RDP 2011-07: Australia's Prosperous 2000s: Housing and the Mining Boom 4. Household Balance Sheets

At the start of the decade, households were facing favourable economic conditions. Steady growth in employment and wages was delivering rising incomes, while wealth was increasing with rapid growth in house prices and steady, if not spectacular, increases in domestic share prices. These factors gave households the confidence to reduce their saving. Further, household saving out of current income was reduced as households moved to a higher debt-to-income level because of their greater access to credit. The saving rate continued the decline that had commenced in the mid 1980s, and by early in the 2000s household spending (net of depreciation) was estimated to exceed household incomes (Figure 7).

House prices had begun to rise from the mid 1990s reflecting a couple of key factors. First, the decline in nominal interest rates associated with lower inflation reduced the initial repayment burden for a given loan size and so increased households' borrowing capability. Second, the increased competition and innovation in the lending market that started with the reforms of the banking sector in the 1980s had greatly increased the accessibility and availability of housing finance (see Ellis (2006) and Yates (2011)). In the late 1990s the rate of dwelling price growth accelerated and in the first four years of the 2000s prices increased at an average rate of 14 per cent.

Rising house prices were accompanied by accelerating growth in borrowing for housing. Growth in housing credit increased from rates around 12 per cent in the second half of the 1990s to over 20 per cent in 2003 (Davis (2011) summarises this and other financial developments over the decade). The sense that this was unsustainable was heightened by the increasing share of this borrowing undertaken by households buying properties to rent out rather than owner-occupy. As discussed in Bloxham et al (2010) and in Section 5, the dynamics of rapid house price and credit growth, in conjunction with some signs of excess in parts of the housing and lending markets, became an increasing concern for the Reserve Bank and other policy-makers. Partly in response to policy measures, national house prices plateaued in late 2003 and were broadly flat in nominal terms over the following two years. While there were some differing regional cycles, notably with falls in nominal prices in Sydney in 2004 and prices in Perth continuing to grow strongly, overall national house prices grew broadly in line with household incomes between 2003 and 2008, followed by a small fall in the national median house price in 2008 (Figure 8). Nevertheless, credit continued to grow at a brisk pace, not slowing to the 12 per cent rates of the late 1990s until late 2005. With growth in household borrowing outpacing that in incomes, the ratio of household liabilities to incomes continued to rise, as did the ratio of liabilities to assets.

Financial asset holdings also increased over the decade. This masked differing trends, with superannuation assets as a ratio to income increasing strongly from around 110 per cent at the start of the decade to over 150 per cent (Figure 9). This reflected strong compulsory and voluntary flows into superannuation and the large share of superannuation invested in domestic equities, which experienced strong returns over the decade. In contrast, non-superannuation financial assets declined as a ratio to income so that by the end of the decade superannuation assets were larger than all other financial assets. The value of households' total financial assets peaked in late 2007 at over 300 per cent of income, but the subsequent falls in values during the financial crisis were larger than for housing and valuations and have yet to recover this previous peak.

As discussed above, several factors contributed to the strong growth in house prices up to the mid 2000s, with a key one being the liberalisation of the credit market. Greater access to credit enabled households to substantially increase their borrowing over the 1990s and 2000s. The growth in household borrowing outpaced house price growth so that housing gearing increased from 11 per cent in 1990, to 21 per cent in 2000, to a little under 30 per cent in 2010. Once house prices and borrowing were rising together, it was difficult to determine whether increased borrowing capacity led to higher house prices or rising house prices spurred increased borrowing.

One benchmark is to compare Australian households' debt levels to that of other countries. In 1990 Australia had one of the lowest household debt-to-income ratios in the developed world at 46 per cent. By 2000 it had doubled to 94 per cent and was similar to that in Canada and the United States. By the end of the 2000s, the Australian ratio at around 150 per cent of household disposable income was one of the highest in a group of comparable developed economies (Battellino 2010).

Even with these higher levels of debt, loan arrears rates and defaults have remained low relative to history and other countries (RBA 2011). Further, most of the debt is held by higher income households who appear well placed to repay this debt (Battellino 2010). Nevertheless, as recent international experiences demonstrate, household debt can amplify shocks. As Stevens (2010b) notes, Australian households would be prudent not to increase their indebtedness at the same rate as over the past two decades.