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Offshore funding key to Aussie mortgage markets

This article originally appeared on AB+F on 13/2/18.

The burden shouldered by Australian banks in funding most of Australia’s net foreign debt liability is critical,  Graham Andersen, chief executive, Australian Mortgage Marketplace.

It’s vitally important that Australia continues to have a strong, robust mortgage market and a diversity of funders that can access offshore funding markets.

It’s not that Australia needs offshore lenders to fund mortgages but rather that offshore lenders are required to fund the accumulated deficit balance with the rest of the world.

So, Australia must develop an expanding array of banks and other funders that can access offshore funding markets to fund the net foreign debt liability and future current account deficits (CADs).

Steller growth

Australia’s GDP has increased by $1.2 trillion since 1980. By international standards it’s a stellar performance with steady growth for most of that time.

Since 1980, Australia –  as deliberate government policy by both sides of politics – has also run a CAD which is somewhat variable on a quarterly basis but has significantly increased over the last 15 years.

Whilst the quarterly numbers are variable, the cumulative figures show a steady increase to an accumulated deficit of $1.2 trillion.

It’s certainly worth contemplating what it means when over the last 37 years, Australia’s GDP growth equals our negative balance with the rest of the world.

As the CAD represents a negative monetary balance, how is this negative balance funded?

Investment postion

To answer this, we look at Australia’s International Investment position.

According to the government statistician, Australia’s net foreign debt liability was $989.7 billion at 30 September 2017.

Historical data released by the Australian Bureau of Statistics reflects the same trend in reverse as the accumulated CAD.

According to the ABS, the net foreign debt position is $1 trillion and this amount funds much of the accumulated CAD.

The balance is made up of asset sales.

Debt ownership

Without taking on the international debt, Australia’s GDP growth would likely have been much lower, decreasing living standards.

If Australia has $1 trillion in “net foreign debt liability”, which sectors owe that debt? Private or public, financial or corporate?

The data tells us that three quarters of Australian offshore debt ($750 billion) is held by Australian banks.

The balance ($250 billion) is the total of government and corporate net offshore debt.

The burden shouldered by Australian banks in funding most of Australia’s net foreign debt liability is vitally important.

Home loans

Over 60 per cent of the assets/loans on Australian bank balance sheets are residential mortgage loans. So, the primary security for lenders to Australian banks is residential mortgages.

Therefore, the state of the Australian housing and mortgage markets is critical to offshore lenders in them continuing to lend to fund the existing net liability position and future CADs.

Once the banks took on the role of funding the majority of the accumulated CAD some 20 years ago, pressure was eased on the federal government balance sheet but it mounted onto the Banks.

The Banks’ reaction was to greatly expand its asset base into what they believe are the lowest risk assets possible in order to placate those offshore lenders that the risk it was incurring was low. That is residential mortgages.

So, rather than run federal government deficits by increasing government spending that ultimately turns into bank deposits funded through offshore government borrowing, Australia chose the path of increasing deposits by increasing credit to residential mortgages through the Banks using offshore borrowings to fund the accumulated CAD.

Taxpayers pay

On a simplistic basis, this does appear to be the same thing, a large portion of the tax paying population of Australia is still responsible for repaying the offshore debt either through tax payments to governments or their mortgage payments.

Unfortunately, the different methods produce strikingly different results.

Over time one method (running government deficits) is a controlling negative feedback loop whilst the other   (expanding private bank balance sheets) creates a positive feedback loop with negative consequences.

Running continual federal government deficits to spend is transparent but against the austerity doctrine and would surely have forced the credit rating agencies to strip Australia of its AAA.

As the twin debt and deficit grows to fund the cumulative CAD, the poor effect kicks in and this negative feedback loop effectively forces governments to adopt policies to curb debt and offshore spending growth and even go into reverse.

Negative but manageable

Running decreasing government deficits may have negative consequences but they are manageable.

The antithesis of that process is borrowing through banks and “low risk” residential mortgages where the ever-increasing debt to fund the CAD creates a wealth effect through house price increases, strong bank balance sheets and low funding costs.

It creates a positive feedback loop that has severe negative consequences as it compounds on itself turning “low risk” mortgages into high risk through ever rising debt levels and transferring responsibility for too much debt onto younger generations or speculators.

Or to put it another way, Australia needs to continue to borrow to fund the CAD because that expands the housing market which is backing Australia’s external liabilities.

There is no winding back of this situation where there are not significant negative consequences.

One problem, two seemingly similar methods for dealing with it, but two very different outcome