Christopher Joye and I have an opinion piece in the Australian Financial Review today on our Aussie Mac report (over the fold).
Home loans need an Aussie Mac
Christopher Joye and Joshua Gans
Australian Financial Review, Thursday 27th March, 2008, p.79.
In a report published today by Melbourne Business School, we argue that the markets for primary residential mortgage-backed securities (RMBS) are not operating efficiently. Our contention is that the instability in international capital markets will almost certainly have long-term consequences for the cost, flexibility and availability of Australian credit in both the residential mortgage and business lending sectors. The difficulties faced by Australian lenders trying to securitise AAA-rated home loans via the primary RMBS market, which has been the source of over $284 billion of cost-effective “off balance-sheet” funding since 2002 alone, has resulted in the withdrawal of major participants (eg, Macquarie Bank and RAMS) and a dramatic reduction in the capacity of smaller providers to offer credit (eg, Adelaide Bank, Challenger, Credit Union Australia, Bank of Queensland, Members Equity, Suncorp, Resimac, Heritage Building Society, etc).
The advent of RMBS securitisation in Australia during the mid 1990s transformed the mortgage market by intensifying competition to the demonstrable benefit of households. With the effective closure of these markets, the rationing of credit has already begun (on an ‘intra-market’ basis) with a striking increase in industry concentration. According to Fujitsu Consulting, the Big-5 majors’ new home loan market share has risen from circa 75% (pre sub-prime) to nearly 90% today. The ‘reintermediation’ of the major banks back into the home loan market is also forcing them to ration credit in other, more capital-intensive, sectors, such as small business lending (which has a 100% risk-weighting rather than the 35-50% risk weighting applied to home loans). The scaling back of these competitive forces will have negative long-term ramifications for Australian households and small businesses.
Importantly, the evaporation of third-party liquidity for Australian home loans has occurred in spite of their extraordinarily low historic default rates, which rank among the best in the world, and the exceptional overall health of the domestic economy.
Under our proposal, the Commonwealth would guarantee the credit worthiness of an Australian government agency, which we loosely call ‘AussieMac,’ thereby lending it Australia’s AAA credit rating. This would allow AussieMac to issue substantial volumes of very low cost bonds into the domestic and international capital markets. The funds raised through issuing these bonds could be used to acquire high-quality AAA-rated Australian home loans off the balance-sheets and warehouse facilities of lenders (including the majors). AussieMac would, therefore, serve to guarantee liquidity in the Australia home loan market in the event that other private sources of capital were to supply insufficient funding, such as is currently the case.
Historically, similar initiatives in the US, with the now privatised government sponsored enterprises, Fannie Mae and Freddie Mac, and in Canada, with the government-owned CMHC, were created with precisely the same mandate that we have in mind: ie, to “stabilize mortgage markets and protect housing during extraordinary periods when stress or turmoil in the broader financial system threaten the economy.”
AussieMac’s liquidity guarantee would restore deep competition in the Australian mortgage industry and enable lenders that originate high credit quality home loans to always access a readily available source of finance. In this way, the establishment of an AussieMac-like agency would help to resolve the illiquidity currently evidenced in the primary RMBS market and help to insulate Australian households and the financial system at large from exogenous global shocks that have nothing to do with the integrity of the Australian economy.
The funding advantages afforded to AussieMac should ensure that it is a profitable going concern that does not require any meaningful public subsidies. This is certainly the case with the CMHC in Canada and Freddie Mac and Fannie Mae in the US, which do not draw on any government funding whatsoever to support their securitisation activities.
While it seems far from our shores, the global credit crisis will impact on the Australian economy. It is not something that can be avoided by pointing to the integrity of the Australian economy, its financial system, or the quality of Australian home loans. We can still be drenched by the storm. And we can still be faulted for not having adequate shelter. The Federal Government needs to take an active role in constructing that shelter; not simply as a result of the current crisis, but because of what it may mean for our economy over the next decade or more.
Christopher Joye is CEO of Rismark International. Joshua Gans is an economics professor at Melbourne Business School. Their report is available at http://www.mbs.edu/jgans.