What a difference a month or so makes. Back in August, RBA and Treasury officials paraded before the Senate and stated categorically that the markets were working as expected and the non-bank exit was but a blip and they would return forthwith or, at the very least, the expectation of their return would provide much needed competitive discipline to the major banks. And just to prove them right the banks played ball and dropped interest rates with the RBA.
But now another interest rate cut may be around the corner and with enviable profits it is not clear that the banks will follow suit. Nonetheless, I nearly fell off my chair when I heard the Treasurer, Wayne Swan, say this in Parliament yesterday:
We also, in that legislation, gave authority to the government for the AOFM to be more active in the area, should that be required. We stand ready to take further action in the mortgage market to make it more competitive so that Australian families out there get a fair deal. That is the government’s position.
This was surprising that the Treasurer all but ruled out such intervention only a few months earlier and the non-political executive branch had ruled it out as unnecessary. As it is unlikely that moral suasion will work again, I guess the Treasurer doesn’t want to face an electorate with limited bank competition.
So let me revisit the case for the intervention as I summarised it in July:
- Home lending is funded from two sources: deposits and securities.
- Thanks to the US subprime crisis, securities have dried up in Australia.
- The result is a contraction in supply, a rise in interest rates on mortgages, credit rationing of SME business lending and the major banks now having 90%+ of the home lending market (reversing a decade or more of competitive gains).
- Non-deposit taking institutions (and smaller banks) have been left out in the cold. Compared with the US and Canada that have GSEs where they are still operating competitively.
- An Australian GSE would bring back the securitisation channel. By using the government’s AAA-rating it would restore confidence to that market and so long as the GSE was not backing non-conforming (high risk or subprime) loans then there would be no cost to the government.
- The only risk would be a major housing meltdown (of the kind seen in the US recently) but in that situation the government is already carrying that risk by an implicit guarantee to the banks.
- There would be no moral hazard as loans backed by the GSE would have to be conforming.
- There would be no crowding out because supply is currently tight and the GSE could have a mandate to only ramp up activities in liquidity constrained times.
- At present, there is no other solution that offers to do all of this and back sustainable competition in home lending. (The spectre of re-regulation looms as a lack of a securitisation pathway removes the Wallis justification for de-regulation).
- And that is why we need a GSE.
The RBA and Treasury officials now appear to agree with 1-3 but don’t otherwise care. The Treasurer (and indeed the Opposition too) are now down on 4 and 5. But in the US, they have gone all the way to 10 with a nationalisation of the mortgage securisation business; the ultimate in government intervention and support and with no claims what so ever that this isn’t a market worth supporting.
When it comes down to it, Australian businesses (non-bank lenders) have failed but there has been no bail out. To be sure, this hasn’t caused a meltdown but it has left consumers with extra interest rate payments (now at a cost of almost $2.4 billion). And now Malcolm Turnbull has stepped left over the government and is calling for liquidity to address this and restore competition. It is not hard to imagine that Labor politicians are left wondering how they appear to have gotten themselves alligned with Terry McCrann and the CIS. The answer is that the advice they are getting is flawed both ideologically and factually. It is time for them to treat it just as advice and then consider their own predispositions on government intervention in failing markets.
Using the Australian Office of Financial Management was one thing that Chris Joye and I recommended as a transitional measure towards a government sponsored enterprise that did a transparent and committed job of ensuring liquidity in mortgage-backed securities. Others have called for the same thing. Right now that seems like a compelling proposition as our ‘too big to fail’ banks become even bigger. Indeed, perhaps because of that, the Treasurer should use the AOFM just to assist the non-major lenders. After all, the majors are against all that moral hazard and so assisting them would really be something they are dead against.
[Update: This post appeared in Crikey, 26th September 2008]