Australia’s financial regulators have been condemned as contributing to a “precarious situation” in which the housing market is “holding the rest of the economy to ransom”.
Lindsay David, founder of LF Economics, said in The Big Rort: A Mortgage Market Built on Deceit and Fraud that the Australian economy is “creaking under the weight” of historically high household debt and warned that a “fair proportion” will “never be repaid”.
Further, the analyst argued that the Australian Prudential Regulation Authority (APRA) and the Australian Securities & Investments Commission (ASIC) were culpable for their lack of regulatory enforcement and poor monitoring of mortgage control fraud.
He explained that mortgage control fraud is the practice of lenders intentionally defrauding borrowers by lending “far in excess” of borrowers’ ability to service the loan.
Referring to a number of Parliamentary submissions made by LF Economics, Mr David said there is “evidence to suggest the regulators have played a critical role in allowing mortgage control fraud to flourish" even in the face of consumer protection laws.
According to the founder, Australian lenders’ practice of measuring serviceability using a combined loan-to-value ratio (LVR), as opposed to an individual LVR, has allowed property investors to use earlier purchases as collateral to “extreme” levels.
He said: “Under these conditions, lenders produce guaranteed, exceptional short-term profits through a four-part strategy: extreme loan growth, high leverage, minimal loss reserves and declining underwriting standards.”
Labelling the phenomenon a “white-collar crime”, he added that the practice had reached “epidemic levels, especially in direct lending to high-risk borrowers and repackaging these loans into seemingly high-quality RMBS”.
Mr David said: “The unfortunate reality for victims of mortgage control fraud is that our regulators do not investigate allegations brought to their attention despite forensic evidence (paper trails) demonstrating evidence of fraud.”
A ‘house of cards’
Mr David said that the Australian “house of cards” has “ballooned”, courtesy of lenders issuing of loans against unrealised capital gains. He called it a “classic mortgage Ponzi finance model”.
“Based upon our research, LF Economics understands that many mortgages that are either delinquent or in default are those with an officially listed LVR in the 50 per cent to 70 per cent bracket at time of origination despite the actual loan size often being 90 per cent or larger.”
Pointing to a lack of regulatory enforcement and a “complete disregard” to the National Consumer Protection Act, Mr David claimed that housing sector participants “have been able to create an expanding house of cards by issuing interest-only loans to owners for the purchase of either an investment property or a new home for their adult children with very little or even no cash deposit.”
According to Mr David, Australia’s major banks have exhausted their risk profiles, and as such, there is an "increasing risk of the wholesale lending community eventually walking away from the Australian banking system”.
He warned that when Australian lenders’ mortgage control frauds, “Ponzi financing” and use of combined LVRs come to light, wholesale lenders will have “little alternative” but to pull back or charge higher premiums.
“Many international wholesale lenders — who assist in funding the banking system — may find out the hard way that they have invested into nothing more than a $1.7 trillion ‘piss in a fancy bottle scam’.”
CBA and Westpac are most at risk of a wholesale lender walk-off, he added, as their mortgage books are “the most overleveraged”.
However, lenders in general “carry the inevitable risk” that comes with lending in a “vastly overvalued” market, he said.
Regulators 'have failed to protect borrowers'
“Our financial regulators, ASIC and APRA, have failed to protect borrowers from predatory and illegal lending practices,” Mr David continued.
“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 founder concluded: “Despite many arguing [that] the Australian housing market resembles a ‘perfect storm’, it better resembles a fraudulent scam that more often than not only comes to light when it is too late. We have ASIC and APRA to thank for this.”
[Related: APRA limits ‘extraordinarily successful’]