Coalition to right Costello’s SMSF wrong

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By Leith van Onselen

Assistant Treasurer, Josh Frydenberg, has revealed that the Abbott Government is considering limiting the ability of self-managed superannuation funds (SMSFs) to leverage into investments. From The AFR:

Assistant Treasurer Josh Frydenberg said the government will crack down on borrowing by self-managed superannuation funds but will not follow a recommendation of the financial system inquiry to ban it outright.

An increase in SMSF borrowing to purchase investment properties has helped drive up house prices and been criticised for increasing the financial system.

“You don’t want to see people have their retirement income savings so highly leveraged that they end up being severely damaged as result of another financial crisis”..

“Banning it is a strong measure. We will announce what we do there when we respond to David Murray but it is certainty a live issue”…

Limiting SMSF leverage would be a great move, although an outright ban would be even better.

The final report of the Murray Inquiry into Australia’s financial system warned of the embryonic growth of SMSF property leverage, and explicitly recommended banning their ability to borrow:

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Remove the exception to the general prohibition on direct borrowing for limited recourse borrowing arrangements by superannuation funds…

Further growth in superannuation funds’ direct borrowing would, over time, increase risk in the financial system… In addition, borrowing by superannuation funds implicitly transfers some of the downside risk to taxpayers, who underwrite adverse outcomes in the superannuation system through the provision of the Age Pension…

As discussed in the Interim Report, the Inquiry notes an emerging trend of superannuation funds using LRBAs to purchase assets. Over the past five years, the amount of funds borrowed using LRBAs increased almost 18 times, from $497 million in June 2009 to $8.7 billion in June 2014…

The GFC highlighted the benefits of Australia’s largely unleveraged superannuation system. The absence of leverage in superannuation funds meant that rapid falls in asset prices and losses in funds were neither amplified nor forced to be realised. The absence of borrowing benefited superannuation fund members and enabled the superannuation system to have a stabilising influence on the broader financial system and the economy during the GFC. Although the level of borrowing is currently relatively small, if direct borrowing by funds continues to grow at high rates, it could, over time, pose a risk to the financial system…

Borrowing by superannuation funds also allows members to circumvent contribution caps and accrue larger assets in the superannuation system in the long run…

It is also inconsistent with the objectives of superannuation to be a savings vehicle for retirement income. Restoring the original prohibition on direct borrowing by superannuation funds would preserve the strengths and benefits the superannuation system has delivered to individuals, the financial system and the economy, and limit the risks to taxpayers.

The architect of Australia’s superannuation system, former Treasurer and Prime Minister Paul Keating, has also called for curbs on SMSFs using leverage to invest in Australian residential property, arguing that it “is making it nearly impossible for younger people, owner-occupiers, to afford to house themselves” and arguing that “we can’t persist with the position where our children cannot afford to house themselves and that is where we are now”.

Allowing super funds to leverage into property and other investments was, of course, another blunder by former Treasurer, Peter Costello. In permitting leveraged investment, Costello effectively turned super from being a retirement savings system into a speculative vehicle, in turn dramatically increasing the riskiness of Australia’s retirement savings and financial system, and further inflating Australian house prices.

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Chalk SMSF leverage as yet another Costello wrong that must be righted.

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About the author
Leith van Onselen is Chief Economist at the MB Fund and MB Super. He is also a co-founder of MacroBusiness. Leith has previously worked at the Australian Treasury, Victorian Treasury and Goldman Sachs.