Beware mortgage funds - losses or fund freezes could be occurring over the next few years ...

Key points:

  • In "normal" times, mortgage funds with conservative LVRs can be good stable fixed interest investments earning a better return than cash.

  • And we did recommend some mortage funds up until somewhere like 2003 or 2004 or thereabouts.

  • But we ceased recommending them then because we could see the rising private debt bubble in Australia .... which as you know, accept for Japan post 1989, has always been a pre-cursor to economic depression in countries like Australia and USA - going back 150 years. In the 1930s and 1890s economic depressions, house prices in Sydney and Melbourne fell about 35%, and major house price falls can result in major losses for lenders such as mortgage funds.

  • And indeed, during the 2008-2009 Global Financial Crisis, a there were substantial losses in some mortgage funds and fund freezes in other mortgage funds. Some references:

  • https://www.smh.com.au/business/cba-freezes-mortgage-fund-20100113-m705.html

  • https://www.moneymanagement.com.au/features/editorial/its-time-investors-face-truth-about-frozen-funds

  • https://www.sbs.com.au/news/aussie-mortgage-fund-39-set-to-freeze-redemptions-39

  • https://asic.gov.au/about-asic/media-centre/key-matters/information-for-investors-in-frozen-funds/

  • And the above mortgage fund freezes occurred without Australia having a house price crash during the Global Financial Crisis - but in the US for example, where there was a house price crash going through the GFC, there were major losses in mortgages. In the following article, Luci Ellis, from RBA conveys that story.

  • https://www.rba.gov.au/speeches/2009/sp-so-150409.html

  • "The first consequence of this was the failure of a number of US mortgage lenders.... After years of underestimating risks on mortgage-related and other complex securities, banks and other investors started to realise just how risky these securities were."

  • And Australia's private debt bubble has grown quite substantially in thw Western developed world. I think there is only 1 western developed country with higher household debt to GDP at this time - as most of those with high mortgage debt to GDP in 2007, had major house price crashes in 2008-2009.

The above chart is from RBA's Luci Ellis paper referenced above. https://www.rba.gov.au/speeches/2009/sp-so-150409.html Is is useful to remember that the losses in UK and US banks was driven substantially by losses on their mortgage loan books through the GFC. Yes, in the first instance, in the US it was fear of those losses (and lack of market liquidity), but they turned into actual losses.... and the bank share prices only recovered very slowly. As late as 2016, the US bank share price index was still only half of its 2007 level.

Again, this chart is from Luci Ellis's paper referenced above.

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