From the excellent Wilson Sy, reproduced with permission.
Recently, on 13 August, the Federal Court rejected the case of Australian Securities and Investments Commission (ASIC) against Westpac for irresponsible mortgage lending and ordered the regulator to pay the bank’s costs. Such failures at enforcing regulation have occurred numerous times in the past and have cost taxpayers many millions, for little benefit.
The paper “The farce of fake regulation: royal commission exposed Australia” explains how enforcement failures have led to fake regulation in Australia. In relation to ASIC, the paper noted:
The new commissioner Sean Hughes declared that the mantra at ASIC going forward will be “Why not litigate?” He appears to have a short memory because he should know well from his past experience working at ASIC how costly, unsuccessful and unpopular litigation has been for the regulator. What is the point of more litigation recommended by HRC, if it only ends in failures?
The Hayne Royal Commission (HRC) discovered the lack of enforcement of regulation for past decades, but did not go far enough to discover why. The reason is: due to the underlying neoliberalist assumption of market efficiency, Australian financial regulation was not designed to protect consumers. Indeed, it is caveat emptor as noted by Wayne Byres, the chair of the Australian Prudential Regulation Authority (APRA).
In the ASIC vs Westpac case, the judge probably did not understand why a lender such as Westpac would knowingly make bad housing loans risking losses to the bank itself. So the litigation hinged around the interpretation of responsible lending as to whether there is legal flexibility on the part of the lender to assess mortgage serviceability by using the benchmark Household Expenditure Measure (HEM) rather actual expenditures of individual borrowers.
Clearly, complex rules by regulators on how a business should be run can usually be refuted by actual evidence and experience. That is, ASIC does not have enough business knowledge or access to hard data to prove conclusively that the HEM criterion is the main cause of irresponsible lending. Therefore, unproven causality was inadequate to compel a conviction.
There are so many other aspects of mortgage serviceability to which one could attribute irresponsible lending that it is difficult to see how picking one single aspect will lead to successful prosecution by the regulator. Probably, by taking on Westpac, ASIC was merely showing that it was following the HRC recommendation for more enforcement. Without understanding the real problem, HRC has been ineffective in reforming the financial system, as nothing much will change.
The real reason for why the banks lend irresponsibly is not incompetence, but conflict of interest, because the bad loans they create can be packaged and on-sold to unwary investors as mortgage-backed securities. Those mortgage-backed securities can be used for speculation with credit default swaps (CDS) and they can be sliced and diced to create other derivative securities such as collateralized debt obligations (CDO).
Hence irresponsible lenders can avoid adverse consequences to themselves by securitizing their loans. One proven way of removing the perverse incentive to lend irresponsibly is to remove banks’ ability to securitize their mortgages by separating commercial lending from securitization under the prohibition which was the US Glass-Steagall Act. When banks are broken up so that they are no longer “too big to fail”, they can be allowed to suffer the natural consequences of bad loans without being rescued with “bail-out” or “bail-in” and without protection from bank-runs by banning cash.
