Part3: A big-short scenario for Australia has been getting a lot of attention this week. John Hempton, Bronte Capital‘s chief investment officer (a hedge fund) and Jonathan Tepper, an economist and founder of Variant Perception (an Independent Global Macroeconomic Research that presents itself as “contrarian investment analysis”) believe that Australia is heading to a scenario eponymous to the book and movie, which describe how the 2007 sub-prime crisis originated and how a few people saw it coming and made money betting on it.
After their thesis copied from the Australian Financial Review, and the opposite view from JP Morgan that says such a big-short scenario “will take years”, and that there is no way house prices will crash 50 per cent, here is another piece about the regulator ASIC who claims it’s got the Big Aussie short covered.
Who’s right? Only history will tell.
ASIC says it’s got the Big Aussie short covered
The Australian regulator with direct responsibility for tracking the risks of a “Big Short” style meltdown in the property market says last week’s controversial report on the topic was not news to him.
“It was interesting…it has not prompted us to open a new line of inquiry,” says Michael Saadat, the Australian Securities and Investment Commission’s senior executive for deposit takers, credit and insurers.
Mr Saadat was referring to a report by business analyst John Tepper and hedge fund manager John Hempton which argued that the Australian property market was a bubble similar to the US in 2007 and the industry was rife with reckless lending like that depicted in the film “The big short”which just won the Oscar for Best Adapted Screenplay.
Mr Saadat, who has two young children, says he has not yet seen the movie but he says that ASIC is dealing or has dealt with many of the issues raised in the “Big Short” report. In fact, last week ASIC had a consultation meeting for a review started last year into how mortgage brokers remunerate their salesman and whether excessive commissions encourage risky lending.
“Interestingly, in reading your coverage there was an article that was actually calling for a review of changes to broker remuneration structures. So again it’s quite timely that ASIC has just kicked off that review.” says Mr Saadat.
ASIC got interested early last year after Australian Prudential Regulation Authority data showed the the share of new mortgages that were interest-only had risen to a record of 43 percent in the March quarter and that loans were increasingly going to owner-occupiers rather than investors.
Mr Saadat says ASIC was worried that interest-only loans were being made to people who could not afford to pay normal principle-and-interest loans and would struggle once the interest-only period ended and they had to repay principle.
Mr Saadat admits ASIC did not send out a team to the western suburbs of Sydney to talk to taxi drivers and “shadow shop” as Tepper and Hempton did in their report but he says he used ASICs powers of compulsion and went through the front door. It examined about 140 loan files from 11 lenders and conducted site visits to the major banks.
The report published last August expressed disappointment with banks slack lending standards. In many cases, the only explanation in the files for why an interest-only loan was being made was the vacuous phrase “to purchase a property.” Banks also were not making enough effort to assess borrower’s ability to repay and often underestimated how much repayments would rise once the interest-only period expired and borrowers had to start paying back principle as well.
But the review found a few things that suggested most borrowers were reasonably able to repay their interest-only loans.
First in general the loans were mostly being made to better off clients.
Also loan-to-valuation rates were lower for interest-only loans which meant that borrowers had put down big deposits and if they had to sell they could clear their debt.
Another comforting sign was that owner-occupiers borrowers often had interest-only loans in conjunction with off-set accounts which meant they were effectively paying down the loan via their off-set accounts. Borrowers just wanted the flexibility to be able to redraw.
Still ASIC extracted from the banks a series of promises to improve their lending standards. “We are not too worried that they are going to go back on their word,” says Mr Saadat. Most banks have stopped selling loans with interest-only periods longer than 5 years.
In the meantime ASIC has started a review into mortgage brokers who sell a lot of the interest-only loans for the banks. ASIC will go through a sample of their loan documents and is also planning to get information on how they pay brokers. For instance they will match whether certain remuneration structures are linked to higher default rates.
That report is due by the end of the year. In the meantime interest-only loans as a share of total mortgages have fallen from 45 percent to 36 percent in the past six months and their dollar value has fallen by 11 percent in the past year.
“There are some really important structural differences between the Australian market and some other markets around the world. The regulation of consumer lending is different to other jurisdictions and has been for some time,” says Mr Sadaat who is a former head of consumer compliance at Citigroup in Australia. “It includes a number of conditions that are designed to promote responsible lending.”