Saturday, July 19

Saving a nation from debt

In the western world, fuelled by asset price appreciation and particularly in relation to real estate, an unhealthy appetite gained momentum over many decades for credit as householders leveraged that increased equity in their homes by borrowing for both current consumption and investment. Lending institutions became less concerned about the ability of borrowers to repay their loan, whether it is housing, consumer or commercially related. The idea you should have sufficient deposit to support any loan application and had demonstrated a prior saving ability sufficient to reasonably repay the loan almost disappeared.
Hence, in the period leading up to the global financial crisis, western countries collectively reduced their savings to zero and in some cases it become negative. Given the aftermath of the GFC there has been a mild reversal to saving, but this has been thwarted by the prolonged use of quantitative easing, which acts as disincentive to savers with negative distortions to asset price inflation.
But private debt in Australia remains at very high levels which should demand a national narrative to explain the future risks, such as the adverse impact on overburdened indebted households, and lending institutions once interest rates revert to higher long term median rates. What is missing is an understanding of how voluntary real private savings are such a critical funding source of sustainable capital to achieve advancements in productivity and higher income.
In Australia, we have now come to the “end” as far as any further options are available for households and businesses’ to borrow more to sustain their living standards. This was previously made possible due to increased leverages in the provisions of debt. What sustained the system and “bought” time was increases in debt, often inappropriately funding consumption, with typically the source of this increase in debt levels from a lowering of deposits in housing, counting the double income for couples to increase borrowing capacity and borrowing from asset price inflation. This debt culture was further fuelled by poor policy which is “anti-saving”.   

Hence what is needed is incentives for savers and to end the present anti-saving policies. One of the distortions of the Australian economy is “negative gearing “where an investor borrowings interest cost exceeds gross income of the asset acquired. The favourable tax allowance afforded negative gearing not only reduces tax income but distorts the allocation of capital and results in inflated asset prices, particularly in property, to be kept artificiality high.
Putting more emphasis on savings requires a fundamental change in policy mix, to ensure there are tax incentives for savers and to phase out negative gearing over time. There is no reason why, over several decades ahead, we could not reduce private debts by 50%, and encourage more investment in long term infrastructure bonds and with less spending on consumption. In this regard government debt should increase, with the issuance of new securities but offset by the savings of the private savers who invest in national assets that deliver future productivity gains in excess of the interest rates paid to savers.


susan said...

As 'negative gearing' wasn't a term familiar to me I just looked it up on wikipedia. Now I understand It's the process of taking out a loan to purchase something (either property or stocks) whose value is equal to or less than the cost of servicing the loan in hopes of future profit. Is that right? While it all sounds far too complicated and dangerous for me I do know that similar things are going on in Canada where the interest paid on savings, even long term locked-in accounts, is in the range of 2%. It's even worse in the US. I read an article in The Globe and Mail (Canada's newspaper dedicated to finance) that suggested investors would be better off buying stock in real estate investment trusts than in purchasing condominiums they have no intention of living in themselves. We've noticed there are a lot of empty condos right here in Halifax while more are built every year.

It seems to me that what ordinary people need is simply a safe place to put their savings where they can earn a reasonable rate of return. 'Negative gearing', known in the US as 'flipping', and to me as gambling sounds like the worst sort of savings plan.

I hope Australia does put the idea you've discussed into place. Then maybe Canada will follow.

Lindsay Byrnes said...

Hi Susan,
Yes - Negative gearing occurs where an investor borrows money to buy an asset, but the income from that asset doesn’t cover the interest on the loan.
In Australia this loss (which is the excess of the interest over net income) is tax deductible. Hence as negative gearing allows the loss to be deducted from taxpayer’s taxable income, those on the top rate reduce their tax by 50% of the losses. This encourages taxpayer to employ negative gearing to reduce their tax on the basis they will enjoy future capital gains on any subsequent sale, which also will receive favourable tax treatment.
Australia is one of the very few developed nations other than Canada and New Zealand to allow negative gearing that inflates house prices. However there are no restrictions on negative gearing here that apply overseas.
Unfortunately I don't see any evidence for governments adopting policies to facilitate saving against debt, yet the longer they wait the harder the transition to normality will be. Getting only 2%, after locking in to a long term is madness. There are many long term infrastructure projects in health education and nation building which will achieve future productivity benefits well in excess of that and will boost employment. All I can do is to point this out in my letter as was published in the AFR – which was an abbreviation of this post.
Best wishes