The global financial crisis that started with the US subprime meltdown and now continues to spread through investment banking is impacting upon the Australian financial system. The source of funds for lending provided by securitised assets has all but dried up. The problem is that we have no institutional structure to step into the breach.
Contrast this with the US where the whole thing originated. Daniel Gross in Slate today outlines a number of New Deal originating institutions that exist in the US and are protecting the real economy from their own financial instability. One in particular is of relevance for Australia:
The Federal National Mortgage Association (Fannie Mae), which was created in 1938. Fannie Mae purchases so-called conforming mortgages (mortgages under a certain size) made by other lenders and packages them into securities, which it effectively insures. (Here’s a historical table of the conforming loan limit, which was $417,000 for a single home last year.) Fannie Mae and its brother government-sponsored enterprise, Freddie Mac, are playing a central role in the federal response to the housing crisis. The stimulus package boosted the size of the loans Fannie and Freddie can buy, from $417,000 to “125 percent of the area median home price in high-cost areas, not to exceed $729,750.” And then earlier this month, OFHEO, the body that regulates Fannie and Freddie, said it would lift the cap on the amount of capital they could use to buy mortgage-backed securities and make loans, providing “up to $200 billion of immediate liquidity to the mortgage-backed securities market.”
As it happens, for the past week or more, Christopher Joye and I have been working on a proposal for a similar government sponsored enterprise for Australia to undertake precisely the same role Fannie and Freddie are providing the US. The idea is Christopher’s; I have helped with the competition and policy rationale. Our report (available here) was released today. It provides a detailed case but, in many respects, the Gross article sums it up nicely. The US have protection, we do not even though we face precisely the same problem and even though it is not our fault.
There is much at stake here. A dried up source of loans from securitisation will make it harder for smaller mortgage providers to compete as they have done for the last decade. That competition has saved us at least a couple of percentage points on our home mortgages. Without that source of funds that competition will similarly dry up and maybe for a long time.
In addition, the mix of funding will change. All banks — large and small — lose that funding source. As the base reverts to deposits, lending reverts to the less risky as credit is rationed. That means fewer loans for low-income households and for SMEs. This is not good news for our currently growing economy.
Finally, when all is said and done, when the RBA eventually gets around to lowering interest rates, those lower rates may not be passed through when credit rationing is already taking place. That will put a kink in the effectiveness of monetary policy as well as potentially causing the Federal Government political problems.
We suggest setting up an Australian version of the US (and Canadian) institutions — AussieMac. It would guarantee securitised loans using the government’s AAA-rated status. That will keep lending costs down but in a way that costs the government little more than the operational expense of setting up AussieMac. To our eyes, it looks like low-hanging policy fruit. Now, how to get our government to pick it …