Who’s in the mood for another financial crisis?

You guys ready for another financial crisis? Coz one is surely on its way.

So says the Bank for International Settlements, the global monetary watchdog owned by central banks.

“That end may come to resemble more closely a financial boom gone wrong, just as the latest recession showed, with a vengeance,” said Claudio Borio, Head of the Monetary and Economic Department at the BIS.

This is the conclusion of the latest and most contradictory BIS report in years. On the one hand it claims the economic conditions of the last year are the most favourable they have been since the Global Financial Crisis, and that unemployment rates have fallen back to levels consistent with full employment. (I do not know how it reaches this conclusion unless it counts the creation of casual and part time jobs towards full employment, despite the fact that at least two-to-three of said jobs are likely going to the same people, struggling to make ends meet).

In reality, there has been no true economic recovery since the end of the Global Financial Crisis, as countries relied on a sharp increase in personal and business debt, rather than addressing banking malfeasance and employment conditions as a whole. In fact the BIS claims the future is likely to bring with it an almost permanent state of boom-to-bust crises. Rather than those that were at the centre of the last crisis (the US and UK), the countries most vulnerable to the next financial crisis include those that have accumulated high levels of household debt and emerging market economies, “including some of the largest, and some advanced economies largely spared by the GFC”.

Japan’s central bank has made large net purchases of government bonds, in order to hold the interest rate on government debt at 0%, while emerging markets such as China are showing private debt to GDP ratios much higher than what existed in the US and UK prior to the crash of 2008. China’s ongoing private and public debt is nearly 270% of GDP, according to Goldman Sachs, with the great majority of this debt in the non-government sector, and its economy is slowing.

Incidentally, the US is not far away from this figure, but a much higher percentage of US debt is government debt. Australia’s debt is also close to this amount, but with much more household debt than China. And the Chinese economy is growing much faster than the US or Australian economies. Australia’s Debt Service Ratio is at 15% nationwide, according to the latest LF Economics report, “far higher than the US, UK and Spain at the peaks of their housing bubbles”, and with household debt to GDP of 125% and private debt to GDP over 200%. The housing bubble which helped Australia stave off the worst of the global financial crisis may in fact only have delayed an inevitable downturn, or even a crash.

“I don’t believe there is another mortgage market globally where a banking system leveraged their household sector as much as ours is without a systemic collapse,” says economist and LF Economics co-founder, Lindsay David.

David claims Australia mistakenly copied Ireland’s pre-GFC wealth creation model by allowing banks to over-lend and “engage in Ponzi finance” of interest only loans, leading to property valuations which created an informal market where increasingly parents are left on the hook having assisted their children to enter the property market with informal loans and mortgage guarantees.

“The Finance, Insurance and Real Estate Sectors do not care and have no incentive to consider the financial wellbeing of first home buyers and their guarantors after purchase,” the report reads.

“Financial regulators have ignored the Ponzi lending practices of lenders.” Australia, Canada, Sweden and Switzerland are particularly vulnerable, having experienced 2-3% growth rates in household debt last year, due largely to the fact that homebuyers had to cough up more cash to outbid rival property buyers.

“Excessive indebtedness has been one of the root causes of financial crises and the ensuing deep recessions,” the BIS warned in its most recent report. Especially household debt, which Australia has in spades.

“Increases in interest rates beyond what is currently priced in markets could weaken consumption considerably,” the report reads.

“Furthermore, there is growing evidence that household indebtedness affects not only the depth of recessions but growth more generally. In an influential paper, Mian et al (forthcoming) find that an increase in the household debt-to-GDP ratio acts as a drag on consumption with a lag of several years.”

This is what happens when you have growth without employment increases.

Economist Dr Steven Hail told Hello Humans a lot of people don’t like the prospect of lower property prices, but it is part of what Australia, and many other countries need in the long run. The difficult thing is achieving this, while at the same time staving off recession or worse another financial crisis.

“That is part of what we need, while defending full employment throughout a transition to affordable housing, and a system where your house is no longer seen as a speculative asset,” he said.

“Nobody dares say it, but we need far lower house prices, and we need to do this while avoiding a recession. Hard to do, and almost impossible, given current policy settings.

“The building of affordable homes where people need to live, the provision of decent jobs where people want to live, and the tight regulation of lending against property to limit pressure on prices, are all part of the solution.”

The economist admits this policy won’t be popular with people who see the market valuation of their homes fall. “But better a managed process than an eventual crash, slump and banking crisis,” he said.

Touche.