Capital capers, bonus bonanzas and more: How banks and debt are changing society

A friend’s mother is in a quilting group of women of a certain age who meet every few weeks, and on Monday she reported that all her friends were exhausted. That’s ­because all of them are constantly minding grandchildren for working daughters who can’t afford full-time childcare.

In a speech on Tuesday, the deputy governor of the Reserve Bank, Guy Debelle, fleshed out that little slice of suburban reality with some data: “Over recent decades, the participation rate of mothers with dependent children has trended higher, rising by 10 percentage points since the early 2000s to 73 per cent. Over the past decade, the rise in participation has been most pronounced for mothers with children aged between 0 and 4.”

This is a huge, quiet change in our society. Why is it happening? Because of debt, says Debelle. “The rise in debt levels has broadly coincided with the increase in the participation rate of females.”

He rather spoils the clarity of the moment by wondering which way the causality goes. Are debt levels higher because more households have two incomes and can afford to borrow more? Or is it (as I suspect) that more women with young kids are working because of the amount of debt the family has had to take on to buy a house?

The data is inconclusive on that but it’s certainly true that housing debt has exploded — from 15 per cent of GDP in 1980 to 95 per cent now. As a proportion of income, total Australian household debt has gone from 50 per cent in 1980 to 200 per cent now.

And it’s also true that a place to live in has become much more ­expen­sive, relative to incomes. In 1980 the capital city house price-to-­income ratio was 2: now it’s about 7.

Houses didn’t get expensive on their own, spontaneously, like a star going nebula; it happened mainly because of the transformation of banking that reached its bloody culmination this week with Westpac blowing its brains out. You might be ­wondering what money laundering and child exploitation have to do with house prices, but bear with me.

It all began with Basel 1 in 1988. As a result of a series of bank failures in the 1980s, a group that ­became known as the Basel Committee on Bank Supervision met in Switzerland to establish the minimum amounts of capital that banks would be required to hold.

In doing so, they came up with the idea of “risk-weighted assets” — that is, that some loans could be discounted when calculating the capital needed for them because they were less risky than others. Cash, gold and US Treasuries could be weighted “0 per cent”, so no capital needed at all. Residential mortgages were weighted at “50 per cent” — that is, only half the loan needs to be counted against capital. Unsecured loans were, and are, risk-weighted at 100 per cent or more.

In subsequent versions of the Basel rules, banks were allowed to set their own risk weightings, and so in Australia for a while they fell to below 20 per cent for residential mortgages (that is, only a fifth of a loan needed to be counted against capital), until they were not ­allowed to do that any more.

APRA has re-assumed control and set the residential mortgage weightings at between 35 and 50 per cent for loan-to-value ratios of up to 80 per cent.

Housing debt rose gradually through the 1950s and 60s as the baby boom parents bought houses, but then it took off after 1988, paused in 2008-09 and then took off again, because capital is expen­sive and banks looking to boost ­return on capital naturally do whatever requires less of it.

Soon after the transformation of bank capital rules in the late 80s came the transformation of their executive remuneration.

After Westpac (yes, Westpac) nearly went broke in 1992 because of lending excesses in the 1980s, it hired American Bob Joss, a senior executive at Wells Fargo, to rescue it on a massive salary. After that, not only did all bank salaries escalate rapidly, so did the complexity of the bonus schemes to justify the larger sums.

The bonuses — STIs and LTIs — were tied to either total shareholders return or return on equity, or both. In other words, bank executives were encouraged with cash to make as much money as possible with as little capital as possible.

The combination of the Basel capital rules and the bonus culture in banking was like mixing nitric acid and glycerol to form nitro-glycerine. Bankers were incentivised to lend against housing, so that’s what they did. (As an aside, they were also ­incentivised to make as much as possible from advice and cash transfer fees, which don’t require any capital at all, and the result of that can be seen in evidence to the royal commission and the allegations by Austrac).

That accounts for the supply-push side of the rise of household debt; the demand-pull came from the negative gearing tax break and, more recently, the collapse in interest rates, in turn caused by low wages growth and technology.

So here we are with household debt greater than national GDP and about the highest in the world, and no one quite sure how bad that is, or whether it’s bad at all.

Some say, “yeah but household assets are much more”, which is true, but it feels like debt is more real and pressing than asset values that rise and fall and aren’t crystallised anyway. Others say, “yeah but interest as a percentage of ­income is really low”, which is true, until it’s not.

One thing is for sure: the price of houses and the amount of debt required to buy them are changing society. Workforce participation is up because more mothers and more older people (because they still have a mortgage) are working, and so is underemployment because people want/need more hours to service their debt.

And the other way society has changed is that banks dominate the sharemarket, our super, our lives, and when they stuff up, it’s a very big deal.

Alan Kohler is editor in chief of InvestSMART.com.au