It is useful to be well aware of the human power of self-deception. For example, how many times have you heard an economist or a spokesman for the Reserve Bank of Australia (RBA) say that Australia could never have a US-style housing bust because bank lending standards here never approached US subprime levels? We heard it so many times we stopped counting.
'Banks in Australia and Canada had more conservative lending practices in their home markets than their counterparts in the United States and the United Kingdom. While sub-prime mortgages accounted for around 13 per cent of the US mortgage market in mid 2007, the closest equivalents in Australia and Canada accounted for around 1 per cent and less than 5 per cent of their mortgage markets, respectively.'
Glenn Stevens, RBA Governor
Australia and Canada — Comparing Notes on Recent Experiences
Sydney May 2009
'Fortunately, lending standards in Australia did not loosen as much as in some offshore markets. There was very little sub-prime lending of the form more common in the United States for example, where loans were provided to those with poor credit histories.'
Guy Debelle, RBA Assistant Governor (Financial Markets)
The State of the Mortgage Market,
Sydney, March 2010
'While there was some sub-prime lending activity in Australia, it was on a small scale, and mainly by non-bank lenders. As such, arrears rates on housing loans have remained at low levels, and Australian banks have remained profitable.'
Ric Battellino, Deputy Governor, RBA
Will Australia Catch a US Cold?
New York, September 2011
'As the RBA has made clear many times before, one important reason Australia did not go down the same road as the United States is that lending standards didn't ease as much here. Even at its peak, subprime lending was only ever a tiny fraction of the total. Low-doc loans were also a small niche.'
Luci Ellis, Head of Financial Stability Department, RBA
Prudent Mortgage Lending Standards Help Ensure Financial Stability
Sydney, February 2012
With those in mind, consider this from Anthony Klan in today's Australian:
'Subprime-style lending practices were rampant during the last property boom despite claims by lenders that local practices were superior to global standards. The Australian has exclusively obtained hundreds of internal emails between lenders and mortgage brokers that lift the lid on the extent of aggressive — and in many cases predatory — lending practices in the five years leading up to the global financial crisis.'
It turns out Australian mortgage brokers and banks used every trick in the US subprime book to expand lending during the housing boom. There were low-doc loans. There were no-doc loans. And mortgage brokers often did not even call potential borrowers to verify that their employment or income information was correct.
This was all standard practice in a credit bubble. Mortgage brokers work on volume, and they don't own the loan. Their incentive is to approve as many loans as possible. Those loans then go to a bank or bigger firm which securitises them and sells them to investors. No one along the chain actually 'owns' the risk.
'In a series of precedent-setting legal cases,' Klan reports, 'nine judges before six courts have found in favour of borrowers stung by lenders who failed to ensure borrowers were able to repay before writing a loan...In almost all cases in which borrowers have lost some or all of the money borrowed, judges have overwhelmingly sided with borrowers and ordered mortgages to be extinguished, or drastically reduced, within 30 days.'
So Australia had its own dirty little secret subprime market after all. According to Fitch Ratings, low-doc and no-doc loans represent between 8–10% of the total national mortgage market, or between $96 and $120 billion. 'One in 20 loans held by the big banks is low-doc or no-doc, with the figure rising to about one in 10 across the market, as non-bank lenders hold the highest portion of such loans,' Klan reports.
Is 10% of the mortgage market nothing to worry about? Surely that entire 10% of loans won't go bad. But everything in economics happens at the margin. When the last marginal borrower is in the market — by definition, the borrower least suitable to take out a large loan — the market has reached its natural limits of expansion. Contraction follows.
Contraction is not good for business, especially if your business is lending money. You can see why the non-bank lenders were especially keen to keep the housing bubble growing. But don't be surprised if this lending boondoggle follows the global pattern: peripheral players get gradually wiped out as the asset rot moves its way inward to the core. The core of the system is the Big Four banks.
By the way, do you think it's a coincidence that The Australian is publishing this story after all its content has moved behind a pay-wall? A publisher is only really independent if he's accountable to his subscribers and not his advertisers. If The Australian relied on advertising income from banks, the construction industry, property developers, and real estate agents, it would never be able to publish an article exposing what a bubble Australian real estate has become. Kudos to Klan for his work.
And incidentally, this is why the Daily Reckoning doesn't sell advertising space to brokerages, companies, or anyone else. The income from selling ads would certainly be attractive, but it would compromise our independence and our ability to say what we really think. What's the point of having your own publishing platform if you can't say what you really think?
For the record, nearly all of our income here at the Daily Reckoning is subscription income. The products you see advertised in our e-letters are the newsletters and research services we publish. That revenue gives our analysts the liberty to focus on their area of expertise full-time and publish what they recommend. We don't have to worry about displeasing advertisers. We only have to worry about publishing ideas you find valuable. This arrangement also allows us to spend about four hours a day working on something we give away for free: the Daily Reckoning.
But it all works out in the end. The DR is our chance to share with you the ideas you might not get anywhere else. For example, RBA governor Glenn Stevens is seemingly telling Aussie businesses to get used to a structurally higher Aussie dollar. Stevens reckons Australia's relationship China underpins the long-term strength of the Aussie dollar.
Maybe he's right! But we reckon the Aussie dollar is the quintessential 'risk asset'. It's by no means a 'safe haven' currency. And in the next 36 months, it could be a major casualty in the currency war between China and America. More on that next week. Until then…
for The Daily Reckoning Australia
From the Archives...
The Avalanche and the Phase Transition of the Financial System
2012-06-08 – Greg Canavan
A Financial Crisis that Repels Private Capital
2012-06-07 – Eric Fry
Floating Towards Japan's Economy on a Sea of Bad Debt
2012-06-06 – Bill Bonner
Pirate Politics to Save the European Union
2012-06-05 – Nick Hubble
China's Economy… Where All is Not As It Seems
2012-06-04 – Greg Canavan
If you already subscribe to The Daily Reckoning, or if you simply found what you read here interesting, then feel free to share our views and insights by posting them to your favourite network, blog or news feed:
- Americans Behind On Mortgage Payments
- RBA Buys $780 Million in Residential Mortgage-Backed Securities
- The Great Correction Continues on the US Housing and Mortgage Market
- Mortgage Backed Securities Put Our Financial System at Risk
- Subprime Loans Caused the Initial Illness, Option ARMs will Cause the Relapse
About the Author
Dan Denning is the author of 2005's best-selling The Bull Hunter (John Wiley & Sons). He began his financial publishing career in 1997 and has covered financial markets form Baltimore, Paris, London and, beginning in 2005 Melbourne. He’s the editor of The Daily Reckoning Australia and the Publisher of Port Phillip Publishing.