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Will no one rid me of these evil moneylenders?

By Nicholas Gruen - posted Friday, 11 January 2008


Not only is life tough but you try finding a parking spot in a busy shopping centre. Whenever I do I can usually find some place where they could have fitted an extra parking spot. And pretty obviously if they’d have done so I could park there. Well actually I couldn’t. If there was an extra parking space, chances are it would be full too and I’d have to keep searching.

The housing affordability crisis is a bit like that. Of course if we can increase the supply of housing then we can all enjoy better housing. But when it’s in limited supply it has to be rationed. So if we increase the grants people get to buy houses, they’ll all bid against each other and end up back where they started. Well actually they’ll end up a bit further back than that - because the new arrangements involve churning money through government coffers for no good reason and some level of waste is inevitable.

I’m having to remind myself of my parking rage when I think of the growing community anxiety to stop all this predatory lending that’s driving people to the wall. You know the story. A comment by Graham Bell on a post on the sub-prime crisis and its implications for prudential supervision raised the issue.

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I’m not accusing Graham of anything so heinous, but I can’t help thinking of all those Jews sucking the blood out of Europe before Hitler sorted them out.

This idea that progressively laxer and ultimately predatory lending standards is trapping poor Australians - innocent Australians - into the current “mortgage stress” they’re in flies in the face of all the evidence I’ve seen in running a mortgage broker.

About a year or two into running Peach, “Doris” gave us a ring. She was a receptionist. She was earning an OK wage - I think around $35,000 a year gross and she was single. If I had been in her position I’d probably have been living in a group house and saving more of my pennies. But I wasn’t in her position. She had been working and renting for the previous five years and was paying - had paid throughout her tenancy - about 50 per cent of her income in rent. She had a deposit and wanted to borrow to buy a house. If you recall at the time rental yields in less posh areas were about 7 or 8 per cent which meant that she could finance the repayments on the mortgage for substantially less than the rent.

Being an economist, I had a naive faith that even though this wasn’t normal, it shouldn’t be too hard to persuade a lender to lend to her. Peach’s more prosaic General Manager was not impressed with my impression and convinced me that I was wrong.

I guess I shouldn’t have been that surprised. I already knew that despite a spotless 20-year credit history and plenty of equity, I couldn’t refinance my existing home mortgage. Because you see, having started a new business, I couldn’t “afford” the repayments. That is I couldn’t demonstrate current income sufficient to do so. I was happy if the bank took my house if I fell behind on payments, but no such luck. There were no takers despite the obvious stupidity of the situation - my existing bank never did any reviews of my ability to repay the loan.

Now there’s an urban myth out there that says that lending has become much more cavalier since then. But it’s only slightly true. Serviceability formulas of at least some lenders have become a little more permissive, and rightly so given reduced economic volatility and even more reduced volatility of interest rates. But only a little. It is true that acceptable loan to valuation ratios (LVRs) have risen (from 95 per cent to 100 per cent and higher if you want to pay much higher interest rates). However that’s because of increasing appetite for risk (or more probably a reduced assessment of the actual risks involved) from mortgage insurers. And since lenders are the main risk takers here, they won’t lend unless the whole package is serviceable.

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And despite what you’ve heard, even today, lenders against residential mortgages remain an overwhelmingly conservative bunch. They move very slowly and typically no one is “out there” innovating with any great gusto. They tend to move pretty much together defining “industry practice” (the practice to which they might be held accountable if someone defaults on a loan and a consumer lawyer argues that the loan was “predatory” and so unenforceable).

There’s an obvious reason lenders are conservative - like government regulators, there’s much less upside from making a good judgment (just the 2 per cent margin on the interest) than there is downside from getting it wrong (where you can lose 10 or 20 per cent of your capital without too much trouble).

And there’s government regulation. The Uniform Consumer Credit Code (UCCC) makes loans that people can’t afford unenforceable unless they are for investment. But if you think that the regulation is the main reason for the conservatism - think again. Lenders are actually more conservative lending for investment (where it’s pretty impossible to get an LVR over 95 per cent) than they are for owner occupation even though the UCCC requirements on serviceability only cover the former.

For all these reasons there’s very little risk taking or predatory lending against residential mortgages among Australian lenders. Still, Graham Bell says this:

Quite a few of those who become victims of low-doc “loans” could well be true dropkicks and absolute dills, real born losers, but the rest are both impoverished and very ambitious … a very dangerous combination in our troubled times. Do you imagine that some very nasty groups would neglect to seek out willing recruits from among those who have lost everything?

Sorry but your present discussion, necessary and interesting though it is, seems to me to be like rearranging the deck-chairs on the Titanic when there is a far more urgent and potentially hazardous issue to be tackled.

I wonder if Graham has tried to take out a low-doc loan - that is a loan on which income is not fully documented.

First, most of them have rates that are only about half a per cent above the discount rates available on fully documented loans.

Second, they are generally difficult to get without substantially more equity than those on full doc loans. More than 80 per cent LVR and your cost of money rises sharply and at 90 per cent the market is getting seriously expensive and thin.

Third, “low-docs” loans are still subject to the UCCC. The lender certifies their own income and if the amount they certify won’t service, the UCCC makes the loan unenforceable if the borrower defaults - i.e. it makes it commercially unviable (the spellchecker thinks “unviable” means “enviable” which gives you some idea of how widespread this moral panic is!). Anyway this kind of lending represents 15 per cent of the market in Australia and about the same in the US - where it’s not called “sub-prime” but “Alt-A” - sounds like a keypad shortcut. (If I press “Alt-A” in Word the “table” menu drops down - but I digress …)

There are also “no-doc” loans. It beats me as to why they’re more expensive when “low-doc” borrowers can lie about their income and if no-doc borrowers come with plenty of equity. But there you go. They are. And they’re expensive at 80 per cent LVRs and virtually impossible to get at LVRs over 85 per cent.

These are sometimes classed with “low docs” and sometimes with “non-conforming” loans. Non-conforming loans tend to be Australia’s equivalent of what the Americans call “sub-prime” loans. I used to think that banks overdid their abhorrence for those with credit defaults - I’ve certainly fallen for some sob-stories. Or perhaps they were legit. Stories of people living in group houses and moving out and finding that the people who’d moved in had made overseas calls on their telephone accounts etc, etc. Quite small defaults. Anyway, a recent study suggests that those with blemished credit records are five times more likely to default again - which doesn’t seem so surprising.

In any event, “non-conforming” loans are expensive and account for about 1 per cent of our home loan market - as opposed to the market share of “sub-prime” loans in the States of about 15 per cent!

So when I think of what’s happened in the market for housing loans I think back to that empty parking space - the one that would be handy if it were there, but which, if it were there would still have a car parked in it.

What has happened is that as money becomes available, people find themselves effectively bidding their own borrowing capacity against that of their neighbours. And so people with similar incomes each compete with others of similar incomes (or of lower incomes and higher risk appetites and/or stronger desires to consume now rather than later).

So those parking spaces are filling up - and people are feeling the pinch. There is an interesting case one might make that we could all do ourselves a favour by rationing credit. I’ve not read or thought much about it, but the argument would be that competing against each other for houses is like standing up to get a better view at the footy. In the end everyone stands up and everyone is worse off. A decent model would bring out the ways in which that analogy is revealing and ways in which it misleads.

But a moment’s thought would show the political impossibility of re-imposing credit rationing, of governments interposing themselves between willing lenders and willing borrowers and effectively robbing people of the ability to become home owners. For while credit rationing would help lots of people who have got a good sized deposit (by keeping down the price of houses), all those without such a deposit would be the ones from which the government confiscates the Australian dream. I don’t think so.

It’s so much easier to let off a bit of steam against those evil, bloodsucking moneylenders who are driving us all to our doom, and to call for community action - regulation - to stop this cancerous evil.

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First published at Club Troppo on September 29, 2007.



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About the Author

Dr Nicholas Gruen is CEO of Lateral Economics and Chairman of Peach Refund Mortgage Broker. He is working on a book entitled Reimagining Economic Reform.

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