Smart Investing with Robin Bowerman: Double jeopardy of debt
Fri, 8 May 2009 2:30pm
VANGUARD INVESTMENTS AUSTRALIA
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Smart Investing with Robin Bowerman 
Double jeopardy of debt
Among investors most hurt in this severe bear market are those who followed an extremely high-risk borrowing practice in an effort to maximise their exposure to shares.
First, these investors borrowed heavily against their family homes to buy shares in the then fast-rising market. Then, they borrowed against those same shares using margin loans to buy even more shares.
In other words, debt was stacked upon debt.
The Minister for superannuation and corporate law, Nick Sherry, calls this a “double-debt trap”. In past blogs, Smart Investing has tagged it a “double jeopardy” of debt.
When share prices plunged, such investors typically lost not only their entire share portfolios but their homes as well. And in many instances that have become publicly known, many of the investors were on eve of retirement or in early retirement when they entered the borrowing arrangements.
Fortunately, investors should soon gain much more protection from this borrowing practice.
Yesterday, Nick Sherry released draft legislation to regulate margin lending. And the proposed laws include provisions clearly designed to significantly reduce the likelihood of investors falling into the double-debt trap.
When the draft legislation becomes law, lenders will be required to assess a would-be borrower’s “true” loan-to-value ratio. As Sherry explains: “This means the lender can no longer assume the money brought to the table isn’t itself debt; a major new improvement that will see the risk of people losing their home significantly reduced.”
Further, advisers will have to provide advice about whether a margin loan is appropriate for a borrower’s circumstances and can be afforded without causing substantial hardship.
The draft legislation is posted on the Treasury’s website (http://www.treasury.gov.au/contentitem.asp?NavId=037&ContentID=1533). And also see the Federal Government’s Consumer Credit site for a brief rundown on the imminent regulation of margin lending. (http://www.treasury.gov.au/consumercredit/content/default.asp).
Sadly, it has taken a nasty bear market and the suffering of thousands of older investors to publicly expose the potentially destructive practice of double borrowing with marginal loans.
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