The era of financial deregulation left Australian consumers in good shape to deal with the downturn, contrary to widespread opinion.
Although households are carrying higher debt, they have substantially greater wealth, income and savings than they did a decade ago.
Both Treasury and the Reserve Bank believe the financial resilience of Australian consumers, particularly compared with their American peers, will stop the inevitable recession from turning into a financial crisis.
The Reserve Bank last week updated its 2002 analysis of household finances, based on the household income and labour dynamics (HILDA) survey conducted by Melbourne Institute. The HILDA survey has now been tracking the same group of about 9000 households since 2001.
The analysis shows that there was virtually no change in gearing between 2002 and 2006, with the ratio of debt to assets going from 23 to 24 per cent.
This was the period when the party between the banks and households hit a crescendo, with loans to households soaring at an annual rate of 20 per cent by early 2004.
However, asset values were rising almost as fast as the debts. After making adjustment for inflation, the Reserve Bank says the median debt of mortgagors rose from $118,000 to $171,000 over four years, while the value of their assets rose from $414,000 to $557,000.
A striking finding is that although there was a boom in negatively geared investment property in that period, the median level of gearing on investment properties fell from 56 to 49 per cent.
The head of the Reserve Bank's financial stability department, Luci Ellis, says the unchanged leverage in Australia is a sharp contrast with the US, where the ratio of mortgage debt to real estate assets rose from the 30 per cent level it had maintained from the 60s to the 90s to reach 45 per cent by 2006, which roughly marks the peak in the US housing boom.
With housing prices now slumping, that gearing ratio is climbing towards 60 per cent.
Ellis, who conducted path-breaking research on the US housing crunch while on secondment with the Bank of International Settlements, says people will borrow as much as financiers will lend them, and in the US, that was a lot, often with no questions asked.
In a speech last week, Ellis said excesses were avoided in Australia, partly because APRA increased the capital required to be set aside for riskier mortgage products and also because Australia had its housing boom earlier. The boom here started to falter in late 2003, even before the Reserve Bank lifted rates to make sure.
There was an increase in the number of mortgagors with high gearing (loan to value ratios of 80 per cent and more), rising from 6 to 10 per cent between 2003 and 2007, but this is much lower than in the US.
Even if the current stability in house prices proves no more than a lull, the Reserve Bank believes there is little prospect of falling house prices pushing large numbers of buyers into negative equity.
Ellis says the risk of loan default escalates when home buyers have difficulty with repayments and can neither refinance nor sell if the mortgage is worth more than the home.
In the US, the housing market has been caught in a vicious circle where foreclosure sales have intensified the downward spiral in prices, pushing more buyers into negative equity.
Not only is the consumer balance sheet in reasonable shape, their income growth has also been strong. Ellis says that is one reason why Australians are not as overstretched as US consumers. Australian real incomes rose by 20 per cent over the past decade, where real incomes in the US barely budged.
The relative Australian affluence was largely the result of the resources boom, which greatly boosted national income. Wage income has increased at an average annual rate of 7.3 per cent since 2003, compared with average growth of 5 per cent during the 90s.
As the downturn hit, disposable income got a boost from tax cuts, interest rate cuts and the Government's budget hand-outs. In the final quarter of 2008, these forces combined to raise household income 13.6 per cent, or almost $2 billion a week, above the level of a year before.
Another key difference between Australia and the US has been in the way the increased wealth of the last decade has been used.
Financial deregulation provided the ability to draw down home equity, and in the US this contributed to a consumption boom.
Australians also made use of the ability to draw down home equity, but Reserve Bank research has shown this was mainly used for reinvestment in the home or the purchase of investment property.
In the US, consumption rose from a long-term average of about 65 per cent of GDP to a peak of 72 per cent in early 2007. In Australia, the same figure has barely shifted from its long-term average of around 55 per cent for the last 30 years.
The unwinding of leverage is destined to suppress consumption in the US for years to come which, given the importance of the US consumer to the global economy, means slow growth will continue for years to come. However, consumption in Australia never got out of hand.
With a stronger financial position to start off with, Australian consumers are in a position to lift savings without slashing their spending. The savings rate soared to 8.8 per cent, its highest since 1990, in the December quarter.
Treasury's chief economist, David Gruen, argues that although financial deregulation reduced private savings, by enabling people to borrow to finance consumption, this has been offset by the superannuation regime, with econometric assessments establishing that it has resulted in a net addition to savings, rather than simply shifting savings from different investments.
Although consumers surveyed for the Westpac/Melbourne Institute confidence survey said their finances were in worse shape than a year ago, a clear majority expect to be in better shape in 12 months' time. A majority also believes now is a good time to buy major consumer items.
The recent and surprising strength of consumer confidence is unlikely to withstand rising unemployment, and the accompanying forced home sales. However, the financial strength of Australian consumers means that rising unemployment is itself unlikely to be the catalyst for deeper economic problems.
