| Australia’s sub-prime crisis is no longer a secret In 2012 I began a PhD about Australia’s sub-prime crisis. It was quashed three months from the approved completion date after my fifth supervisor resigned. My research back then exposed what the Royal Commission is confirming now. But the Royal Commission still hasn’t quite cottoned on to what the implications are. The ABC is reporting on a specific finding. The one that puts the whole economy at risk. Westpac’s ‘robo-approvals’ process was exposed to the Commission. Consumer advocate Denise Brailey has been saying for years that bank computers automatically approve loans, without questions asked. That brings into question the quality of the information that mortgage brokers and applicants supply. Now that borrowers and investors in mortgage backed securities have evidence that the banks approved loans without checking them, the banks could be open to lawsuits. That’s not all… According to Australian law, if you can prove your mortgage broker or banker manipulated your loan application form to get it past lending standards, there’s evidence to suggest it can force the bank to cancel your loan…but you get to keep your house. Consider this for a moment. In the 2008 crash aftermath in Europe, people were held liable for their debts, no matter what. In parts of America, they had jingle-mail. The borrower just sent the bank the keys and was no longer liable for the debt associated with that house. But in Australia, the defrauded borrower may get a free house! According to Denise Brailey, banks train mortgage brokers how to fudge the data so there could be many potential cases out there. By the way, two Sydney fund managers went around the mortgage brokers and banks pretending to be self-employed graphics designers. They were offered mortgages in excess of their applications… How Australia’s housing bubble formed The most interesting part of Australia’s sub-prime mess is how surprised everyone is. Why do the bankers lend to people who can’t afford their debt? It makes no sense. At the very heart of the issue is something I have not seen any other analyst write about. It’s the distinction between default risk and collateral risk. While house prices are rising, it makes sense to borrow money to buy a house you can’t afford. The worst-case scenario, for you and the lender, is to sell your house. The borrower gets to keep the capital gain and the bank’s risk of not being repaid is tiny. But stick to the crucial point. While house prices rise, default risk is almost irrelevant because collateral risk is zero. The rising value of the house covers the bank’s risk of a major loss. If house prices stop going up, suddenly collateral risk and default risk strike in a dangerous way. If bankers can’t rely on rising house prices to bail them out of bad lending decisions, the default risk of their borrowers makes a comeback. It becomes the deciding factor on whether a loan makes sense or not. Over the last few months, house prices in Australia have begun dropping. The spike in collateral risk, and the return of default risk, is leading bankers to realise they’re sitting on a time bomb. At the margin of this issue are interest only loans. Because borrowers don’t repay the principal, the collateral risk kicks in when house prices stop going up, not just when they fall. According to Brailey, many borrowers don’t have a clue they’re actually paying an interest only loan. They just think they have a mortgage, with no idea what sort that might be. And nobody told them about the spike in repayments which is coming as many of those interest only loans turn into normal principal + interest loans. The idea was for them to sell their investment property before then, for a tidy profit and plenty of fees for the banks. Denise is fighting it out with bankers and regulators about just how many interest only loans are out there. She estimates 80%, while regulators say it’s 30%. Thanks to the Royal Commission, bankers have tightened lending standards. But lending is contracting. Without demand from the marginal borrower, who can’t afford to buy, house price demand is evaporating. The banks are on the hook for their dodgy loans, and for ordinary losses on their loan book. We appear to be re-enacting the sub-prime crisis. But under Australian law, it could be even worse. | Until next time, |  | | Nick Hubble,
For The Daily Reckoning Australia |
| 
