Australia’s shadow banking Ponzi scheme

The Australian 12:00am May 26, 2018

Alan Kohler

 BEWARE: Australian Elites Shadow Banking Ponzi scheme. Negative Gearing a hidden VILLAIN

Non-bank lending in Australia is really big. How big? No one knows, although moves are afoot to find out — next year.

Australia’s version of shadow banking is based on four things that are special to this country — first, the fact that virtually all residential development is “build to sell”, as opposed to “build to rent”, as it is in the United States; negative gearing; the retreat of the banks from ­financing property development; and finally, immigration — lots of it.

In the absence of the banks, a huge industry has developed to funnel yield-hungry high-net-worth individuals’ and family office money into property development outside the banking system.

For most wealthy people, if not most people, the idea of putting money on bank term deposit at 2-3 per cent interest is ludicrous, so the banks simply don’t get the money.

They don’t want expensive money anyway, really: they have been making tons of easy, low-risk money taking a margin of 2 per cent or so on 25-year first mortgages that require very little capital, so why stress scrabbling for business that’s more demanding?

So high-net-worth individuals — not even all that high really — are getting 15 per cent or more secured by first mortgages on residential apartment developments, through non-bank operators that have been sprouting like mushrooms after rain in a paddock at Noojee.

It works because the property developers are paying interest rates of 20 per cent and more — sometimes much more — leaving fat margins for the non-bank lenders as well as high yields for the investors.

So why are those developers prepared, and able, to pay usurious credit card interest rates for their debt?

Because they flip the flats fast, usually off the plan before they’re built, and easily cover these short-term financing costs with the profits: 20 per cent interest for a year or two can be comfortably buried in the prices of the units.

It is made possible by the Australian custom of “build to sell” and is an absolute gravy train for all concerned: the “depositors”, the intermediaries and the developers.

Unlike in the US, rental properties in Australia are almost entirely owned by individuals — because of negative gearing. In the US, residential developments are “built to rent”, and owned as long-term investments by the institutions that fund the project — the same as office building and shopping centre developments are structured in Australia.

In America there is a lot of competition between building owners for tenants, which means the buildings are usually well-built, well-maintained and often have concierges and other services to attract good tenants.

Nothing like that here. The business model for apartments in Australia is for quick sales of individual apartments to individual or family negative gearers, with the cheapest possible construction costs.

The urban landscape is dotted with blocks of separately owned apartments where the interest on the debt is tax deductible against the owner’s salary as long as it’s “available to rent”. That means there’s little or no pressure to get the highest possible rent, or even to rent it at all. In fact the lower the rent, the bigger the tax-deductible loss which, in many cases, is the whole purpose of the investment.

And the thing that keeps the music playing in this game of musical chairs — or is it a Ponzi scheme? — is Australia’s high level of immigration, and the fact that all of the immigrants are cramming into east coast cities, increasing the demand for rental units.

And this huge shadow banking industry is almost entirely opaque and will be so at least until next year.

In the 2017 federal budget, as part of the government’s crackdown on banking that was designed to head off the calls for a banking royal commission (which eventually failed, of course), Scott Morrison announced plans to force
non-bank lenders to report to the Australian Prudential Regulation Authority.

That turned into a consultative process, then a draft bill and finally an actual bill, that was passed earlier this year. The new law will require non-authorised deposit-taking institutions to provide data to APRA by July 2019.

It also gives APRA a “reserve power” to make rules about their lending activities, “should these activities be determined to be materially contributing to risks of instability in the Australian financial system”.

The Treasurer said: “While the government is of the view that non-bank lenders are not materially contributing to risks at the moment, this APRA power is a new ‘tool on the shelf’ that APRA can use to manage risks should they emerge in future.”

Yes, well, that’ll be some time after July 2019. Better late than never.