Another ponzi trick exposed

Merrill Lynch analysts (full report below) have sprung the banks on another method they use to expand the amount of money they can lend to anyone and everyone. From Banking Day:

The long-standing use by banks of the poverty line as a proxy for living costs is the subject of a fresh, but sceptical, review by a team of Merrill Lynch banking analysts.

The sell-side analysts at Merrill Lynch assessed the living costs used by major banks in Australia to work out the maximum loan a borrower could afford (taking into account other criteria such as the loan size, deposit and property valuation).

Merrill Lynch reverse-engineered the home-loan calculators used by banks – available on their websites – to work out the cost of living banks must use in assessing loans.

The analysis suggests that while banks, in theory and, according to them, in practice, make use of the Henderson poverty line for most cases, they may actually apply even lower living costs.

“Surprisingly, the average bank cost-of-living assumption is seven per cent lower than the poverty index, 14 per cent lower than our barebones budget, and even more for our adjusted [living costs, based on] ABS survey [data], says the report.

“From discussions with bank management, their cost of living assumptions should reflect the poverty index.”

The actual scorecards banks use in assessing loan applications must differ from those available to customers researching their loans.

Stephen Ries, senior manager of media relations at ANZ said, in an email, “There are several factors that we consider when assessing lending. Just because an online calculator provides an indicative amount it does not mean a customer will be automatically approved for that amount.”

Steve Batten, senior media adviser at Commonwealth Bank said the bank “uses baseline affordability criteria – as does the industry as a whole – to ensure that customers can service the loan, and apply buffers on interest rate and expenses over and above basic expenses, which provides for some contingency should interest rates rise.”

The Merrill Lynch analysts argue in their report that “the banks, using low default living costs, are able to artificially inflate the level of debt they can provide to borrowers.

“In our view, living at the poverty index would be unsuitable for mortgage borrowers, and the banks’ default living costs are even below the poverty index and well below any other comparable budget. We believe the banks’ default living assumptions underestimate the real cost of living for mortgage borrowers. While it might be plausible for a borrower to keep within such a low budget for the short-term, we question if it is sustainable.”

Using alternative and higher levels of living costs, modelled by Merrill Lynch, the researchers found that for a couple with one dependent a big bank’s “approval in principle” for a loan (and subject to a range of assumptions) would fall from the mid $400,000 level to less than $400,000 using what they term “normal” costs.

The maximum loan approval would fall by more than half, to around $200,000, using a higher level of living expenses that makes more realistic assumptions and is based on surveyed household living costs, and which makes adequate allowance for entertainment.

The relevance of using the Henderson poverty line (a relative measure compiled by the Melbourne Institute) attracted regulatory scrutiny from the Australian Prudential Regulation Authority in 2006 and 2007, but has not been raised publicly as an issue since then.

I can see one flaw in this argument. If ML has reverse engineered from online calculators then, as reader Sarah P. has pointed out in other articles, we need to factor in that the calculators themselves are marketing tools and probably inflate potential customers credit potential.

Nonetheless, the breadth of the discrepancy between what might be considered prudent lending criteria and what has been reverse engineered suggests there is fire behind this smoke.

It is interesting also to canvas the way in which the broader media reported the Merrill report.  Business Day bizarrely reported it as:

Prospective borrowers have been cautioned to get a home loan while they can.

Some may soon find it tougher to borrow, with major banks expected to quietly turn the screws on who qualifies for a home loan.

Steep price rises across a number of key household items, combined with tougher lending rules, are likely to lead banks to take a more cautious view on how much they lend.

This is in contrast to the stand banks have been taking in recent months where they have been relaxing lending standards, mostly by increasing the maximum loan figure against the value of a house, or the loan-to-valuation ratio (LVR).

Which is pretty much the worst advice I can remember from a newspaper. And one wonders why such editorial license is being deployed anyway. The report itself offers the following actual analysis:

Average loan size – notwithstanding current strong income growth, average loan sizes are likely to fall, as borrowers have less net-assessed income to service the bank debt.  There are some borrowers who previously refrained from leveraging to the maximum amount, and could still service the same amount of debt, even if the banks tighten lending standards. Nevertheless, we think, on balance, those borrowers will still refrain from borrowing the highest amount.

House prices – with a fall in the average loan size, house prices are likely to follow.  We see that house prices and average loan size have a strong relationship, which should continue in future periods.  We note the end result would be a correction in housing prices.  The extent of the correlation would depend on the magnitude of the banks’ tightening.  The ten year average of annual median house price growth to annual house price growth is 1.2x.

So why is Business Day suggesting the report encourages people to rush in and buy? The Australian does a better job but doesn’t mention the likelihood of falling house prices either.

Merrill Lynch


  1. “Merrill Lynch analysts have sprung the banks”
    Ahh.. Finally, the investment banksters are putting their MBA degrees to good use.
    “Which is pretty much the worst advice I can remember from a newspaper”
    But, alas, while the standard of investment banking is improving,the standard of business journalism is going down the toilet.

  2. ML should know a heap about lending to unqualified borrowers with their record in US sub-prime. HH the calculators are not marketing tools and are the ones used in banks approval departments.
    As I’ve pointed on numerous occasions the lack of recognition of risk in stressed loan servicing ratios leads to under capitalised bank balance sheets and cheap funding through mortgage rehypothecation.
    Unfortunately, any public recognition of the problem will not save the mortgagor victims or stop where we are headed

  3. Surely, lending ‘below the poverty line’ is predatory lending. Don’t your guys have laws against that sort of thing? Likewise you can’t lend at 500% p.a. and such…….

  4. Agree janet, Class Action against predatory banksters by anyone who goes into negative equity would be an appropriate response to a crash in house prices occasioning home loan defaults.

    The days when banks bottom line was viewed as the benchmark for sane economics in this country are done.

  5. Hey brad – what about a class action against the Fairfax-Banks property cartel for their continued spruiking and denying of the facts. This article gives straight financial advice, borrow now…to avoid not being able to borrow later, which as others have pointed out is horrible advice (and Id say misleading advice based on any objective standard).

  6. I was discussing this issue with my mortgage broker friend on the weekend,who advised that the ‘living standard’ requirement has added an additional $500/wk in the banks assessment of on the average home loan, so therefore the banks have lowered their LVR’s to compensate.

  7. There you have it an admission that there is a strong correlation between lending volumes and house prices.

    now can they all agree that house prices are so inflated because of the biggest credit bubble in the history of banking?

    damage control rather than flapping gums is what we need from these prize idiots now.

    begin fixing the problem before it’s too late

  8. The comments I posted on the article reproduced on never made it thru the [email protected] Anyway, here it is:
    This is shamelessly low business journalism. The lead to this story should have been that Merrill Lynch found out that banks are using online calculators that assumed that the mega mortgage mugs will be ok living below the poverty line after making mortgage payments.
    “But in terms of the ongoing portfolio, I’m as confident as I can be in terms of the quality that sits there.”
    ..says David Liddy, BoQ CEO who is retiring from his post with a nice lil golden parachute. I hope his benefits are tied to the performance of the bank’s loan book for the next 10 years and there are clawback provisions.