Westpac and its Bet on the RBA and Interest Rates

Well we couldn’t find any Westpac bankers to high-five yesterday. It seems they were keeping their head down to avoid the flak.

Which is a shame because they should be holding their heads high for an ingenious move.

Sure, it may not pay off quite as they planned due to the ‘scabs’ at National Australia Bank flinching and only raising interest rates by 0.25%.

But it’s the NAB bankers that will find themselves outcasts at the next Banking soiree. While the Westpac bankers will be welcomed to a rapturous and sympathetic ovation: “You tried your best boys and girls.”

If you’re still confused by what the heck I’m going on about, let me explain…

Westpac’s action in increasing mortgage interest rates by more than the Reserve Bank of Australia’s (RBA) 0.25% cash rate increase highlights the complete and utter futility of trying to manipulate the interest rate market.

We’re told by central bank lovers that the RBA plays a vital role in steering the economy in the right direction. It increases interest rates to slow the economy and it decreases interest rates to stimulate the economy.

But what does it do now? It’s got one bank that’s obviously trying to slow the economy quicker than the other.

Westpac increases rates by 0.45%, but the NAB only increases them by 0.25%. If the clever folk at the RBA thought the economy needed to be slowed quicker then you’d think they’d have gone for a 0.5% increase.

So, come next February and the next interest rate decision will the bank increase rates again because that’s what they planned to do anyway. Or will it cut them to take into account that Westpac has increased them too much?

Or will it just leave the rate as it is?

Oh, what a to-do. However will they get themselves out of this pickle?

But why are we so highly in praise of Westpac? Simply put, if it wasn’t for the ‘scabs’ at NAB, the banks could have gifted themselves a bumper payday for the next few months.

All Westpac was doing was betting on the RBA continuing to increase rates through the early part of next year. Quite clearly, it’s thinking was, if the RBA is going to put rates up and harm all the lovely lending banks do, why not get in first and at least try and make some money out of it.

That’s what they did. Their first gamble was that the other banks would follow. Their second gamble was that the RBA might think again about increasing rates at the February meeting, seeing as the banks were increasing rates anyway.

But as I mentioned above, it shows the complete futility of having a central bank artificially manipulating interest rates.

Whatever rate the RBA decides it will be wrong. It’s not possible for a central bank – or anyone for that matter – to micro manage an economy just by raising or lowering an interest rate.

Whatever they do it will always have unintended as well as intended consequences.

I mean, we’ve just come through a period where debt problems have engulfed the entire world and what was the RBAs response? It was to cut interest rates to ‘emergency’ low levels in order to encourage more borrowing.

So therefore, it’s hardly surprising that borrowing has increased during the last twelve months.

But the most worrying aspect of the actions by the RBA are the chumps looking after the shop.

A couple of weeks ago, RBA deputy governor Ric Battelino gave a speech at the 6th National Housing Conference.

You can even listen to his speech if you like. It’s the usual blah, blah effort. But one of the standout comments is on page 8 of the transcript. It’s this:

“Lower interest rates have allowed households to take out bigger home loans, without increasing housing loan repayments. In turn this has given households more buying capacity in the housing market, which has been reflected in house prices.”

Got that, “Lower interest rates have allowed households to take out bigger home loans.”

Well we knew that. We’ve banged on about it all year.

But rather than being concerned about this fact, Mr. Battelino appears to see this as a positive sign, because people can borrow more money without it costing anymore – Yet!

Seriously, this is one of the most powerful guys in Australian finance and he’s making an economic argument that a six year-old would be embarrassed by.

But not only that, it seems as though Mr. Battelino is living in cloud cuckoo land. We love this comment on page 10 of the transcript:

“On plausible assumptions, the deposit needed by first-home owners may now be around one and a quarter years’ income, almost twice what it was 15 years ago.”

Really? The average Aussie income is around $65,000. Is the RBA really trying to suggest that banks are asking for an $81,000 deposit from first home buyers?

Even if the first home buyer is earning below the average income, say $50,000, do we really believe the banks want a $62,500 deposit?

What utter nonsense. If banks were really demanding that level of deposit there would be no need for the first home buyers bribe.

The reality is, all you need to do is show the bank you’ve saved $10,000 over a few months and they’ll fall over themselves to give you a loan.

Show them you’ve saved just a couple of grand and they’ll suggest you get someone to go as guarantor. Either way, the loan is yours.

It’s no wonder the four major banks are able to play these guys for fools.

But given his comments above, and the following comments, we’re surprised Mr. Battelino hasn’t gained the nickname Pinocchio. Here’s what he said in the same speech about the Australian mortgage securitization market:

“The Australian mortgage securitization market, like securitization markets everywhere, has suffered reputational damage from the events in the United States. However, Australian mortgage-backed securities have not experienced credit problems.”

Hmm, no credit problems eh? If you ignore the fact that $15 billion of mortgage funds are frozen then he’s right there aren’t any credit problems.

But just ask one of our Money Morning readers whether there’s any credit problems in the mortgage market. We received this email from one reader yesterday:

“My mother died last April and we have been trying to wind up her estate. We asked how long it would be before the money [from the mortgage funds] could be released and were told it could be 2-4 years unless we could prove hardship. Seeing that none of us are registered with Centrelink we have just have to wait. No one will tell us the final price we will get when they are released but have been informed that at the moment it is less than when we first tried to sell them.”

It’s ten-times more worrying for those who haven’t died and are relying on the income from mortgage funds! Funds which are frozen harder than a polar ice-cap.

I don’t know about you but that seems like a credit problem to me. And it’s more than reputational damage. It’s because no-one wants to buy the mortgages at the price quoted by the funds.

Which isn’t surprising considering Mr. Battelino’s admission that borrowers have used the artificially low interest rates to leverage themselves up more than ever.

Not that the banks are worried, because according to yesterday’s Australian Financial Review (AFR), “Borrowers can cope, according to banks.”

The banks are bound to say that. There’s not much chance of them saying, “Oops! We’ve stuffed up and given out too many loans.”

Instead the banks are still spouting the usual line about them having a “buffer zone” with their lending policy. That’s the idea that banks build in an extra 2% to account for future interest rate rises.

It’s good PR claiming to have a buffer zone. It’s just a shame that it’s a complete lie.

We had interest rates at an all-time low. “Emergency” low interest rates as you’ll recall. So how come if banks normally have a 2% buffer they haven’t initiated an “emergency” 4% buffer, or 5% buffer?

As an example take a look at the chart below:

It’s the history of RBA interest rate levels since 1990. The blue line indicates the official Cash Rate, and the red line indicates approximately where the banks’ mortgage rates are.

The green line is the supposed buffer zone. The amount extra that banks supposedly factor in for future interest rate rises.

The only problem with their buffer theory is that even now, after the RBA have increased interest rates have increased by 0.75%, the green’buffer’ line and the banks’ mortgage rate line are still a long way below ‘normal’ non-emergency rate levels.

Forget about this idea that the banks are lending conservatively and that borrowers are ahead with their repayments.

The RBAs own deputy governor has admitted that people are borrowing more than ever before. He’s admitted that rather than borrowing less and therefore incurring a lower interest cost, borrowers are choosing – or being forced – to borrow more than ever and therefore paying a greater amount of interest than if they’d borrowed a smaller amount in ‘normal’ times.

What this means is that when the RBA increases interest rates back up to 5%, 6% or 7%, borrowers will be paying interest at 7%, 8% or 9%. But it won’t be the same repayments that borrowers had two years ago when rates were at that level.

The repayments will be much bigger because: “Lower interest rates have allowed households to take out bigger home loans…”

Bigger home loans that have enabled Australians to build the biggest houses in the world… Mwahahaha!

If Mr. Battelino and his boss can’t see that’s a recipe for disaster then they seriously need their heads examined.

Cheers.
Kris.

60-Second Market Round Up
by Shae Smith

The S&P/ASX200 had quiet trading day yesterday, ending the day only 12 points higher to close at 4,774.60. However, Chris Kimber from Bell Financial Group believes “…the All Ordinaries will push past the 5,000 mark before Christmas.”

The Dow Jones Industrial Average had a late sell-off which saw the Dow close down 86 points to 10,366.15. Information that retail sales only had a marginal increase from last year and the nonmanufacturing index was down 1.9 to 48.7 drove shares further into the red. Read more here.

In the UK overnight, the FTSE dropped 0.27% to 5,313

The Nikkei was up a huge 3.84% overnight, reaching a five week closing high of 9,977.67

The price of gold has once again reached another new high. Overnight, gold reached $1,226.56

The price of spot gold in Australian dollars is trading at $1,307.85, while in US Dollars it is trading at $1,207.80. The price of silver in Aussie dollars is $20.40 and in US Dollars it is $18.84.

The Aussie dollar versus the US dollar is trading at USD$0.9238, and against the Japanese Yen JPY81.56

Crude oil closed at USD$75.72

For the biggest movers on the market yesterday click here…

Tagged as: bankers, Battelino, biggest houses, central bank, debt, interest rates, mortgage funds, nab, National Australia Bank, reserve bank of australia, westpac