In Business and Politics, Where DOES the Buck Stop? / by Adam Howard

There has been a lot of talk lately about indebtedness; our supposed staggering amount of household debt, our national government debt, our State debt, the World, as a whole, swimming in debt.

Debt is, of course, assumed here to be a bad thing.  It carries an interest cost which grows as the debt level grows.  This interest bill then leaves less income that can be used to pay for the essentials of life.

Debt also creates a psychological burden, as well as a financial one. 

We owe someone.  We are in their debt.  And they need to be paid.  The relationship of the creditor (the lender) and the debtor (the borrower) is fraught:  the clearance or full repayment of a debt means that relationship is over. 

And the debtor wants to end the relationship because owing someone creates a feeling of subservience, of inadequacy.  The creditor has acknowledged that inadequacy by agreeing to lend us money for a price.

So, despite loans enabling us to live in nice houses, drive nice cars, have big screen TVs, have low cost healthcare, well run essential service providers, we hate the lenders.  Hate ‘em with a passion.

Now, just as much of us have hoped, bankers are copping it…in a big way.

Both regulators; the Australian Prudential Regulation Authority (APRA) and ASIC; are peaking under every rock in the banking world, looking for “risk”. 

Interest Only home loans = risky

Loans over 80% of the property value = risky

Investment loans = risky

Overseas borrowers = risky

Small business debt = risky

And when they find it, they and the government are no longer shy about shouting from the rooftops the names and positions of those to blame for the risk.

It makes my job as a broker difficult.  Takes longer to get an approval.  There are more conditions placed on business loans.  Rates are moving like never before.

But I am OK with it.  In fact, I like it.  Here’s why.

I am accountable.  Not in a proud, chest beating way.   Just in a “the buck stops with me” kind of way.

From the customer’s perspective it’s like this:

No approval?  My fault.

Missed settlement?  My fault.

Rate too high?  My fault.

Fees to much? My fault.

Got to provide too much information?  My fault.

And then, from the banks’ and regulators’ perspective it’s like this:

Not enough information provided?  Your problem.  Declined.

Valuation is too low? Your problem.  Declined.

Interest only home loan request?  ASIC are investigating you.  Your problem.

Loan paid out early?  We will get the money we paid you back from you.  Your problem.

A loan you introduced goes into default?  No more commissions for you and you will be scrutinised.  Your problem.

Make too many mistakes on your applications?  The regulators will investigate and you could lose your license.  Your problem.

And like I said, I am OK with all of that.  I like it.  I can control that.

In order to be licensed and to offer credit facilities I need to be licensed and deemed to be a responsible person by ASIC.  And I need to show that by my actions, the records I keep, the feedback provided by the lenders and those who ask me for help with loans.

But then on the flip side, that makes me a harsh and vocal critic of the banks.  Not because of the notion of the big, bad bank; the often used cliché that the natural personality of a corporation is that of the psychopath.

No.  Because they are full of compromised individuals making decisions based on self interest.  A total lack of accountability.

So it filled me with joy last week when I heard the heads of our major banks were now to be held to a similar standard as I am by the same regulator.

Yes, Shayne, Brian, Ian, Nick and Andrew will all be required to front up each quarter and explain that, in return for their $8m plus a year, they have acted responsibly and ensured the banks they head have too.

And that makes sense, doesn’t it?

I mean, surely if they get to command those types of pay checks they need to own that level of accountability?  You can’t just turn up and say “Yes, our bank stiffed thousands of wealth/insurance/banking customers out of millions of dollars.  Sorry.  Really.  We are sorry.  And we have changed.”

No.  Not good enough. 

Remember, I have been inside these behemoths and I know what’s in a short term incentive document (that’s the one that tells you which hoops of fire you need to jump through in order to get your bonus.)

Mine was based, to the tune of about 85%, on growing revenue, growing customer numbers and growing balance sheet.

In different roles and different banks there were certain “gate openers” (nice term, huh??) such as a minimum dollar amount of loans settled, and if you didn’t hit that number you didn’t qualify for a bonus at all.

Sure, there were bits in there too about customer satisfaction and responsible lending (code for when a loan goes into default), but they had a negligible impact if you managed to sell a lot of debt.

And my inside info on one bank CEO’s short term incentive qualifiers was it was only to grow revenue and grow balance sheet.

Nothing in their about happy banking, about taking care of people, about being responsible when you lend.

So, accountability hits the banking sector.  Excellent, I say!!

Now, on another topic there has also been a lot of talk about “productive” and “unproductive” debt.

Our boy, The Right Dishonourable Scott Morrison, Treasurer of Australia, has made that a key point in the lead up to the release of his recent Budget. 

Clearly in an attempt to distract us from the large pile of debt the Federal Government is now sitting on.

Quick footnote:  hidden in one of the supporting documents for this year’s Budget was approval to increase our Federal debt ceiling to $600 Billion.  That’s a lot of dough.

As you can see from the story, Scotty doesn’t define what a good and bad infrastructure project looks like, just that they exist.

But I must say, I agree.  There are productive and unproductive assets.  Some assets have a better return than others and benefit more people than just the immediate buyer and seller.  Here is how.

If I write a loan for someone to buy a house for $600k to help someone buy a house for $750k, then that generates the following income:

-          $750k for the vendor;

-          Stamp duty for the State Government of about $25K;

-          A settlement agent will charge $1k;

-          The real estate agent gets paid $15k;

And that’s about it.  The bulk goes to the vendor, or the seller, and they get to do what they want with it.  Maybe they repay the bank; or put it in the bank to earn interest, or put into listed equities.

If the asset is then leased out it will generally be leased for about 3% - 5% of the total value on an annual basis.  So, at $750k that will mean annual rent of about $25k to $38k rent pa.

That either goes into the land lords pocket or back to the bank for debt repayment, after a property manager takes their cut.

Not very productive from two perspectives:  the asset itself doesn’t create a lot of income in the form of rent; it’s was called a low-yielding asset; and when it is bought and sold the sale funds generated don’t benefit a lot pf parties and the sale process doesn’t create a lot of other income that flows to a wide range of parties.

Not very productive.

But what about buying a business?  One that is already trading?  Or even setting one up?

How about a café?  I have helped out with a few of those over the years.

Maybe a café generating about $600k pa in revenue?  Has about $120k pa in net profit that goes to the owners, pays about $225k pa to suppliers for food and beverages that are then sold, pays about $150k in wages to its staff.

The money paid to suppliers is paid to a variety of businesses, and that money then also goes to paying wages.

These wages plus the direct wages paid by the café owners then go to meeting the living expenses of a number of families.

This is what’s called the multiplier effect, and the multiplier effect of a little café is quite high, but surprisingly the purchase price isn’t.  In the current market it might cost somewhere between $150k and $180k to buy a café like the one I have described.

This is what makes a small business like this café a productive asset; generating a net margin of 20%, a return on investment of between 75% and 100% each year.  Yes, a lot of work goes into generating that return, and there is risk involved, but it’s a high return.

So, why don’t more people invest in cafes or other small businesses?  Why do they stick to the ol’ tried and true approach of buying an investment property?  Well, as you probably could have guessed, I have a few theories.

Firstly, ignorance.  I think most people don’t think too hard about ow they could make some extra money via investing.  They follow the pack, and that means property or shares.

Secondly, people are lazy and don’t want to work that hard.  They like the idea of passive income, which is income that flows when you are asleep.  Rent and dividends do that, while profits from businesses don’t.

And finally, risk.  The majority of people don’t understand how money can be made in a range of industries, and they certainly don’t understand how to minimize risks or avoid common mistakes.  This means they avoid taking the first step.

So, people accept the low return and wait and hope against hope that the value of their home and investment property will go up and they can cash in.

It’s not a great investment strategy…is it? Buy, wait and hope.

In addition, in 1985 the Federal Government began providing incentives for people to invest in and speculate on property by introducing negative gearing and discounts on taxes paid on capital gains.

The thing is, negative gearing applies to any interest paid on any investment, not just property, so if you borrowed to buy a stake in a business, then the interest on that debt would also potentially be tax deductible.

But people continue to buy property….

And now what do we have?  A society with high levels of household debt, most of which was used to buy low-yielding, illiquid property assets on the belief that they would all go up in value over time. 

And we hate the fact we are all in debt to such a degree, so we hate the banks that allowed us to borrow this much money.

Meanwhile it is harder than ever to actually borrow money from a bank to invest in a productive asset, if that’s what you wanted to do.  Borrowing to invest in property is still, by comparison, much easier, despite all the scrutiny on this area.


Finally, remember I said that the Federal Government doesn’t actually define a productive versus unproductive asset?  Well, they don’t explicitly define it, but if we look at the Budget we can see where the money is going and where it isn’t.

That probably gives us as good an impression as anything about what the government thinks, wouldn’t you say?

Infrastructure spending was the big winner, with the Budget including a commitment of $75 Billion to go to rail, road and air transport infrastructure over the decade 2017 – 2027.

That’s big money, and I guess shows us that the Federal Government is prepared to put its money where its mouth is.

I have mixed feelings though.  Transport infrastructure assets have a fraught history as productive assets.  There is a long list of private/public partnerships involving toll roads and bridges which have failed to make money.

But then, the multiplier effect of building something big is very high.  The money spent flows across a large part of the economy, so maybe that’s the goal?

What about the losers?

University students will be hit hard, with fees rising, HECS repayments kicking in at a lower threshold and universities subject to efficiency dividends.

Science and Technology research has also copped it in the neck, with the CSIRO experiencing a further budget cut, a continuing wage freeze and having to pay efficiency dividends.

What happened to the age of innovation, Mal?  What about the age of ideas?  I guess its back to garden shed, rather than down to the local TAFE or uni….

So, there doesn’t appear to be much benefit, at least in the Federal Government’s view, in supporting higher education or further research.  Not much financial return or benefit to the national interest??

Here is a quick link to the ABC’s summary of winners and losers:


So, onward and upward right? 

Just not if you are a banker, student, scientist, retiree or welfare recipient??

Until next time….