September 22, 2007 12:00am
"They might turn the Foxtel off, they will stop going out, they will probably cut down on the takeaway," the Lifeline counsellor says. There are other cuts that people suffering "mortgage stress" make to cope with paying hefty proportions of their income to keep up with loan repayments. Insurance might go. "Not only the house, but their personal insurance, their car insurance, those sort of things will lapse -- certainly the rates notices as well," she says. Some even skip dental care or just bulk-up on credit cards to pay for groceries. Unfortunately, she could meet more people doing this in the credit crunch stemming from US mortgage woes. But lower spending on those extras is just one ramification for Australia.
Australia might see greater repossessions, less stock-market dabbling from mums and dads, or prolonged housing market malaise. The prices paid for businesses might dip and competition for takeovers dwindle. If things go really pear-shaped overseas, Australian economic growth could slow. But most see Australia's economy as remaining strong despite global shocks emanating from the US sub-prime lending woes. Such sub-prime loans are basically Australia's equivalent of non-conforming loans (those handed to people with bad credit history or the like). But a swathe of Americans have been unable to repay these debts. This triggered problems with big lenders, flowed to credit markets and spread globally. Only this month, British authorities moved to bail out beleaguered mortgage lender Northern Rock where worried customers queued to withdraw savings.
In the US this week, the Federal Reserve Board cut interest rates by 0.5 per cent to improve fund flows. In Australia, investors were so jumpy that a false rumour about Adelaide Bank seeking emergency funding knocked almost 7 per cent from its share price. That reflected a rough time for other financial stocks, although they rebounded the next day along with the market. But Intersuisse analyst Peter Russell says the volatility might prompt greater reluctance for people to invest new cash into shares. "While you might move your existing exposures around . . . it's difficult to see people adding a lot until the picture becomes a bit clearer," he says.
The cash some Australians have for investing might dwindle with mortgage costs rising. Higher costs have especially hit those using smaller lending institutions, which themselves are facing higher costs for funds. A JP Morgan/Fujitsu report this week said US sub-prime issues and subsequent increased cost of wholesale funding (for lenders) would lead to increased pricing for lending. "This will see the number of Australian households under severe stress rise from 70,000 to 113,000," it said, adding the caveat that banks might actually refrain from passing on increased funding costs.
Mortgage stress should mean less cash to spend, especially on those big-ticket items like plasma TVs. But so far, it hasn't crashed retailers like Harvey Norman which last month reported an "insatiable demand" for the latest technology products. Richard Gibbs, global head of economics at Macquarie, links this to Australia's robust employment market. But sub-prime jitters and higher oil prices will trigger greater caution in customers, he says. Gibbs also reckons less borrowing could sap the housing market. CommSec this week linked a slump in data on home sales -- an 8.6 per cent fall in August from the previous month -- on "the latest rate hike".
Fat Prophets senior equities analyst Greg Canavan says a possible slowdown in the mortgage industry could flow through, more slowly, to consumption because "you're not getting the housing wealth effect from rising property prices". But problems with mortgages and consumption might already lurk in credit cards. Figures from the Reserve Bank this week showed the average credit card balance was $3002 in July -- down from $3014 in June. But Australians still owed $41 billion on credit cards.
Lifeline's Fletcher has seen people boost credit card levels to cope with mortgage stress "to pay living expenses like groceries". The JP Morgan/Fujitsu report said that in 1997, the outstanding amount on a credit card equalled roughly one month's disposable income. By 2007, it was three months' worth. "Emerging mortgage stress is being hidden within the growing reliance on credit cards to increasingly fund day-to-day living," it said.
Intersuisse's Russell also points out that until recently, cheap debt had pumped prices of takeover targets. "But when that's changing, which it is, then prices relax back and the fringe competitors drop out," he says. Despite the gloom, Macquarie is predicting 4.25 per cent growth for Australia in fiscal 2008 and says predictions have not been tempered on any sub-prime concerns. "It doesn't seem to be slowing (growth),"
Macquarie's Gibbs says. The threat to Australia's economy lies in overheating, he says. That would be if wages jumped, economic competitiveness slipped and the RBA needed to avert adding easier credit into the system. But what about increasingly dire sub-prime scenarios? Gibbs says for the sub-prime to really smack Australian growth would require another wave of significant upheaval in US capital markets. That's because the Australian-US economic links are through the financial system and credit markets. "If there was major ongoing disruption there, then that would spill over," he says. But Gibbs feels this has probably been averted due to the Fed rate cut this week and promise of more if needed. Another dire scenario would be a complete "disengagement from risk-taking", he says. Overseas investors in that case could dump the Australian dollar, which is regarded as a risky asset. "We would then see the cost of capital into Australia to support the current account deficit increase enormously and that would really crunch the economy," he says. Gibbs argues Australia's real economic activity is more tied to greater Asia. While some might argue that a US collapse could sap China's imports to America, Gibbs says China has a large penetration into the US which adds to stability.
Fat Prophet's Canavan, however, says there could be pain whether a threat is real or perceived. "Because everyone's jumping on to the resources story based on the long-term China thing, I think any news out of China that might spook the market might have an effect on your bigger commodity stocks or your base metals," he says. Tightening credit could mean tightening lending standards, and Lifeline's Fletcher says some borrowers thought they could transfer from a non-bank lender to a bank's lower rates after a few years. "I would suggest the banks are going to look pretty hard at the clients who are going to want to move over," she says. In that case, counsellors like Fletcher might find themselves busier.
