Zero, 5,041, 50,050 or 261,987. That is how many times Westpac might have breached responsible lending laws between December 2011 and March 2015.
The imprecision evident in that range of numbers is the key reason why Federal Court judge Nye Perram knocked back the bank’s proposed settlement with the corporate regulator, ASIC.
Essentially, around the time a trial was slated to begin, Westpac finally caved and offered ASIC $35 million in penalties to drop its responsible lending court case.
As it has done in recent years, ASIC insisted on some admission of liability as part of the deal.
But here’s the catch — ASIC and Westpac couldn’t agree on exactly which loans contravened the law, nor even concur on exactly what the law actually required.
While Justice Perram grudging acknowledged the “admirable ingenuity” of ASIC and Westpac’s lawyers to “gloss over the very real differences that exist between them” he was ultimately left frustrated.
His pet peeve was the lack of agreement about which loans breached the law — while ASIC and Westpac agreed that at least 5,041 did, even on those Justice Perram wasn’t convinced.
“I simply do not accept that the conduct specified in the declaration is conduct which could possibly be a contravention of s128,” he wrote in the judgment.
“I will not declare conduct which is not unlawful to be unlawful.”
That means Westpac might be in the clear. It might be completely fine to use the Household Expenditure Measure (HEM) — a low-ball benchmark of living costs — to assess whether home loans are suitable.
Hayne has a very different view and the banks are worried
So why would Westpac fess up to a crime it potentially didn’t commit?
Over at the banking royal commission, former High Court judge Kenneth Hayne appears to have adopted a very different view during his hearings.
He seems to believe the HEM is completely inadequate, even as a floor when assessing expenses, let alone as a substitute for what customers have declared. Instead, he wants banks to actually check people’s bank statements to find out how much they are really spending.
If Hayne’s view prevails, all 261,987 of Westpac’s loans might have breached the law.
At a maximum penalty of $2.1 million a piece, that’s a theoretical maximum fine of $550 billion — more than five-and-a-half times the bank’s current market value of $96 billion.
Obviously, that is an unrealistic penalty, but illustrates that Westpac’s liability could be more in the realm of the Commonwealth Bank’s $700 million money-laundering fine than the $35 million settlement it agreed to.
Indeed, calculations show Westpac would’ve still come out in front on those home loans if it paid the $35 million fine.
In the end, it was simply prudent business for Westpac to eliminate the risk of a massive fine by paying a much smaller one, even if there was a good chance it had done nothing wrong.
Wider implications for other banks … and homebuyers
The real danger now for all the banks, big and small, is that a revised settlement where Westpac does admit liability for specific breaches or a court case that it loses might set a precedent not only for the regulator to go after other lenders, but also for customers whose loans go bad to sue for their losses.
That is because most other lenders also use the Household Expenditure Measure as a benchmark to test whether customers can afford to meet their loan repayments.
Many use it as a floor to stop customers submitting unrealistically low living expense estimates in order to qualify for bigger loans, which they often struggle to repay.
In fact, as Justice Perram pointed out in his judgment, for 80 per cent of Westpac’s loan applicants the HEM was actually higher than their declared expenses, meaning it limited what they could borrow.
This is statistically almost impossible, given that the HEM is based on the essentials spending of the median (middle) household in an area and the discretionary spending of a household at the top of the bottom quarter. That means the overwhelming majority of households spend more than the HEM.
Given that it is highly unlikely the HEM calculations by the Melbourne Institute are this far out, it seems most likely that many loan applicants are understating their expenses, either innocently or deliberately.
These have been dubbed “liar loans” by UBS analysts, who have done several surveys showing just how widespread mortgage fraud has been in Australia.
Kenneth Hayne’s solution — to forensically examine loan applicants’ bank statements to cross-check their spending — appears to have been widely adopted by banks to head-off the risk of lawsuits for breaching responsible lending laws.
This has already resulted in a moderate “credit squeeze” as institutions adopt a more realistic assessment of what borrowers can really safely afford to repay.
The fear amongst many analysts is that recommendations from the royal commission combined with the potential fallout from the Westpac case could turn the credit squeeze into a “credit crunch”.
As the amount of money people can borrow to buy houses gets cut, so to does the price they are able to pay.
In the crunch scenario, some analysts are warning that 10-20 per cent house price falls could become 20-30 per cent, probably with a recession to match.
So what happens now? Westpac and ASIC sit down at the negotiating table and try to strike a fresh deal that satisfies the court.
The next directions hearing is set for November 27. If they haven’t struck a deal by then, it’s possible it’ll be listed for a hearing, in which case we might have to wait for years and through many appeals, probably to the High Court given what’s at stake, to find out how banks must assess loan applications to comply with the law.
There’s an awful lot riding on the final outcome of ASIC v Westpac.