Revealed: More Secret Loans

Revealed: More Secret Loans

More on housing today… it never stops, does it!

But first, it seems another of Australia’s “safe and secure” banks needed a secret loan from the US Federal Reserve.

Last December we picked up on a story the rest of the mainstream financial press ignored.

It was the fact that National Australian Bank [ASX: NAB] and Westpac [ASX: WBC] had secretly borrowed billions of dollars from the Fed in 2007, 2008 and 2009.

None of those loans were disclosed to the market.

That was strange.  Because you would have thought that at a time when banks were falling over – and liquidity and solvency of banks were being questioned – a huge loan from a foreign central bank would be material information.

You’d think it was something shareholders should know about so they could make an informed decision on whether to risk their money on bank shares.

Apparently not.  None of Australia’s banking regulators could give a hoot.

If you were a subscriber to Money Morning through December and January, you’ll remember we made many enquiries to the banks and to the Australian Prudential Regulatory Authority (APRA), the Reserve Bank of Australia (RBA), and the Australian Securities Exchange (ASX).

The end result, after receiving unsatisfactory answers from them, is that they now just ignore our questions.

We sent our last email to the RBA on 23rd February, asking again:

“1.       Is the RBA surprised that neither NAB or Westpac considered it important to inform the RBA that they were borrowing funds from a foreign central bank?

“2.       Is the RBA surprised that neither NAB or Westpac have contacted the RBA since the information on the loans was released by the US Federal Reserve on 3rd December?

“3.       Why hasn’t the RBA contacted NAB or Westpac requesting an explanation for the loans and an explanation for why the RBA wasn’t notified about the loans?”

No reply.

And how did Australia’s docile mainstream press cover this bombshell?  Weakly.

The only effort… sorry, we should say half-effort… was a mainly syndicated article from the New York Times with a few comments added by Fairfax’s Eric Johnston.

And so, it seems Mr. Johnston has been handed the short straw again.

Late last week, the US Federal Reserve was ordered to release more secret information on loans made to banks.  This time it was for loans made through the Fed’s “Discount Window”.

There were some big loans made:  JPMorgan grabbed USD$12.9 billion in March 2008.  But that was just the beginning of JPMorgan’s greed.  All up, it borrowed from the Fed’s

Discount Window 254 times!

On almost every occasion the amount was in the billions rather than millions.

But it wasn’t just American banks.  There was Credit Suisse of Switzerland.  BNP Paribas of France.  And Mitsubishi UFJ of Japan… along with hundreds of other foreign banks.  Including…

Yes, that’s right, two Australian banks.

Which bank’s turn?

The Commonwealth Bank of Australia [ASX: CBA] borrowed a total of USD$100 million in 2008.  And BankWest – now part of CBA – borrowed USD$11 million between September 2008 and January 2009.

Now, we’ll agree these aren’t huge numbers.

Not compared against the billions borrowed by some of the US and European banks.

But it’s another hole in the cardigan for those who believe Australia’s banking system is somehow unique and different from every other banking system.

As we explained when we exposed the secret loans to NAB and Westpac, the banks didn’t borrow from the Fed out of choice.  They didn’t borrow from the Fed because they saw an opportunity to borrow at a low interest rate.

They borrowed from the Fed because credit markets had frozen.  And for banks that need to continually roll over credit every day to avoid insolvency, that’s a big deal.  At that time the only way to ensure access to credit was to beg for dollars from the US Federal Reserve.

But amazingly, just as the Aussie regulators don’t seem bothered, the docile Aussie mainstream press couldn’t give a stuff either.

The only reporting on the issue has been the effort from Eric Johnston at The Age.

Although he has bothered to get a quote from the CBA.  A CBA spokesman said:

“Given the fragility of markets at this time [2008], the group was taking the precautionary measure of trialling our access to various central bank windows to ensure that our systems and processes were in order should the situation worsen such that we needed emergency funding.”

Fair enough.  It’s always a good idea to test the brakes just in case you need them.

In this case the CBA supposedly decided to test the brakes twice.  Once in July 2008.  And again in November 2008.

But if you believe the bank was simply “trialling” access to central banks, you’re kidding yourself.  Just as NAB and Westpac needed access to secret loans during the economic meltdown, so did the CBA.

Press silence

But still, it amazes your editor that aside from the half-baked article in The Age, not a single one of Australia’s finance writers can be bothered to mention it.

Not a word on the subject from Mr. Kohler, Mr. Bartholomeuz, Mr. Gottliebsen, or Ms. Maley over at Business Spectator.

And not a sentence or paragraph on it in Australia’s so-called leading financial newspaper, the Australian Financial Review.

We can’t explain the silence.  I mean, the mainstream press is usually beside themselves to draw even the slightest connection between overseas events and Australia.

On March 11th, an earthquake and tsunami struck Japan.  On March 11th the Sydney Morning Herald reported, “No word from hundreds of Aussies in Japan”.

On February 22nd, an earthquake struck Christchurch, New Zealand.  On February 22nd the Sydney Morning Herald reported, “Nearly 450 Australians attending a medical conference have been caught up in the Christchurch earthquake.”

Yet when it comes to connecting Australia’s Ponzi banking system with the collapse of US and European banks, the mainstream press prefers silence.  As with the Australian property market, Australia is different and needn’t worry.

Why isn’t the press reporting it?  We know there’s a cosy relationship between the press and corporate Australia.  But the non-reporting of the secret Fed loans takes the cosiness to a whole new level.

Back to housing…

Grateful to have missed out

We warned about the current house price collapse over two years ago.  Few believed us.  You should see some of the emails we received back then – when I’ve got a few spare minutes I’ll try and dig them out and show you.

But now, things have changed.  Those who wondered whether they’d made the right decision are now sending letters thanking us for our advice.  Such as this letter:

“I took your advice 2 years ago and got out of all real estate in SEQ.

“Glad I did as comparable properties are very flat and heading south to say the least…

“Needless to say that my weekly rent is considerably less than a mortgage for the same value property, we are in a property that ordinarily we would not have been able to enjoy, and I managed to negotiate my rent down after the first year.

“Friends and family couldn’t understand why at the time and appeared to feel sorry for us that we would stoop to such lows!!

“Look who’s laughing now ”

And this one:

“I managed to stumble upon your daily column at the end of 2009. It was December and I was close to signing up for two new investment properties… One of your articles, about the Housing Bubble, prompted me to spend two days analysing my impending purchase of these two houses (financed and leveraged to the hilt). I spent hours calculating all the variables etc, but it boiled down to, if I believed house prices could continue to double (7-8 years) when the ability of people to finance these was at the limit in 2009.

“I pulled out ‘SO THANK YOU’. Today I have no debt, cash in the bank and am a

subscriber to Australian Small Cap Investigator and happily punting my spare cash on yours (and my own) share recommendations and buying Gold/silver. If I lose anything I do not lose any sleep.”

Although that hasn’t stopped the property bulls from claiming we’re talking rubbish.

Returns aren’t all they seem

Money Morning reader Philip Sigglekow (he’s given permission to use his name) sent us this letter on Friday:

“10 years ago I bought a property in Abigail street Hunters Hill… for $700K built a new house on it for $550,000.00 and I have a bank valuation 2 weeks old for $2 million dollars.”

That’s pretty good.  Turning $1.25 million into $2 million – providing it sells for that price.

However, while the numbers may look impressive, is it really that good?

It’s a 60% return in ten years.  So it’s not as good as the “house prices double every 7-10 years” nonsense spruikers tell you about.

But, it’s still good, if someone’s mug enough to hand over the readies.  And providing a bank is willing to agree with the valuation.

However, it’s only a good result if Mr. Sigglekow was a cash buyer.  And even then, for just a 60% return, sticking the $1.25 million in a ten-year term deposit would have likely returned a bigger profit.

Because over ten years, a 60% return works out as roughly 5.5% per year, compounded.

If Mr. Sigglekow financed the property with a mortgage then the return would probably be no better than breakeven… once you take into account mortgage repayments.

Of course, if the property was paid for in cash, and he had a tenant paying rent, then we’ll agree that’s a good return – 60% price appreciation plus we’ll say a 5% rental yield.  That wouldn’t be bad at all.

But that’s still history.  We’ve never argued that property has always been a bad investment.  History tells you it’s done well for thirty-odd years.

Our point is that the good times are over.  The Ponzi housing bubble has burst and prices are hitting the skids.

But still, it got us thinking…

Some of the property spruikers we’ve had run-ins with claim we’re only talking down house prices because we want people to buy shares instead.

The simple fact is, that’s not true.  Few people make a choice between buying a house or investing in small-cap shares.

It’s not really a case of one or the other.

Housing, for example, will typically need a deposit of $20,000 (at least) and monthly repayments in the thousands.

Small-cap shares on the other hand, can be bought with as little as $500 and no ongoing repayments.

However, there is one similarity.  And it’s this…

Housing now riskier than small-cap stocks!

Right now, as we speak, the Australian housing market is riskier to your wealth than small-cap shares!

I know what you’re thinking.  It sounds crazy.  But think about it for a moment.

I know I’m going to get some stick for this comparison but I’ll make the point anyway.

The fact is, it shouldn’t be that way.  Small-cap stocks can make you a lot of money.  But that’s because you’re taking on a big risk.

But with bubble-level house prices, you’re taking on a big risk too.  Only it’s marketed as safe bricks and mortar.  But at the current prices there’s nothing safe about investing in housing at all.

I’d never encourage anyone to borrow hundreds of thousands of dollars to invest in small-caps, yet in the case of property spruikers that’s exactly what they’re asking you to do… leverage yourself up to the eyeballs on an investment that’s riskier than small-cap stocks.

If you don’t believe me, look at the zero house price growth around Australia right now, and compare it to returns for small-caps.

I’m not saying you should sell your house and buy small-cap shares.  I’m just proving the point about the ridiculously high price of housing and the risks of buying today.

Housing should be a low risk and low growth investment.  But thanks to spruikers and easy credit, the housing market has become distorted beyond all recognition.

Let me put it another way…

Let’s say, sticking $100,000 in a bank account is a no-risk investment.  Don’t forget the taxpayer still guarantees deposits.

So after two years earning 5% interest each year you’ll have about $110,250 in your account.

Now let’s see what kind of risks you have to take in small-cap investing to get at least that return of 5% per year.

Well, all you’d have to do is put $97,000 in a savings account and punt $3,000 in small-cap shares.

If we take my record in Australian Small-Cap Investigator as an example, after two years you might have $106,942 in the savings account and $4,200 in your small-cap trading account.  All up you’d have $111,142.

That’s slightly better than putting your money in a bank account, but you’ve taken on more risk.  But your downside is pretty low, you’ve only risked three grand.

If you wanted a bigger return then you’d allocate more cash to small-caps and potentially lock away bigger returns.

Now look at housing.

In order to make a 5% return on housing you would have to take your $100,000 to use as a deposit to buy a $400,000 house with a 25% deposit.

That means taking out a $300,000 mortgage.  That size mortgage will cost you monthly repayments (mostly interest for the first few years) of $2,173.

So, at the end of the first year you’ll have spent $126,076 (deposit and interest).  At the end of the second year you’ll have spent a total of $152,152.

That means, in order for you to make the equivalent of a 5% return each year – comparable to a term deposit – the value of the house needs to increase by 15.5% over two years!

$300,000 mortgage to make $10,000!

Now, maybe you think that’s OK.

Maybe you think it’s worthwhile taking out a $300,000 mortgage, and paying $52,151 in interest to make a profit of $10,000 two years from now.

But if that’s all you’re going to make, why not stick the cash in the bank?

And if we took this example to the next level, here’s where you get proof that housing is a riskier investment than small-caps…

Let’s put the investments in order, from lowest risk to highest risk.  It’s clear the bank account has the lowest risk because there’s no risk of loss – thanks to the taxpayer guarantee.

Next is the combination of savings account and small-caps comes second.  Simply because your only risk of loss is the three grand you’ve thrown at small-caps.  The money in your savings account is secure – again thanks to the taxpayer guarantee.

Then there’s the highest risk – housing.  You’re potentially losing $26,000 per year in interest costs with no guaranteed return.  That’s in addition to any losses you’d make if the price of the property falls.

But even if prices were flat, after four years your $100,000 deposit is toast.  You’ve spent $100,000 on interest costs.  If you only sold the house for your purchase price of $400,000 you’ve lost a hundred grand.

You pay back the loan to the bank.  You get your $100,000 back.  But you’ve spent $100,000 on interest in the meantime!

As I say, I know the property spruikers will give your editor a kick in the teeth for this one.  And I also concede you can’t live in small-cap stocks or a bank account, whereas you can live in a house.

The point I’m trying to make is purely on a risk comparison.  Doubtless you’ve been told your whole life that nothing is safer than bricks and mortar as an investment.  Well, in risk terms that’s just not true.

Many property investors and buyers ignore the holding costs of property.  They only focus on capital growth and forget the losses they’ve made on interest charges.

With the high price of housing right now, property investment is as risky as it gets.  So if you’re thinking about buying into the Australian housing bubble right now, just make sure you’re aware you’re taking a bigger risk than if you were punting on a tiny small-cap mining stock!

If that doesn’t cause you to pause and think, then nothing will.

Cheers.

Kris Sayce

For Money Morning Australia

Tagged as: asx, bank, housing, press, rba, regulations, report, small-cap, stocks