'Liar loans' could spark mortgage crisis, says ASIC chief Greg Medcraft

A broken mortgage broker remuneration model and loose lending could trigger a subprime mortgage crisis, according to the the outgoing chief of the Australia’s corporate regulator.

Australian Securities and Investments Commission chairman Greg Medcraft said the situation in Australia was not comparable to the US subprime mortgage crisis, but said Australia should learn lessons from what happened in the United States.

Earlier this week, a UBS report said the amount of home loans extended based on "factually inaccurate" information is estimated to have reached $500 billion.

Medcraft said observations in the UBS report were consistent with ASIC's findings on responsible lending.

"It is amazing how people keep saying, 'It couldn't happen here'," Medcraft was cited as saying at a Reuters Newsmaker event by The Australian Financial Review.

"Thinking about the subprime crisis, [the] big issues were basically the issue of overstatement of income, understatement of expenses and overstatement of property values."

Factually incorrect mortgages on the banks' books were known as "liar loans" during the global financial crisis.

The UBS report suggested more borrowers were lying by under-representing their expenses and living costs. Borrowers were also over-stating income and assets and understating loans.

It said the level of liar loans meant the impact on the broader economy from a housing downturn was likely to be more severe than anticipated by the banks.

However, Finance Brokers Association of Australia labelled the UBS analysis "reckless" because the analysis was not based on UBS data or data from a bank or a lender.

In 2015, ASIC reviewed interest-only home loans and found 11 lenders, including the big four banks, had to change their home lending practices because they fell short of their responsible lending obligations.

The ASIC found that a majority of the lenders relied on indices to estimate the living expenses of borrowers rather than assess borrowers' actual living expenses.

In March, the regulator took Westpac to court, alleging the mortgage lender failed to properly assess whether potential borrowers could repay their home loans.

Medcraft said there could be more court cases of a similar nature in future.

He said irresponsible lending is facilitated because of the mortgage broker remuneration model which rewards brokers for securing larger loans for their clients.

"The mortgage commission is based on [the model] the larger their loans, the more you get. So logically what would you do?

"It's human behaviour. I'd do it," he said.

He said problematic aspects of the mortgage broker remuneration model included volume rebates, which are bonuses paid to brokers based on the overall volume of home loan sales.

 “Soft dollar" benefits, such as brokers' membership to loyalty programmes run by lenders which gives brokers improved service, were also a problem. 

The increased regulatory scrutiny has forced banks to tighten their lending practices in the past few months. 

In July, National Australia Bank has introduced tougher credit controls on new loans and reassessed its appetite for risk as household debt blows out to record highs.