Australia's decade-and-a-half-long debt binge is coming to an end and a new era of austerity, in which consumers pay down their debts, live within their means and save for the future, is beginning, the Reserve Bank governor, Glenn Stevens, has predicted.
As US authorities were forced to stump up $US85 billion to prevent the collapse of the insurance giant American International Group, Mr Stevens said it was time for a debate about how debt-fuelled asset bubbles could be prevented in the first place, as opposed to regulators simply waiting to "clean up the mess afterwards".
The Australian sharemarket closed in the red for a third consecutive day, bringing total losses for the week to almost 4pc so far.
However, Mr Stevens said the Australian financial system was "weathering the storm well".
While tight-lipped on the timing of any future interest rate cuts, Mr Stevens's optimism that Australia's financial system would not be engulfed in a Wall Street-style crisis, led financial markets to scale back expectations of a dramatic half a percentage point cut next month.
A more modest quarter percentage point move is still expected.
But amid the financial maelstrom, Australian households were likely to bunker down and focus on repairing their debt-burdened balance sheets.
"There is … a good chance that households will for some time seek to contain and consolidate their debt, grow their consumption spending at a pace closer to income, and perhaps look to save more of their current income than in the recent past," he said.
Since the early 1990s, households had run up their gross debt as a proportion of annual disposable income from about 50pc to 160pc.
A period of low inflation, low interest rates and rising incomes has enabled Australians to indulge their love affair with housing.
"As we have become wealthier, our aspirations for housing in terms of position, quality and size have naturally enough increased.
"But … there is only so much well-located land … In the end, a lot more of our income is devoted to housing, acquired by servicing mortgages, than was once the case."
Relaxed lending standards had also fuelled the debt boom to the point where "anyone who was creditworthy - and some who were not - have been able to access ample amounts of credit".
But with the world entering a new period of constrained credit and tightened lending criteria, Mr Stevens said he expected Australian consumers would begin to rein in their big-spending ways.
"It is possible that we are witnessing the early part of a new phase where the household spending and borrowing dynamic is different from the past decade and a half."
Because this would have the knock-on effect of depressing business activity, governments would be increasingly expected to step into the void to invest in necessary infrastructure.
However, this was a position the Federal Government, with its multi-billion-dollar surpluses, was well qualified to fill.
"Most governments would kill for a set of fiscal accounts like the ones we have."
As regulators around the world grappled with the question of how to prevent another debt storm brewing,
Mr Stevens outlined three approaches:
• Try to stop players from taking excess risks by forcing them to hold greater assets to back their loans
• Keep interest rates higher than otherwise
• Do nothing.
Without indicating which of the first two options he preferred, Mr Stevens indicated the third was no longer an option.
Concern about asset bubbles is not expected to deter the Reserve Bank from cutting interest rates again before Christmas.
Markets expect a quarter of a percentage point cut when the Reserve's board meets on October 7; this will be followed by a string of cuts, taking the official cash rate down to 6pc, from 7pc now.
Figures released the week before on the pace of household and business borrowing are likely to provide a critical indicator.
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