Sub-prime crisis in Australia? A deeper insight

Seminar Paper, 2007

11 Pages, Grade: 1,3


Table of contents

II. Relevance of sub-prime mortgage market
a. Recent problems in the US-market
b. Reaction of the stock markets in Australia

III. Structure of the mortgage markets
a. Loan policy of Australian banks and real estate financial institutions in the last few years
b. Risks and effects of this policy
c. The way to minimize this risks
d. Problems of investment funds

IV. Market reaction of the risky practice of loans granting

V. Actual problems

VI. Conclusion

VII. References

I. Relevance of sub-prime mortgage market

a. Recent problems in the US-market

Favourable economic conditions over recent years have caused the world economy’s growth to be above-average rates over past years (RBA, 20071). Unusually low volatility, coupled with credit spread remaining at low levels; have caused many asset prices to be at historical high. The September quarter of 2007 has seen a sharp increase in loan arrears in the sub-prime market, particularly residential mortgages in the United States, as well as an increase in volatility in other market, despite having a strong growth. The global markets recent strong growth and performance in the past four years may be attributed to low inflation rates and greater macroeconomic stability, causing term and credit risk premiums to be lower, and the strong developments in Asia, influencing pricing (RBA, 20071).

Sub-prime mortgages are offered to borrowers who, through poor credit history or unstable incomes, do not meet the requirements of more credit worthy mortgages. High interest rates, poor credit ratings, and financial circumstances make sub-prime lending risky for lenders and borrowers. This lending of money, with extremely tough conditions, can lead to default, as the borrowers can not meet the terms on contract.

As the availability of teaser rates started to decline, the American housing affordability reduced, causing housing prices to drop. As housing prices fell, a Negative Momentum Effect took place causing property prices to fall further, leaving borrowers with a mortgage that is worth a considerable amount more than their house or asset. This unbalance resulted in debtors ‘walking-out’ of mortgage contracts (Dougherty et al., 2002). Defaults in sub-prime mortgage contracts have led to the credit crisis in the United States, as lending companies were falling into bankruptcy. This not only resulted in a sub-prime crisis, but also banking, liquidity and collateral crises, which in turn has lead to a crisis of the central bank (The Economist, 2007). These effects and crises caused financial problems in the United States, and have led to problems within global and Australian financial markets.

b. Reaction of the stock markets in Australia

Initially the Australian stock markets fell by 7-8%, due to the US credit squeeze and its consequences within Australia (ASX, 2007). Since this fall, the Australian and global markets have recovered strongly to be at roughly the same level prior to the drop.

II. Structure of the mortgage markets

a. Loan policy of Australian banks and real estate financial institutions in the last few years

To describe the home loan policy in Australia we rely on information from the company websites of the four major banks (ANZ Banking Group, Commonwealth Bank of Australia, National Australia Bank, Westpac Banking Corporation), former building society St. George Bank and one of the most important loan companies RAMS Home Loan Group. All of these six entities provide lot of information about their different home loan offers on their websites.

An analysis of all banks and real estate financial institutions in this approx. 38 billion AU$ market would need more space than this paper allows.

All of the six institutions offer a variety of different home loans. They all offer both variable and fixed rates. Fixed rates mean that the interest rate is fixed for the whole repayment period. There are fees applying for paying back earlier. Variable rates mean that the rates are fluctuating with the market. There, the rate starts e.g. at 7.38% and will go up to about 8.00% or go down to 6.5% depending on the market. In most cases fees have to be paid when applying for a home loan. These fees are up to 600 AU$ at the beginning plus about 10 AU$ per month. For a 20-year loan this fees sum up to 3000 AU$ which have a value of about 2000 AU$ today[1].

They all have special offers to attract lenders. They e.g. give a flat screen TV valued at 999 AU$ by lending 250,000 AU$. Also, they offer loan contracts with no repayment obligations for the first five or ten years except the interest payments. This possibility lowers the payments in these first years. For the following years of a loan with e.g. a 25-years repayment period there are only 15 or 20 left to pay back the loan. In these years the payments will be very high to amortize the loan down to zero.

To attract every people earning any money, they all offer so-called low-doc loans. Applicants for these loans need less documentation about their income.

The application for a home loan is made as easy as possible by the banks in offering up to six different application ways: Direct call, calling the Personal Mortgage Manager, visiting the banks branch, the bank visiting the applicant, fill out formulas, print them out and send it by post or fax and the online application possibility. The banks try to do everything to make the application of a loan as easy as possible.

So, the lending institutions use the whole range of risky loan policies the credit legislation of Australian government and Basel II let them.

d. Risks and effects of this policy

About two thirds of all Australians live in their own house. (ABS, 2006/2001) This share was constant over the last five years. In 2001, 39.7% of all Australians lived in their fully owned houses or flats, while 26.3% lived in houses being purchased. Up to 2006 this proportion changed to 32.6% living in fully owned houses and 32.2% living in houses still being purchased.

During the same period the rent increased by about 31% to an average rent of 190AU$/week (like household income). In contrast, average housing loan repayments increased between 2001 and 2006 by 50%. This is the reason why in 2006 house owners being in purchase of their home had to pay 30% of their income for repayments comparing with 25% in 2001.


[1] Calculated with 6% p.a. as a 240-period annuity of monthly payments of 10 AU$ with a payment at time t=0 of 600 AU$.

Excerpt out of 11 pages


Sub-prime crisis in Australia? A deeper insight
Capital Markets
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ISBN (eBook)
ISBN (Book)
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Sub-prime, Australia, Capital, Markets
Quote paper
Artur Penkala (Author)Christopher J. Kightley (Author)Moritz Meidert (Author), 2007, Sub-prime crisis in Australia? A deeper insight, Munich, GRIN Verlag,


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