Have you ever wondered why the phrase “second-hand car salesman” has become a pejorative term throughout western society? After all, the occupation of second-hand book dealer or furniture salesman has not taken on the same connotation.
I think it arises as a direct consequence of combining a relatively complex and difficult to understand product with a commission-based sales model – where both the opportunity and the incentive to exaggerate and mislead in order to sell a particular product are present.
Can we therefore be surprised that a rise in the use of sales commissions to sell home mortgages corresponds to a rise in bad debts?
In recent years the share of home loans being written by Australian mortgage brokers has grown and is currently believed to be between 30 and 40 percent, while the US has traditionally exhibited an even higher percentage. That means that the home lending process is driven not only by demand from borrowers and a desire to earn interest by lenders, it is also driven by the broker’s desire to make the sale and thus receive commission.
The surge of difficulties arising from the US subprime debt market is at least, partially, a result of that dynamic. Lenders have been convinced to lend on inadequate security to borrowers whose income is tenuous or insufficient to cover interest increases. The result is bad debts for lenders and the loss of equity for homeowners as forced sales cause a collapse in values.
In a similar way, when Australia’s universal superannuation system is combined with commission-based selling, sub-optimal financial outcomes are a likely result, as investors are sold products which are too expensive, too risky or performing poorly.
Garry Weaven is Chair of Industry Funds Management, an investment service provider to the superannuation industry, a director of Members Equity Bank, which is owned by 40 superannuation funds, and a director of Pacific Hydro.
