Our cities will stop working without a decent national housing policy

From The Conversation.

We have to move the housing conversation beyond a game of political football about negative-gearing winners and losers. Australia needs a bipartisan, long-term, housing policy. Why? Because we have a slow-burn, deepening crisis that is affecting Australians who are already highly vulnerable and disadvantaged. They include:

The UN Rapporteur on Human Rights, following a visit in 2007, concluded that Australia was failing to deliver the fundamental human right of adequate housing because of the lack of any co-ordinated national strategy. Nothing has changed since 2007.

A failure to join the dots of housing policy

Our cities will stop working if we do not do something. A decent long-term housing policy is not just about the million or so Australians who are in housing need, marginal housing or homeless. In reality, housing demand and supply for all tenures is intricately connected.

Failed first-time buyers rent privately, increasing demand and rent levels. This pushes lower-income families towards social housing waiting lists and, at the end of the queue, those on marginal incomes are more likely to experience homelessness. Investors push out would-be home buyers by leveraging generous tax breaks that are not available to renters who are saving up to buy.

Rental affordability is worsening, including for key workers in our cities. First-time buyers are having difficulty entering an overheated market. We face the prospect of a permanent “generation rent”.

Changes in the value of new lending, 2008-2016

Changes in the value of new lending to investors, first-home buyers and subsequent buyers from December 2008 to March 2016. CoreLogic, ABS

More than 40% of people in private rental pay more than 30% of their income for housing – and this is after taking into account Commonwealth Rent Assistance. The 30% threshold is generally recognised as the level at which financial stress is experienced.

While states and territories have a wealth of experience and a clear role in delivery, the fact is the Commonwealth government must take a leadership role in co-ordinating national housing policy and connected programs across the four sectors of our housing system: home ownership; affordable private rental; social housing; and specific housing for Aboriginal, disability and homelessness needs.

It can be done; it has been done before. In 1945, Australia also faced a housing crisis. Despite skills and materials shortages and the financial difficulties of the post-war economy, the Commonwealth built 670,000 homes in ten years.

Decent housing underpins jobs, growth and productivity. Well-located, affordable housing is critical for preventative health, to provide a stable home environment for education and self-confidence, and for a productive workforce.

We need a national program of home building to meet the shortfall in all forms of housing. While this will not in itself resolve all problems, it is critical to a successful housing policy.

How much will it cost and where’s the money?

This is the subject of a new research report, Towards a National Housing Strategy, by Compass Housing working with a group of peak bodies, housing academics and community housing providers.

The Ache for Home report lays out a plan for a $10 billion social and affordable housing fund. St Vincent de Paul

To get the long-term benefits of decent housing, we must recognise that providing this has an up-front cost and we are in a tight fiscal environment. The Ache for Home Report estimates a A$10 billion housing bond could meet the needs of the 100,000 currently homeless people. Across all tenures, Australia could build 500,000 homes in ten years for an annual investment of $12.5 billion.

Even if the Commonwealth government took full responsibility for funding a national building program of such scale, the annual investment would equate to less than one-fifth of the current annual cost of capital gains (CGT) exemption on the main residence. The bonus of investment on such a scale could be the boost to the wider economy in which each $1 spent on construction created a $1.30 gain.

A national housing strategy would need to do two key things to raise the cash needed:

  • rebalance current tax settings to redirect money to where it is most needed; and
  • revise fiscal settings to attract more private capital into housing.

Innovative financial models have been developed internationally that can bring private finance to the table. The development of an arm’s length, government-funded financial intermediary to provide loan guarantees within a housing bond approach is one model with merit. It is used in the UK, the US and Europe.

Rebalancing subsidy arrangements across housing sectors means ring-fencing current housing support and redirecting it across the housing system. Reforms of capital gains tax exemptions and discounts, as well as negative-gearing concessions, are contentious, but are levers to improve housing supply.

CGT exemptions for the main residence cost taxpayers $54 billion in 2014-15. Nearly 90% of the benefit went to the top 50% of earners. And the costs are increasing. The CGT discount of 50% on capital gains, including investment properties, will cost $121 billion by 2018-19.

Negative gearing amounts to an average saving of $2,900 per year for the 1.2 million who claim. However, its impact on the budget means it costs the remaining Australians $310 per year each in tax that they would not otherwise need to pay.

Across these subsidies alone, a modest redirection would provide for a significant start-up fund for affordable housing, to be leveraged with private investment funds.

A national bipartisan approach would allow an independent review of all subsidies and recommend rebalancing options. It could also ease financial stress in the private rental sector by examining the current caps and levels of Commonwealth Rent Assistance to improve prospects for the many families where renting is a lifetime housing solution.

Without a national, integrated approach to housing, Australia will by default continue the mistakes associated with seeing the four sectors of the housing continuum as discrete and conditioned by different factors.

Authors: Ralph Horn, Deputy Pro Vice Chancellor, Research & Innovation; Director of UNGC Cities Programme; Professor, RMIT University;  David Adamson, Emeritus Professor: Social and Community Policy, The University of South Wales

 

How do Labor and the Coalition differ on NBN policy?

From The Conversation.

As hinted in earlier announcements by Shadow Communications Minister, Jason Clare, Labor’s much-anticipated policy for the National Broadband Network released Monday commits the party – if elected – to move away from the Coalition’s fibre to the node (FTTN) network and transition back to a roll-out of fibre to the premises (FTTP). This was the central pillar of Labor’s original NBN.

The FTTN roll-out will be phased out as soon as current design and construction contracts are completed.

This is a major shift away from the Coalition’s focus on FTTN technologies, which was a key part of their election platform in 2013. After a number of delays, FTTN equipment is now being rolled out around Australia.

Labor will continue with the Coalition’s plans to deliver NBN services on upgraded versions of Telstra and Optus’ hybrid fibre coax (HFC) infrastructure. No doubt Labor would like to move away from HFC, but the contracts for the HFC network are already signed, and it is probably too late to remove HFC from the NBN.

Apart from a commitment to deliver FTTP rather than satellite services to western Tasmania, there are no significant changes to the fixed wireless and satellite parts of the network.

Labor forecasts that its revamped NBN will be completed by June 2022, with FTTP being available to 2 million more homes and businesses than would have been the case under the Coalition’s current plans. At the completion of Labor’s NBN rollout, approximately 39% or around 5 million homes and businesses will have access to FTTP, compared to 20%, or 2.5 million, under the Coalition.

A 39% FTTP coverage is considerably less than the 93% target in Labor’s original NBN plan. But in a significant longer-term policy initiative, Labor has promised to commission Infrastructure Australia to develop a plan to upgrade the 2.5 million premises served by FTTN to FTTP. This will mean that all fixed-line connections in Australia will eventually be either FTTP or HFC.

Labor’s new policy recognises the possibility that new fibre-to-the-distribution-point (FTTdP) technologies might become attractive in the future, but has reserved judgement on FTTdP until the technology is more mature. NBN Co is already looking at this technology.

Significantly, FTTdP is compatible with FTTP and offers a straightforward upgrade path to FTTP.

Can NBN Co deliver Labor’s new network?

Labor has pointed out that NBN Co has an in-house FTTP design and construction capability as well as the IT systems necessary to manage FTTP. In addition, legal agreements in place with Telstra to provide access to Telstra’s ducts and pits.

In fact, in recent months, NBN Co has been rolling out FTTP (including fibre to the basement in multi-dwelling units) at a rate of about 10,000 premises per week. This has been underway at a time when NBN Co has been focusing on ramping up its FTTN and HFC rollout.

With a shift away from FTTN construction, and a shift of resources to FTTP design and installation, it is entirely feasible that NBN Co could double the rollout rate to around 20,000 premises per week. This would be more than enough to serve the 5 million premises targeted over the five-year time-frame of Labor’s roll-out plan.

Are Labor’s costings sound?

Labor has not published a detailed budget for its NBN plan. But the total estimated cost ($49 billion to $57 billion compared to the Coalition’s budget of $46 billion to $56 billion) appears to be plausible.

There are a few key factors that support this:

  • The cost of installing FTTP has decreased significantly over recent years, aided by new efficient construction techniques and new fibre cables with smaller diameter.
  • The ongoing operational expenditure needed to keep an FTTP running is considerably lower than for FTTN.
  • FTTP will remove the need to be repair and maintain Telstra’s ageing copper network, a cost that NBN Co currently bears.
  • As the demand for higher-speed services over FTTP grows, NBN Co will receive higher revenues from its FTTP network than its FTTN network. Labor claims this will increase the rate of return on the NBN investment from 2.7% under the Coalition to 3.9% under Labor.

What will be the impact of Labor’s policy?

Many critics have highlighted the severe limitations of the Coalition’s slow-speed FTTN network and its relative inability to drive digital innovation.

The pace of FTTP roll-outs around the globe is increasing as other countries recognise the critical importance of super-fast broadband to economic growth.

AT&T, a major United States telco has essentially stopped constructing FTTN networks, and has announced a major increase in FTTP deployments in response to customer demands for higher speed.

In Australia, the Coalition’s FTTN exacerbates the “digital divide”, the gap between broadband haves and have-nots. Here’s how.

  • Those homes and businesses lucky enough to be served by FTTP can access very-high-speed internet now and even higher speeds in the future. Meanwhile, those premises stuck with FTTN will struggle with lower speeds and find that their connection is obsolete within a few years.
  • For those customers with FTTN connections, the speed of their service will be affected by their distance from the node. The greater the distance, the lower the speed.
  • The Coalition’s technology choice program enables FTTN customers to pay for an upgrade to FTTP, but at a cost depending on the distance from the node. A business that needs FTTP and is some distance from the node may have to pay $5,000 or more for an upgrade, while another business close to the node would pay considerably less.

The NBN has been a key issue in the past two elections, so will Labor’s new policy be a vote winner? The policy to move back to FTTP provides a clear differentiation from the Coalition’s FTTN-centric strategy.

Many Australians recognise the importance of super-fast broadband as a driver of innovation in the digital economy, and will no doubt think of this on July 2.

Author: Rod Tucker, Laureate Emeritus Professor, University of Melbourne

Insider trading is greedy, not glamorous, and it hurts us all

From The Conversation.

Much of the focus on the insider trading case of Oliver Curtis has been on the titillating details of the man’s social life, his wife and past relationship with his partner in crime John Hartman. However all this misses the point, it’s not about what the pair gained and stand to lose from the insider trading, it’s what we all lost.

Last week Curtis was found guilty of insider trading. His unethical behaviour hurts your retirement wealth and damages the integrity of our investment systems. It’s true that he wasn’t an “insider” to the companies he was trading. He had no knowledge of CEO and Board decisions or other company-specific material price-sensitive non-public information.

Rather, Curtis was receiving non-public information about buying and selling taking place at a friend, John Hartman’s, funds management firm. The firm Hartman worked for, Orion Asset Management, managed around $6 billion of funds at the time and the trades Hartman was privy to were often sufficiently large to affect prices.

The illegal trading took place through 45 buys and sells of “contracts for difference’ (CFDs) between May 2007 and June 2008. In simple terms, CFDs are securities which allow the holder to bet on stock gains and losses.

Most trades don’t affect prices, in a way that most fish don’t create waves. Large value ‘block’ trades though can impact prices like a humpback whale breaching.

Curtis was “front-running” these large trades using CFDs. Front running is a practice of placing orders ahead of upcoming block trades in order to benefit from the anticipated up or down movement it will have on the stock price. ASIC estimated the net profits Curtis made through this strategy amounted to over $1 million.

What’s the problem?

While there are legal forms of front running and insider trading, the kind of trading undertaken by Curtis is illegal for good reason. It is widely considered unethical, adds to the costs of investing, and destabilises core financial systems.

It is hard to believe Curtis and Hartman did not know they were breaking the law, particularly given Hartman’s testimony and the unambiguous wording. The ethics of insider trading, however, can be more complex.

In 1990, Jennifer Moore argued that the key ethical considerations are: fairness, ownership of property rights, and harm. Curtis was unethical in each of these ways.

Curtis and Hartman took advantage of an unfair access to information that the rest of the market didn’t have about large pending trades. Hartman’s employer owned the rights to that information and did not grant permission for that information to be shared.

While there appeared to be no victims, front running reduces the potential profits for those outside the illegal trade. In other words, other market participants were disadvantaged.

That disadvantage translates to added costs of investing and lower returns for everyone else. That includes the $350 billion of ordinary Australians’ superannuation wealth tied up in ASX traded securities.

This is the first major point that has been lost with the misdirected focus on the socialite’s Instagram pages.

Destabilising the system

The second and even more critical risk, however, is the potential erosion of the integrity of our financial systems. Lawful investors may shift their portfolios to other markets if they consider that there may be other illegal insider traders like Curtis still out there. Why play in system rigged against you?

One argument thrown up as a defence for insider trading is that if the insiders bring information to the market sooner, then prices will be more efficiently priced. There is little empirical evidence to indicate this works in reality.

Stock price efficiency is based on what is known about a company. Prices are most efficient when they reflect all known information, and “discovering” this efficient price is when new information (such as earnings announcement, CEO retirement, etc) becomes known.

Recent research on this topic in the U.S. found that insiders benefit for themselves with little of their inside information spilling over to benefit the public through more efficient prices. Strict regulation deters illegal insider trading with minimal adverse impact on this price discovery process.

The unscrupulous will continue to pursue ways to counter regulations. Recent studies detecting shifts in informed trading away from more heavily monitored equities markets to derivative and bond markets (which currently have less public data monitoring) point to this.

The public should expect more from those managing their wealth. Glamourising the lifestyles of those who have broken the law and acted unethically damages the good work being done by many others in our financial institutions. Illegal insider trading is not a victimless crime and we should not let tabloid distraction make us forget that.

Author: Danika Wright, Lecturer in Finance, University of Sydney

Is small business really the engine room of Australia’s economy?

From The Conversation.

It seems that in Australian politics – and this campaign in particular – everyone loves a small business.

Just before this year’s federal budget, Treasurer Scott Morrison said of small businesses: “they are the hope of the side.” Somewhat less pithily, but no less adoringly, Labor’s official policy on small business declares:

“Small businesses make a huge contribution to national prosperity and supporting Australian jobs. Small businesses play a central role in the economy. Over 2 million businesses – sole traders, partnerships, trusts and small employers – have helped underpin 25 years of economic growth.”

In fact, the only thing the major parties seem to disagree on is whether a small business has less than $2 million in annual revenues (the Labor definition) or less than $10 million (the Coalition definition).

But do small businesses, for desperate want of a better term, create “jobs and growth”?

The first relevant fact is that small businesses employ a lot of people. According to figures compiled by Saul Eslake, and discussed in a terrific piece by Adam Creighton in The Australian, business that employ fewer than 20 people account for roughly 45% of private sector employment.

Businesses with 20-199 employees account for about 25%, and businesses with 200+ employees, around 20%.

So small businesses are important employers. Check. Only problem is, they haven’t created a lot of jobs in the last five years. As Creighton pointed out, those small business created 5% of the growth in private sector employment since 2010, while businesses with more than 200 employees created 65% of that growth.

In one important sense, this should not be surprising. When looking at the landscape of firms of different sizes, existing firms exhibit what economists call “survivorship bias”. The very fact that a firm exists today means that it was created, and succeeded.

Big firms were created and really succeeded. So it’s likely that today’s big firms are, on average, more successful than today small firms at, well, getting big. And the way that happens is by, you guessed it, employing more people.

So much for the positive political economy of why politicians are desperate to ingratiate themselves with small businesses. There are a lot of them, hence a lot of potential votes.

But the real question, of course, is what tax policy should be. The Labor party wants to cut the company tax rate from 30% to 25% only for businesses with less than $2 million turnover. The Coalition wants to do that for all businesses, but over 10 years. In the medium term both parties want to cut taxes for mainly for small businesses, albeit to varying degrees.

To answer that question, we first need a quick primer on why everybody (at least until very recently in some cases) agreed that cutting company taxes help workers and the economy more broadly.

Roughly speaking, the amount of “stuff” produced in the economy depends on two inputs: capital and labour. Lowering the company tax rate attracts more capital – especially since Australia is a small, open economy. More capital means more stuff because capital is useful in production.

Moreover, more capital means that the marginal return to more labour goes up, too. That is because, generally speaking, capital and labour are complements in the production process. More of one makes more of the other more valuable at the margin.

Aside: forget all the jibberish you have recently read about dividend imputation and franking credits. That’s a second-order issue – the key is the complementarity between capital and labour.

This increased marginal return to labour means more jobs and higher wages–capital made labour more valuable, and labour captures some of that benefit. This is why Treasury has estimated that two-thirds of the benefit from a cut in company taxes flows to workers.

Now, do small businesses or big businesses use more capital? Answer: big businesses (See here, page 3). So it is big businesses that will increase the amount of capital they use the most from a cut in company taxes. And it is big businesses that will thus drive more employment growth and higher wages.

To sum up. Small businesses employ lots of people. But they haven’t driven much of the job growth in Australia over the past five years. And a company tax cut won’t cause them to stimulate employment as much as it will for bigger businesses.

We should cut company taxes, and we should cut them for all firms. But it makes no sense to favour small businesses over bigger ones.

That’s the economics of the matter. What we are witnessing in this election campaign – on both sides – is pure politics.

Author: Richard Holden, Professor of Economics, UNSW Australia

Will Australia’s digital divide – fast for the city, slow in the country – ever be bridged?

From The Conversation.

This week the Productivity Commission released an issues paper as part of an inquiry into the adequacy of Australia’s Universal Service Obligation (USO) for telecommunications, in light of changes in technology and demand.

The USO was formulated in a different age when the internet was in its infancy. Today, its requirement to provide access to standard telephone services and payphones to all Australians is akin to mandating the availability of horse and buggies by carmakers operating in the age of the Tesla.

Indeed, Australia’s USO probably needs to be considered in the light of a largely converged and complex telecommunications environment.

The issue is shaping up as a sleeper in the current federal election, especially in the bush. During Tuesday night’s episode of Q&A, telecast from regional Tamworth (400 km north of Sydney), the issue featured prominently. Tony Windsor, who is running as an independent candidate against deputy prime minister Barnaby Joyce in the seat of New England, received the biggest cheer of the night when he said of telecommunications infrastructure: “do it once, do it right and do it with fibre”.

City dwellers might be forgiven for thinking that this is the latest, high-tech version of the “whingeing farmer” syndrome. They would be wrong. Rural Australia has very real and legitimate concerns regarding the growth and probable permanency of the digital divide.

For many years regional Australians have had to contend with demonstrably inferior internet speed and reliability than their fellow Australians. This problem is compounded by the fact that their need for broadband services is greater than their urban cousins due to the importance of broadband for education, healthcare and business.

These additional connectivity requirements are increasing exponentially as technologies like Smart Farming, remote sensing and genomics create vast amounts of data. These are agricultural examples of the Internet of Things – an emerging paradigm that promises huge improvements in agricultural efficiency and environmental management, but requires constant and unconstrained internet access.

Like most public policy dilemmas, it’s all about money. Labor’s initial policy was full Fibre to the Premises (FTTP – the Rolls Royce option) but its policy these days is looking increasingly similar to the Coalition’s – with both looking quite different from Tony Windsor’s “do it with fibre” admonishment.

It has been estimated that the full FTTP option to all (or the vast majority) of Australian homes and businesses would cost an additional $30 billion. In the context of Australia’s current and likely future fiscal situation, this has been seen in Canberra as too much to spend.

The reality on the ground (or in fact in orbit) is the NBN’s Sky Muster satellite (launched in 2013 and switched on this month, with another launch soon to follow). According to an NBN spokesperson, there are 600 technicians connecting homes as fast as they can and by mid-year 2017 around 85,000 premises will be connected.

This multi-billion dollar investment certainly improves internet access for rural and remote Australians but it also sets a constraint as to what regional Australians should expect in the future.

Sky Muster is decidedly akin to a Holden Commodore (but at least not a Kingswood) in comparison to the FTTP’s Rolls Royce. It’s fair to say rural users are generally much happier with these new services than the historical interim arrangements. However it is also clear that what Sky Muster offers will be inferior to what is being offered in the cities, potentially cementing for the foreseeable future regional Australia’s “second class” status.

The essential problem with Sky Muster and similar satellites are their innate physical limitations. While this is true of all network technologies, there is real concern that user demand, especially at peak times, will quickly overwhelm the satellites’ capacities creating the need for ISPs to shape user download speeds.

One consequence of this will be downtime for important synchronous activities like e-conferencing and the like, but also a lack of functionality in the emerging IOT systems that require an unconstrained, always-connected network state.

Another problem relates to cost. Urban consumers are used to paying around $100 per month for unlimited and relatively reliable broadband complementing fast 4G cellular when they are away from home. Early Sky Muster plans are slower and offer far less data, especially during peak times when people are actually awake.

Rural communities are rightly concerned that the launch of Sky Muster may well be as good as it gets. While this is clearly better than what the country people have had, the divide between the bush and the cities in this and other areas is seemingly becoming wider and more permanent.

So, as the Productivity Commission grapples with the question of what the USO should look like in 2016 it will really need to consider what it should look like in a decade or two. This question will challenge the Commission’s rationalist economic predilections.

The answer relates not so much to the current and future economics of accessing the internet but more so the nature of fairness in Australia. The key question is how willing we are as a nation to see rural Australia fall further behind the cities in this fundamental aspect of our national infrastructure.

Authors: John Rice, Professor of Management, University of New England; Nigel Martin, Lecturer, College of Business and Economics, Australian National University

 

It’s time we broke up the retail arms of Australia’s Big Four banks

From The Conversation.

The idea of separating out the arms of the “Big Four” banks like insurance and superannuation from their core banking business is gaining traction in Australia. It featured in the Greens’ banking and finance election policy. However this is not a new idea; Australia is just catching up to banking reforms already made by the UK.

The proposals by the Greens are, in international terms, actually quite tame. The Greens talk about “looking at breaking up the banks,” rather than actually breaking them up. They also suggest applying a “tax deductible levy of 0.20% on the asset base of institutions worth greater than $100 billion” on the “too big to fail” Big Four.

Other jurisdictions have gone much further than the Green’s proposals. For example, following the recommendations of the Vickers’ Inquiry into the UK banking system, banks with assets over £25 billion, will be required from 2017 to split off their retail banking activities into separately managed entities that can be floated off, if the holding company goes belly up. Similar rules are also to be enacted throughout the European Union.

Far from local banks being well-regulated, the latest research on managing systemic risk by the Bank of England shows that Australian banks are simultaneously extreme outliers, in regards to size relative to GDP, yet among the lowest of their peers as regards capital requirements. This is extremely risky, especially given the banks’ exposure to the Australian housing market.

The Australian taxpayer is providing a guarantee for such risky behaviour which the Reserve Bank estimates to be worth some $3.5 billion per year to the big four banks.

One of the Green’s proposed considerations is to investigate:

“The nature of vertically integrated business models, including: i. the integration of everyday banking, financial planning, wealth management and insurance within a single entity; ii. whether the incentives provided encourage illegal or unethical conduct; and iii. whether the incentives provided are aligned with the duty of care to customers.”

This term “vertical integration” is a classic illustration of the problems that arise in so-called Universal Banking. The concept of Universal Banking, sometimes called a “financial supermarket”, in which many financial services are sold under the one roof, goes back to the 19th century in Germany.

This is where German banks not only took deposits and made loans, but also funded and even made equity investments in companies. This one-stop shop was credited with helping to make Germany an industrial superpower in the late 19th century.

On the other hand in the UK and USA, there was strict separation of retail banks and so-called investment (or merchant) banks. In the USA, this separation was enshrined in the famous/infamous Glass Steagall Act of 1933 which was an outcome of the Pecora Commission into the Wall Street Crash of 1929.

In the UK, a strict separation lasted until 1984, when the Thatcher government implemented the so-called Big Bang, which broke down the barriers between commercial and merchant banks. Subsequently, there was a massive consolidation of banks, merchant banks and eventually building societies.

US banks, such as Citicorp and JPMorgan, joined in the takeovers of UK firms even though technically it was still forbidden in the USA. However in 1999, after pressure in the industry and with almost unanimous congressional support, the Glass Steagall Act was repealed and the concept of a one-stop shop for financial products became the accepted business model around the world.

In Australia in the year 2000, NAB acquired MLC Life Limited, which was the insurance and investment arm of Lend Lease. Soon afterwards the other big three Australian banks followed suit, acquiring investment firms and insurance companies. For example, Colonial Mutual insurance was acquired by the Commonwealth Bank to become its scandal-ridden CommInsure subsidiary.

The prevailing model of Universal Banking in Australia is barely 15 years old.

Why did Universal Banking become the accepted model around the world?

There are two arguments usually put forward for Universal Banking: economies of “scale” and economies of “scope.” The argument for scale is, the bigger a bank is, the better it can leverage its resources, especially expensive technology. The more depositors a bank has the more money it can lend and in a sort of virtuous circle, the more depositors the bank can attract, always provided that the banks treat their depositors fairly, of course.

Scale is important. For comparison, the largest retail bank in the world by market capitalisation is the US based Wells Fargo bank which has some 70 million customers worldwide, mainly in the USA. That is about three times the population of Australia.

Last financial year, Wells declared net income of around A$30 billion (US$ 22.9 billion) which is almost identical to the total declared by the Big Four banks. On a per customer basis then, Wells appears not to be as efficient as Australian banks, or just possibly Australian customers may be getting a very raw deal from their banks.

Economies of scope means that a bank, using its presence in the market, can expand the products it sells to existing and new customers. This so-called cross-selling is infuriatingly obvious in Australian banks.

Under a universal banking system banks are offering customers other types of products, they may or may not want. Alan Clark/Flickr, CC BY-ND

An example of this is a consumer, when attempting merely to pay in a cheque, can be bombarded with questions about whether they would like insurance with that. It is a form of diversification, expanding and hopefully stabilising sources of income.

In pursuit of scope, the largest Australian banks have all acquired investment management and insurance companies, bundling these acquisitions up into fashionable “Wealth Management” units. According to KPMG, these units provided a 25% of the Big Four’s profits in 2015. The problem is that the Big Four banks have proved to be not very good at “wealth management.”

The original reason for diving into the wealth management business was the pot of gold that is Australian superannuation, which is growing year on year through mandatory contributions and today sits at just over A$2 trillion – who could lose? Certainly not the superannuation funds managers.

But could they outperform others? Unfortunately not, as the largest bank-owned retail funds consistently underperform not-for profit industry funds – not really surprising as industry funds operate on a not-for-profit basis.

And all the while, people are deserting the retail sector in droves to run their own Self-Managed Superannuation Funds (SMSFs). In 2016, self-managed assets total some A$592 billion or 30% of the total super pot of just over A$2 trillion, exceeding the retail sector and growing each month.

If the prospect was only ever little more than a pipe-dream, it became a nightmare as pensioners lost their savings in the GFC, created incidentally by banks. And today the prospect of even the middle class living in poverty in retirement has become a reality. In Australia, with the average super balance for men at retirement being just less than $300,000 (much less for women), ASFA, the industry body for super funds, concludes that” many recent retirees will need to substantially rely on the Age Pension in their retirement”.

Is the rationale for seeking economies of scope still valid?

Technology has changed everything. In the 20th century, people still went into banks to withdraw or deposit money, to make payments, to ask for a mortgage or to talk about investments.

It was quite possible then for the banks to catch customers at the counter and sell them something they may not want or need but nonetheless may be good for them, like an insurance policy.

But a lot of people don’t go to banks much anymore. They get cash when they check out at the supermarket.

They visit websites or mortgage brokers when they are looking for a mortgage. They search websites that compare deposit and investments offers, and there are a myriad of ways that people can pay bills or make payments for online goods.

People are deserting bank branches for the internet and the importance of face-to face contact and opportunities to cross-sell have diminished.

If there is no pot of gold at the end of the Wealth Management rainbow for banks nor their customers, then the boards of Australian banks must look to strategies other than Universal Banking.

Unfortunately, the subject of banking reform was not addressed fully by the Financial Systems Inquiry, headed as it was by the architect of CommBank’s vertical integration strategy, and the subject has since become a political football.

The Green’s policy would be seen as a minimum and meek in most other jurisdictions, while the industry’s response is shortsighted and defensive. The subject is too important to be trapped in this stalemate.

Author: Pat McConnell, Honorary Fellow, Macquarie University Applied Finance Centre, Macquarie University

Sydney’s wild weather shows home-owners are increasingly at risk

Last week we highlighted the timely new report from the Climate Institute, which warned of the consequences of more violent weather on property for owners and their bankers. Just five days before the super storm hit!

From The Conversation.

Eastern Australia’s wild weather has left coastal homes teetering on the brink of collapse, and has eroded beaches by up to 50m in parts of Sydney.

Now the attention turns to the clean-up. There are several legal issues for owners of damaged properties, particularly the question of if and how they can be compensated.

While the recent events cannot be attributed directly to climate change, they are certainly consistent with a warming world. Our institutions are ill-prepared for a potential increase in the frequency and severity of such events.

Insurance

Unfortunately, the success of insurance claims for damaged homes in Sydney will depend entirely on the terms of their policies. Some policies don’t cover erosion at all. Some policies only cover it if it occurs within a certain proximity of another insured event (for example, within 48 hours of a named storm event). Some policies also comprehensively exclude coverage for damage caused by actions of the sea.

What’s more, while insurance will cover damage to buildings, policies do not extend to cover damage to or loss of land. This is especially problematic in the case of damage caused by waves and storms, because erosion will often result in loss of land.

Under the traditional law doctrine, where land is lost to erosion, the Crown automatically gains title to the inundated land, without any obligation to pay compensation. So even if a home-owner is insured, they may find themselves with no land to rebuild on.

Legal proceedings

Another potential avenue for home-owners to pursue is proceedings against the relevant local government for negligent approval of development. The success of this type of proceeding is highly speculative – much will hinge upon when the development was approved and how much information on the coastal hazards was available at that time.

Where development was approved decades ago, it may be difficult to prove that a local government was negligent, because of the limited state of knowledge at the time. In the case of more recent development approvals, there may be an argument that a local government had a high level of knowledge of the risk and control of risk information. These are the type of factors a court will look at in assessing negligence.

On the flip side, a court may also find that a landholder knew of and accepted the risk. Negligence proceedings are by no means a guaranteed avenue for landholders to recoup their loss, but are an avenue that Collaroy landholders may be able to explore.

Disaster assistance

Where insurance is not available, and there are no strict legal rights against government, landholders may request disaster relief or assistance from government.

Despite the lack of any legal compulsion to do so, Australian governments have a long history of providing disaster relief to citizens when an extreme weather event causes property damage.

A recent Productivity Commission report estimated that, over the past decade, the federal government spent A$8 billion on post-disaster relief and recovery. State governments spent a further A$5.6 billion.

However, the availability and amount of a payment are not guaranteed. This may depend upon the number of other claims for assistance, and any other demands on government resources. A claim for disaster relief from government may be an option for Collaroy landholders, but many other home-owners are also affected by flooding due to the recent extreme weather – and so potentially there are many other requests for relief.

What should we learn from this event for the future?

While the pictures of houses being lost to the sea in Collaroy are confronting, these images may become more commonplace. The most recent scientific report from the Intergovernmental Panel on Climate Change suggests that, under a business-as-usual scenario, a global sea-level rise in the range of 0.53-0.97m by 2100 is likely.

Even if emissions are immediately reduced, a global sea-level rise of 0.28-0.60m by 2100 is still possible. This will be especially problematic in Australia, with an estimated 711,000 residential addresses located within 3km of the shore and less than 6m above sea level – not to mention the billions of dollars’ worth of government infrastructure also located in these regions.

As sea levels rise, some properties may be permanently inundated. Others may be hit by storm surge impacts or erosion, which may be exacerbated by sea-level rise.

If these events continue to attract disaster relief, the financial burden will become too great for governments to bear. Furthermore, government disaster assistance does not solve the more intractable problem of land being lost to the sea.

The pictures from Collaroy should therefore prompt a discussion about how we, as a society, can deal with the potential impacts of coastal hazards on existing developments.

This is a challenging question to answer, but there is an opportunity to address it in a planned and co-ordinated fashion.

Author: Justine Bell-James, Lecturer in Law, The University of Queensland

Limiting access to payday loans may do more harm than good

From The US Conversation.

One of the few lending options available to the poor may soon evaporate if a new rule proposed June 2 goes into effect.

The Consumer Financial Protection Bureau (CFPB) announced the rule with the aim of eliminating what it called “debt traps” caused by the US$38.5 billion payday loan market.

But will it?

What’s a payday loan?

The payday loan market, which emerged in the 1990s, involves storefront lenders providing small loans of a few hundred dollars for one to two weeks for a “fee” of 15 percent to 20 percent. For example, a loan of $100 for two weeks might cost $20. On an annualized basis, that amounts to an interest rate of 520 percent.

In exchange for the cash, the borrower provides the lender with a postdated check or debit authorization. If a borrower is unable to pay at the end of the term, the lender might roll over the loan to another paydate in exchange for another $20.

Thanks to their high interest, short duration and fact that one in five end up in default, payday loans have long been derided as “predatory” and “abusive,” making them a prime target of the CFPB since the bureau was created by the Dodd-Frank Act in 2011.

States have already been swift to regulate the industry, with 16 and Washington, D.C., banning them outright or imposing caps on fees that essentially eliminate the industry. Because the CFPB does not have authority to cap fees that payday lenders charge, their proposed regulations focus on other aspects of the lending model.

Under the proposed changes announced last week, lenders would have to assess a borrower’s ability to repay, and it would be harder to “roll over” loans into new ones when they come due – a process which leads to escalating interest costs.

There is no question that these new regulations will dramatically affect the industry. But is that a good thing? Will the people who currently rely on payday loans actually be better off as a result of the new rules?

In short, no: The Wild West of high-interest credit products that will result is not beneficial for low-income consumers, who desperately need access to credit.

I’ve been researching payday loans and other alternative financial services for 15 years. My work has focused on three questions: Why do people turn to high-interest loans? What are the consequences of borrowing in these markets? And what should appropriate regulation look like?

One thing is clear: Demand for quick cash by households considered high-risk to lenders is strong. Stable demand for alternative credit sources means that when regulators target and rein in one product, other, loosely regulated and often-abusive options pop up in its place. Demand does not simply evaporate when there are shocks to the supply side of credit markets.

This regulatory whack-a-mole approach which moves at a snail’s pace means lenders can experiment with credit products for years, at the expense of consumers.

Who gets a payday loan

About 12 million mostly lower-income people use payday loans each year. For people with low incomes and low FICO credit scores, payday loans are often the only (albeit very expensive) way of getting a loan.

My research lays bare the typical profile of a consumer who shows up to borrow on a payday loan: months or years of financial distress from maxing out credit cards, applying for and being denied secured and unsecured credit, and failing to make debt payments on time.

Perhaps more stark is what their credit scores look like: Payday applicants’ mean credit scores were below 520 at the time they applied for the loan, compared with a U.S. average of just under 700.

Given these characteristics, it is easy to see that the typical payday borrower simply does not have access to cheaper, better credit.

Borrowers may make their first trip to the payday lender out of a rational need for a few bucks. But because these borrowers typically owe up to half of their take-home pay plus interest on their next payday, it is easy to see how difficult it will be to pay in full. Putting off full repayment for a future pay date is all too tempting, especially when you consider that the median balance in a payday borrowers’ checking accounts was just $66.

The consequences of payday loans

The empirical literature measuring the welfare consequences of borrowing on a payday loan, including my own, is deeply divided.

On the one hand, I have found that payday loans increase personal bankruptcy rates. But I have also documented that using larger payday loans actually helped consumers avoid default, perhaps because they had more slack to manage their budget that month.

In a 2015 article, I along with two co-authors analyzed payday lender data and credit bureau files to determine how the loans affect borrowers, who had limited or no access to mainstream credit with severely weak credit histories. We found that the long-run effect on various measures of financial well-being such as their credit scores was close to zero, meaning on average they were no better or worse off because of the payday loan.

Other researchers have found that payday loans help borrowers avoid home foreclosures and help limit certain economic hardships.

It is therefore possible that even in cases where the interest rates reach as much as 600 percent, payday loans help consumers do what economists call “smoothing” over consumption by helping them manage their cash flow between pay periods.

In 2012, I reviewed the growing body of microeconomic evidence on borrowers’ use of payday loans and considered how they might respond to a variety of regulatory schemes, such as outright bans, rate caps and restrictions on size, duration or rollover renewals.

I concluded that among all of the regulatory strategies that states have implemented, the one with a potential benefit to consumers was limiting the ease with which the loans are rolled over. Consumers’ failure to predict or prepare for the escalating cycle of interest payments leads to welfare-damaging behavior in a way that other features of payday loans targeted by lawmakers do not.

In sum, there is no doubt that payday loans cause devastating consequences for some consumers. But when used appropriately and moderately – and when paid off promptly – payday loans allow low-income individuals who lack other resources to manage their finances in ways difficult to achieve using other forms of credit.

End of the industry?

The Consumer Financial Protection Bureau’s changes to underwriting standards – such as the requirement that lenders verify borrowers’ income and confirm borrowers’ ability to repay – coupled with new restrictions on rolling loans over will definitely shrink the supply of payday credit, perhaps to zero.

The business model relies on the stream of interest payments from borrowers unable to repay within the initial term of the loan, thus providing the lender with a new fee each pay cycle. If and when regulators prohibit lenders from using this business model, there will be nothing left of the industry.

The alternatives are worse

So if the payday loan market disappears, what will happen to the people who use it?

Because households today face stagnant wages while costs of living rise, demand for small-dollar loans is strong.

Consider an American consumer with a very common profile: a low-income, full-time worker with a few credit hiccups and little or no savings. For this individual, an unexpectedly high utility bill, a medical emergency or the consequences of a poor financial decision (that we all make from time to time) can prompt a perfectly rational trip to a local payday lender to solve a shortfall.

We all procrastinate, struggle to save for a rainy day, try to keep up with the Joneses, fail to predict unexpected bills and bury our head in the sand when things get rough.

These inveterate behavioral biases and systematic budget imbalances will not cease when the new regulations take effect. So where will consumers turn once payday loans dry up?

Alternatives that are accessible to the typical payday customer include installment loans and flex loans (which are a high-interest revolving source of credit similar to a credit card but without the associated regulation). These forms of credit can be worse for consumers than payday loans. A lack of regulation means their contracts are less transparent, with hidden or confusing fee structures that result in higher costs than payday loans.

Oversight of payday loans is necessary, but enacting rules that will decimate the payday loan industry will not solve any problems. Demand for small, quick cash is not going anywhere. And because the default rates are so high, lenders are unwilling to supply short-term credit to this population without big benefits (i.e., high interest rates).

Consumers will always find themselves short of cash occasionally. Low-income borrowers are resourceful, and as regulators play whack-a-mole and cut off one credit option, consumers will turn to the next best thing, which is likely to be a worse, more expensive alternative.

Author: Paige Marta Skiba, Professor of Law, Vanderbilt University

Tax-free super is intergenerational theft

From The Conversation.

A number of politicians have struggled this week to explain the Turnbull Government’s proposed changes to superannuation. Given the complexity of the area, that’s not surprising. And this complexity explains why intergenerational “theft” through superannuation has continued for so long.

Transition to retirement (TTR) provisions, introduced by the Howard Government in 2005, were supposed to encourage people to keep working part-time rather than stopping work entirely. Yet most people using a TTR pension have continued to work full time. In practice the provisions have simply been a gift enabling older people to pay less tax than younger people on similar incomes.

No-one has ever explained why we should have an age-based tax system, beyond the politically cynical observation that these provisions were introduced when demographics produced an unusually large number of voters aged 55 to 64. Some of these voters are now objecting vociferously to losing their privileges – but they were never justified in the first place.

The tax breaks of TTR pensions

Transition-to-retirement (TTR) pensions, as they stand today, have three features. They allow people to withdraw money from superannuation from the age of 60 without tax penalties. They allow older people to continue to contribute to superannuation while they withdraw funds. And they bring forward the age at which earnings on accumulated superannuation balances cease to be taxed (the superannuation earnings of younger people are taxed at 15%).

These provisions are a boon to older taxpayers. One benefit is the opportunity for “super recycling”, in which a person continues to work full-time and to consume their wage income, but pays around $5000 a year less income tax. People over 60 can put the maximum amount into superannuation from their pre-tax income, and then withdraw the money immediately. They pay much less income tax because their contributions to super are only taxed at 15%, whereas ordinary earnings are taxed at their marginal tax rate.

The precise benefit of super recycling varies depending on income, as our recent Super Tax Targeting report shows. For workers aged between 60 and 64 who earn between $65,000 and $150,000, super recycling reduces the amount of tax paid by about $5000 a year. To put this in context, a 60-year old earning $75,000 then pays as much income tax as a 40-year old earning $57,000.

There are also big benefits for an older worker who takes a TTR pension and stops paying tax on the earnings of their superannuation well before they retire. Take someone with a superannuation balance of $500,000 – a larger balance than seven in eight Australian taxpayers of that age – and earning a 6% return. A TTR pension reduces the annual tax paid by around $4,500. If they take a TTR pension at age 56, they will save around $40,000 in tax by the time they stop working at 65. If their superannuation balance is higher, the tax benefit is proportionately larger.

Not a transition to retirement scheme at all

All the evidence suggests the TTR pensions are mainly used by high-wealth individuals to reduce their tax bills while they continue to work full-time. In a study published last year the Productivity Commission concluded that:

…the tax concessions embodied in transition to retirement pensions — designed to ease workers to part-time work prior to retirement — appear to be used almost exclusively by people working full-time and as a means to reduce tax liabilities among wealthier Australians.

The misuse of TTR pensions is reflected in the confusion about how many people will be affected by the Government’s changes. The Government estimates that some 115,000 people will be affected by the change.

Critics counter that the changes could affect more than 500,000 super accounts classified as TTR pensions. But many of these almost certainly belong to people who have in fact fully retired, but haven’t bothered to tell their super fund to change the classification of their pension. They have little incentive to get their paperwork up to date, because the TTR pension already provides all the benefits of tax-free super earnings to which retirees are entitled.

However many people are affected, these arrangements bear little resemblance to the now explicit objective for superannuation – “to provide income in retirement to substitute or supplement the Age Pension”. They don’t encourage additional saving. They do little in practice to delay retirement. Instead they are part of an age-based tax system that allows older Australians to pay less income tax than younger Australians with similar incomes.

Reducing the rorts

So the Government’s announcement in the May Budget that it would reduce the extent of these benefits should be no surprise.

The Government proposed to reduce the amount that can be contributed to super from pre-tax income from $35,000 to $25,000. As a result, a 60-year old earning a wage of $75,000 a year would only save $3,700 per year through super recycling rather than $5,800 per year.

However, there may be little change in practice because the Government also proposed yet another complexity that future politicians will also struggle to explain. People will be able to make additional pre-tax contributions if they contributed less than the limit of $25,000 in the previous five years. Although this is supposed to help women with broken work histories catch up on building their super funds, past practice shows that such provisions are primarily used by older men to minimise their tax.

The government also proposed to tax super earnings at 15% unless a person retires (and so forfeits the ability to make additional contributions to superannuation). Those withdrawing money from their superannuation, but also working and contributing to superannuation, will then pay 15% tax on the earnings of their super fund, just like everyone else still working.

Why the Government should stick to its guns

The Government has been attacked over the last week as it emerges that these changes will affect some people “only” earning $80,000 a year, who might be in the top 20% of income earners, but are not in the top 4%. Coalition backbenchers are reportedly concerned that some of their supporters will pay more tax. Financial planners are nervous that they will have less tax planning to offer.

But the outrage misses the vital question: why do such generous tax breaks exist at all? They lead to individuals with above average incomes paying less tax than younger Australians on similar incomes. They do almost nothing to contribute to the ostensible purpose of superannuation.

For more than a decade, superannuation tax concessions have been absurdly generous to older people on high incomes. They are one of the major reasons why older households pay less income tax in real terms today than they did 20 years ago, even though their workforce participation rates and real wages have jumped.

Superannuation tax breaks cost more than $25 billion in foregone revenue, or well over 10% of income tax collections, and the cost is growing fast. Lower-income earners and younger people have to pay more in other taxes – now and in the future – to pay for the tax-lite status of so many older Australians. The proposed changes are just the beginning of much needed reforms to superannuation to end intergenerational theft from the young.

Authors: Brendan Coates, Fellow, Grattan Institute; John Daley, Chief Executive Officer, Grattan Institute

Mortgage brokers: ASIC goes fishing

From The Conversation.

The Australian Securities and Investments Commission (ASIC) inquiry into the way mortgage brokers are paid may uncover some isolated shady dealings but the system of remuneration for brokers is already regulated well enough by intense competition.

Assistant Treasurer Kelly O’Dwyer announced the inquiry last year in line with recommendations from the Financial System Inquiry and ASIC recently commenced the inquiry with a scoping paper. The focus is likely to be on whether the advice of brokers is in the best interests of the customers.

As always, there are questions about whether the remuneration incentives for brokers distort their advice. And, again as always, there are questions about whether the fact that big banks own some brokers leads these brokers to favour the products of their owners, and not necessarily to offer the products most appropriate to the customer.

In many ways, the inquiry is just part of the ongoing reviews of different parts of the finance sector. The same arguments are likely to be rehashed.

In announcing the review, ASIC Commissioner Peter Kell was clear that:

“We are focused on consumer protection issues in the context of personal credit products, ranging from small amount credit contracts through to home loans.”

There has been some discussion in the press that loans organised by brokers default at a higher rate than loans written by banks. The Australian Prudential Regulation Authority (APRA) might regard this as a concern for financial stability, but ASIC will be concerned with whether people are getting loans they really should not be. The focus will clearly be on consumer outcomes.

It’s worth looking at the mortgage broking sector mainly because it has been growing rapidly and is now quite big. About half of all mortgages are provided through brokers, up from 40% a decade ago. The upfront commissions for brokers are about 0.5%, which yields annual revenue of close to A$2 billion.

So it is a big and rapidly growing financial sector and ASIC has duly been charged to have a look around for problems. Australia already has laws addressing any concerns. The National Consumer Protection Act has, since 2011, put the onus on providers to act in the best interests of customers. ASIC is really just checking up that the law is being complied with.

While there may be some bad behaviour, it is hard to see what the concern is. People have a choice.

They can go to their own financial institution and buy a mortgage direct from the manufacturer. Alternatively, they can look around among financial institutions to find the mortgage that works for them.

Now they can also go to one of the dozens of mortgage brokers to see if one of them can find a better deal. From the customers’ point of view, there are hundreds of retail outlets (banks and mortgage brokers) offering mortgages.

The fact that mortgage brokers are taking market share away from the banks suggests that customers really appreciate the mortgage broker effectively cutting the buyer’s cost of searching.

There shouldn’t be a problem with the banks paying the broker for delivering the customer, as there is a clear cost saving to the bank. It does not need to have as many branches or as many staff.

Seen from the bank’s point of view, it can originate the mortgage through its own branch and incur some overhead and running costs, or initiate the loan through the broker channel and pay the broker for its overhead and running costs.

Ultimately, the client is buying a product, in this case a mortgage. The price the customer pays is transparent, as are the terms and conditions.

If brokers were not providing a good service, customers could easily swing back to searching for their own mortgage among the banks, or simply walk down the street to another broker. Smart customers will thus keep the providers honest and make sure competition works as it should.

There is a not a lot of academic research into the issues associated with remunerating mortgage brokers. What there is tends to be from the US, which has not had a good record in managing mortgages over recent years. The most relevant paper suggests that loan quality can be improved though requiring registration, higher education standards and continuing education and/or by requiring brokers to post bonds.

The ASIC inquiry will uncover more information about the sector. It may also find some people have behaved badly (as in any area of human endeavour), but it’s hard to see a significant structural problem in a very competitive market.

Author: Rodney Maddock, Vice Chancellor’s Fellow at Victoria University and Adjunct Professor of Economics, Monash University