Australia’s $1.7trillion “Ponzi Scheme”
If you recall our recent article about the 4 Corners program on the prospect of Australia heading towards a “disorderly” property crash, you will remember that young couple with a combined income of $135,000 and a $1.2m mortgage over multiple investment properties. On Wednesday this week a report emerged from LF Economics titled “The Big Rort” and it concluded that the banking vehicle that allows couples such as this to cross collateralise properties has set up a $1.7 trillion “house of cards”
From News Limited:
“The Australian mortgage market has “ballooned” due to banks issuing new loans against unrealised capital gains of existing investment properties, creating a $1.7 trillion “house of cards”, a new report warns.
The report, “The Big Rort”, by LF Economics founder Lindsay David, argues Australian banks’ use of “combined loan to value ratio” — less common in other countries — makes it easy for investors to accumulate “multiple properties in a relatively short period of time despite high house prices relative to income”.
“The use of unrealised capital gain (equity) of one property to secure financing to purchase another property in Australia is extreme,” the report says.
“This approach allows lenders to report the cross-collateral security of one property which is then used as collateral against the total loan size to purchase another property. This approach substitutes as a cash deposit.
“This has exacerbated risks in the housing market as little to no cash deposits are used.”
The report describes the system as a “classic mortgage Ponzi finance model”, with newly purchased properties often generating net rental income losses, adversely impacting upon cash flows.”
Hmmm… a property Ponzi scheme… US subprime mortgage instigated GFC anyone? As the GFC demonstrated, and why the “house of cards” or “scam” references used in this report are so apt, is that too much loosely controlled debt predicated on ever increasing asset values must eventually fail as the small issue of ‘cycles’ is somehow forgotten. In this case, as in the US, the cycle is almost self-perpetuating as, with so little to no equity, once the property market takes a small downturn, the forced sales send that into a spiral. As the report says:
“Profitability is therefore predicated upon ever-rising housing prices,” the report says. “When house prices have fallen in a local market, many borrowers were unable to service the principal on their mortgages when the interest only period expires or are unable to roll over the interest-only period.”
In our last article we talked about the impact on our banks and retailers but this article raises another critical point in that our banks have enjoyed “remarkably affordable funding” from overseas enabling Australian banks to issue “large and risky loans”. The risk they warn of is the international wholesale lending institutions walking away from the Australian banking system, leaving our banks with the double hit of falling asset security values and evaporating funding. Whilst our banks are to blame the report puts the ultimate blame on our regulators, saying “ASIC and APRA have failed to protect borrowers from predatory and illegal lending practices,”.
But is it just the banks and regulators fault? One of the leading independent property analysts in the country, Matthew Gross of The National Property Research Co., was undertaking research in regional Queensland as the report was released and tweeted this:
“As I drive around many Queensland regional cities and look at the devastation that property spruikers have caused in local communities and the enormous amount of wealth that has been lost from families, it is very easy to see how a domino effect could unfold. Gearing increases risk, it is that simple. Perhaps an inquiry should also be conducted into property marketing practices, excessive agent commissions which are not disclosed and property developers using predatory techniques as well...and then there is the old adage, buyer beware.”
This is an excellent point. The fact is, Australia has seen an extraordinarily long bull market in property. We have a whole generation who has never seen any meaningful correction in the capital cities (the regions is a whole other story as Matthew alludes). It is therefore understandable that this generation could believe somehow that property is somehow different, that this bull market will never end. Yet again we remind you of the 4 most expensive words in investing… This time is different.