Tighter Credit Controls
posted: Wednesday, 29th April 2009 - 12:21 • category: Business
Why Tighter Credit Controls is
Bad News for You
Wednesday, 29 April 2009 - Melbourne Australia
By Kris Sayce
Why Tighter Credit Controls is Bad News for You
We Have spent a lot of time looking at property recently. There's good reason for that. There are two bubbles left yet to burst in major economies.
One of them is the bond bubble in the US. The other is the property bubble in Australia.
Part of the reason for both is due to a massive increase in credit. In Australia part of the increase in credit has come from 'free money' from government bribes. Something we've consistently warned is distorting the market and priming the bubble even further.
You may think then, that the announcement late last week by finance minister Nick Sherry on tougher lending standards would meet our approval.
Actually, when we think about, you probably wouldn't think that at all - you just know we'd be against it.
Well, we are. But before I go into the details of why it's a bad move for consumers and how it will make the Australian finance market even less competitive, here's the background on what the new rules will cover...
According to the assistant treasurer Senator Nick Sherry:
"For the first time, Australia will have laws that prohibit irresponsible lending to consumers by all types of credit providers. This is a major enhancement to our consumer protection regime and is a decade overdue."
He goes on...
"Some families who can in fact maintain a reasonably sized mortgage are often saddled-up with more debt than they need and often more than they can repay. This can lead to losing everything and it just won't be tolerated anymore."
"The responsible lending laws will make it illegal for a lender, known as a credit provider, to extend credit for a consumer that is unsuitable based on their needs and their financial capacity."
"The laws will also make it illegal for brokers and other intermediaries, known as credit service providers, to suggest credit for a consumer that is unsuitable based on their needs and their financial capacity."
"The legislation will assist consumers to more confidently borrow money while limiting the risk of being saddled with unmanageable debts."
So, what's the problem with that? Surely there couldn't be anything wrong with making sure people don't take out bigger loans than they can afford to manage.
Here's the problem. This proposed legislation, as with most legislation ends up just creating more inconsistencies and more loopholes to be exploited. If you want to solve the problem of too much credit going to those that can't afford it, then you can only do this by offering a truly free market.
You see, there are two types of market - a free market, and an un-free market. In a free market there would be many banks and credit providers. The banks and credit providers would compete for business based on their own criteria.
They would set interest rates based on what they believe to be the credit worthiness of the borrower. Most credit providers would fall into the mainstream. They would offer 'average' market rates on borrowing, and average market rates to savers.
In addition you would get riskier and more conservative lenders. Just as you have riskier and more conservative savers and borrowers. At one extreme you would have the conservative banks. They would only lend to 'blue-chip' customers. Those that they perceive to have virtually no risk of default.
They would then be able to attract conservative savers. Those savers that don't want their deposits to be invested in credit default swaps, or collateralized debt obligations, or subprime mortgages - or dare we say it, first home-buyers.
Consequently the conservative savers would receive a lower rate of interest. But, in a normal free market that is what they would expect to receive. It's the age-old concept of risk-reward.
At the other end of the scale would be the lenders who are prepared to lend to much riskier borrowers. They would charge a higher rate of interest. They may require additional capital from the borrowers. And, these banks would be able to offer a higher rate of interest to savers - who would know that the bank lends to those with a higher risk of default.
But again, risk-reward. They know the risk, they are prepared to take that risk.
In an un-free market - which is what we have and this legislation is about to make even less free - arbitrary, non-commercial laws only serve to have the opposite effect to that which is intended.
This new regulations will have a number of knock-on effects. The obvious one is that it will impair competition. If there is to be a national one-size-fits-all approach to lending then it makes it very difficult for smaller competitors to offer something that is different.
It will merely consolidate the industry into the four major banks, plus their differently branded subsidiaries. Why do you think Westpac has been keen to keep the RAMS Home Loans name? It is to paint a false picture of competition when in fact the opposite is true.
Remember, it is not just the easy availability of credit that has caused the property bubble. It is prior intervention and distortions created by legislation and public policy that has caused it.
We've written extensively on them before - home-buyers grants, and government guarantees for the banks.
Without either of those, the major banks would have a greater incentive to be more careful with who they lend money to. In a free market, if they overland to those with inferior credit then they would suffer the consequences with higher defaults, lower revenues, lower profits and potentially a loss of deposits as risk averse savers take their money elsewhere.
It's unlikely the four-pillar banks will speak up against the proposal. And why should they. They are already in a market dominant position. They have little to lose and much to gain. And those that are able to borrow will find their borrowing costs pushed higher even though the risk to the banks is lower.
Besides, as the submissions to the Senate enquiry on the Australian Business Investment Partnership (ABIP or Fairy Ruddbank) show, they have cosied up nicely to the government.
And don't be fooled by the PR spin coming from the banks either. We noticed with amusement the headline, "Mortgage interest rate price war 'set to erupt'" on the News.com.au website.
The story quoted NABs head of mortgages, Steven Shaw saying ""In the lead-up to the new financial year we'll probably see more banks become competitive in the fixed-rate market."
It's a typical smoke and mirrors trick. We're all in favour of banks making profits. They have to. If they didn't they wouldn't be in business and we'd have nowhere to keep our money safe. But we're also in favour of competition.
Because it is only in a free and competitive market that the consumer (borrower and saver) can truly get the best price and best value for their money.
www.moneymorning.com.au
