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Personal insolvencies moved in lock-step with rate rises during previous crises and that points to a huge increase this year, says insolvency specialist.
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Bankruptcies ‘to triple if history repeats itself’
09 February 2023
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10 minute read
Rate rises, inflation and personal bankruptcies moved in lock-step during previous crises and there are reasons to fear history will repeat itself, Jirsch Sutherland says, which would triple the current rate.
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National insolvency expert Michael Chan said a graph of rates and bankruptcies pointed to a sharp rise in insolvencies if 2023 paralleled previous slowdowns.
“When rising interest rates are coupled with inflationary pressures, past trends have shown a corresponding rise in bankruptcies,” Mr Chan said.
“There are distinct correlations: there was a sharp economic slowdown in the mid-90s (following the 1991 recession) when the cash rate and bankruptcies rose simultaneously; bankruptcies and the cash rate were almost in lock step during the 2007-08 global financial crisis; and it’s a similar situation now.”
He said during the GFC many householders had used the equity in their home to invest in rental properties and were caught short.
“When interest rates spiked, the rental income was not sufficient to cover the mortgages on those investment properties. During that time, there were a lot of bankruptcies that occurred when properties were over-encumbered,” he said.
“At the moment, a lot of properties purchased through the last two years still have a good amount of equity and savings to stave off these ongoing issues.
“The question is whether or not they're going to have the funds or the reserves to pay these ongoing, massive interest rate hikes and in particular the cost-of-living pressures that are currently hitting everyone right now.
“While bankruptcy numbers are currently still stable and homeowners still have some savings, cracks are appearing.
“For example, staff cuts and recession warnings are more prevalent, the tax man is lurking and regulators are getting ready. We are already seeing a definite increase in corporate insolvencies and believe personal insolvencies will follow.”
The RBA raised interest rates for the ninth time this week – by 0.25 basis points to 3.35 per cent – after the annual inflation rate hit 7.8 per cent in December. And the RBA surprised economists with a stern warning that there were more rises to come.
“The board expects that further increases in interest rates will be needed over the months ahead to ensure that inflation returns to target,” it said.
This year the full impact of higher rates is expected to hit as many as 800,000 households coming off loans fixed at very low rates during the pandemic. If rates approach 4 per cent, the Jirsch Sutherland graph suggests personal insolvencies could triple to 15,000 this year.
“Based on historical numbers, I don't think that's a pessimistic view,” Mr Chan said, with property buyers blindsided by the speed of interest rate rises.
“We were being told that interest rates weren’t going to rise until 2024 but instead, we've had these nine quick interest rate hikes in the last nine months. I don't think many people would have budgeted for such a steep increase so quickly.”
He said the impact would show up towards the end of the year and in the past, bankruptcies had kept going up for four to five years after rate rises.
Rather than keep increasing rates, the RBA should wait he said.
“They're increasing so quickly, we’re not seeing the spiral effects. They just have to let it run for a little bit and then we'll see how it's actually affecting. When you speak to people around you, you know they are all tightening their belts. They just need to let it run its course at the moment.”
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