How a simple message has unleashed the debt weapon that destroyed the financial world in 2008

You know, if VanEck wanted to impress me with their investment advice, they couldn’t have chosen a worse person to send it to than me!

The reason why will be explained in a moment.

Long-term readers of the Property Cycle Investor (PCI) newsletters would be aware of the following screen grab.

And for good reasons. That newsletter detailed the very scary fact that we have now entered the realm of GFC 2.0. The same people. The same misuse of leverage. And all due to happen right at the time the current 18.6-year Real Estate Cycle said it would occur.

So, imagine my intrigue when I notice the following arrive in my inbox.

Opening with the following sentence.

Residential mortgage-backed securities represent one of Australia’s fastest-growing forms of structured finance. In 2024, this asset class hit a landmark $56.35b of issuance, representing 31% year-on-year growth since 2017. 

Oh dear – THIS again!

I know it was a big call to come out and scream to the world that GFC 2.0 was arriving. But what about now? The single biggest contributor to the so-called Global Financial Crisis of 2007-08, if you believed the mainstream.

Now it is touted both here and across the world as one of the fastest growing areas of structured debt.

So, allow me, dear reader, to once again sound the alarm for you. VanEck is a huge investment fund, I’ve no doubt many reading this now have received a similar email from them. Which makes you their target audience.

Let’s look now at the offer being made.

And once we do, let’s give room for the real estate cycle to pass its judgement. At the very least, you’ll have both sides of the argument to make the best decision possible. Plus, underscore precisely why I believe in the following.

That GFC 2.0 IS coming.

Firstly, a disclaimer. I’ve nothing against the good folk at VanEck. They do a great job looking after their clients’ money, and they employ very knowledgeable and competent people to provide advice and oversee their customers’ investments.

The problem is when you apply the lens of the real estate cycle to this. Which is what we shall do here.

One of the byproducts of this time in the cycle is deregulation. It takes many forms and means different things to different people. For our purpose though, deregulation allows for previously illiquid or off-limits exposure to certain assets to become mainstream in appeal.

That fact means of course there is very little public knowledge about these assets. Hence companies like Van Eck send out promotions like the one I received.

From the email.

Mortgage-backed securities are also one of the least well-known asset classes. This lack of familiarity, we think, has not been for any lack of appeal so much as the limited access investors have had to this type of debt security.

Since the first issuance in Australia in 1986, residential mortgage-backed securities investment has been restricted to fund managers and professional investors, with high minimum entry costs, which typically start at $500,000.

Nothing controversial here, I’d say. However, it’s when I first looked upon this graph below when I realized no amount of sweet talking could ever persuade me to hand over my money.

Note the blue colored part of the chart. This is your professional money and fund managers or insurance groups. Generally speaking, they are the type who would normally qualify to include mortgage-backed assets in their portfolios.

If you study the real estate cycle, then something else immediately sticks out to you here. The large spike into 2007/08, and the subsequent near vertical falls from that same peak.

Followed by a larger and larger base forming since the 2011/12 bottoms.

One that is rising. Say I wasn’t really involved with investing or finance back in 2008, your eyes would “still” be drawn to the shape of this chart.  Plus, a quick 5-minute search on Google would give you plenty of historic articles about what happened back then.

It made me wonder; “how did the VanEck people explain the risks inherent in this type of asset, given they have demonstrated just how quickly $100 billion or so can disappear, to brand new potential investors?”

I decided to read further into this email. Below are some excerpts I think you may find interesting.

The continued creditworthiness of Australian mortgage borrowers is evidenced by the low levels of arrears and delinquencies, even throughout finance crises such as the GFC, COVID and the recent cost-of-living crisis.

Does that statement really stand up to scrutiny? Oh well, perhaps there’s further context here we can find.

Additionally, we have not observed a spike in the issuance of ‘non-conforming’ loans, which are riskier than what are known as ‘prime’ loans. On the contrary, prime loan issuance has continued to outnumber non-conforming by a significant margin – a trend that may reflect investor preference.

Well, that’s more comforting, right? It appears then that, at least for Australia, our mortgage market is strong, with low delinquencies (actually quite true, with them at near historic lows) and the overwhelming preference for professional investors to place their capital into mostly these ‘prime’ loans.

And if the stock market is any guide, one of the world’s biggest banks, The Commonwealth Bank (CBA) not only holds the single biggest mortgage loan book in the country, but its share price has, by the time you read this, either hit or surpassed its all-time high price.

Given the more stringent rules and regulations concerning capital requirements for the big 4 banks, allied with historically low non-conforming loans, perhaps VanEck is right here.

That these residential mortgage – backed securities really are ‘safe as houses?’

No doubt, the big banks look really solid right now. The problem? Well, it turns out there are other banks also offering mortgages. And those banks are also deciding to package up their loan books and rehypothecate them into asset-backed securities (ABS).

These other banks are denominated via the above chart as non-banks. But they have another name, shadow banks.

Banks and non-bank lenders that originate home loans can issue mortgage-backed securities to fund their home loans. While major banks used to be the main issuers of mortgage-backed securities, they have been overtaken by non-bank residential mortgage lenders in recent years for a number of reasons.

Aha. Now we have it. This is why having the ability to use the lens of the real estate cycle is so important for you. Look again at that above chart. Note as you move from left to right the amount of red.

That is the biggest ‘red’ flag I can think of. An astonishing increase in mortgage-backed securities issued by these shadow banks. Recalling the primary collateral here are home loans. It begs the question; just how many loans are these banks actually writing here?

So, what are the risks here? Amazingly, in their effort to sell you on their ASX-listed VanEck Australian RMBS ETF, instead they explain the fact that we are looking at arguably the weakest link in the credit creation chain in Australia!

In the last decade, banks have also pulled back significantly from mortgages as their lending standards became more conservative – a shift largely driven by regulatory restrictions on consumer lending.

This has driven a lot more business over to non-bank mortgage lenders. This transition, however, has not led to a deterioration in credit quality. While non-bank lenders are not subject to APRA’s [Australian Prudential Regulatory Authority] regulation they are bound by the same ‘responsible lending’ regulations as the banks regarding strict credit assessment and serviceability checks for consumers.

Not subject to APRA’s regulations! But what does ‘responsible lending’ in this context actually mean? We can visit the ASIC (Australian Securities & Investments Commission) website to get the official ruling.

Credit licensees must comply with the responsible lending conduct obligations…The key concept is that credit licensees must not enter a credit contract with a consumer, suggest a credit contract to a consumer or assist a consumer to apply for a credit contract if the credit contract is unsuitable for the consumer.

As a credit licensee, you must decide how you will meet the responsible lending obligations.

Look again at the amount of non-bank ABS issuance that has been recorded since 2017. Add in the fact we have a government right now seeking re-election with promises of 5% deposit loans.

I ask you bluntly; how do you think these non-banks have decided to meet their responsible lending obligations?

So, it begs the question, do you have a mortgage written by one of these non-banks? Do you have an offset account against those same loans? Finally, as a Property Cycle Investor newsletter reader, what do you know is due to happen a few years from today?

Perhaps you’re stumped here. Maybe you really don’t know what’s coming? No problem, that’s easily fixed. Become our newest Boom Bust Bulletin (BBB) member.

Let the BBB guide you on the inherent timing of the economy only knowledge of the land market can give you.

Each month this history and knowledge will be yours via monthly written editions and video postcards that will help explain the real estate cycle like never before.

I leave it in your capable hands. I’ve shown you what VanEcks view on this subject is, and today you have my own. For mine, we have found the stash of dynamite that will blow the credit system in Australia into pieces.

Ironically, in a promotional email. Do you find it ironic? Or do you find it scary?

You must be prepared. That time isn’t tomorrow, it’s now.

GFC 2.0. It’s coming – again.

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