Guy Debelle Deputy Governor Reserve Bank of Australia GPO Box 3947 Sydney NSW 2001 Australia
Dear Mr Debelle,
I refer to your speech of 6 December 2018 titled, “Lessons and Questions from the GFC”, Address to the Australian Business Economists Annual Dinner in Sydney.
A number of your comments in this speech have given me cause for concern.
Here are three quotations from your speech:
“Finally, I will pose a critical, but unresolved, question: what is the right amount of leverage in the system? When is there too much?”
“But we still don’t really have a great handle on what level of leverage is dangerously excessive for governments, households, banks and corporates. This surely is a major challenge for the economics profession to address.”
“How much debt is enough and how to best manage the risks are two of the large questions remaining unanswered, ten years after the GFC.”
As a mortgage broker, I need to be able to answer the first part of number three above, for every client. And if I can do it, I’m sure you can too.
How much debt is enough?
Let’s start with an individual taking out a mortgage to buy an owner occupied residence.
If the borrower can only handle repaying the mortgage at the lowest historic interest rate seen in the past 30+ years and no more than that, is the debt too much?
For those people taking out a new a mortgage, what is the maximum comparison rate the borrower can handle without being forced to sell his or her home?
Is this maximum rate less than the current stress tested interest rate of 7.25% used by most lenders, or more? If it is, they should not be taking out the mortgage.
Scale up to make it macro
There are a finite number of new mortgages taken out each month in Australia, which can be identified.
Individual borrowers will have differing maximum interest rates they are able to repay.
Expense verification of individual mortgage applications + sample auditing across lenders’ completed applications at a statistically significant level, would create the data set to know how risky this month’s new home loans are.
An ethical mortgage broker / lender needs to know whether an individual is taking on too much debt.
However, the RBA should also know whether borrowers as a whole, have taken on too much debt each month, as it is in the public interest.
In particular, the RBA should know what proportion of borrowers taking out a new mortgage each month are capable of servicing a delivered interest rate of 7.25%.
This is a modest goal, given the RBA had the cash rate above 7% only ten years ago.
What good is monetary policy if insufficient attention is given to making sure households can properly handle the likely average interest rate in the long run?
I would have hoped the RBA would take more initiative and ownership on this topic than, “This surely is a major challenge for the economics profession to address”.
Does the RBA have a view on what a safe maximum interest rate would be, with which to stress test new home loan applications? Or would that be another hypothetical question for the economics profession?
Knowing whether the Government, business or households are taking on too much debt each month, via audited sample testing for example, is most definitely in the public interest.
And promotion of the public interest is the first stated value of the RBA (www.rba.gov.au/about-rba/our-values.html).
The appropriate level of leverage for households is where they can service their debts at the upper maximum possible long-term interest rate.
There is absolutely no uncertainty about what the appropriate level of leverage is for individual households. It is the RBA’s responsibility to frame monetary policy to ensure households can reliably service their mortgage over the term of their loan.
No other Government entity has the mandate, indeed authority, to do so.