Sub-prime:Who will pay?

Who will pick up the bill, if the current crisis in the US sub-prime mortgage market worsens?

To an extent, central banks around the world have already answered that question, by showing that they are prepared to kick in billions to steady world financial markets.

That question, though, is still worrying authorities.

The Treasurer, Peter Costello, admitted that today.

“I think the fall out from the US sub-prime market has a considerable way to go,” he told reporters in Melbourne.

The Reserve Bank’s assistant governor (Financial System), Philip Lowe, had also broached the subject, in a talk he gave to a conference on Globalisation and Systemic Risk, in Chicago, earlier in the day.

His analysis was more detailed than the Treasurer’s

Mr Costello delivered his usual commercial for the government.

He said its good economic management had seen Australia safely through both the US recession of 2000-01 and the 1997 Asian economic crisis. Admitting that the US might well be about to “turn down” again, Mr Costello urged voters to stick with the proven performer.
“We can keep Australia strong with experienced management and good policy,” he said.

Mr Lowe said Australia’s flexible exchange rate, its open capital market and its “relatively deep securities market had helped it weather those storms.

He was too diplomatic, of course, to recall that much of the credit for that was due to a Labor Treasurer, Paul Keating, rather than to Mr Costello.

However Mr Lowe did mention a new risk, that has so far received very little, if any, public attention.

He said changes in the global financial system had “clearly run ahead of the supporting regulatory framework.”
“We are ,moving inexorably to a world of global financial institutions that are operating in global markets,” he said.

“Yet crisis management largely remains essentially local.”

The risk this presents is serious.

Mr Lowe, himself, put that very eloquently.

“Who pays for any bailout?” he asked, rhetorically.

That question has yet to be answered.

It should not, however, incite panic.

True, the Great Depression of the 1930s was produced, largely by major countries adopting beggar thy neighbour policies, when the going got tough.

But the world has learnt much since then. The integration of world financial and trading systems, under globalisation, has been both rapid and powerful.

Mr Lowe, however, has clearly done the world a great service by pointing out, so clearly, that serious risks still remain.

Want to read more? You can at www:rba.gov.au

Debt:The new risk

There is a hidden danger in Australia’s family debt patterns, according to the Reserve Bank.

But it’s not where you might expect.

The bank’s Deputy Governor, Ric Battellino, made it absolutely clear today that he does not believe The Economist’s famous prediction that Australia’s debt binge will “end in tears.”

But that doesn’t mean that the Reserve Bank is comfortable and relaxed with Australia’s spiralling household debt levels either.

Mr Battelino says Australian families are “running a highly mismatched balance sheet.”

The assets, on that sheet, are mainly property and shares.

The liabilities, of course, are mainly the debt used to acquire those assets.

So what’s the problem?

“This balances sheet structure is very effective in generating wealth during the good economic times,” Mr Battellino says.

“But households need to recognise that it leaves them exposed to economic or financial shocks that can cause asset values to fall and – or – interest rates to rise.”

Mr Battellino frankly admits that the explosive growth in family debt, seen over the past decade or so, is without precedent in this country.

However, he points out that household debt levels did rise sharply in Australia, at least twice previously.

That happened both in the 1880s and the late 1920s.

That, alone, will probably startle some.

Both periods were followed by sharp economic setbacks.

However, Mr Battellino believes the present debt bubble might be more robust.

He says it is misleading to think that it has been driven by struggling young couples, desperate to get their first home.

In fact, he says, most of the debt has been taken out by higher income families, in their forties and fifties.

Those, in fact, who can both afford and sustain the repayments.

Could, they, however, survive a sharp downturn in property prices, set off by a world wide credit crunch?

Some questions, Mr Battellino does not attempt to answer.