Goldman Sachs accused of fraud

17/04/2010 2:12:21 PM

The US government has accused Wall Street's most powerful firm Goldman Sachs & Co of fraud. They sold mortgage investments without telling the buyers that the securities were crafted with input from a client who was betting on them to fail, which they did to the tune of $US1 billion ($A1.07 billion).A hedge fund, capitalised on the housing bust. The civil charges filed by the Securities and Exchange Commission are the government's most significant legal action related to the mortgage meltdown that ignited the financial crisis and helped plunge the country into recession.The news sent Goldman Sachs shares and the stock market reeling as the SEC said other financial deals related to the meltdown continue to be investigated. It was a blow to the reputation of a financial giant that had emerged relatively unscathed from the economic crisis but who continued to play the same games that brought down the US economy in the first place

The fraud allegations focus on how Goldman sold the securities. Goldman told investors that a third party, ACA Management LLC, had selected the pools of subprime mortgages it used to create the securities. The securities are known as synthetic collateralised debt obligations.

The SEC alleges that Goldman misled investors by failing to disclose that Paulson & Co. also played a role in selecting the mortgage pools and stood to profit from their decline in value. Two European banks that bought the securities lost nearly $1 billion, the SEC said. The global game continues."Goldman wrongly permitted a client that was betting against the mortgage market to heavily influence which mortgage securities to include in an investment portfolio, while telling other investors that the securities were selected by an independent, objective third party," SEC Enforcement Director Robert Khuzami said in a statement.

economy and property

The Australian economy has returned to debt-driven growth, with the household sector carrying the full burden for the private sector. Will this period of debt-driven growth last as long as in previous bubbles when our private debt to GDP ratio was half what it is today?
Banks & mortgage lenders have been biggest beneficiaries as mortgage debt has risen from under 20% of GDP in 1990 to over 85% at end of 2009.
So how does Australia keep house prices high? By encouraging households to get into yet more debt.The rise against GDP is far more dramatic than against household disposable income because other government policies—the stimulus package itself and the RBA’s 4% cut in interest rates—boosted disposable income dramatically in 2009 (but even so, mortgage debt is now a higher proportion of household disposable income than before the GFC). The Boost-inspired house price bubble was financed by households adding another 6% of GDP to their already unprecedented debt burden, when prior to The Boost they were on track to reduce mortgage debt by about 3% of GDP in 2009.We’ve avoided hitting the ground of deleveraging by climbing to a higher cliff but stepping off the cliff will eventuate unless there is a totally new solution to the dilema. Saying all this we have Grace on our side because we are still an expanding relatively new country with a growing population that does need a place to live.
Australia’s still unburst bubble drove the real price of housing to 140 percent above the level of June 1986–that is, real house prices are now 2.4 times what they were in mid-1986
Australia's Debt Bubble has kept going while other countrie's have already popped is the same old reason-debt. This is the biggest debt bubble in our history. The previous two record highs were in 1882 at 104% of GDP, and 1931 at 77% of GDP. Record debt is 158% as of March 2008.
large reason why Australia has had such a mild GFC so far is because Australian households were enticed back into debt by the First Home Vendors Boost, and by the impact of the Government stimulus package upon household disposable incomes.Households were reducing their mortgage exposure prior to the introduction of The Boost: mortgage debt had peaked at 81.3% of GDP in June 2008, and was trending down prior to the Boost. It then hit a bottom of 80.3% in December 2008 before rising to an all-time high of 86.8 in January 2010.The change has been less extreme when mortgage debt is measured against Household Disposable Income (HDI), since the Australian government’s stimulus package and the interest rate cuts by the RBA boosted household incomes by almost ten percent last year. As a result, mortgage debt fell only slightly as a percentage of HDI, from 133.6% to 130.3%, and it took longer to fall. But ultimately, even though incomes had been boosted so substantially, the increase in mortgage debt last year finally exceeded the increase in incomes: by January 2010, the mortgage debt to HDI ratio had hit a new peak of 134.2% The overwhelmingly important reason why this happened is the policy that the Government called the First Home Owners Boost.

Gearing and Super

ONE way to get around the non-concessional contribution caps for superannuation is to use gearing. Under super tax rules, to avoid paying excess contributions tax of 46.5 per cent, you are allowed to contribute only $150,000 a year in non-concessional contributions. However, you can utilise a three-year cap by making a one-off contribution of up to $450,000 if you are under 65 and then not contributing any more than that for another two years.So if you have a commercial property worth more than $450,000 that you want to transfer into your self-managed super fund through an in-specie contribution, you could run into difficulties.By using gearing, however, you can borrow the value of the property either from a financial institution or from yourself or your business at a commercial rate.This is because whatever you borrow is not included as a contribution provided the borrowing arrangement complies with the conditions set out in the law.In fact, you can borrow as much as the fund can service. It's worth noting, however, that most commercial lenders apply an interest cover ratio where the fund's investment income must be a set multiple of the interest cost of the loan. Failure to meet this ratio may give the lender the ability to call on the loan.You can use this strategy to bolster your superannuation balance, regardless of what you make in non-concessional contributions.Of course, gearing into superannuation is not for everybody. Whether it's to invest in shares, property or works of art, it's a complex process that requires sound financial advice and a cost-benefit analysis to make sure it's the optimum route for your circumstances.And it is not cheap either, with estimates running into the thousands of dollars just to establish the loan. Additional costs may include legal advice to establish proper trust and other arrangements, transaction and stamp duty costs and asset administration fees. The importance of establishing the loan and trust arrangements properly cannot be understated as there may be unnecessary capital gains tax and-or stamp duty costs if you don't.Before 2007, superannuation funds were not allowed to borrow to purchase assets. However, uncertainty about whether instalment warrants and instalment receipts involved borrowing meant there was a need to change the legislation.The new rules not only allowed SMSFs to invest in more traditional instalment warrants and instalment receipts generally involving shares, but also in non-traditional instalment warrant arrangements over such assets as property. However, it's important to be aware that the normal investment rules that apply to SMSFs also apply to investments that are purchased using an instalment warrant borrowing arrangement. For example, you cannot make an in specie contribution of a residential property into the fund although you are at liberty to buy residential premises on the open market as long as it is not purchased from yourself or a related party.However, a number of grey areas in the treatment of instalment warrants within super have proved a deterrent to gearing in SMSFs.Last month, the government moved to clarify how instalment warrants will work, particularly in relation to capital gains tax.When an SMSF buys a property or shares through an instalment warrant, it has to set up a separate trust. This separate entity is known by a variety of names: a bare trust, a security trust, a warrant trust or a debt instalment trust. They are basically all the same thing.
If your fund were buying a property under an instalment warrant arrangement, it must be held in the trust until the debt is paid in full, at which point it is transferred into the SMSF. The grey area was always whether that transfer triggered capital gains tax.But last month, Financial Services, Superannuation and Corporate Law Minister Chris Bowen announced an amendment to the tax law so that a superannuation trustee entering into a limited recourse borrowing arrangement to purchase an asset would be treated as the owner of the asset for income tax purposes."The changes will ensure that trustees to superannuation funds who have entered into permitted limited recourse borrowing arrangements will not face CGT obligations at the time the last instalments are paid," Bowen says.Another grey area was whether the super fund trustee or the instalment warrant trustee should be the one to declare any income earned on an asset.The latest announcement confirms it is the super fund trustee who should declare the income. And equally, the fund can claim a tax deduction from earning that income."If structured properly, it will look as though the investment trust does not exist," says Philip la Greca, technical services director at Multiport. "Income flows through to the fund; dividends and depreciation flow through to the fund. It looks as though the fund owns the asset directly."La Greca goes on to say the issue of CGT has been a big concern given that an asset held for five or 10 years could have a reasonable capital gain.Another issue is stamp duty, which, rather than being a federal tax like GST and CGT, is administered by the states and territories. Generally speaking, however, the transfer of a property from a bare trust to an SMSF should be exempt.The recent announcement also brought gearing property into SMSFs into the framework of financial products.As a result, providers have to be licensed. In the past, real estate agents and property developers had been promoting the strategy and this has caused some concern. The move to licensing underlines the importance of having sound financial advice to ensure the strategy is right for your SMSF's circumstances.A downside of having property in your SMSF is that not only is it an illiquid asset but it can also be a large chunk of your fund's investments.What would happen, for instance, if one of the members of your SMSF were to die early and the fund had to make a payout?Deb Wixted, head of technical services at Colonial First State, says in such circumstances it could take time to unwind the arrangement and could be expensive.She also comments that although the latest government announcements have cleared up a number of issues, there is still a lot of scope for interpretation."The Australian Tax Office is still sifting through the issues, so what you do now could still be called into question in the future," Wixted says.But there are other positives in gearing, not least that if the fund still holds the property when it enters the pension phase there will be no capital gains tax payable on the sale of the property. But the wisdom seems to be that the gearing should be well and truly completed by then, otherwise you may have problems with cashflow at the time you may be needing to draw an income out of your super on which to live.Another plus is that once you are in the pension phase, the rental income will no longer be tax assessable, although that also means the interest costs won't be deductible.Of course, gearing into super is not all about property. Indeed, most reports are that while there are plenty of inquiries about borrowing to buy property within super, very few actually end up going down that road.Far more popular is the use of instalment warrants for direct share purchases or to invest in managed funds, although with the latter it may be simpler to invest in a geared managed fund rather than have your SMSF undertake the gearing.Graeme Colley, national technical manager at ING Australia, says borrowing to buy shares in your SMSF means the fund can enjoy the benefits of franking credits. With fully franked dividends taxed at 30 per cent already and your SMSF only paying 15 per cent tax on its earnings, the fund can use the 15 per cent difference to offset other income in the fund.And if you are gearing into these shares, then, assuming the market remains positive, you benefit from the extra exposure. Of course, if shares tumble then you will take a bigger hit.On the shares front, Macquarie, for example, has Equity Lever, which allows you to get leverage in an SMSF.Peter van der Westhuyzen, head of sales and marketing at Macquarie Margin Lending, says Equity Lever has been on the market for some 18 months and has enjoyed strong support."Equity Lever gives you increased investment size in a tax effective environment along with diversification," van der Westhuyzen says. Just as the banks want a low loan-to-value ratio when customers are borrowing for property, the LVR for Equity Lever is below 50 per cent.The initial investment can be as low as $20,000 but the interest rate on the product is 9.55 per cent. borrowing to invest, whether inside or outside super, can be fraught.But if the fund makes the right investment and can service the loan, you could be bolstering your super benefits.And given that superannuation payments are tax-free to those aged over 60 and there is no capital gain on assets sold when in the pension phase, it makes for a reasonably solid argument.If the limited recourse loans start to offer competitive rates of interest and the grey areas of gearing are cleared up, it may well prove an effective strategy for your SMSF.
Gillian Bullock From: The Australian April 14, 2010

GFC

While GDP certainly decreased during the GFC, Australia avoided sliding into an official recession. And while the unemployment rate rose (reaching a high of 5.8% in June 2009), those that retained employment actually experienced an overall increase in disposable income.Many Australians are actually in a better position now than before the downturn – what with significantly lower interest rates (currently at 4%, compared to 7.25% at the start of September 2007) and greater national disposable income (estimated by IBISWorld to reach $194,500 in the March 2010 quarter compared to about $181,000 million in late 2007).Add to this lower fuel-prices (now at US$80 per barrel compared to US$145 per barrel in mid-2008) and it's not surprising that household spending has been relatively strong over 2009-10.

Where to from here?

Average Australian households remain better off now than before the GFC and the first home owner boost encouraged many Aussies to enter the mortgage market – meaning we are just as indebted now as pre-GFC. Interest rates, fuel and electricity prices have all risen and many Australian families will again feel the pinch this year and onwards.Nonetheless, conditions are forecast to continue to improve, with IBISWorld projecting that slow economic growth in the March 2010 quarter will be replaced by solid growth for the remainder of the year, as households continue to spend and businesses join the fray.IBISWorld also expects the unemployment rate to continue to trend downwards and, barring any reversal of the improving trend internationally, the Australian economy will remain strong for the foreseeable future.

John Edwards of Residex speaks

The markets across Australia are indicating that they have passed the first peak in a normal part of a growth cycle. For most capital cities this means that we will see a slowing in the rate of growth (but still growth) during autumn and winter and a move back to higher rates of growth in the second part of the growth cycle.

This second phase or part of the growth cycle is usually longer and stronger than the initial growth period. The cycle has moved to being more normal, with upper cost areas of the market now leading the way forward. This is as one should expect as confidence among the ranks of our executive and upper management groups become stronger. It will flow on to other areas as corporate profits improve and there is lower unemployment and some wages growth.

Slowing is evident from the number of slightly negative growth numbers in the month of February for houses. The relatively strong performance in the unit market is evidence that investors have become much more active.

Here are the house and unit market statistics for February 2010.

Houses
		Growth	Growth
Area	Median value	Feb 09 to Feb 10	10 year average
ACT	$501,500	9.45%	10.74%
Melbourne	$547,500	16.32%	10.16%
Brisbane	$469,000	6.52%	11.81%
Sydney	$634,000	13.28%	6.62%
Perth	$481,000	2.00%	11.67%
Hobart	$362,500	5.20%	11.98%
Darwin	$501,500	11.20%	11.28%
Adelaide	$400,000	7.95%	10.48%
Units
		Growth	Growth
Area	Median Value	Feb 09 to Feb 10	10 year average
ACT	$394,000	7.84%	10.98%
Melbourne	$422,000	16.39%	9.85%
Brisbane	$357,500	3.10%	10.36%
Sydney	$444,500	10.41%	6.00%
Perth	$391,000	7.27%	11.08%
Hobart	$277,000	9.01%	12.50%
Darwin	$410,500	17.02%	11.09%
Adelaide	$306,000	8.01%	11.57%

Darwin houses are at last taking a breather and the growth for the month was for the first time negative in more than a year. Its rental yield remains the highest of all capital cities and will cause further investor interest which will continue to drive prices but at a lower level given the cost of property which is now relatively high by comparison to the other opportunities. The cost of an unit investment here is now only very marginally lower than in both Sydney (8%) and Melbourne (3%).

Graph 1: Major Capital City Trends

Graph 1 Major Capital City Trends clearly shows that the market is now softer than it was in September/October 2009.

The auction clearance rate in Sydney last week was approximately 65% while the clearance rate in Melbourne was in the 80% range. The impact of the RBA to increase interest rates has been more noticeable in Sydney but is a reasonable outcome given the higher cost of housing and the larger mortgage position for most when you consider that Sydney has been more expensive over a longer period. The momentum and confidence of Melbourne property buyers in a city which is growing strongly is likely to carry its growth phase for longer than in Sydney. However, both cities are exhibiting a slowdown as we move into winter. In both capitals investors are active in the unit market and prices are moving forward.

Our other cities are also exhibiting a softening but it is not as noticeable as in the two majors (see Graph 1). Again, this result is probably an expression of the lower impact of unaffordability and the RBA´s move on interest rates. (see Graph 2 Minor Capital Cities Trends).

Graph 2: Minor Capital City Trends

I have recently been reading suggestions and arguments about a price bubble in Melbourne forming.

I can see no evidence of this. Yes, houses are too expensive across Australia but that position is unlikely to change for at least a decade as it will take that length of time for governments to correct the stock shortage issues.

Further our population needs to expand to satisfy the fundamental needs of a growing resource sector. Add to this – the recent breaking of the drought and it is clear that Australia is in very good shape with the population more likely than not to see growth in wages, and reductions in unemployment than anything else. Add to this – a banking network that is strong and has the capacity to continue to lend to this sector and needs to, to maintain profits and we have a recipe for moderate to good total returns from our housing assets. Please note that I speak of total returns as the affordability issue will lead to renting becoming more normal than in the past and creating moderate capital growth, but at the same time causing rentals to rise.

But I digress a little. The RBA interest rate increases are having a slowing affect and the data is clearly showing that the rate of growth is moving back a little. This in itself points to a "bubble" being avoided as the growth rate would need to be increasing for there to be the potential of any major problem. One last point on this; our more than 170 years of data tells us that capital growth rates in the last 60 years are less each cycle and hence as property becomes more expensive, bubbles become harder to create. Having said that, we have to bear in mind, any long period of moderate growth with excessive bank lending with higher leverage being allowed or encouraged can lead to problems if the economic circumstance of the country turns down.

Our banks are well controlled and governed so a rapid adjustment to our housing values to make them affordable looks very unlikely.

With the market moving to a normally quieter period during winter, it is a good time to identify opportunities. For me winter is the best time to purchase as there is less competition in the market and sellers at this time are usually more anxious. You probably have a better opportunity to negotiate that bargain, particularly in Melbourne.

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new banks entering the market

The decision by Credit Union Australia and AMP Bank to slash variable interest rates on home mortgages is good for the property market and will spur competitive activity, industry experts have said.The move by the two lenders came as Westpac chief executive Gail Kelly reportedly told a private briefing the bank would continue to raise interest rates due to cost pressures despite political pressure from Canberra.Credit Union Australia announced a 25 basis point cut in its variable rate to 6.37%, putting its products well below the interest rates offered by the big four banks. The closest competitor is NAB at 6.74%."We agree with the Treasury Secretary that the banking sector has become more concentrated over the last few years. There is a crying need for more competition and we are taking an active step in driving that competition," chief executive Chris Whitehead said in a statement."At the end of the day our profits go to our customers, not shareholders, in the form of investment in more competitive products and services. We are already a leader in the delivery of great service – this reduction in our SVHL rate means we are keen to take a leadership position in the products we offer as well."The statement comes as the property market is heating up. AMP Bank cut its rates late last week to 6.27%, while Aussie Home Loans also continues to finalise a $1 billion funding program in a return to the industry. Additionally, Macquarie Bank issued nearly $500 million worth of low-doc loans earlier this week.CommSec chief economist Craig James says he was a little surprised by the move, but says it makes sense as more players fight for the lower-end of the market."I think it's a move which has grabbed a lot of attention and I feel CUA will win a little bit of market share out of it. When you see Macquarie getting into the game again with low-doc loans, I think it shows there are more players coming into the market.""Economically speaking, it isn't a surprise, and if it's true that the banks are starting to gouge, the barriers to entry will remain high and give these lenders somewhere to move. There is a new context for the new players, and it's a good thing for the market which may make the banks watch their backs a little more."SQM Research founder and Advisor Edge property researcher Louis Christopher says the broad message of these cuts indicate the market is moving into a more competitive state, indicating a good time for investors to enter the market."The good news for borrowers is that there is now a lot of choice, and it's merely a case of doing your homework on these sorts of things. Certainly the expectation is that rates will continue to rise rather than fall, and people need to take that into their outlook. Also consider it may be a competitive deal now, but rates are going to rise no matter what.""But certainly in terms of the fact there is some competition, it is a good thing for the broader economy and borrowers, and has the potential to encourage other lenders and encourage greater growth."

Iron ore and world economy instability

Chinese Premier Wen Jiabao not only warned the world of a possible return to recession, but was subject to impassioned pleas by steel makers over the enormous price rises looming in iron ore. The Australian economy depends more than any other in the world on the Wen Jiabao forecast and the iron ore strategic discussions.Whether we have a global recession will depend in part on whether the world cost of money rises substantially as the US, European and other governments step up their borrowing. In turn, that will partly depend on how much of the global money demand China can fund.But when it comes to iron ore pricing, it is China that caused the problem and Wen Jiabao has made the first moves that may lead to a big fall. The spot market for iron ore is double the 2009-10 contract prices, so the Chinese are looking at a truly enormous rise in costs, which will flow right through the Chinese economy. That spot iron ore price increase was mainly driven by incredible spending by the Chinese on infrastructure and dwellings as part of their response to the global financial crisis. In turn, that forced the Chinese steel mills to pay big prices on the spot iron ore market to gain material to satisfy the demand.A lot of the Chinese infrastructure spending was very productive, but a vast amount was wasted. The Chinese have built empty blocks of apartments, roads and rail that they will not need for years.This took place because the bulk of the capital expenditure was undertaken by local governments. Imagine what would happen if our local councils or state governments had the ability to borrow virtually unlimited amounts of money. Almost certainly they would spend it to satisfy local vested interests. The Chinese behaved exactly as you would expect equivalent bodies in Australia to do.According to JPMorgan, Chinese local governments were responsible for some 80 per cent of the capital spending and therefore dominated demand for our iron ore and are the main drivers of the price rises. It is also a force fuelling overall inflation in China.Even though it is the wasteful spending that is causing the problem, reversing the policy will be hard. But Wen Jiabao has taken an important first step removing the guarantees that enabled the local councils to borrow. In theory at least, the central government will then have a much bigger say over what takes place, but slowing the economy means many jobs will be lost.The stance of BHP is that annual iron ore price talks are just too disruptive, but a switch to spot prices would see the price sky rocket. Gradually, Rio Tinto and Brazil's Vale are coming to a similar view although they are sensitive to the Chinese demand for certainty.But one way or another, iron ore pricing is going to be much more orientated to the spot price and/or other short term price mechanisms.If Wen Jiabao is successful in curbing the expenditure of the local governments, then we will see a significant fall in the demand for iron ore late in 2010 or 2011, assuming current tasks are completed. Such forecasts have been made in the past and have been wrong as the demand for iron ore just keeps rising. But Wen Jiabao's prediction of a possible global recession is unprecedented.Both BHP and Rio Tinto believe that the Chinese growth story will not be a straight line graph and will have big variations. We will need to watch the curbs on Chinese local government work. And if the Chinese do pull back, Australia will bear a lot of the short term pain.

This article first appeared on Business Spectator.