Is there an industry with a shorter memory than politics? Other than perhaps the investment community? Merely three years after US mortgages almost caused a global economic meltdown, the Australian government has quickly forgotten the lessons learnt, proudly spending taxpayer dollars propping up the mortgage sector.
One of the key reasons underlying the collapse of the US housing market was the way the mortgage sector operated and the willingness of the government, and investment banks, to “securitise” mortgages. Quasi government bodies Fannie Mae and soon after Freddie Mac played a large role in the securitisation process, with investment banks (led by Solomon Brothers and Lewis Ranieri of Liar’s Poker) supercharging the sector soon after.
The principle underlying securitising mortgages is that it allows banks to lend more money, by removing risk from their balance sheets. In basic terms, lenders no longer carry the risk of a default of the borrower, instead, that risk became borne by an investor looking for a slightly higher yield.
The problem should have been quite obvious. If a bank lends money to a borrower and the loan remains an asset on the bank’s balance sheet, it will be careful to ensure that the borrower can repay the loan. If it sells the loan to a third party, the lender would be less concerned about default. In fact, all it would be concerned about would be making the loan and finding someone to purchase it. That is pretty much what happened.
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Of course, the situation in the US was worsened by the use of CDO and synthetic CDOs (which were basically bets on whether home owners would default), but essentially, the issue arose courtesy of securitisation and the separation of risk and responsibility.
How does this all relate to Australia?
Despite the lessons that should have been learnt from the GFC, the Australian government is not only condoning securitisation, but actually using taxpayer money to undertake it. Bizarrely, the government is even boasting about the “returns” it is getting from risking public money, as a recent article by Eric Johnston in Business Day shows.
Most Australians wouldn’t realise this, but the Australian Office of Financial Management, under the auspices of the world’s greatest Treasurer, Wayne Swan, has been spending billions of dollars of taxpayer money propping up the non-bank mortgage sector.
Since October 2008, the AOFM has “invested” $13.37 billion in RMBS. The AOFM claimed that “without this funding, new lending by financial institutions other than the major banks would have been lower and their ability to provide competition to the major banks, now and in the future, would have been curtailed”. That of course is true — but that certainly doesn’t make the investment a wise one. When financiers investing their own money won’t touch an investment, it’s fair to say the government shouldn’t be. The AOFM noted that the investment had generated a “return” of 6.07% — barely more than a term deposit. Bear in mind, these were securities purchased from second-tier banks and non-bank institutions including Bank of Queensland (which recently reported a doubling in mortgage arrears), Resimac and Macquarie Group.
If there is a problem with these mortgages, and the borrowers default on the loans — it will be the poor old taxpayer left to carry the can.
In trumpeting its purchase of residential mortgage backed securities, the AOFM proudly noted that “there has never been a credit-related loss on a rated prime Australian RMBS”. Like those who believed that US housing prices would never fall, the Australian government has dived headlong into funding the Australian residential property sector oblivious to the risks of a housing downturn.
While many are quick to blame capitalism and the free market for the global financial crisis, the US mortgage sector was far from a free market. Fannie and Freddie were operating with an implied government guarantee (that guarantee become somewhat less implied and more explicit when the US government had to spend $US150 billion (with plenty more to come) bailing out the appallingly managed organisations). A free market doesn’t have taxpayers subsiding the purchase of assets. If the market were really free, rational players would have stopped providing finance for housing purchases, which would have prevented the housing bubble and subsequent bust.
In Australia, our housing market is equally far from free. The Rudd government did its best to prolong the housing bubble by creating the first home owner’s grant, at the same time, our perverse system of negative gearing capital gains tax encourages speculating on housing, rather than investing in productive assets. If that isn’t enough, the federal government guaranteed retail deposits (thus lowering the cost of funds for banks) and also wholesale lending (allowing them to borrow more by relying on the government’s credit rating).
But the government’s intervention in the RMBS market is by far the most risky use of taxpayer money to bankroll an asset that has long been removed from its intrinsic value.
If non-bank lenders are unable to finance their lending activities from the market, they should not be lending money at all. The solution isn’t for the government to place at risk taxpayer dollars when the market is clearly saying something very different.