‘John Bull can stand many things but he cannot stand two per cent.’
So wrote Walter Bagehot in the 19th century classic, Lombard Street.
What he meant by that was that your average saver (represented by the fictitious John Bull) could put up with a lot…but he couldn’t put up with an interest rate of 2%.
It’s been that long since I’ve read the book that I can’t remember what John Bull did in protest at having to put up with 2%. But he probably got out of cash and speculated on something.
Railways were hot at the time. Maybe John helped finance US and European railway construction. Or maybe he ‘invested’ his savings in Australia’s (and particularly Melbourne’s) property boom of the 1880s. Only to see it end in tears in the 1890s, with his savings disappearing. 2% probably didn’t seem that bad in hindsight.
Whatever the reason, John Bull didn’t leave his cash sitting idly in the bank earning ‘2%’.
Yesterday, the Reserve Bank left official rates on hold at a crazy low 1.5%. They’ve been in the John Bull-agitating range since May 2015. That’s when former RBA boss Glenn Stevens cut the official rate from 2.25%.
So for two years now, John Bull hasn’t been able to stand it. He has clearly thrown in the towel. He (and Mrs Bull, no doubt) have finally realised that savers get treated like dirt in this day and age. They, perhaps angrily, now see that the age-old virtue of thrift is no longer something to be proud of. In the golden age of the central banker, the saver is a sinner and must be punished.
Obviously, no one likes to be punished for living within their means. So they do the only rational thing in response to an irrational policy — they stop saving and do the opposite. They borrow.
Borrowing is exactly what Mr and Mrs Bull have done in Australia — with increasing fervour — over the past few years. Low interest rates and only a nod to lending standards by the banks have made this easy.
And look what Mr and Mrs Bull get for their efforts. Rising house prices and rising wealth! The savings come magically and effortlessly.
For the savings to materialise, they just require more and more Bull families to come to the same realisation, and to shift their savings accounts to mortgage accounts.
But what’s this?
The authorities are displeased. They do not like what the Bull family have done. As the Financial Review reports:
‘Reserve Bank of Australia governor Philip Lowe has warned too many banks are giving loans to badly stretched borrowers, increasing the risk of a wave of defaults if even small shocks hit the economy.
‘In a clear shot at both state and federal governments, Dr Lowe also insisted that boosting supply is the only real way to break the trend of house prices outpacing incomes and that the latest regulatory crackdown on lending is only a stop-gap measure.
‘“Too many loans are still made where the borrower has the skinniest of income buffers after interest payments,” Dr Lowe said late on Tuesday.’
The Patrician class doesn’t like what they see, either. From The Australian:
‘Former National Australia Bank boss Don Argus has added to warnings about the overreliance of interest-only loans, declaring it is going to “lead to tears” as interest rates eventually move higher.
‘After a widely expected decision by the Reserve Bank to leave its official cash rate unchanged at a record low 1.5 per cent at its monthly board meeting yesterday, Mr Argus declared that borrowers had “forgotten” the cyclical nature of interest rates.’
Is this all the Bull family’s fault?
When house prices move significantly higher — and I mean significantly above a working family’s ability to save to keep up with the increases — what are they going to do?
They go into a bank and realise that they can’t borrow enough to live where they want to live. So they have to adjust their aspirations. But after looking for a few months in their aspiration-adjusted neighbourhood, they realise this downgraded dream is getting away from them too.
Thankfully, the bank has a solution. It’s called an interest-only loan. It allows the Bulls to borrow more. Don’t worry that you’re not paying it back, the bank reassures them, let the market build equity for you.
The Bulls take the plunge, borrow more than they should, and create equity for the seller. And they hope, if only subconsciously, that someone will do the same for them down the track.
This form of borrowing has become so popular (or necessary) in Australia that interest-only loans now account for 40% of all loans. And in remarks made at a recent Reserve Bank Board dinner, Governor Philip Lowe said:
‘…too many loans are still made where the borrower has the skinniest of income buffers after interest payments. In some cases, lenders are assuming that people can live more frugally than in practice they can, leaving little buffer if things go wrong.’
The buffer is even more frugal living, which is not what an economy based on consumption wants to see.
From this you can be sure that the RBA will be very reluctant to raise rates. They will await signs of inflation really taking hold before increasing rates. Consumer price data for the March quarter is out at the end of April, so we’ll have a better idea of the RBA’s thinking then.
In the meantime, consider interest rates on hold. This is part of the reason why the market remains bullish. The focus in the media might be on the economic risks of a housing bubble, but the market says that, for now at least, you should not be worried about a housing led bust.
The combination of mega crazy ultra-low interest rates and rising commodity prices is actually bullish for Australia’s highly-leveraged economy. ASX 200 futures suggest another healthy gain today, which tells you this housing angst is just that.
So make hay while the sun shines people. Leave the housing stress to the authorities, and Mr and Mrs Bull.
For Markets & Money
Editor’s Note: This article was originally published in Money Morning.