One of the most significant conundrums of the global financial crisis is that it was created essentially by the US Federal Reserve pushing US interest rates down, and holding them down for too long, thereby flooding the world with liquidity, and underwriting a debt explosion.
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Yet the policy response to the GFC was to again flood the world with liquidity, again driven by extremely low interest rates.
A global debt crisis has led to the risk of yet another global debt crisis.
This week the International Monetary Fund released a study on the impact of debt in general, and household debt in particular. Australia ranks near the top of the list of those exposed to the risk of another debt or credit crisis.
The study showed that while overall debt can have a positive effect on growth and employment for a few years, the debt burden soon reverses this and serves as a general economic burden – the growth effects are reversed, and the odds of another financial crisis increase.
Our household debt is some 120 percent of GDP, and over 220 percent of disposable income. As much of this debt is mortgage debt, households are exposed to a possible future fall in house prices, and/or an increase in interest rates.
A most disturbing feature of our mounting debt crisis is the poor understanding of the mortgage risks. A third of borrowers that have taken interest-only loans don’t understand how their mortgage works. Also, 70 percent of borrowers with interest-only loans are currently under moderate to high levels of financial stress. This suggests that the effect of any increase in interest rates will be greater than most expect.
While debt to income ratios are at record levels, interest payments to income are well down. However, this emphasizes just how sensitive households will be to any future increases in interest rates, and/or fall in house prices.
Unfortunately, this situation has been left to drift to the point where our governments and policy authorities have no easy, short-term, “silver bullet”, solutions any more.
The Reserve Bank simply can’t rush to increase interest rates because of the likely impact on debt-laden households, not to mention the impact on overall economic growth, and on our exchange rate, an appreciation of which would work against export-orientated industries.
Yet, to lower interest rates further, which may be necessary due to our weakening economy, would further encourage mortgages, and compound the risks of a debt crisis.
It is very difficult to predict how this very challenging and unprecedented situation will unfold. History would suggest that circumstances will be left to drift until some crisis intervenes.
There is little doubt that there could be another GFC. The global liquidity splurge has created an enormous debt overburden, along with significant bubbles in global property, share, bond, and currency markets.
If you overlay this with the risk of a climate induced financial crisis, as the world’s major asset owners – pension and superannuation funds, sovereign wealth funds, and insurance companies – are still predominately invested in climate-exposed industries, you are starting to get a realistic assessment of the risks now being run financially.
It is, quite frankly, staggering that our domestic policy debate, and our political leaders, overtly ignore the magnitude and urgency of these risks. Of more concern, is how the global policy authorities prefer to simply “stick their heads in the sand”, hoping that it will all go away, or that, somehow, they will “muddle through”.
