terms of detail and dont think it was ever legislated.
 
Great fable Mark. But what happens if they all come in and ask for their money back at the same time? BANK RUN!!
 
Haha i didnt think that gaurantee was still in place - thought it was temporary to wade of GFC confidence effects.

I'm not sure i buy into the private debt statistics mattering all that much. If its being used productively, and generates a return that outstrips its cost - the more the better (with stability in mind).
 
Haven't thought very deeply about this. But all I know is, in the collapse of USA, Greece, Italy, Spain, Portugal etc the only measure that matters to people were public debt to GDP.

In fact, in Greece, private debt to GDP was one of the lowest in the Euro zone.
 
Australia runs persistent current account deficits. So each year our private debt levels increase - or our net foreign liabilities - to fund that CAD. So long as we run CAD's, the private debt levels are not coming down - the rate of increase my fall if the CAD falls, but we're not going to be a surplus economy anytime soon.

In other words, Australia imports capital from the rest of the world - we use it to fund our investments (both good and bad).

So long as good sustainable investments are made its a good thing. My view is private debt isn't a good measure to look at in isolation - it doesnt point to a detioration in anything. Should look closer at sustainability measures, rather than aboslute liability figures.

E.g. take a look at CAD figures, if it starts getting beyond 6%+ of GDP consistently, we could have sustainability concerns.
 
Haha i didnt think that gaurantee was still in place - thought it was temporary to wade of GFC confidence effects.

Closed to new liabilities in 2010.

That aside, the RBA has long had a duty to protect the stability of the financial system - the power to act is always out there (the deposit guarantee just made it more explicit and put some limitations on it).

And if the proverbial ever hit the fan again - imo they'd simply dust off the guarantee and rehash it.

Not as though the people in Treasury, the RBA and places like APRA don't talk about these things over their morning coffees.

No problems, it's all guaranteed by the guy at the top of the hill...Tony :D

Actually, the last explicit guarantee was (according an old post of mine) limited to $20k (which I assume was per customer, per bank).
 
I suspect to paint the illusion of bulletproof big four banks, our gov has allowed our banks to issue covered bonds. These instruments are as safe as houses given they are covered by depositors who are meant to be first in queue in a bank liquidation but now sit behind these special bonds. So withdraw the gov guarantee but allow covered bonds. Is it really that subtle no one noticed?

Our banks argued in 2010 they were at a disadvantage to their overseas counterparts.... Wayne swan thought good idea that our banks be more like Spanish or American ones and passed regulation to allow these covered bonds.... I'm only an engineer but **** I can even see this is just gaming the system to allow more broad money in Australia and by extension more private debt.

So the bonds are covered by depositors and the deposits are covered at least implicitly by the australian government...

And our pollies carry on about the miners making good from our fair country. At least miners go it alone without government support.

While I firmly trust market economics banks are a special case. At the risk of sounding like a crackpot, Banks should at least be heavily regulated if not owned by the gov.

If you think our banks having around 10pc cApital ie the differemce between their loan assets v deposit liabilities makes them safe you are an optimist in my opinion. A 10pc write down in their loan assets and they are history ie donut capital left. To then comply with capital requiremets they have to bring their loan book back from hundreds of billions in any one of the big four banks (as if only one would be struck in isolation) back to zero... ie loose 60-70bn and any one of our banks and by extension all of us are stuffed... Sure it takes an economy wide event for this to happen but no economy is immune to 20 pc asset writedowns over the decades, and bringing it back to the op yes private debt matters because this leaves both individuals but worse our broader economy exposed.

Anyway apologies for the drunken d and g but it's good, even if only for me, to get this off my chest.
 
And our pollies carry on about the miners making good from our fair country. At least miners go it alone without government support.

Haha this is a quality post for this time of the night! Admittedly, my ability to comprehend it was quite limited!

Not sure the miners have it completely support free. Favourable depreciation, instant exploration write-offs, etc are pretty favourable in a capital intensive industry.
 
I suspect to paint the illusion of bulletproof big four banks, our gov has allowed our banks to issue covered bonds. These instruments are as safe as houses given they are covered by depositors who are meant to be first in queue in a bank liquidation but now sit behind these special bonds. So withdraw the gov guarantee but allow covered bonds. Is it really that subtle no one noticed?

Our banks argued in 2010 they were at a disadvantage to their overseas counterparts.... Wayne swan thought good idea that our banks be more like Spanish or American ones and passed regulation to allow these covered bonds.... I'm only an engineer but **** I can even see this is just gaming the system to allow more broad money in Australia and by extension more private debt.

So the bonds are covered by depositors and the deposits are covered at least implicitly by the australian government...

And our pollies carry on about the miners making good from our fair country. At least miners go it alone without government support.

While I firmly trust market economics banks are a special case. At the risk of sounding like a crackpot, Banks should at least be heavily regulated if not owned by the gov.

If you think our banks having around 10pc cApital ie the differemce between their loan assets v deposit liabilities makes them safe you are an optimist in my opinion. A 10pc write down in their loan assets and they are history ie donut capital left. To then comply with capital requiremets they have to bring their loan book back from hundreds of billions in any one of the big four banks (as if only one would be struck in isolation) back to zero... ie loose 60-70bn and any one of our banks and by extension all of us are stuffed... Sure it takes an economy wide event for this to happen but no economy is immune to 20 pc asset writedowns over the decades, and bringing it back to the op yes private debt matters because this leaves both individuals but worse our broader economy exposed.

Anyway apologies for the drunken d and g but it's good, even if only for me, to get this off my chest.

Also banks are heavily regulated. They have their own watchdog purpose built to look over them! APRA.

They are indeed central to the functioning of a well working economy, and the costs of failure are extraordinary. Hence the additional oversight.

In Australia, the competitive dynamics make it quite simple for the oversight function. Oligopoly structure means theres really only 4 major players that can shake the market (loosely). Easier to control 4 banks than 40.

Part of the reason why macropru policies, which target financial stability, are less favoured in Australia compared to other countries.
 
That's the question I'm asking. They are not exactly comparable, but if we consider GDP is the country's income, how high can private debt get relative to that before it is no longer serviceable? As it is we've had to drop rates down to record lows to sustain economic growth under the current burden... how much higher can it get?
I would venture to say that an overwhelming proportion of folks are still near to their maximum serviceability levels already.

A few years ago, it was stated that the Average Aussie spends 105% of their income.

Despite the recent statements that folks are decreasing debt and saving more, I'd wager that the figure would still not be much below 100%.

Let's call it 90% to be generous.

People's habits haven't really changed; they are still spending, just in different ways and different areas.
 
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