Return of the money power

Finance now dominates everyday life in Australia
Kosmas Tsokhas

In an era when households have been incorporated into financial markets, it is said that they have the opportunity to acquire assets, which will appreciate in value and generate a yield or an income, whilst lines of credit can smooth uneven patterns of income and expenditure. Making sense of this is not easy, but in their new book, Risking Together, Dick Bryan and Mike Rafferty cut to the chase when they draw on statistics from the Reserve Bank of Australia: on the one side, in 2017 total household debt was around $2.24 trillion, equivalent to about $90,000 for every Australian, with the heaviest debt levels in middle-income and middle-age households that were buying property and paying off student debt; on the other side, with increasing debt aligning with rising property prices, average equity in homes has grown, while interest payments as a percentage of income have declined due to low interest rates.

To paraphrase Bryan and Rafferty, it is not debt levels as such that are a reason for concern, but debt in circumstances when interest rates are more likely to rise than fall, when house prices are more likely to decrease than to increase, and when household incomes are unreliable rather than stable. When the authors analyze what they refer to as the household balance sheet of assets and liabilities, Bryan and Rafferty find that, no matter how frugal or resilient, low-income and middle-income households are vulnerable to variable and temporary employment — personal and credit card debt is used to get through short-term loss of incomes or unforeseen expenses. It is only in the top 20 per cent of households that income other than wages or salaries, sole trading or government benefits are important, such as profit, interest and rent.

In the light of their acute observations on income disparities, Bryan and Rafferty evidence that there are growing inequalities in household net worth measured by assets less liabilities. For most of the bottom 20 per cent of the income distribution and the middle-income groups under the top 20 per cent, the family home is the biggest asset, followed by superannuation, motor vehicles and in some cases equity in an investment property. For the top 20 per cent of households, the family home is the biggest asset, followed by superannuation, they also benefit from shares, businesses, discretionary trusts and investment properties. When Bryan and Rafferty turn to household liabilities, they reveal that the top 20 per cent have the lowest liabilities to assets ratios, even though they have little aversion to borrowing, whereas the middle-income groups have the highest level of debt (of which, on average, 70 per cent consists of home mortgages).

In the post-war period, banks lent on what was for them a sensible formula based on a minimum equity and a debt servicing ratio, so that, if a borrower defaulted, enough equity would remain in a house for the bank to obtain the value of its loan. The repayment ratio meant that a maximum of around 30 per cent of income was to be used on debt repayments to allow enough to keep up with the cost of living. By the 2000s, there was a switch in favour of net-income surplus assessment, because borrowers continued to repay their mortgages even after they had lost equity in their houses, until at the extreme they could no longer cover their repayments and meet basic consumption expenses.

Bryan and Rafferty elaborate on how this switch allowed a higher level of borrowing than the debt-servicing ratio method and led to the packaging and selling of residential mortgage-backed securities on financial markets. This sort of securitisation was a transfer of default risk on loans from the mortgage originators to the security buyers, who were owed the monthly payments on the mortgages. This gave the mortgage originators a motivation to adopt the risky net-income surplus method of setting lending limits, which calculated how much of a borrower’s current after-tax income had to be spent on a basic standard of living, without taking into account future variations in income or changes in the cost of living, such that what remained was defined as the surplus that could be diverted to the repayment of loans.

Readers will appreciate Bryan and Rafferty’s discussion of securitisation, which involves contracts for regular payments, whereby the ownership of such payments is separated from ownership of the contracts themselves, such that the seller receives an up-front sum. Most of the contracts issued in Australia are for residential mortgage-backed securities in which the underlying asset is a bundle of mortgages. Although only a small amount of the total value of mortgage lending goes into the purchasing of securities backed by household payments, Bryan and Rafferty anticipate that, while this is unlikely to catch up with or over-take non-securitised mortgages, it can be expected to grow step-by-step. One reason can be traced to the shortage of relatively safe securities that can hold their value to generate an adequate long-term income stream, when markets for equities are unstable.

Furthermore, car loans, health and home insurance, mobile phone and internet services, electricity and gas utilities, credit card and student debt are tied to contractualised time-based payments that have started to be securitised. Importantly, consumers who read Bryan and Rafferty’s description of securitisation will be able to make some sense of how this has fed into price increases, as default risks are included in the trades, so that the interest rate on a mortgage or the price of a utility (such as electricity) has to be sufficient to earn a yield or rate of return in proportion to the default risk taken on.

Still, overall, the largest household asset after the family home is superannuation. Bryan and Rafferty stress that wage and salary earners are not only forced to contribute to superannuation but are also compelled to take on the risk of variable returns, contingent on whether they choose low-risk or high-risk investment portfolios. In this way, without them really understanding what is happening, those whom Bryan and Rafferty — without conscious irony — define as ‘ordinary people’ are actually participating in financial markets, whereby about 25 per cent of their superannuation balances go into overseas equities and bonds. Of the rest that remains in Australia, 25 per cent goes into the stock market and 20 per cent into cash and government bonds.

Hence, the risks of market fluctuations that impact on the returns from funds managed by financial institutions over-burden superannuants, whose account balances and incomes in retirement will go up or down according to asset performance The executives and shareholders of financial institutions will meanwhile lick their lips as they continue to receive more than $1 billion every week in guaranteed compulsory superannuation deductions from payrolls, from which they extract commissions and fees of $23 billion per year — with no ultimate responsibility for returns on the investment. To mitigate these and other risks they carry, households are expected to become financially literate, or to employ a financial adviser. Unfortunately, the banking and financial planning industries have confesssed to the cold-blooded and unscrupulous pursuit of commissions over client needs, fees charged for no service, forged client signatures, reconstructed files, and incorrect advice.

A distinction needs to be drawn between discretionary and fixed household expenditures. Bryan and Rafferty point out that it is fixed expenditures that attract securitisation because borrowers and customers have little alternative but to fit in with contractual regular payments — for housing, consumer durables, utilities and services necessary for the conduct of their everyday lives. Despite the growth in household participation in the labour market, Bryan and Rafferty explain that increases in total family incomes have not resulted in much discretionary expenditures. This is because most of the additional incomes have been allocated to the treadmill of old and new fixed expenditures — on housing mortgage repayments, childcare and education, utilities such as electricity and telecommunications, insurance policies and compulsory superannuation deductions As a share of total expenditure, these fixed expenditures have increased faster than inflation and wages.

Interestingly, it is the middle-income groups above the bottom 20 per cent of the income distribution and below the top 20 per cent that get the closest attention from financial institutions. These households hold the greatest potential for expanded securitisation and, as a consequence, are checked to ensure that they are unlikely to default, or to put it differently, that the rate of default is predictable. Therefore, lenders and service providers are not prepared to wait and see what happens. Instead, because they believe that many borrowers and consumers cannot be trusted and need to be guarded against, they profile households before they sign them up to a loan or contract, to see whether they have the characteristics of persons who have a propensity to default, and, once they have a loan or contract, to monitor them to ensure their ongoing compliance.

Without deviating from their emphasis on the inequality built into financialisation and securitisation, Bryan and Rafferty add that households attempt to handle financial risk when they spread their investments across a range of asset classes, whereby wealthy households tend to be diversified because they are in the best position to take advantage of family trusts, negative gearing, capital gains, superannuation and tax concessions, whilst the assets of middle-income households tend to be concentrated in the family home. Irrespective of whether the value of housing assets purchased has grown faster than the debt incurred, the debt-to-income ratios of middle-income households, on whom the screw is tightened and loosened and tightened again, have left them most exposed to the risk of default.

For readers who have been unable to detect the devilry within contractual obligations, Bryan and Rafferty, with clear and simple prose, uncover something of the rationale behind the deeds and misdeeds that characterise financialisation and securitisation. Even if borrowers and consumers were previously unaware of the dark arts practised by credit reporting firms and rating agencies, through the comprehensive and frequent, intrusive and clandestine, collection of data interrogated by algorithms to match personal characteristics and household attributes to current and future risk profiles, they can now learn from Bryan and Rafferty that this brings about what amount to ‘risk report cards’ on most Australians. So, when households apply for credit or a contract, the amounts lent, the terms and conditions will be modified to reflect assessments of loan-to-value ratios and probabilities of arrears or missed payments or, at the end of the process, default, although this will not necessarily guarantee an end to over-lending and over-borrowing.

Whilst the Reserve Bank takes the temperature of the balance sheets of the banks, which contain an immoderate $1.25 trillion in mortgages in what is an over-heated real estate market, for their part, Bryan and Rafferty argue that households are required to calculate and act like financial units, analogous to hedge funds, which exercise leverage by borrowing money for increasing their exposure to assets in which they have little equity. Bryan and Rafferty unravel something of the mystery of what hedge funds do when they explore how households can be said to take long or short positions, such that, in a similar manner to professional investors, householders look to profit from or insure against the return on an asset in anticipation of movements in the future price, playing the odds between long-speculative and short-hedged positions.

Readers may find it hard to assimilate the idea of households behaving like hedge funds. Bryan and Rafferty alert us to the extent that, all at once, households have roles as workers, consumers, investors, borrowers and sources of payments that sustain securitisation, by means of the financialised version of Henry Ford’s view that wages should be sufficient to enable workers to purchase the cars they produce — only now, the aim is to ensure that workers can afford to meet the contracts that support the securities backed by their household payments. Householders may imagine that they are merely repaying a mortgage or car loan owed to a bank, or paying an electricity bill to an energy corporation. They may be surprised to learn from Bryan and Rafferty that they are actually involved in the production and issuance of a financial asset or service no less than those who work for wages and make products in factories. Taking this comparison further, Bryan and Rafferty report that families feel that they are held in the hands of something they cannot get out of because they are being financially ‘overseen’ and ‘managed’ in a manner not unlike workers in factories.

At this stage, given the centrality in Bryan and Rafferty’s analysis of a hierarchy of classes or strata of households with different incomes and assets, which all think and act not unlike hedge funds, readers will be forgiven for finding themselves in two minds. This is especially so when Bryan and Rafferty claim that the way a surplus is extracted from factory workers producing more than they receive in wages is akin to how the supervision of households enables a surplus to be extracted by an unfair exchange of risks, taking on the risks of precarious and unstable income that are greater than the risks of default faced by finance. Then again, surveys of wellbeing have brought to the surface subterranean rumblings over financial stress, so that it is not wishful thinking and certainly not unreasonable to expect that those householders represented by trade unions could demand that an explicit debt-related price be built into wages to compensate them.

Kosmas Tsokhas lives in Canberra. Dick Bryan and Mike Rafferty, Risking Together: How Finance is Dominating Everyday Life in Australia, Sydney: Sydney University Press, 2018. pp. xv, 234. $25 paper.