As anticipated in Crikey last Friday, the Treasurer, Wayne Swan, moved just a few hours later to intervene in the mortgage securities market. The Federal government now stands ready to provide up to $4 billion in credit to back prime mortgages.
This is an unprecedented but welcome intervention. Put simply, it is the first step in restoring a source of credit supply to non-major lenders and provides hope that interest rates will bear closer relation to underlying costs. We estimate that the breaking of this relationship since November last year has led to Australian home owners paying around $2.4 billion more in interest payments than they would have had competition been as strong as previously.
There are several comforting things about this move from an economic management perspective. First and foremost, as recent events have shown, the operation of these mortgage securities markets is complex and non-transparent. Distilling market imperfections and failures and devising appropriate interventions is difficult. That the use of the Australian Office of Financial Management to restore confidence in the market has now received bi-partisan support and been enacted in a timely manner is a triumph, as Peter Martin has written, of good policy above politics.
Second, it is a policy that manages the uncertainties that exist. There have been claims for many months that mortgage securitisations were unsustainable and not valued by investors. That is, the market closed because demand was not there. We, and others, have claimed otherwise. The issue is the supply of funds to those markets that dried up when investors became spooked by the subprime mess. Intervening in this case is something that has broad support. For instance, recently, Jonathan Kearns and Philip Lowe of the RBA wrote:
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Given this, there would seem to be a strong case to consider such intervention only if…the lack of liquidity, or misalignment in prices, was the result of some clear market failure, and was not likely to be rectified in a timely way; and any intervention was not likely to materially distort the pricing of similar assets or affect the structure of the market in normal times.
They were talking precisely of the residential mortgage backed security market.
The government’s move targets the supply problem. But here is the point to nay-sayers (such as the Australian Financial Review’s editor) who claim that such intervention is bad. If we are right and it is a supply problem, the market will bounce back as a result of the intervention. However, if we are wrong, and it is a demand issue, there will be little to no demand for the government-back securities. In that case, no harm done in trying. This is appropriate risk-managed policy and should be applauded.
Joshua Gans is an economics professor at Melbourne Business School and Christopher Joye is CEO of Rismark International. More information on this issue can be found at aussiemac.org.