In October 2008, as the global financial crisis was reaching a crescendo, Treasurer Wayne Swan directed the Australian Government spend taxpayer monies buying residential mortgage backed securities (RMBS) from banks and non-bank lenders. At the time, Swan stated that “developments in international capital markets … have reduced liquidity … and constrained the ability of lenders to access funding from this source”.
The taxpayer monies were used to buy $8 billion worth of residential mortgage-backed securities, with a further $8 billion approved in 2009. At the time, the Government sought to differentiate its investment in mortgages from that of the US Government, noting:
This investment is very different from the initiative proposed by US Treasury Secretary (Henry) Paulson in response to financial market conditions in the US. Unlike the US, Australia’s banking system remains profitable and soundly capitalised. Australian banks do not have significant exposures to troubled mortgage‑related assets, reflecting our robust lending standards and low rates of mortgage default.
Whereas the US Treasury is being forced to issue debt to invest in existing troubled mortgage assets, such as securities backed by sub‑prime mortgages with high default rates, the AOFM will invest only in newly issued, prime, AAA rated RMBS that meet strict criteria in relation to the quality of the underlying mortgages.
Sign up for a FREE 21-day trial and get Crikey straight to your inbox
(The securities were rated AAA by at least one major credit rating agency — this would be one of the same agencies that rated sub-prime toxic debt in the United States AAA before the credit crunch).
Why did the Government do this? Most likely because Kevin Rudd and Swan were petrified of a housing collapse and the subsequent damage it would do to their standing in the polls (even though in reality, lower house prices would benefit more people than they would harm). The fact that securitisation of mortgages have been blamed as a large cause of the US housing collapse (and subsequent credit crunch) were not a concern to the Government. (Admittedly, the decision was not a partisan one, with the original idea coming from former Opposition leader Malcolm Turnbull).
The major problem with securitising mortgages is that it breaks the chain of responsibility. Historically, a bank would lend a mortgagor money. If that mortgagor was unable to afford the repayments, the bank would be forced to write down the loan. As a result, lenders were very careful who they gave their precious capital to (while banks have very high asset levels, they use a small amount of equity — a lot of bad loans can quickly bankrupt a bank). When a financial institution securitised a mortgage (or a bunch of mortgages) it effectively absolves itself from direct responsibility. It no longer owns the rights to the repayments. When that happens, the lender cares less for the ability of the borrower to repay.
What the federal Government effectively did in 2008 was allow banks (and non-bank institutions such as Liberty Financial, AMP Bank and Challenger) to continue making loans — the fact that the risk of non-repayment had increased was less important, the taxpayer was footing the bill anyway. The Government needed to step in because the market believed that the securities were too risky and the institutions would not have been able to raise money to fund their loans. (This purchase of mortgage-backed securities was in addition to the government guaranteeing $160 billion in debt issuance by the banks).
It appears that the Government’s standards in buying the mortgage-backed securities were not especially high. The Australian Office of Financial Management’s 2008-09 annual report noted that the mortgages it purchased were able to have a loan-to-valuation ratio of up to 95%, half of the loans were able to be “interest only” and it also even allowed “low doc’ mortgages to included in the pool. Despite those risks, for the 2009 financial year, the average return for the portfolio was a meager 4.8%.
Sadly for many Australians, not only did taxpayers appear to receive a very low return (especially commensurate to the apparent risk), but actions such as the RMBS purchases and the first-home-buyer’s grant have had the direct effect of causing what appears to be a housing bubble. Recent data indicates that in 2009, residential property leapt by more than 11% (in Melbourne, the increase was more than 15%) — this compares with an inflation rate of less than 2%.
The Government’s actions were twofold. First, the home buyer’s grant allowed young purchasers an immediate boost to their equity (or their deposit) — the home buyers were then able to use loan-to-valuation ratios of upwards of 90% to drastically increase their buying power. The banks and non-bank institutions were able to keep lending to freely partially because they were being funded by the Government. In a perverse way, Australian taxpayers were directly making their own home purchases more expensive.
As economist Steve Keen noted, the affordability problem was then magnified because those vendors selling homes to leverage and bonus injected buyers would then have a further $100,000-$200,000 cash to invest in another property. That cash could then in turn be leveraged into even more buying power, effectively pushing up prices for the upper-middle bank of housing (it was this band rising that would have led to the dramatic increased in median prices in 2009).
The other benefit of continued high lending was that it acted as a floor for property prices. So long as banks kept funds flowing to property purchasers, the billions of dollars of arguably overpriced collateral on their balance sheets (namely, residential property) would remain unimpaired.
While the RBA appears only mildly concerned about housing affordability (pointing to increased incomes, ignoring the fact that those higher incomes are largely based on stimulus and a temporarily rampaging China), Australian house prices appear wildly expensive by historical or international standards.
Based on RP Data’s median house price, Australia’s price to household disposable income ratio (using the ABS data from 2008) is 6x — virtually double the historical and international figures.
So far, the Australian property market has continued its merry march skywards. If the music stops, it will get very ugly for taxpayers and young buyers — sucked into purchasing their first property thanks to generous leverage from banks and government grants.
Kevin and Wayne’s best laid plans to rescue Australia’s property market and gain them votes may backfire at precisely the wrong time.