Australian banks are breaking primary support levels. There are two major reasons for this. One is the precarious level of household debt as a result of the housing bubble. The first graph below shows how housing prices have more than doubled compared to disposable incomes (after tax but before interest payments) over the past 30 years. And how household debt has risen, not as a result of, but as the underlying cause of, the housing bubble. Without rising debt there would be no bubble.
Growth in Australian housing prices is now slowing, prompting fears of a correction.
The second reason is falling returns on equity. Banking regulators have increased pressure on major banks to improve lending standards and increase capital backing for their lending exposure. For decades banks were given free rein to increase lending without commensurate increases in capital, to the extent that the majors hold only $4 to $5 of common equity for every $100 of lending exposure. Low interest rates, increases in capital and slowing credit growth have all contributed to the decline in bank equity returns to the low teens.
By Neel Kashkari:
Three strikeouts in four at bats would be barely acceptable in baseball. For a policy designed to prevent taxpayer bailouts, it’s an undeniable defeat. In the past few weeks, four European bank failures have demonstrated that a signature feature of the postcrisis regulatory regime simply cannot protect the public. There’s no need for more evidence: “bail-in debt” doesn’t prevent bailouts. It’s time to admit this and move to a simpler solution that will work: more common equity.
Bail-in debt was envisioned as an elegant solution to the “too big to fail” problem. When a bank ran into trouble, regulators could trigger a conversion of debt to equity. Bondholders would take the losses. The firm would be recapitalized. Taxpayers would be spared……
The problem is that it rarely works this way in real life. On June 1, the Italian government and European Union agreed to bail out Banca Monte dei Paschi di Siena with a €6.6 billion infusion, while protecting some bondholders who should have taken losses. Then on June 24, Italy decided to use public funds to protect bondholders of two more banks, Banca Popolare di Vicenza and Veneto Banca, with up to €17 billion of capital and guarantees. The one recent case in which taxpayers were spared was in Spain, when Banco Popular failed on June 6……
The Minneapolis Fed President has hit the nail on the head. Conversion of bondholders to equity may be legally plausible but psychologically damaging. Similar to money market funds “breaking the buck’, conversion of bondholders to equity in a troubled bank would traumatize markets. Causing widespread panic and damage far in excess of the initial loss. Actions of Italian authorities show how impractical conversion is. Especially when one considers that the affected banks were less than one-tenth the size of behemoths like JPMorgan [JPM].
Banks need to raise more equity capital.
Source: New Bailouts Prove ‘Too Big to Fail’ Is Alive and Well – WSJ