Canberra, we have a problem

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 …

6 thoughts on “Canberra, we have a problem”

  1. Aren’t there already providers of Lenders Mortgage Insurance in the Australian marketplace? You seem to be suggesting that because of the credit crunch, the federal government should set up a government owned enterprise (a bit like Aussie Post) that would somehow calm the markets and provide liquidity by buying mortgages for a fee. I don’t see that would help any.


  2. Yes there are: Genworth and PMI Mortgage Insurance are the two dominant providers of LMI in Australia (they currently insure away the default risk associated with over $400 billion worth of Australian home loans). They do not, however, provide any direct liquidity to the primary RMBS securitisation markets, which have historically been the source of funding for nearly 20% of all Australian home loans. All they do is “credit enhance” these assets, which, to be frank, are not in need of a great deal of credit enhancement. Put differently, if we set aside for the moment that “prime” Australian home loans have incredibly low default rates (as at November 2007 only 0.84% of all Australian prime mortgages were in 30 days or more arrears according to S&P), the presence of the “mortgage insurance” supplied by Genworth and PMI has done nothing to prevent the collapse of the $50 billion per annum RMBS securitisation market. As Gans and Joye note in their paper, this market has effectively closed for reasons that are completely unrelated to the health of the Australian economy, our housing finance industry or household balance-sheets. And the ultimate casualties will in all likelihood be competition and the cost, flexibility and availability of housing finance in this country.


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