Yesterday at the Senate Inquiry into bank competition John Symond, the household name behind Aussie Home Loans, gave the new banking reforms a roasting. Symond, the jocular non-banker renowned for his forthrightness, delivered on cue:
I'm disappointed that the Treasurer, in announcing his initiatives, has failed to consult with that sector that brought on competition, the non-banks ... who have been totally shut out of the current funding environment ... It wasn't the banking sector that brought competition, it wasn't the mutuals ... but to suggest the mutuals can become the fifth force in banking, quite frankly, is a joke.
As Symond says, the reforms contain a dark irony, but not the for the reason he suggests.
To understand why the joke is at the expense of the non-bank lenders we need some history. It was government intervention that got the non-banks into business.
In 1987, the New South Wales Government sponsored the formation of the First Australian National Mortgage Acceptance Corporation. At the same time, the Victorian Government established the National Mortgage Market Corporation.
Not to be outdone, the Queensland Government legislated the Secondary Mortgage Market Act to support a program for ‘originators’ in that state. One private provider was also founded to compete with the new government lending shops: MGICA Securities, a subsidiary of AMP Ltd.
These early initiatives came to grief in the bond market meltdown in the lead up to the recession of 1990–91. But the non-bank phoenix rose from the ashes in 1992 when John Symond founded Aussie Home Loans with the backing of Macquarie Bank, and John Kinghorn launched RAMS with the support of Citibank.
As with non-bank lenders in the United States, Aussie Home Loans and RAMS relied on investment banks to manage the securitisation process. From the mid 1990s they generated securities similar to the Wall Street MBS, called residential mortgage-backed securities (RMBS). The securities were generally bought by a mix of local and foreign investors. They were extraordinarily successful, seizing 7 per cent of the outstanding mortgage market by 2006.
The non-bank lenders had no regulator and no rules outside of regular trade practices and corporate law. And with investors globally becoming more accustomed to shadow banking, the standards that determined which Australians were creditworthy began to erode.
The non-bank lenders first introduced low-documentation or ‘low-doc’ loans in 1997, then ‘no-doc’ loans by 1999. Subprime or ‘non-conforming’ loans, given to people with bad or impaired credit histories, also proliferated in the late 1990s.
Subprime specialist non-bank lenders sprouted and issued subprime RMBS. These securities first appeared in 2000 and by the end of 2006 some A$6.8 billion had been sold. The market was growing at 150 per cent per annum and looked set to burgeon when the GFC struck.
This growing network of mortgage brokers held no deposits, had no reputational risk and was paid by fees for mortgage volume. In 2009, amidst the rising arrears rates for Australian RMBS, the highest levels of default were apparent within broker-originated loans.
Endemic malpractices included getting clients to sign blank declarations of affordability (and income if relevant) and then working back to how much the client needed to earn to afford the loan.
When the market was in its mania, there was little subtlety in this practice. Audits of the files would readily demonstrate differences in handwriting. Some remarkable outcomes eventuated. Elderly applicants, either retired or in blue-collar occupations, were claiming to have extraordinarily high incomes.
In 2005, GE Money introduced what it called a ‘sanity test’ to forestall these types of occurrences.
Another trick in the fraudster’s handbook was to put up the application as an investment loan (therefore getting the benefit of the potential rental income to augment serviceability) when it was clear that the application was actually for owner occupation. This went hand in hand with the practice of ‘necking kids’; that is, not declaring dependents to increase the applicants’ available income.
In 2007, the Federal Court ordered one mortgage broker to pay a former client A$32,000 in compensation after the broker falsified documents to ensure a A$365 000 mortgage for the 20-year-old, unemployed, dyslexic and homeless man. The same broker was in court for similar abuses in 2009.
To get the final punch line in the non-bank story we must turn to another comment from yesterday's Senate Inquiry proceedings from John Laker, Chairman of the Australian Prudential Regulation Authority (APRA). The head of Australia's most important banking authority made an appearance to endorse the recent position put by Glenn Stevens that competition, like chocolate, can be too much of a good thing:
I would caution that in the period 2002/2003, we did see quite strong competition in housing lending which took the form of a dilution of credit standards and that was a form of competition which we were uncomfortable with," he said.
"These are low doc loans for instance, not low doc loans per se but credit underwriting standards, no doc loans would be closer to the sort of concerns that we would have. They are add a competitive pressure to meet the customer by finessing overriding, changing strong credit standards, in some cases end up as an issue.
Thankfully, we now have a large slice of Australian mortages back on bank balance sheets where they can be monitored and reserved against. Which is where the RBA and APRA seem determined to keep them.
This post is in part adapted from The Great Crash of 2008, co-authored with Ross Garnaut