The Australian mortgage market has expanded drastically due to banks issuing new loans against the unrealised capital gains of existing investment properties. This has created a $1.7trn “house of cards,” according to a new report from LF Economics founder Lindsay David.
Entitled The Big Rort, the report argues that the banks’ use of combined loan-to-value ratios 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 said. “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.”
David’s report criticised the system for being a “classic Ponzi finance model,” with newly purchased properties often generating net rental income losses, which in turn adversely impacts cash flows.
“Profitability is therefore predicated upon ever-rising housing prices. When house prices [fall in a local market, many borrowers are unable] to service the principal on their mortgages when the interest-only period expires or are unable to roll over the interest-only period.”
LF Economics argues that while international money markets have hitherto provided affordable funding (enabling Australian banks to issue “large and risky loans”), there is a growing risk that the wholesale lending community could walk away from the national banking system.
“[Many] international wholesale lenders ... may find out the hard way that they have invested into nothing more than a $1.7 trillion ‘piss in a fancy bottle scam’,” the report said.
LF Economics largely assigns blame for this mismanagement on Australia’s financial regulators, the Australian Prudential Regulation Authority (APRA) and the Australian Securities and Investments Commission (ASIC).“ASIC and APRA have failed to protect borrowers from predatory and illegal lending practices,” the report said. “Although ASIC has no official ‘duty of care’, APRA does, and will have some serious questions to answer in relation to systemic criminality within the mortgage market committed by the financial institutions they regulate. The evidence strongly suggests the regulators have done nothing to combat white-collar criminality in the mortgage market.”