If you give a teenage male a bottle of hard liquor and the keys to a high-powered sports car, there’s a good chance the night won’t end well.
This is a case of ‘known knowns’ leading to a ‘known’ consequence.
One we’ve seen, sadly, all too often on the nightly news.
In the book On the Psychology of Prediction, acclaimed psychologists Kahneman & Tversky wrote (emphasis is mine)…
‘For if we can explain tomorrow what we cannot predict today, without any added information except the knowledge of the actual outcome, then this outcome must have been determined in advance and we should have been able to predict it,
‘The fact that we couldn’t, is taken as an indication of our limited intelligence rather than of the uncertainty that is in the world.’
If, with hindsight, we see the factors are all there for us to predict an outcome in advance, then failure to see the outcome is a result of limited intelligence.
Failure to see that youth, speed and alcohol could end badly is a blindingly obvious lack of intelligence.
The same goes for giving loans to people who cannot demonstrate they have the capacity to service that debt over the longer term…what happens if one partner losses their income? what if rates go up? what if property values fall?
None of these are unreasonable questions to ask in advance.
Yet, as we know from evidence provided at the Banking Royal Commission, these and other questions — like ‘are these your real living expenses?’ — have not been asked.
In the haste to shove as much money into the hands of wide-eyed (both the gullible and the greedy) borrowers, the banks and brokers have displayed their limited intelligence and unlimited greed.
The predictable outcome of this failure to act with a measure of prudence and responsibility, is now on show.
This is the headline from the ABC News on 19 September 2018…
Source: ABC News
Here’s an extract from the news article (emphasis is mine)…
‘As Australia’s levels of household debt relative to disposable income hit historic highs, experts are warning of a perfect financial storm on the horizon for struggling home owners with a surge in repayments set to hit interest-only home loans over the coming 12 months.’
The words ‘historic highs’ and ‘debt’ — like, ‘youth, speed and alcohol’ — are well-known predictors of disastrous consequences.
Borrowers who were given interest-only loans — to make repayments easier to manage — are facing the prospect of having the loans converted to P&I (principal and interest) over the next 12 months.
Adding some ‘principal’ component to the interest repayment means a higher monthly loan commitment…one that households may struggle to meet.
Now, who would have thought that was possible (he says with tongue firmly placed in cheek)?
Just how much pain is in store for interest only mortgage holders?
According to the ABC article (emphasis is mine)…
‘Credit Ratings agency Moody’s has predicted the situation will worsen as a growing number of interest only loans convert to principal and interest, adding about 30 per cent to monthly fees based on current interest rates.’
And this 30% hike in monthly repayments is ‘based on current interest rates.’
What Happens if Rates Go Higher?
With every 0.25% increase in rates, the ‘water level rises’.
Households that were once treading water, start drowning.
The RBA (the institution that lowered rates to encourage households to go deeper into debt) says it has no intention of raising rates any time soon. That’s true.
But the same cannot be said for international interest rate markets…where the major banks source nearly one-third of their loan funding from.
The US 10-year bond rate (the global benchmark by which all other rates are based on) has more than doubled from its ‘historic low’ of 1.37% in 2016.
By the way, are you seeing a predictable pattern here with the use of the adjective ‘historic’? History tells us that nothing stays ‘historic’ indefinitely.
Anyway, back to interest rate.
Is there another ‘surge’ in the US 10-year bond rate coming?
Please excuse me when I say it’s somewhat laughable that a 1% increase in rates is considered a ‘surge’.
For those of us who had debt in the early 1990s, a rate increase of only 1% would have been cause for great rejoicing. Oh how times change.
The ‘surge’ terminology is a reflection of the historic debt mess we’ve created for ourselves.
In the context of US mortgage rates, the recent ‘surge’ in rates has only taken US borrowers back to 2010 levels.
However, the difference between now and 2010, is household debt levels — in dollar terms — are higher.
The trend in the US rates is coming to our shores.
This is a ‘known known’.
Therefore, anticipating an increase in mortgage stress and subsequent defaults doesn’t require any great insight into the future.
Community confidence levels rise and fall with house values.
Feeling wealthy — albeit on paper — feeds into consumer spending.
‘What’s a bit of credit card debt when our house has gone up so much in value.’
When property markets fall, there’s a discernible shift in household thinking.
‘Perhaps we should act with restraint.’
Economic contraction happens at the margin.
Households paying P&I have less to spend.
Less Money to Spend
Those who have a disposable dollar, may — due to a change in social mood — decide to hold back a little.
Credit usage is more carefully considered.
Consumption — funded by a combination of saving less and borrowing more — has been the mainstay of western economies.
One person’s spending is another’s income. Disrupting that arrangement has consequences…the greater the disruption the greater the hardship.
Less dollars spent on consumption will put pressure on businesses that borrowed excessively (corporate debt) to finance share buybacks, dividend payouts and takeovers.
Defaults in the corporate sector are also an obvious outcome in this daisy-chain of global debt.
There’s nothing like a wave of defaults for bond (international interest rate) markets to start re-pricing debt…increasing rates to compensate for the higher risk of not being paid.
Those higher bond rates will need to be passed on to borrowers…one of whom is Australian mortgage holders.
A vicious cycle gains a downward spiralling momentum.
The reason this outcome is so predictable is because we’ve been here many times before. This is not new. It’s an all-too-familiar pattern that’s been repeated over the centuries.
The only thing different about this time is the historic nature associated with the elements of this pending crisis.
Debt has never been higher and rates never been lower.
Assuming the laws of physics have not yet been repealed, the predictable snap back (as equal and opposite forces collide) is going to be heard around the world.
And here’s another predictable prediction…those who created this crisis-in-the-making will all put their hands up in horror and say ‘no one saw this coming’…it was a perfect storm.
These feeble excuses only serve to demonstrate the limited intelligence of those who preside over the global financial system…but we already knew this.
Because, who, in their right mind, would prescribe a cure of ‘more debt to solve a debt crisis?’
When the next crisis hits, central bankers will have earned the right to add a few more letters after their names…D…U…M…B.
Editor, The Gowdie Letter