What to do . . .

I’m thinking about Aussie Mac again.  The Federal Government has been led to water but only wants a sip – it’s investing $4 billion of its surplus in buying mortgages when the credit that was taken out by the collapse of the residential mortgage backed securities market was around ten times that size. The banks have stepped into the breach, but only by diverting credit that might otherwise be available to business.

Judging from her wise words here, Janet Albrechtsen who is kindly supplying economic policy advice to Americans via the Wall Street Journal would not be in favour of Aussie Mac. Indeed, she’d see it as going down that disastrous road that the Americans have been treading with the debauching of Fannie and Freddie.

Thomas Palley who shows more convincing signs of knowing what he’s talking about, provides a broad canvass. He’s talking about the problems of the US financial market, which are more acute than ours. But his analysis leads to the conclusion that our Government, having begun to prepare to sip, should start drinking.

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Ken Parish
15 years ago

But is Lindsay listening?

15 years ago

Can’t agree. I don’t see any place for government in the mainstream mortgage lending game. If the central bank buys and sells RMBS, then it’s doing so as an adjunct to the overall movement of capital. Governments investing tax-payer funds into a marketplace which is besieged currently with an inordinate number of teetering second & third tier funders and mortgage managers seems to me to be akin to throwing $100 bills out of a high-rise office window. That aside, surely a start-up operation in current times would walk a competition tight-rope. The risk seems inordinately large.

15 years ago

Oh dear, please dont do it, govts are flat out mismanaging other services without adding another string to their bow.

Kev the supposed diplomat forgot about Japan not once but several times and now he wants to get into finance.

15 years ago

So, am I correct in assuming you’d happily risk an entry into that marketplace, Nicholas, as a means of providing competition which doesn’t exist for institutions which currently hold all the cards? I’d love to play 500 against you some time. I bet you call seven hearts as an initial bid.

15 years ago

The banks have stepped into the breach, but only by diverting credit that might otherwise be available to business.

It makes sense to me for the Government to be a lender of LAST resort, but we are a long way from last resort here, that’s for when no other options exist (and in theory, only a very unusual event or serious mismanagement would get us to that point).

Business has lots of options available to it that other borrowers don’t. For example, floating on the share market, or “Angel” capital, or private sale of shares to other businesses. Business finance is USUALLY much more risky than a mortgage because there is are less physical assets (although physical assets are no guarantee that you can’t get burnt by a poor valuation). Since most people in the world are currently nervous about taking risks, floating a business on the share market right now would not raise as much money as the same business would have done two or three years ago. However, that’s what markets do… they assign prices to things, and the prices bounce around. Supply and demand, don’t you know?

Look at it another way: if all those market participants are nervous about taking risk, then this is the market gathering information from many sources and bringing it together to give a final answer (the price). On what basis does the Federal Government have better information than those other sources?

What you are effectively claiming is that our Federal Government should say, “Hey, all these nervous investors are wrong, they think the price of credit should be $X but we say the price should be $Y, and we are going to push money into the system until the price moves.” Once you have decided that the Federal Government should set prices, why not just get it to set the price of my groceries while you are at it? Bring back wage fixation too. Maybe just pay everyone the same wage and that would be nice and simple.

Governments investing tax-payer funds into a marketplace which is besieged currently with an inordinate number of teetering second & third tier funders and mortgage managers seems to me to be akin to throwing $100 bills out of a high-rise office window.


Better for them to be giving a tax break to anyone paying a mortgage on house and land valued under (say) $250k only if the mortgage holders are living in that house for that financial year. Then they can say it is genuine “safety-net” style charity for those badly hit by the credit crunch, rather than sneaky charity for the finance industry. We can all argue about the relative importance of government charity but at least call it by the correct title.

15 years ago

“We can all argue about the relative importance of government charity but at least call it by the correct title.”

Concisely offered, Tel. No place in a supposedly free market system for arbitrary government intervention on the basis of ‘investment’ favouring taxpayers. It’s a complete furphy, and as you categorise it, charity. The US bail-out gig is in many ways a necessary last resort and while many would categorise it as socialism, it’s being driven by fear. Fear that an empire on the edge of collapse, might just tip over unless 350 million US citizens come to the rescue of a few thousand corporate executives.

15 years ago

While I am not an independent third-party in this debate, I think that we have addressed many of these criticisms in the past. A useful starting point is our latest op-ed in The Oz:

Chris Joye and Joshua Gans | October 02, 2008

FOR those of us in the business of coming up with good ideas, the innovations we propose rarely see the light of day. And when they do, it typically takes years of toil. But it was just six months from the publication of our paper by Melbourne Business School’s Centre for Ideas and the Economy on March 26 to the Government’s announcement on September 26 that it would adopt our proposal to intervene in the market for AAA-rated mortgage-backed securities.

In between, the idea was backed by industry groups, smaller banks, building societies and non-bank lenders. It was also supported by the 2020 Summit and a Senate select committee on housing affordability.

But there were also many critics, including the leading banks, the Reserve Bank and the Treasury. The Treasury at least appears to have changed its tune. And judging by the Opposition’s comments, the proposal has bipartisan support.

Our idea was simple. We argued that when critical economic markets fail because of the absence of the public goods of a minimum-level of liquidity (that is, trade) and pricing integrity, governments have a responsibility to temporarily intervene to assist in resuscitating activity and pricing visibility. The Reserve Bank does exactly this in the context of the banking and foreign exchange markets.

We were careful to note that the Government itself should intervene – not a subsidised private entity such as Fannie Mae or Freddie Mac – and that such injections of liquidity should only be justified by extreme emergencies.

In particular, we proposed that the Government capitalise on its AAA credit rating to issue low-cost bonds and use these funds to acquire very high-quality, low-risk AAA-rated mortgage-backed securities in order to assist in restoring liquidity to Australia’s securitised home-loan market, which had not operated effectively since November 2007.

We were at pains to state that we were agnostic as to how our idea was put into operation, but did, for the record, advise the Government to use the Treasury’s Australian Office of Financial Management.

Despite the predictions of many, Australia’s mortgage securitisation market, which has served as such an important source of funding for non-bank lenders, building societies and smaller banks, has not yet recovered and remains economically shut to this day. By this we mean that the pricing available in the market is not sufficiently low to enable lenders to source capital to underwrite home loans on an economically viable basis. Even the Reserve Bank agrees with this point.

The closure of the securitisation market has, according to Fujitsu Consulting, resulted in the big five (now four) banks’ market share of new home loans increasing from about 75 per cent before the sub-prime crisis to about 90 per cent today. At the same time, many non-bank lenders have fallen by the wayside while the smaller banks and building societies have struggled to compete. As we anticipated, the inability to source funding in this market has had other consequences, such as contributing to the severe credit rationing seen in the corporate and small-business lending markets, and wreaking havoc on the conduct of monetary policy with a deterioration in the linkage between the RBA’s cash rate and actual lending rates.

Market failures of this kind can occur because of information asymmetries, such as we have seen in the US with the non-transparent AAA-rated investment structures that held sub-prime securities, and because investors have a tendency to over and under-react to events that can in turn trigger protracted asset-price booms and busts.

George Akerlof won the Nobel Prize in Economics for showing that while markets are ordinarily the best means to allocate goods and services, when you have imbalances in the information that people possess when engaging in transactions – such as an understanding of the true risks underpinning complex financial market securities – they can fail, with catastrophic consequences. The introduction of mark-to-market accounting practices, whereby assets are constantly revalued using (sometimes ineffectual) market prices, has only served to exacerbate these risks.

In today’s highly interconnected world, global financial crises are being transmitted with ever-greater frequency. In the last decade we have been rocked by the Russian debt crisis and consequent collapse of Long Term Capital Management, the tech boom and subsequent wreck, and now the credit boom and bust. The point is that notwithstanding the intrinsic strength of Australia’s economy and financial system, we can be adversely affected by events that are seemingly far removed from our shores.

Despite some of the protestations to our proposal, the notion that governments have a critical role preventing financial market crises is, in fact, a cornerstone of our capitalist system. One of the main reasons central banks were established was to serve as a lender of last resort and prevent bank runs. Bank panics in the US led to the establishment of its centralised banking system in 1913.

The stability of the financial system has been a long-standing responsibility of the Reserve Bank, which “focuses on the prevention of financial disturbances with potentially systemic consequences”. The Reserve Bank also regularly intervenes in the currency market to stabilise our exchange rate on the basis of its belief that currency values have a tendency to deviate significantly from fair value, which can inflict significant costs on the real economy.

When Australia’s central banking system was set up in 1959, home loans were funded almost exclusively through deposits. That is, securitisation markets and non-bank lenders did not exist. So while today, banks and building societies are regulated by the Australian Prudential Regulation Authority and have their liquidity needs protected by the RBA, the securitisation market, which has grown to provide nearly a quarter of all the funding for home loans and which was a key source of funding for so many non-bank lenders, building societies and smaller banks, benefits from no government infrastructure to protect it in times of extreme duress.

We need to go back to first principles and think about how we can improve the regulatory regime in order to accommodate recent capital market innovations such as the emergence of securitisation.

As the RBA and Treasury have noted over the years, there is a fundamentally sound economic basis as to why securitisation should exist. But we have an asymmetrical regulatory system that disproportionately favours deposit-taking institutions; indeed, it barely acknowledges these new markets. It is, therefore, time that Australia’s Government developed an explicit policy regime to regulate the participants in, and protect the liquidity of, the AAA-rated mortgage-backed securities market.

Joshua Gans is a professor of economics at Melbourne University. Chris Joye is chief executive of Rismark International.

15 years ago

here’s the questions that you haven’t answered:

You identify that there is a risk of market failure, very well, everything in life involves risks. I think that none of us would support intervention based only on a vaguely perceived risk of failure, we would want some real evidence of a real problem. You cite as one of your metrics the relative centralisation of the mortgage sector, and I agree that a diverse market is “healthier” than a narrow one. However, we have to pick a threshold where we decide that there is a real problem. The “cos I say so” threshold doesn’t seem appropriate in a Democratic society. If you do have a threshold for determining market failure, can you explain your calculations? Why this threshold and not some other arbitrary point? Who gets to choose this threshold and on what basis should we trust this knower of good and bad markets?

Once you have evidence of real market failure, and you decide that the price of borrowing needs to be moved from the current price (as determined by the failed market) to some new price. Who determines the new price, and how? What special information is available to this new price determination that was not available to the market participants? Maybe I would like to choose a price… I could come up with a lovely price, much better than market price. Why not use my price instead? Why not ask Joe’s fruit shop how much money he would like to borrow and what rate he would like to pay?

What special characteristic makes the market for loans fundamentally different from the market for wages (or any other price of goods)? All of your arguments could equally be used to support direct government intervention in wage fixation. After all, imbalances in the information exist in the job market where the employee going for a pay rise does not have information about his/her fellow employee wages while the employer has full information about all wages in the company. Do you also support government intervention to move the price of labour? Should the price of labour go up or down? I’m not pretending that all markets are the same, but I would think the onus is on you to explain what makes your arguments specific, otherwise we have to presume that they apply in the general sense.

With regards to regulation, I do see the need for government intervention as a rulemaker and referee to ensure that the system is fair. There have been cheats and liars through all of history and I suspect that the phrase, “a fool and his money are soon parted” has been proven right on many occasions. We do need someone to ensure transparency and consistency in the system so that there can be a system at all. However, should these rules directly affect pricing?