Thursday 5th May 2016
NEWS TICKER: MARKET ROUNDUP —Markets tanked today (almost everywhere bar the PRC) as economic data from China and an 18% lunge in profits at HSBC sapped market confidence. The bank reported an adjusted profit before tax of $5.4bn for the first quarter, down 18% on the same period last year. Citing challenging market conditions, the bank reported first quarter(Q1) pretax profit before adjustments of $6.1bn, down from $7.1bn in the first three months of 2015 but beating analysts’ forecasts of a pretax profit of $4.3bn, according to Reuters. In Hong Kong this morning the bank’s shares were up on the news, as expectations had been for much worse. Earnings per share came in at 20 cents, down from 26 cents per share in the same period last year. HSBC held its first-quarter dividend in line at 10 cents per share. In London HSBC fell 3.5p to 449p as the bank said it put in a "resilient" performance in difficult market conditions, with the entire investment banking sector suffering after stock markets tumbled at the start of 2016 amid an oil price rout. However, as we reported earlier today indexes across Europe paid the price of lower than expected manufacturing data from the Caixin/Markit Manufacturing Purchasing Managers' index (PMI), rather than Chinese bourses. The DAX fell 1.5% lower and the CAC40 dropped 1.1%. Commodity stocks were also on the back foot despite the price of oil rising 0.4% to 45.99 US dollars a barrel. Glencore ended the day down 7.5p to 155.5p, Rio Tinto fell 96.5p to 2205p and BHP Billiton slipped 34.8p to 897.4p – AQUISITION—M&A maven Cavendish Corporate Finance has advised bfinance on the investment in the company by private equity funds managed by Baird Capital. Current bfinance CEO David Vafai will continue to lead the consultancy in this next, exciting phase of its growth. He will be joined on the board by Andrew Ferguson, managing director at Baird Capital, and CFO Mark Brownlie, as directors. Also joining the board as chairman is Tim Trotter, who founded public relations group Ludgate, co-founded Citywire, the information service for the global fund management industry and is a non-executive chairman at a number of financial services and asset management related blue-chip companies. The deal with Baird follows a strong period of successes for bfinance. Recent high-profile mandates for bfinance include advising on a $1bn alternative beta strategy programme for a U.S. corporate pension plan, a USD 1.2bn private equity search for Swedish State pension fund AP7, and multiple searches across asset classes on behalf of Australian superannuation funds. The deal marks a strong start to the year for Cavendish. It follows shortly after the sale of Periproducts to Venture Life Plc, the sale of Gloucester Rugby club to new owner Martin St Quinton, the sale of B2B creative marketing agency Twogether to Next 15 Plc and the debt raise for Pets Corner following a highly successful 2015 during which the company completed over 20 deals –AIIB/ADB— In a shift in strategy the Asian Infrastructure Investment Bank has signed a financing memorandum of understanding (MoU) with the Asian Development Bank, the second partnership signed in the space of a few month by the challenger development bank. AIIB, set up to counter the ‘hegemony’ of Western dominated aid institutions, has been struggling to dispel its image as a rival to existing NGOs. The bank secured a similar arrangement with the World Bank during the International Monetary Fund-World Bank spring meetings in Washington last month. This MoU sets the stage for the banks to share funding costs for projects. The ADB said it is already in talks with the AIIB around ventures in the road and water sectors, the first of which is expected to be a 64-kilometre highway connecting two cities in Pakistan’s Punjab Province. - ASIAN TRADING SESSION - The Nikkei and Topix indexes took the brunt of risk off sentiment today as investors gave a distinct thumb down to last week’s decision by the Bank of Japan not to cut rates further. The Nikkei225 fell 7.41%, while the Topix went down 7.25% in a somewhat bloody trading session. Continuing with the pattern set down for most of this year, the yen by contrast continues to appreciate, touching at one point 105.81 again the dollar, the yen’s highest point for almost two years. The Bank of Japan in response rattled a few sabres, threatening to intervene should the yen appreciate further; but investors continued to test the yen’s upper limit. Yann Quelenn, market analyst at Swissquote noted this morning: “The yen has climbed 13% against the dollar since the start of the year and there a strong support lies at 105.23, which is now clearly on target.” The other story in the Asian session was the surprise move by the Reserve Bank of Australia to cut The Reserve Bank of Australia on Tuesday cut the cash rate to a record low of 1.75 per cent in a bid to head off falling prices and an economic downturn. Market commentators now expect a second cut before the end of the year, although some say the June quarter inflation figure, out in August, will determine the RBA's next move. The latest cut puts Australia firmly into the group of countries with an ultra-loose monetary programme, or should that be a noose around falling interest rates and bond yields. Reserve Bank governor Glenn Stevens said the decision was based on last week's surprisingly weak inflation figures. "Inflation has been quite low for some time and recent data were unexpectedly low," he said in a statement. The AUDUSD fell to 0.7572 from 0.7720 on the news, though the ASX All Ordinaries rose 1.94% on the day, with the S&P/ASX100 rising 2.24%. The index is now up 6.8% on the month, though up only 1.32% over the year. Aside from China and Australian indexes, boards across the region ran red for most of the session. The S&P BSE Senses was down 1.75%. The Kospi100 was also off by 1.50%, while in Singapore the Straits Times took a beating, losing 4.39% today, bringing it down 0.26% over the month and down 2.58% over the year. The Hang Seng also had a tough day, falling 3.68% today, though it is up by 0.87% over the month and down 5.65% over the year. In China, the Shanghai Composite was up 1.13% in trading today, though it is still down 0.56% over the month and down 15.44% over the year. The Shenzhen Composite had a better day, up 3.29%, and is up 1.45% over the month, but still down 16.45% on an annualised basis. The upbeat market sentiment was interesting, given that the Caixin Manufacturing PMI weakened to 49.4 in May from 49.7 in April, softer than market expectations and marking a 14th month of contraction; data that usually would have sent investors to the hills. Go figure. The data indicated that softness in labour markets and exports continue. Meantime, the central bank set the USDCNY mid-point at 6.4565. There is still mixed data emanating from China. Bank of America Merrill Lynch’s latest China: An Equity Strategist’s Diary research report highlights the nugget that YTD 241 non-government bond issuances have been cancelled or postponed, 120 of which were deferred in April, compared with 315 across the whole of last year. Some 709 bonds worth a total of RMB1.04trn came to market in last month (an 85% success rate). However, says the bank, if the bond market corrects sharply, sectors that rely most on the credit markets to support their day-to-day activities (including developers, banks, brokers, industrials and utilities) could suffer disproportionately as their reliance on credit has grown significantly during the past six months. Among the 120 bond issues affected in April, 70% were from industrials (50 bonds), financials (18) and materials (17). The bank also says a perceived implicit government guarantee on bonds and other moral hazards in the shadow banking sector, including wealth management products, is largely behind the mispricing in corporate credit. With the country’s overall default risk perceived to be low, bonds have become a cheap source of long-term financing for corporations compared to other traditional credit products. At the end of April, an AA+ rated five-year bond yielded 4.3% while the benchmark rate for a one-year to five-year loan was 4.75%. A five-year AA- rated bond offered 6.6%. The overnight repo rate annualised was 2%; seven-day repo, 2.5%; six-month discounted bill, 3%; and the one-year benchmark loan rate came in at 4.35%. Alternative sources of finance cost between 12% and 15% for P2P; 8% for a two-year trust; 19% for private lending in Wenzhou; and 18% to 20% for offline wealth management companies. BAML says a sharp uptick in the number of corporate defaults, coupled with the increasing number of cancelled or postponed bond issuances, shows that the market is starting to reprice risk although this process could last until the end this year. The peak maturing period is April/May with between RMB80bn and RMB790bn of bonds maturing over the period. From June onwards maturities fall to around RMB600bn a month for the rest of the year—SAUDI ARABIA—In another move to liberalise the Saudi Arabian capital markets, the Capital Market Authority (CMA) has approved a request by the Saudi bourse to relax settlement cycles for investors, making the country’s inclusion in the MSCI Emerging Markets Index more likely from next year. It has also announced an overhaul of foreign ownership regulations for listed companies, as it seeks to encourage participation by international institutional investors in a wide ranging programme of privatisations. The CMA announced today that it was widening the definition of Qualified Financial Investors (QFI) to include financial institutions such as sovereign wealth funds and university endowments as well as banks. The regulator says the minimum value of assets under management for QFIs will be reduced to SAR3.75bn (about $700m), compared with the current level of SAR18.75bn ($3.5bn). From the end of June 2017, QFIs will be able to own up to 49% of a company’s capital, “unless company’s bylaws or any other regulation provides for foreign ownership to be limited to a lower percentage". Individual QFIs will be able to own up to 10% of a company’s share capital, compared with the current level of 5%. Foreign investment is now an important element in the government’s wide-ranging economic diversification program, which will also involve partial privatisation of some of the country’s key state owned firms. Over the last few weeks Saudi has signalled its intention to list a 5% stake in Saudi Aramco, a move that could raise in excess of $100bn. The opening of the Saudi stock exchange, the GCC’s largest, to QFIs in June of last year was hailed as a milestone at the time, but has so far failed to attract large scale foreign investment into Saudi equities. Licensed QFIs to date include Blackrock, Ashmore Group, Citigroup and HSBC. However, up to now the firms, in combination own less than 0.1% of the Tawadul’s market capitalisation—STOCK EXCHANGE NEWS—Börse Stuttgart reports turnover in excess of €6.7bn in April 2016. The trading volume was almost on a par with the previous month. Securitised derivatives accounted for the largest share of the turnover. The trading volume in this asset class was more than €2.7bn. Leverage products contributed more than €1.4bn to the total turnover, while the trading volume of investment products was more than €1.2bn. At more than €1.4bn, turnover from equity trading at Börse Stuttgart was around 9% higher than in the previous month. German equities accounted for more than €1.1bn of the total turnover – an increase of more than 7% in comparison with March - while international equities contributed about €299m. Trading in debt instruments generated turnover of around €1.6bn in April, with trading volumes almost as high as in the previous month. Corporate bonds accounted for the largest share of the turnover, with approximately €918m.The order book turnover in exchange-traded products (ETPs) was more than €916m in April. Trading in investment fund units generated turnover of €8m —ASSET MANAGEMENT —Aberdeen Asset Management says pre-tax profits have fallen to £98.8m in the six months to March 31st, down from £185.4m over the same period a year earlier after investors have backed off from emerging markets. The asset management has been affected by changes in end investor asset allocation choices as fund outflows over the period amounted to £38.2bn (£16.7bn on a net basis says the asset management maven); however, the pace of outflows has slowed, compared with the previous six months, when investors withdrew £41.7bn (£22.6bn in net basis). Aberdeen has £292.8bn worth of assets under management, down from £330.6bn a year ago, although it marked an improvement on the £283.7bn at its financial year-end. Despite the challenges, Aberdeen has been active in turning around its fortunes, promising to cut annual costs by £70m by 2017 and has diversified its business proposition by a series of acquisitions, including the takeover of hedge-fund manager Arden, risk-graded portfolio provider Parmenion, and fund-of-funds investment manager—CORPORATE NEWS—Advance Utilico Emerging Markets Ltd says it has has extended its £50m senior secured multi-currency revolving credit facility with Scotiabank for a further two years to April 2018. Shares in Utilico are down 0.1% to 176.75 pence—SPANISH ELECTIONS – Looks like Spain is heading for another hung government. News agency The Spain Report says the latest poll of polls data from Electograph shows only minor changes compared to the results of the last general election on December 20th last year. The order of the parties remains the same: PP, PSOE, Podemos, Ciudadanos and United Left. No party is currently forecast to be close to an overall majority, of 176 out of 350 seats in Congress. Over the past four months, polls have at times suggested a slight shift towards a right-wing PP-Ciudadanos coalition and, in the latest round, the possibility that a joint Podemos-United Left electoral list might overtake the Spanish Socialist Party (PSOE) as the reference for the Spanish left, says the news agency—POLITICAL RISK—maven Red24 advises professionals to avoid visiting Kabul. The firm reports that yesterday, the US Embassy, issued a statement warning of an increased threat of attacks in the Taleban’s spring offensive (Operation Omari) against Afghanistan's government and its Western-backed allies, including the US, on April 12th. Crowded public areas, police and military interests, foreign embassies, foreign guest houses, hotels and government buildings/sites have been listed as probable targets; no information was provided regarding the timing of any planned attacks. Red24 says Taleban attacks in Afghanistan generally increase during the spring and summer months, which generally extend until September, when warmer weather allows militants greater access through usually snowed-in mountain passes from their traditional strongholds along the mountainous Afghanistan-Pakistan border. “Given the extreme and ongoing threat of terrorism in Afghanistan, such warnings by government authorities are taken seriously and regularly result in additional security force deployments. The warning is particularly pertinent given the attacks carried out in the capital on 19 April, following the launch of the offensive, in which at least 24 people were killed as a result of a car bomb attack, in the vicinity of several government ministries and the US Embassy in the Pul-e-Mahmood Khan and Shahr-E-Naw areas. Further incidents are expected to persist,” says the firm in an alert issued today.

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SPEECH/RBA on the housing & mortgage markets

Tuesday, 23 April 2013
SPEECH/RBA on the housing & mortgage markets Luci Ellis, head of the Reserve Bank of Australia’s financial stability department’s address to the Citibank Property Conference, April 23rd on the Housing and Mortgage Markets: The Long Run, the Short Run and the Uncertainty in Between. The speech is reproduced in full. http://www.ftseglobalmarkets.com/

Luci Ellis, head of the Reserve Bank of Australia’s financial stability department’s address to the Citibank Property Conference, April 23rd on the Housing and Mortgage Markets: The Long Run, the Short Run and the Uncertainty in Between. The speech is reproduced in full.

Long Run: Two Core Themes

Normal in a low-inflation world



I would like to start by considering some of the longer-run factors that are shaping outcomes in housing and mortgage markets. The first is that Australia went from being a high-inflation country in the 1970s and 1980s to being a low-inflation country since the early 1990s . Yet housing prices continued to increase at a rapid pace for a period, even after consumer price inflation slowed. The reason is that inflation acts as a kind of credit constraint. Broadly speaking, mortgage lenders decide how much to lend to a household by working out the repayment they can reasonably make, given the household's income and other factors. For a given interest rate, this then backs out to a loan amount. The ratio of that allowable repayment to the borrower's income varies according to their circumstances, but for any given borrower this is roughly how it works. So if average inflation has declined, as it has in Australia, so does the inflation compensation component of interest rates. Nominal interest rates fall, and that translates to a higher loan amount. This diagram shows how that repayment test maps to loan-to-income ratios for different average inflation rates. It shows that even if nothing else changed, the loan-to-income ratio that households could prudently obtain would have almost doubled as a result of disinflation. Since real mortgage rates also came down a bit over this period, we should expect income multiples for individual borrowers to have roughly doubled.

If individual households are now borrowing more relative to their incomes, obviously the nationally aggregated ratio of debt to income would rise. (There is also a second-round effect because nominal income growth is slower, so the debt-income ratios of longstanding borrowers do not decline as quickly. This boosts aggregate interest-servicing ratios as well as debt ratios.) Of course it takes time for this to work through the national aggregate ratios. It takes time before the people who borrowed before inflation declined have paid off their loan and dropped out of the calculation. It also takes time for this additional borrowing capacity to bid up housing prices. But the transition does end after a while, and it is our assessment that it has now ended.

So my first theme on the long run is that the transition period following the disinflation is almost certainly over. The aggregate debt-income ratio has been broadly flat since about 2005 (Graph 3). The ratio of average housing prices to income levelled off a year or so earlier. Consistent with this, interest-servicing ratios might be more volatile, but they, too, look to be cycling around a new, higher average now, rather than still being on an upward trend.

The transition period, and its completion, changed the behaviour of more than just housing prices and debt. One example is household saving behaviour. It stands to reason that if people are increasing their borrowing more than their income is growing, they are probably consuming at least some of that. The household saving ratio did indeed fall during the transition period and has since risen back to something like 10 per cent of income. We don't know exactly what the saving ratio will do in the period ahead. It might be that it has already reached its new long-run average, or it might be that it moves up or down a bit from here. We don't think it will necessarily return to the level in the 1960s and 1970s, because back then it was boosted by a larger contribution from unincorporated businesses. And we don't think the near-zero levels of a decade ago were sustainable in the longer term. Where the ratio ends up between those two extremes is hard to know. But given it has actually been quite stable for the past five years, it seems reasonable to suppose that where we are is at, or close to, a ‘new normal’.

Parallel with these fluctuations in saving, during the boom period of transition, households began to withdraw equity from the housing stock. Some of the work the Bank did on this topic at the time showed that this was partly the result of higher turnover. Put simply, there were more vendors with a lot of equity selling to buyers with much less equity. But whatever the drivers of this behaviour, this, too, has ended. Australia has returned to a more normal behaviour of households contributing equity, in net terms, to the expansion of the housing stock. If our analysis is correct and we are indeed facing the ‘new normal’, it implies a number of things for future outcomes.

First, trend housing price growth will be slower in future than in the previous 30 years. We don't have a strong view about whether the ratio of prices to income should be mildly rising, falling or constant from here. We do not have a target for this variable. But we think it is very unlikely to return to its 1970s levels, or to rise rapidly once again. Nor would we want to see another boom like the one a decade ago.

A second implication is that, if housing price growth is now cycling around a lower average, there will be more periods when prices are falling (a little) in absolute terms. This has implications for the loss given default (LGD) in mortgage portfolios. In my view, this vindicates APRA's decision to require a higher LGD floor than the 10 per cent minimum built into the Basel rules for banks using their own models. It also vindicates its decision to require higher risk weights for non-standard and high loan-to-valuation loans for lenders that do not use their own models.

If trend growth in housing prices will be slower in the future than in the past, trend housing credit growth will necessarily be slower too. This has obvious implications for the rate of growth of bank balance sheets and profits. We have been making this point for a while. Financial stability requires that the owners of banks accept that domestic balance sheet growth will be slower from here than it was in the previous 20 years or so. We would not want banks to ease their lending standards to make more loans and bring back the boom times. Nor would we want them to cut costs in a way that impinges on their risk-management capabilities.

 Demography and dwelling supply: Slower and denser

The other long-term trend I would like to talk about today is physical more than financial, but its economic implications are still profound. Australia had high population growth during the post-war era (Graph 5). Since then it has slowed, but with some bumps along the way. During much of that period, growth in the dwelling stock outpaced population growth. Household sizes were shrinking, partly because the population was ageing and partly because people were having fewer children than in the past.

Population growth surged in the years after 2004, largely resulting from immigration. It was not immediately recognised, because part of the increase came from students and former students, whose long-term residency wasn't immediately obvious. It's fair to say that the fact of this acceleration in population growth wasn't fully appreciated at first. As such, it was therefore not planned for. So at least in some cities, we saw strong demand for housing and rising prices, even though the credit boom had ended, because construction did not rise to meet this surge in demand.

The housing and credit boom of 2002/03 was clearly demand driven, but even it sparked concerns about constraints on housing supply. Those concerns only intensified afterwards, when the pressure really was for more dwellings to accommodate the population, rather than just nicer ones to absorb the extra borrowing capacity. My colleague Christopher Kent spoke about this recently.[3] He noted that if constraints on land supply were the most important factor explaining high housing prices, we would see prices rising fastest where those constraints were most binding – the greenfield sites on city fringes. But that is not what we see.

Part of the perception of supply constraints comes from our view of Australia as a big country. Yes, we have a lot of land. What we don't have much of is land where people actually want to live. In general, desirable land is the land within or adjacent to existing settlements. Australia's population is heavily urbanised compared with other developed countries, let alone most emerging countries.

It is also quite concentrated in a couple of large cities). So the range of acceptable locations is actually more limited than the map would lead you to believe.

Perhaps more to the point, part of the reason why land seems in such short supply is that we each consume so much of it. As this graph shows, Australian cities are the least dense, in terms of population per square kilometre, than the cities of any other sizeable country, developed or emerging. Only New Zealand comes close, and that is partly because its cities are smaller. (Smaller cities tend to be less dense on average.) This is not even a case of comparing Australia with crowded European cities, or the megacities of developing countries. At around 375 people per square kilometre, Sydney is only 40% as dense as Toronto. Melbourne is a bit more than half as dense as Toronto. And of the 276 US cities and towns in these data, only eight have lower densities than Sydney; the largest of those eight cities has only a little more than half a million inhabitants.

If land availability were the problem, we'd expect land costs to dominate the costs of producing a new home at the city fringe. But that's not what we see (Graph 8). Neither do government charges dominate total costs. Rather, it turns out that construction costs are the largest contributor to the total costs of production, and they seem quite high compared with the total cost of a newly built home in some other developed countries.

What are the long-run implications of our demography and geography? I am not a demographer, but it seems reasonable to me to conclude that long-run population growth will be slower in future than in the decades following the Second World War. It also seems reasonable to expect that the decline in household sizes has come to an end.[5] The expansion in the housing stock needed to accommodate any given population increase will therefore be smaller than past data relationships implied.

Even with slower population growth, the price of our low-density life has become unaffordable for some. It therefore seems likely that our cities will become denser over time. If so, the mix of residential construction will be tilted more towards medium-density and high-density dwellings than in past decades. We have already been seeing this shift over the past decade or so .

The Short Run: Monetary Policy Works

Interest rates have been lowered quite a bit over the past year and a half or so. As so often seems to happen, soon after a period of easing we start to hear concerns that monetary policy might not have any effect this time, because of some special factor interfering with normal relationships.  After a period, though, the signs start to emerge. Typically, financial variables like credit and asset prices respond first. Output and inflation adjust later, the well-known ‘long and variable lags’. Recent data have followed precisely this pattern: monetary policy still works. Equity markets are up, and so are dwelling prices . Credit growth has remained quite slow, but loan approvals to investors and existing home owners have been picking up for a while.

This recovery in dwelling prices makes sense given how much affordability has improved as interest rates have declined. The first-round effect on new borrowers is clear from the solid line in this graph; it shows the required repayment on a typical mortgage for a median-priced home, relative to average income (Graph 11). What is less often appreciated, though, is how much affordability has improved on existing loans. The dots on the graph take the same loan conditions, and factor in how much the ratio changes with movements in interest rates as well as growth in average incomes. Because nominal incomes typically rise, the dots are more often than not below the line; on average, it gets easier to pay your mortgage over time. In the recent period, that gap has widened again. Recent buyers – for example, those who bought two years ago – will be finding it easier to make their required mortgage repayment. That is a positive outcome for their financial resilience, and ultimately financial stability. It is certainly already apparent in mortgage arrears rates. But it is also part of the macroeconomic transmission of monetary policy. Some of those borrowers are using the decline in required repayments to pay off their loans faster; this is something we have discussed in detail in recent Financial Stability Reviews. But at least some of them will take advantage of lower interest rates to spend more, or to buy a bigger home.

Over time, non-financial variables start to respond to policy as well. Building approvals have been rising only gradually in recent months, after bouncing back from the latest trough about a year ago. But my colleagues in Economic Group certainly forecast that the recovery will continue in the short run, and there is certainly room for this to happen. If you are wondering how we are going to manage to build extra homes, at the same time as you are wondering where all the workers no longer involved in mine-related construction might go, it might be worth putting those two thoughts together. Consider that indirect linkages can be just as important as direct substitution.

The Uncertainties in Between

Between the short run and the long run, though, an awful lot can happen. Some of the structural, long-term changes I've described today could change some of the relationships and correlations between variables that we have come to expect. One I already mentioned is that if average household sizes are no longer falling, the relationship between population growth and growth in the number of dwellings will change. And if I am right in expecting the share of high-density housing to increase, the dynamics of construction will also change. It takes longer to build a block of apartments on a brownfield site than the same number of dwellings as detached houses at the fringe. Dwelling investment has already become less cyclical in the past 10 years than it was in the previous 20 years . It might well be that construction lags – and concerns about supply – will become even more acute.

The end of the transition to a low-inflation, higher-debt world will also change past relationships in ways that not everyone might expect. Through that transition, property investors paid lower nominal interest rates than during the high-inflation period, but for a long time they continued to enjoy similar rates of capital gain. With slower trend growth in housing prices, total returns on rental properties would fall unless other things adjusted. Sure enough, rental yields, which are a real yield, have been rising in recent years (Graph 14). They are now back to a level that seems like a more reasonable spread over long-run average indexed bond yields, given the investment risk. (And when you consider the current level of indexed bond yields, the rental yield looks even more attractive.) But for given interest rates and rental yields, lower trend capital gains should result in less investor demand than we saw in the past couple of decades. Presumably this will also bring forth less construction activity than we used to see at a given level of interest rates.

On top of these more structural influences on apparently cyclical behaviour, there are also some more recent factors that could change historical relationships. One of these is that lending standards in the mortgage market have tightened, particularly the use of low-documentation loans (Graph 15). Some of this was a deliberate choice by lenders who had become more risk averse in light of the experience of the crisis. Some of it resulted from the drying up in securitisation markets. Many non-deposit-taking lenders could then no longer fund themselves, and market share shifted to the prudentially regulated sector, most noticeably the major banks. And some of it has no doubt been spurred by the recent changes to consumer credit regulation.  

Lending standards are multidimensional. And even within each dimension, such as the loan-to-valuation ratio, we must distinguish between the maximum allowable level and the number of borrowers actually at that maximum level. But it is still useful to think of the lending standards prevailing in the mortgage market on a spectrum of prudence. Australia's is not the most conservative mortgage market out there, but it is nowhere near the position that the United States was in prior to its mortgage meltdown. It wasn't even particularly close to that point before the crisis, when lending standards were a bit easier here than they are now. But as I suggested earlier, it seems likely that the future will bring more periods of (mildly) falling housing prices than we saw in the past. It is therefore appropriate and desirable that lending standards remain at least a bit tighter than those prevailing before the crisis.

Every credit boom or bubble starts with something real, something fundamental. As I also mentioned earlier, we have a pretty good idea of what that fundamental was, and at least some idea of how far the transition would go. And we are pretty sure that the boom we saw in the early 2000s managed to end with a fizzle, not a bust. So we don't expect a sharp reversal from a starting point described by the situation we face now. But we certainly can't rule out the possibility of a major housing downturn in the longer-term future. It is hard to know exactly what the outcome would be because it depends on how we got to that point. Institutions differ across countries, so we can't simply extrapolate from experience elsewhere. And there would need to be another boom first.

That said, policymakers in Australia are only too aware of the costs to the financial system and to the macroeconomy if a major property bust were to happen. Suffice to say that major property busts in general, and housing busts in particular, are one of the key components of the scenarios used in APRA's regular stress testing of the banking system. The results of those tests inform APRA's supervision of each firm. From time to time, they also motivate a tightening up of the whole prudential framework. I should note here that history tells us that when a property boom turns to a bust, the big losses are more often on commercial loans than mortgages. Loans to property developers are usually a bigger source of risk than loans to the households who buy the homes.

The question is whether the authorities should be doing something more than diligent supervision of regulated firms. Internationally there has recently been a lot of talk about macroprudential tools. Many of these tools are intended to be manipulated over the cycle so as to lean against a property boom. But this boils down to waiting until you have a problem and then recalibrating your prudential framework. I can't help thinking that the civil engineers have a better approach, which is to have a safety factor built into the system from the outset. This means treating global minimum standards as minimum standards, being more conservative where local conditions require it, and remaining alert to the risks that could still exist.

Thank you for your attention.

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