Reserve Bank takes cash rate back to pre-1960s but economy not quite swinging yet

Reserve Bank takes cash rate back to pre-1960s but economy not quite swinging yet
Reserve Bank takes cash rate back to pre-1960s but economy not quite swinging yet

The decision by the Reserve Bank to cut the cash rate to 2.5% in August is unprecedented with the benchmark borrowing rate now well below the previous lowest 'cash rate' setting of 2.89% of January 1960.

This was not the official benchmark figure it is today, since the Reserve Bank did not publish a cash rate target until January 1990.

Rather the cash rate was a proxy measure of short-term interest rates at a time when the banking sector was highly regulated and getting a home loan meant making an appointment with your bank manager and wearing your best suit to an interview.

Putting into more meaningful terms - the cash rate is now 50 basis points below what it was at the peak emergency setting following the GFC, though without the dramatic 75 and 100 basis point leaps that were necessary back then to keep the economy from stalling, or worse, going into reverse gear.

The RBA's plan now, as expressed by Brian Redican, senior economist of Macquarie Research, is to get non-mining sectors of the economy to fire (including housing, tourism, manufacturing and retail) by gradually lowering the cash rate to counter rising unemployment and slowing economic growth.

The latest housing finance figures for June and yesterday's ABS capital city house price figures suggest momentum is building.

Furthermore, mortgage rates are approaching what they were following the GFC - but an indication of how the banks have clawed back margins on home loans; to achieve this the RBA has needed to cut the cash rate to 2.5% in mid-2013, compared with 3% in May 2009.

The chart below, prepared by ANZ, shows the standard variable home lending rate and the discounted variable home lending rate.

The discounted rate is now broadly equal to the lows achieved at the peak of the Global Financial Crisis, while the standard variable rate is around 20 basis points above those lows.

Apart from this period, these rates are the lowest since the late 1960s/early 1970s.

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Despite this revival in housing and the enticement offered through low rates, it would be naive of anyone to call the economy and housing market swinging like the 1960s, the last time the cash rate had a "two" in front of it.

Back then, there were no foreign banks, no discount online mortgage offerings, nor the plethora of different mortgage products tailored for different types of borrowers and investors.

There were no honeymoon rates, low-doc loans, reverse mortgages, packaged home loans or off-set accounts with such product innovation only coming to the fore in the late 1990s and early 2000s.

Getting a good home loan rate meant having a good relationship with your bank manager.

The headline home loan rate was also lower at 5.00% through 1959 and 1960, according to CommSec chief economist Craig James compared with an average variable rate heading below 5.5% following the August rate cut.

However, a standard variable rate would not even have been quoted in 1960s, with most home loans on fixed-rates with "flexible" mortgage rates only appearing more commonly in the mid-1960s. Certainly most of the Commonwealth Bank's lending would have been done on fixed-rates. 

Assistant RBA governor Guy Debelle pointed out in a speech in 2010 the differences between mortgage lending today and 40 and 50 years ago.

"In the 1960s and early 1970s, the Australian financial system was heavily regulated," Debelle said.

He highlighted a number of wide-ranging controls including that interest rates that banks could charge on their loans and pay on their deposits were controlled.

"Banks were subject to reserve ratios and liquidity ratios. There were directives on the overall quantity of loans banks should make, as well as moral suasion on who they should lend to.

"Institutions were specialised – trading banks lent to businesses, savings banks held large quantities of government debt and lent to households (almost entirely for housing), and finance companies lent for more risky property loans and consumer credit," he explained.

Finance companies likes of the Finance Corporation of Australia funded Alan Bond's first property speculations now subsumed into ANZ-owned Esanda.

However, this heavy regulation of the banks would later result in them losing market share as the unregulated financial sector, primarily building societies moved in.

The banks’ share of total financial intermediary assets declined from nearly 90% in the early 1950s to 70% in 1970.

"The banks’ share of housing credit was just below 60% in 1976 with much of the rest of the mortgage market being provided by credit unions and building societies. Finance companies, which were generally associated with the banks, often provided top-up funding to bank mortgages but were not a particularly large share of the overall market," explained Debelle.

Compare this with today's mortgage market where banks have 96% of outstanding home loans and credit unions and building societies just 4%.

And there are other differences.

It certainly was not possible as it is today to contact your mortgage broker if you felt you were paying too high an interest rate and ask them to source a better deal with another lender.

Or demand that your bank offer you a better rate.

In 1959/60 Australia's GDP growth was 4.4% compared with 3.1% through 2013.

The unemployment rate was under 2% compare with the current 5.7%, meaning decidely fewer borrowers were worrying about paying off their mortgages.

It certainly was not the market-driven banking and lending system we have today while a high Australian dollar - a key factor in the RBA's decision to cut the cash rate on Tuesday - was not a problem as the currency only floated in 1983.

The floating of the dollar coincided with federal treasurer Paul Keating deregulating the banking system between 1983 and 1985 granting 40 new foreign exchange licences in June 1984; and granting 16 banking licences to 16 foreign banks in February 1985.

Australia’s sixth biggest mortgage lender, ING Direct, only began offering its cheap online home loans and high-interest savings accounts in 1999.

Bear in mind that in 1960, the Reserve Bank of Australia had only just come into official being in under the Reserve Bank Act 1959, tasked with undertaking the central banking functions of the Commonwealth Bank.

The Commonwealth Bank as we know it today, originated from this date offering commercial banking and savings banking activities in the form of the newly created Commonwealth Banking Corporation.

Monetary policy was of course entirely different with no RBA imperative to maintain an inflation target of between 2% and 3%.

And it’s not just the nature of the banking system that was so different, house prices had yet to boom as they did in the 1990s and 2000s.

Housing was far more affordable meaning mothers did not have to go out into the workforce to help pay for the mortgage and buying your first home was not the financial commitment it is today.

The boom in property values prior to the GFC saw house price to income ratios of less than to two in the 1960s rise to above four to one currently.

As for household debt that's in a different stratosphere.

In 1960 household debt to Australia’s GDP was less than 20%.

Today it’s just under 150%.

Larry Schlesinger

Larry Schlesinger

Larry Schlesinger was a property writer at Property Observer

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