A Deeper Look at the Financial Sector Malaise

Things just go from bad to worse for the financial services sector.

But none of this comes as a surprise to those of us who are familiar with how the business operates.

It’s all about product and profit. Clients are simply grist for the mill.

Whether they are alive or not, clients provide the funds from which management fees are extracted.

That may sound harsh and cynical, but when the industry’s culture is distilled, that’s it in a nutshell.

Banks were once the pillars of society…now they are pilloried.

The investment industry is rife with conflicts of interest. Product providers owning product peddlers. Sales targets. Bonuses based on quantity not quality.

There’s many well-intentioned planners in the industry. But they’re trapped in a deeply flawed business model.

The ramifications from this Royal Commission will, or to least should be, far reaching.

The AMP executives actively engaged in making fraudulent statements (lying) to ASIC should have their day in court.

If they don’t, then it sends the message — to the sector and the rest of society — ‘if you are big enough, you have immunity from the justice system’.

Then we have the UBS report — authored by Jonathan Mott — shining light on the quality (or lack thereof) of the Westpac loan book.

This is from last week’s Sydney Morning Herald…

‘Mr Mott told investors the data showed Westpac customers were carrying more debt than he expected, with his analysis finding the typical customer in the sample had total debt that was 5.4 times their income. In 29 per cent of the loans, he said the bank had not completed minimum income verification such as checking a borrower’s pay slips.

‘“This data raises questions regarding the quality of [Westpac’s] $400 billion mortgage book (70 per cent of its loans),” Mr Mott wrote.’

This is a drum I’ve been beating for a long time.

Courtesy of the RBA’s ‘accommodative’ (their word not mine) interest rate policy, households have geared up to the eyeballs and beyond.

In the short term, this ‘accommodative’ policy is great for those who pay homage at the altar of ‘growth’. But there’s no such thing as ‘nothing for nothing’…this short termism is going to come with a long-term cost.

When easy money is on offer, it’s tempting to ‘bend the truth’ a little, to gain access to a greater slice of the lending pie.

Liar loans have been around for a long time. Borrowers and brokers have deliberately failed to declare all of the applicant’s living expenses…to make it appear the borrower has a higher repayment capacity.

Which in turn, means a bigger loan. A so called win/win for borrower and broker…that is until interest rates rise or a Royal Commission exposes the fraudulent activity.

That background brings me to the real topic of ‘interest’ for today’s Markets & Money.

The role central bankers and interest rate settings played in all of this.

This malaise all started with Alan Greenspan

Greenspan’s obsession with economic growth began — tentatively at first — with lowering interest rates to encourage debt-funded consumption…moving the GDP needle higher.

Once Greenspan fully understood the power of the transmission mechanism between lower rates and higher consumption, there was no stopping him, his successors, nor any other central bankers.

The instructions were so straight forward that even these ‘head-in-the-air’ academics could follow them — when things get a little tough economically, turn the interest rate dial further to the left.


The ‘dialing down’ of interest rates provoked two responses.

Firstly, a debt mindset took hold.

And when it comes to all-things-debt, our major lending institutions were happy to play matchmaker in our love affair with debt.

The bankers discovered that applying the prudent lending standards of yesterday would have retarded loan growth.

Any institution that demanded a higher level of accountability was left behind in the pursuit of market share. Boards and shareholders could not afford to miss out on their share of the lending pie…so it became a race to the bottom. Lending standards fell in tandem with interest rates.

Secondly, the lower rates went, the greater the number of people who sought out the services of financial planners. Investors became trapped by the TINA — there is no alternative — mentality.

Investors and retirees were being forced into seeking advice on how to generate a better return than the paltry returns on offer from the banks.

Institutionally owned or aligned advisers comprise around 80% of the planning industry. It’s reasonable to assume that clients seeking ‘advice’ from the ‘owned or aligned’ planners were given recommendations to invest in the products of the institution the planner had pledged their allegiance to.

The banks were big winners on both fronts — handing out loans and peddling investment products.

What we’re seeing play out at the Royal Commission is the unintended consequences of the central banker’s obsession with growth at all costs…facilitated by low interest rates and money printing.

The Royal Commission is bringing into focus the quantum of the costs associated with obsession for growth.

The obvious outcome from the Royal Commission will be higher lending standards. 

Even the RBA sees it coming…

As reported by ABC News on 2 May, 2018:

‘Reserve Bank governor Dr Philip Lowe warns that Royal Commission fallout might force tighter lending standards making it harder for some borrowers to get a loan.’

The choice of words is interesting…RBA Governor warns about tighter lending standards.

Why wouldn’t a prudent banker ‘rejoice’ or ‘be thankful for’ or ‘be relieved’ about improving lending standards?

I’ll tell you why. It’s because they’re gripped by this ‘growth-at-all-cost’ mentality. It’s become so ingrained, that supposedly responsible, intelligent people can no longer see the ‘wood for the trees’. The endless pursuit of debt-funded growth is a giant Ponzi scheme…doomed for failure and misery.

And the Royal Commission has potentially brought that pending hardship a step closer.

Higher lending standards make it more difficult to expand the base of the debt pyramid.

This is not good news for the Aussie property market…a major beneficiary of the formerly lax lending standards.

As fate would have it, the tougher lending regulations are coinciding with rising offshore interest rates…a perfect storm in the making.

While the RBA has indicated cash rates are not going anywhere anytime soon, that’s not the case in international markets. They’re on the way up.

It’s estimated our banks source around 30% of their loan requirements from offshore…so what happens over there, matters here.

Here’s an update on the LIBOR (London Interbank Offered Rate) — the interest rate global banks use to borrow from each other.

All rates — bar one — are at, or above, the level they were at a month ago, and much higher than a year ago.

London Interbank Offered Rate 04-05-2018

Source: CNBC
[Click to enlarge]

Little by little the uptick in rates will filter through to Australian mortgage rates. The truth about the ‘liar loans’ will be exposed in a higher interest rate environment.

The other interest rate mover has been the US 10-year Government Bond.

This is the benchmark rate from which the rest of the financial world takes its cue.

The rate is bumping up against the psychological 3% mark…currently 2.976%

US 10-year Government Bond 04-05-2018

Source: CNBC
[Click to enlarge]

The US 10-year bond rate has risen nearly 1% since September 2017.

The importance of this move cannot be understated…it has a far reaching impact.

Equity markets. Property markets. Bond markets. Loan rates. Currency movements.

These are all measured — positively or negatively — by the movement of the US 10-year rate.

If we take a few steps back and look at the longer trend in the US 10-year rate, we see that rates have been falling since the early 1980’s.

US 10-year Government Bond falling trend 04-05-2018

Source: CNBC
[Click to enlarge]

This 35-year trend created the culture of greed, arrogance and extravagance that’s resulted in a procession of banking executives being publicly shamed…and hopefully, prosecuted.

For every ‘yin’ there’s a ‘yang’.

Will a reversal of this four-decade trend lead to a culture of fear, humility and frugality?


But it won’t happen overnight, and it certainly won’t happen without a lot of personal and financial hardship.

Should that happen, perhaps we could hold a Royal Commission into the RBA’s actions.

That would be interesting…pardon the pun.


Vern Gowdie,
Editor, The Gowdie Letter

Vern Gowdie has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia’s Top 50 financial planners. His previous firm, Gowdie Financial Planning was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top five financial planning firms in Australia. He has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. Vern is is Founder and Chairman of the Gowdie Family Wealth advisory service, a monthly newsletter with a clear aim: to help you build and protect wealth for future generations of your family. He is also editor of The Gowdie Letter, which aims to help you protect and grow your wealth during the great credit contraction. To have Vern’s enlightening market critique and commentary delivered straight to your inbox, take out a free subscription to Markets and Money here. Official websites and financial eletters Vern writes for:

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