The reversal 25 years in the making will be a tough pill to swallow.
Today, the Australian economy is living on borrowed time. Aussie banks are full to the brim of household debt, our lenders mortgage insurers (LMI) can only cover a small fraction of the risk they hold and job losses in 2016 are all but guaranteed. On the back of a mining sector simply extracting too much iron ore from the ground that may never be consumed, the Australian economy is seemingly heading towards its doomsday scenario.
Australia’s double-edge economic sword situation is not unique, nor is it unusual. But it is incredibly leveraged relative what we have seen around the world over the last two decades.
Banks are caught up with significant sums of debt to lend to homebuyers to keep house prices up. If they can’t lend more to homebuyers (or homebuyers are unwilling to take on mega-mortgages), house prices start to fall. When house prices start to fall across the country, our lenders mortgage insurers will start to run out of cash very quickly because when an industry holds less than $1 for every $100 of risk insuring an industry that holds just above $1 for every $100 of risk, there is no margin for error as the default rate rises. Hence would force borrowing rates to spike regardless of the interest rate the RBA sets as the RBA brought interest rates down on an upswing property market to stop it from crashing. This simply leaves a dire scene as the crash will simply be bigger than what it would have been had it happened a few years back.
There seems to be no circumstances where Australian financial regulators have concluded that our LMI’s will not be able to honour their commitments to the mortgage market in their stress testing. Hence it is critical for APRA and the RBA to revise their stress tests to build a battle plan that simply eases the pain of what could be the economic tsunami of Australia’s lifetime. Because there is simply no simple fix to this challenge. Unfortunately Australia cannot afford to bring its interest rate down for too long in a recessionary environment as it would simply render our currency worthless. With less money flying around, the value of our assets fall, alongside the risk of an inflationary shock.
Remember, Australia is a net importer of debt. If foreign funds do not lend to our banks, the economy is shot. If the RBA raises rates to try to attract offshore debt, the economy is shot. We must ask ourselves, was it worth the RBA bringing interest rates down as far as they have at the expense of an inevitable problem? In other words, running out of risk.