What's holding back the wall of money?

When structural change is underway, it makes sense to swim with the tide. And as described in a series of articles over the past week, structural forces are moving the major building blocks of Australian prosperity.

That change is occurring both naturally, through an ageing population, and unnaturally through the tax/superannuation system, and has resulted in a misallocation of resources that affects the lives of millions of people every day.

The problem, and the solutions to that problem described below, are both an enormous political opportunity for the party that ‘swims with the tide’, but also a very difficult argument to make to voters.

To understand, in tangible terms, what needs ‘fixing’, let’s assume a couple, Mr and Mrs Smith, in their mid 70s with a superannuation fund worth $500,000 and a house within 15km of a capital city CBD.

Once upon a time their ‘cheap’ house was on the periphery of the city, but it’s now worth $1,000,000 because it is seen as ‘inner city’ in comparison to newer suburbs further out.

The Smiths draw an income from their super fund, topped up by the pension, but struggle to make ends meet themselves and therefore to help their two adult children and four grandchildren with the kind of gifts any grandparent would like to make.

But then one day, the Smiths see an ad for a ‘debt free’ equity release product in which the bank will buy a stake in their home (at a large discount, in the way bonds are bought at a discounted rates to reflect the ‘interest’ they will pay over time) and decide to ‘sell’ half their house.

Based on normal actuarial principles, a $500,000 stake might be worth, say $350,000 to a bank that has to hold the asset to maturity – and manage risk, particularly ‘longevity risk’.

So the Smiths now have: $500,000 in super, $500,000 in equity in their own home, and $350,000 to consume themselves, to use for the benefit of their children/grandchildren or invest elsewhere.

The beauty of such a scheme is that it allows the Smiths to stay in their own home until death/old age catch up with them. Same neighbourhood. Same friends. And a better standard of living – expensive renovations such as a stair-lift or walk-in bath are now affordable, and Mr Smith will never cut the lawn himself ever again.

There is, essentially, a huge pool of money held back by cultural values (the desire for home ownership) or fear of the future. Allowing that pool to flow to more useful places, without fear/distress to old Mr and Mrs Smith, is something that can be done by the free market, but can be greatly assisted by a government response.

So what is holding the wall of money back?

Firstly, as Ian Harper suggested (A huge opportunity in retirees' hidden wealth, November 12) the expansion of this kind of product by banks and other financial institutions would be greatly assisted by the creation of a government-backed securities market into which half the Smith’s home can be sold.

Equity Release Bonds (if we can call them that), in normal times would carry little unexpected risk. However, the threat of a GFC-style property crash cannot be ignored, and the government’s role would be to offer a ‘put option’ on each bond – a guarantee to buy them at, say, 80 per cent of their value, and hold them through a period of instability in ways private finance houses would not be able to.

Secondly, a push to liberate the capital locked up in homes would shine a light on the elephant in the room – that Australia has two incongruous tax regimes covering the family home and super nest egg.

For purely cultural reasons, we’re happy to pay for our homes in after-tax dollars, and take the capital (often after death) capital-gains-tax-free. In super, by contrast, workers on decent salaries/wages get a massive tax rebate on every dollar put into their fund, pay tax on earnings within the fund over time, and (despite Labor’s plans to change it) take tax-free income at the other end.

Put together, that is a dog’s breakfast of a tax system. Super tax concessions, which still largely follow the Costello model left by the Howard government, are massively regressive and work against both the principle of a ‘progressive tax scale’ and against the principles underpinning the Hawke/Keating move to create the super guarantee in the first place.

As economics writer Leith van Onselen pointed out recently, if you believe in a progressive tax scale, then how does it make sense to give an effective super tax concession of 17.5 per cent to somebody earning in the $37,000-$80,000 bracket, while giving a full 30 per cent to every dollar earned  over $180,000? (See his full argument here.)

The super guarantee was supposed to take normal-income workers out of the pension system by forcing them into long-term investments. Instead, it is heavily skewed to giving tax breaks to wealthier Australians and, worse, still allows a lot of income to be ‘laundered’ through the super system in the last few years of work and then withdrawn a short time later – not a long-term investment at all.

That’s why a reform to unlock housing wealth would also be a reform to overhaul our nonsensical super/housing tax regimes. And that is why I argued on Tuesday that this reform would be as grand a project as creating the super guarantee in the first place, or getting the GST through parliament – very, very difficult, but massively beneficial to the nation.

There is one other factor holding this reform back – a very human factor.

At present, many baby boomers plan to have their assets divvied up by their descendants after they die. That way, they will never see what little monsters their children can turn into when they scrap over the will.

As one homelender told me last week, a large number of people wishing to release equity from their home ultimately give up when they discuss it with their kids and discover the family conflict it can cause.

To my mind, that creates an opportunity for a new kind of financial advice. 

By way of analogy, in a divorce scenario a lawyer will tell you what you can screw out of your ex-partner.

However, in recent years divorces have tended to be governed less by combative lawyers and more by mediators, whose primary question (as it should be) is “what is best for the children?”

A similar service could quite easily be offered to Mr and Mrs Smith. Their $350,000 of released equity could come with sound financial advice – taking into account, in an unbiased way, what’s best for the various family members expected to get a slice of the pie. A bit for school fees, a bit for South Pacific cruises, a bit for a new car.

That is not a job for government, but getting the market up and running is.

The largest intergenerational wealth transfer in Australia’s history has already begun. Some refer to this process as a ‘generational war’ – but it doesn’t have to be that way.

Wars usually start because resources have been locked in the wrong place for too long. 

The political leader that can offer a smoother transition through a government-backed equity release market, would not only be averting a financial ‘war’ - they’d be making Mr and Mrs Smith and the decendants happier, healthier and more prosperous.

There’s got to be a few votes in that.