Home World Business Over-indebted or wealthy? It’s all in the detail

Over-indebted or wealthy? It’s all in the detail

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Oh spare me – now it’s the Australian Bureau of Statistics throwing up a meaningless scary headline to make us think we’re in more trouble than we are – “nearly 30 per cent of Australian households are over-indebted”.

And of course it’s worst in Sydney, Australia’s capital of debt, property speculation and generally louche living.

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Average household debt has doubled in Australia and while the richest 20 per cent of households control over 60 per cent of all wealth, Australia is more equal than it was a decade ago.

The latest ABS survey of income and wealth classified 407,000 Sydney households with property loans as over-indebted – owing at least three times more than they earn annually. It estimated the typical over-indebted household in Sydney was carrying $765,400 in total property debt. 

Yes, sounds appalling. Hanrahan would love it. But it’s also rather meaningless.

Australian households' net debt (gross debt minus deposits and currency) peaked in 2006 and has been relatively steady ... Australian households’ net debt (gross debt minus deposits and currency) peaked in 2006 and has been relatively steady for the past few years despite gross debt soaring. Photo: Glenn Hunt

Who says having debt three times your income is “over-indebted”?

The ABS does because the OECD does in data it compiles on its members, the club rich nations.

And the OECD does because “the threshold of three was selected to imply that a household that saves one third of its income each year would reimburse its debt around 12 years based on prevailing interest rates”.

That sounds to me more like a recipe for great comfort, Utopia, rather than an measure of danger – yet another random rule-of-thumb, like “we must spend 2 per cent of GDP on defence” and “Australian government spending shouldn’t exceed 25 per cent of GDP“. 

It’s such a naïve definition that it doesn’t pass a moment’s reflection. In isolation, the ratio of debt to income is simply misleading.

The ABS uses “household disposable income” as its income measure – the household’s income after tax and Medicare levies and surcharges are deducted. 

graphic

In round numbers: if you have household disposable income of, say, $100,000, and debt three times that amount – $300,000 – and you’re paying 5 per cent interest (more than you should be for a property loan), it’s costing you roughly $15,000 a year, a fraction less than $300 a week out of income of nearly $2000 a week. That doesn’t sound like being “over-indebted” to me.

Turns out the real indicators of financial stress have been improving over the past dozen years.

On the other hand, there’s a strong chance a household with disposable income of $35,000 and debt merely equal to that amount is deeply over-indebted.

Odds are the $35,000 household is renting rather than paying off a mortgage and the debt is on a credit card or worse – say, 20 per cent interest. Some $140 a week in servicing costs out of an income of $700 a week is considerably more dire than $300 out of $2000.

The important thing about debt is the ability to service it, not just the absolute size.

And this particular OECD/ABS effort falls into the now-usual trap of dealing with gross debt instead of net debt.

Australian households’ net debt (gross debt minus deposits and currency) peaked in 2006 and has been relatively steady for the past few years despite gross debt soaring

What’s more, the standard household debt story ignores household wealth. As the accompanying Reserve Bank graph shows – it has grown faster than debt, and not just through real estate.

graphic

This measure of wealth does not include the treasure that is our superannuation system. Australians have some $2.3 trillion in super, most of it invested in a wise, diversified fashion across different asset classes and geographies.

The final piece of the equation for keeping the debt story in perspective is the cost of servicing it.

It’s the cost of debt and the ability to service it that matters most. As the RBA graph shows, low rates mean that despite gross household debt as a percentage of disposable income being at a record high, servicing it is the lowest it’s been in 14 years.

“But we’ll all still be rooned,” say the Hanrahans, “when the Reserve Bank jacks up interest rates!”

Rates likely to fall again

Well yes – and no. The RBA won’t be lifting rates 200 points, back to what it now thinks would be “neutral”, until the economy is humming along, inflation is in the zone and wages are rising nicely – so nicely that they could handle higher rates without falling in a heap. 

The RBA, despite its occasional mistake, is considerably smarter than the Doomsday perma-bears.

What would cause a problem with our debt levels – and therefore our broader housing market – is a meaningful rise in unemployment. It’s not impossible but it is extremely unlikely that we will get a sharp fall in employment and a rise in interest rates at the same time.

Much more likely is that interest rates would be cut further. The RBA still has ammunition should we hit trouble, as does fiscal policy. Despite net federal government debt doubling on the coalition’s watch to nearly 20 per cent of GDP, that’s still quite low for a relatively stable, wealthy nation.

Low unemployment

In the particular case of the alleged danger of Sydney’s over-indebtedness, Sydney has a low and falling unemployment rate, wages are starting to pick up and it doesn’t suffer the obvious high-rise unit oversupply that presently hurts Brisbane and parts of Melbourne.

As the ABS figures show, the “over-indebted” Sydneysiders are three-times more likely to be so through their investment activity rather than own lifestyle.

They’re taking a bet on the country’s strongest economy remaining strong – as it’s likely to thanks to being underwritten for some years by infrastructure investment and the rise and rise of our key services industries.

Fortunately, the ABS has a rich motherlode of other statistics that paint the real story about our economic health. Turns out the real indicators of financial stress have been improving over the past dozen years. 

Most of us wealthier

That’s of no comfort for the people who struggle on a daily basis to make ends meet in this genuinely lucky country, but despite our best efforts after more than a quarter of a century of recession-free growth to convince ourselves that times are tough and getting worse, most of us are wealthier and fewer of us are desperately poor.

Yes, real wages are flat, but, no, income inequality is not getting worse. The real estate thing in Sydney and Melbourne means wealth inequality is becoming a problem and, yes, first-home buyers in those cities are doing it very hard indeed, but it’s not a threat to the national economy and can be worked on.

And you know the funny thing about the group of OECD countries with high gross household debt ratios?

On the OECD’s own measure with 2015 figures, the top five in descending order were Denmark, Netherlands, Norway, Australia and Switzerland. They’re the rich, stable, strong countries that can service the debt – the places where you’d consider yourself very fortunate indeed to live.

But don’t let any of that get in the way of having a miserable day.

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