RBA's Luci Ellis tells World Economic Forum boom-bust cycle fueled by financial deregulation

RBA's Luci Ellis tells World Economic Forum boom-bust cycle fueled by financial deregulation
Jonathan ChancellorDecember 7, 2020

Luci Ellis, the head of Financial Stability Department at the Reserve Bank of Australia (RBA), had her thoughts presented to the World Economic Forum at Davos last month.

She noted Australia's prevalence of variable rate mortgages was seen as stabilizing because it encourages rapid amortization, beyond what the loan contract requires.

But she also noted the use of fixed rate loans is regarded as stabilizing in German-speaking countries. 

Attendees at the World Economic Forum at Davos were told both 1929 and 2008 were financial landmarks, but they were not unique, according to an analytic report prepared by the Steering and Advisory Committees of the Emerging Horizons in Real Estate – Asset Price Dynamics Initiative

"Institutional settings that have been regarded as sources of vulnerability in some cases can be sources of stability in others, depending on the context," Ellis wrote in the report's foreword.

"For example, restrictions on building are seen as exacerbating the 1970s cycle in office property in the United Kingdom, but more recently in Ireland, tighter restrictions might have helped to prevent the geographic misallocation of construction activity.

"Similarly, the use of fixed rate loans is regarded as stabilizing in German-speaking countries, whereas in Australia the prevalence of variable rate mortgages is seen as stabilizing because it encourages rapid amortization, beyond what the loan contract requires."

She observed that many of the recent boom-bust episodes were sparked, at least in part, by financial deregulation.

"Freed of past quantitative restrictions, banks eased their lending standards and expanded credit beyond levels that could be reasonably serviced once the market turned down," wrote Ellis.

"But this shift necessarily only happens once.

"It remains to be seen if these episodes could repeat themselves in the same countries.

"Yet memories fade, and the lax lending standards that characterized some of the boom phases described in this collection have re-emerged in some cases.

"The stance of prudential supervision seems to be important here, in that “light touch” regulatory regimes have frequently failed to prevent excessive risk-taking by financial institutions or their customers."

Ellis noted tax systems that encourage leverage and prudential regulatory regimes that do not effectively curtail imprudent behaviour seem to be common factors in many of the episodes analysed in these case studies.

Another common factor relates to the price of credit: where fixed exchange rate regimes or currency union membership result in interest rates being out of line with the needs of the domestic economy, capital flows and credit supply can fuel a speculative boom in domestic asset markets, particularly property.

"The overarching lesson for policy-makers from the collected experiences is that the social costs of the busts can be large enough to justify preventative policy action," Ellis wrote.

Jonathan Chancellor

Jonathan Chancellor is one of Australia's most respected property journalists, having been at the top of the game since the early 1980s. Jonathan co-founded the property industry website Property Observer and has written for national and international publications.
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