The Global Financial Crisis (GFC) has changed the way Australian households regard risk and manage their saving, spending and their investments. In this post, I look at some of the impacts of these changes.
The shockwave
The GFC was a shock to all households and investors. Debt markets froze, companies and banks collapsed, and the world’s financial system appeared to be balanced on the edge. The global sharemarket fell by around 55 per cent.
These are the types of events that we read about in history books, but never think will happen in our time.
Yet, when an event does take place of this magnitude, it’s often accompanied by a big shift in the way investors regard ‘risk’ and manage their finances.
Prior to the GFC, Australians borrowed a lot
Australia went into the GFC with a fairly strong economy, but there were some serious distortions in our markets.
Like the rest of the world, Australians had been building up their debt levels during the good times. For decades, Australian households maintained reasonable levels of total debt which were around 40 per cent of income. About three quarters of that debt was for housing.
Then through the 1990s and 2000s, these debt levels skyrocketed. By the time the GFC hit, household debt ratios had quadrupled to about 160 per cent of income, as shown by figure 1.
This high level of debt needs a ‘goldilocks’ economy to survive, with everything just right – low interest rates, rising house prices, low unemployment, and rising wages.
We had it for a while, but these conditions can’t last forever. The GFC shock reminded everyone of the need to always be ready for the good times to end.
Figure 1: Household debt to disposable income
Source: Reserve Bank of Australia. Data up to March 2011
Now we are reversing this trend and saving
Households have reacted with a substantial increase in savings, as shown by figure 2. Now, more than 10 per cent of household income is being saved rather than spent – a level not seen for 25 years.
This change has coincided with a continued fall in the rate of growth of household borrowings, from a peak of almost 25 per cent in 2003, to a current level of around 6 per cent, as shown by figure 2.
Figure 2: Household savings and credit growth
Source: Reserve Bank of Australia. Data up to May 2011
This is the slowest rate of household credit growth since the early 1990s recession.
In many ways, the change over in savings and credit growth is a healthy occurrence. It has helped to restrain debt to disposable income levels from climbing to even more unsustainable highs, as shown by figure 1. This in turn has helped to take some of the heat out of the Australian housing market.
But while the housing market has cooled a little, it hasn’t experienced a major correction. Debt to disposable income levels remain historically high, and this means the housing sector is vulnerable to further interest rate rises.
Impact to Australia’s two speed economy
The recent change in the way households manage their finances marks a necessary shift to a more sustainable position. But as households save more and borrow less, they spend less, which is in turn is contributing to the slowdown in Australia’s two speed economy.
For as long as households continue to adjust, the change will be a drag on economic growth. But households aren’t the only parts of the economy going through these types of changes.
Businesses have been undergoing similar adjustments, as they feel the effects of the weaker consumer spending.
The government sector is also adjusting – shifting from a budget deficit to a surplus means more taxes, less government spending, or both.
What this means for investors
The desire to boost savings and not risk has contributed to a huge growth in Australian bank term deposits since 2007.
Figure 3 shows the rate of growth in term deposits reached 50 per cent by early 2009, as investors sought the safety of cash amid falling markets.
Signs are starting to emerge that this trend is moderating, with the savings now sitting in the 10 to 20 per cent growth band.
This growth rate continues to help Australians strengthen their financial house and ensure they have a reasonable buffer in place to manage unexpected changes.
Figure 3: Rate of growth in term deposits
Source: Reserve Bank of Australia. Data up to May 2011
Investors are still jittery over threats to the global recovery, and prone to panic over potential impacts to risk based assets, such as shares, that were very hard hit during the GFC.
An emotional reaction to a shock is usually one of the worst decision-making frameworks. It can perpetuate the cycle of buying at high prices when everything is going well, and selling at low prices when there is a problem.
US studies have shown that this behaviour has helped turn an annual sharemarket return of about 8 per cent over the past 20 years into an average investor return of less than 2 per cent per annum.
A more sound approach is to ‘act and not react’. To have a strategy that allows for stresses and shock – and that doesn’t become compromised by looking backwards rather than forwards.
