Citizens Electoral Council of Australia

Media Release Friday, 19 January 2018

Craig Isherwood‚ National Secretary
PO Box 376‚ COBURG‚ VIC 3058
Phone: 1800 636 432
Email: cec@cecaust.com.au
Website: http://www.cecaust.com.au

Australian banks in path of mortgage tsunami

Australia’s banks may soon be hit by a mortgage default tsunami like the one that struck the USA in 2007, which culminated in the September 2008 banking crash. The US tsunami began in the second quarter of 2007 when the initial “teaser” rate on sub-prime mortgages reset to much higher rates that the sub-prime borrowers couldn’t afford, triggering a wave of defaults. For Australia, 2018 is when many interest-only (IO) loans made in 2013 will reach the end of their five-year IO period and reset to interest plus principal (I+P), requiring much higher monthly mortgage payments. The potential defaults could be the trigger that blows out the housing bubble and crashes the banks—and leaves Australians at real risk of losing their bank deposits if the government succeeds in legislating new “bail-in” powers for APRA that can be used to confiscate savings to prop up failing banks.

IO lending in Australia grew from 30 per cent of all residential home loans in 2013, to close to 50 per cent by early 2017. This means more IO loans will reset next year, even more in 2020, and the most in 2021. This lending was essential to the extraordinary growth of the housing bubble in that time. As with US sub-prime mortgages, banks resorted to such reckless lending because it was the only way those borrowers could qualify for loans at the market’s unaffordable prices. After allowing this risk to build for four years, in March 2017 bank regulator APRA (Australian Prudential Regulation Authority) finally ordered the banks to cap IO loans to 30 per cent of new mortgages. But the damage was done, and now the economy must brace for the impact of more than $250 billion in IO mortgage loans resetting in the next four years.

On a 25-year mortgage of $500,000 at 5 per cent interest, the reset from IO to I+P will take monthly repayments from around $2,100 to over $3,300—more than $1,200 extra per month. That’s a catastrophe in the making when you consider the current state of affairs for most borrowers. The latest survey by finder.com.au in November 2017 revealed that an extra $100 per month in mortgage payments would be enough to push 54 per cent of homeowners over the edge. And a bombshell report by UBS in October 2017 showed that up to a third of borrowers with IO loans might not know they were interest-only!

Banking crash

As bad as this is for borrowers, it is an even greater threat to the big banks, which have the highest exposure to mortgages of any banks in the world—more than 60 per cent of their lending—and are already dealing with rising defaults.

The 2016 film The Big Short dramatises how in the second quarter of 2007 large numbers of US sub-prime mortgages started to reset from low “teaser” interest rates to much higher rates, triggering a wave of defaults. Eventually the defaults reached 7 per cent of mortgages, enough to crash the US housing bubble and render worthless the trillions of dollars of derivatives bets that had been laid on sub-prime mortgages. The resulting bankruptcy of the giant Wall Street bank Lehman Brothers and hundreds of mortgage lenders detonated the global financial meltdown in September 2008.

In the period that Australian banks have massively expanded their mortgage lending, from 30 per cent of their loans to more than 60 per cent—the highest concentration of such lending of any banks in the world—they have inflated the Australian housing market into a massive speculative bubble. APRA did not just allow the banks to do this; it incentivised them, by adjusting the risk-weighting of mortgages to make home loans super-profitable compared with all other types of loans. Like their US counterparts, Australia’s banks have gone on a derivatives gambling bender based on this mortgage lending, expanding their derivatives bets from $14 trillion in 2008, to $37 trillion in 2017, more than 20 times Australia’s GDP. A crash of the housing market will cause an implosion in this pile of derivatives contracts.

Bail-in vs Glass-Steagall

The danger underscores that the government’s bill to give APRA “bail-in” powers to prop up failing banks, which could include the power to bail in deposits, is not an academic exercise. With a banking crash a near-term possibility, this bill is a desperate move. The Financial Stability Board (FSB) at the Bank for International Settlements (BIS) in Switzerland, which is in charge of implementing a global bail-in regime, has identified that while Australia’s banks aren’t the biggest in the world, Australia’s collective banking system is “globally systemically important”, meaning a meltdown of Australia’s financial system and derivatives bubble is capable of triggering a knock-on meltdown of the global derivatives bubble and financial system. The APRA bill is intended to bring Australia into compliance with the FSB’s bail-in regime, so that Australian bank customers can be bailed in to avert bank failures and the financial instability that could trigger another global crash.

Australia is in the enviable position of being able to apply the lessons of the global crash in 2007-08, recognise the danger that is approaching, and take steps to address it in a way that benefits people, not corrupt banks. The solution is clear: reject any form of bail-in that makes innocent bank customers pay for the bankers’ recklessness and fraud, and implement a Glass-Steagall separation of essential banks that hold deposits, from all forms of speculation, including investment banking, insurance, stockbroking, and derivatives gambling. The USA’s Glass-Steagall Act of 1933 was the most successful banking regulation in history, protecting the US economy from any systemic banking crises for the 66 years it was in place until criminal Wall Street banks and corrupt politicians repealed it in 1999, leading to the explosion of speculation that blew up the global economy just nine years later. It is a clear solution, but it is up to the Australian people to rise up and demand this solution, so the government is forced to bend to the public’s will and not do the bidding of the banks as it usually does.

The CEC is leading that fight—join us today!

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