Financial Regulators want ban on SMSF property investment

The Australian reports that the Council of Financial Regulators (CoFR) recommended in February that the federal government impose a ban on property investment through self-managed superannuation funds (SMSFs), but its recommendation was ignored by Treasurer Josh Frydenberg. The CoFR’s call came after 18,000 SMSFs were found to have over 90% of their savings in a single asset class, primarily investment properties:

Regulators urged the government in February to ban property investment through self-managed funds, after the amount of LRBAs [limited-recourse borrowing arrangements] held by the sector rose to $40 billion, a 10-fold increase from the $400 million figure a decade ago.

Ahead of the May 18 election, Josh Frydenberg snubbed a recommendation from the Council of Financial Regulators — which includes the Reserve Bank, Australian Prudential Regulation Authority, Treasury and Australian Securities & Investments Commission — over concerns about LRBAs threatening the savings of individual retirees and the wider financial system.

The CFR raised the alarm that many low-balance SMSF owners had the majority of their savings tied up in a single property, which left nest eggs vulnerable to falls in property prices, and its “preferred option” after the three-year review was a ban.

There’s no doubt that the Howard Government’s decision to allow SMSFs to leverage into property and other investments was a mistake.

Specifically, it allowed SMSFs to be turned into speculative vehicles rather than savings vehicles, in turn dramatically increasing the riskiness of Australia’s retirement savings and financial system, further inflating Australian house prices, and transferring some of the downside risk to taxpayers, who of course backstop the retirement system via the Aged Pension.

SMSF borrowing is known as “limited recourse” because if the borrower cannot pay back the loan, the bank can’t go after any other assets — only the property in question. This is precisely the type of lending that was at the heart of the sub-prime mortgage fiasco that morphed into the global financial crisis a decade ago.

In addition to the CoFR, David Murray –  the chairman of the Financial System Inquiry (FSI) – has similarly recommended that SMSFs be banned from borrowing to invest because of the risks posed to the financial system:

“Superannuation funds should not be leveraged, including SMSFs, because leverage magnifies risk. If the system is unleveraged, then if asset prices rise, bubble and fall then all the loss is contained within the superannuation funds and does not have another contagion effect because there are no forced sellers of other assets”.

Independent economist, Saul Eslake, has also described the Howard Government’s decision to allow super funds to borrow as “the dumbest tax policy of the last two decades”:

“The last thing Australians really needed in the last 20 years is yet another vehicle or incentive for Australians to borrow more money in order to speculate on property prices continuing to rise”…

“You might have thought that someone would have heard the term ‘limited-recourse borrowing’ and recognised that there were some significant risks associated with it that we could have done without in the Australian context.”

Having mums and dads using the tax-subsidised position of superannuation to buy property, and feeding the bubble, is a recipe for disaster.

It’s a crying shame the Coalition continues to ignore both the FSI’s and CoFR’s recommendation to ban super fund borrowing. In doing so, it has added another layer of pro-cyclicality and risk to Australia’s housing market, with the potential to exacerbate any future bust.

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