Opinion & Commentary
Borrowers lose as mortgage industry takes its $4bn win
The government's decision to add a further $4 billion to its existing $16 billion investment in residential mortgage-backed securities (RMBS) will help the mortgage securitisation industry, but do very little for retail borrowers.
The government has still not made a compelling case for taxpayers to take up a portion of the wholesale funding of the smaller bank and non-bank mortgage securitisers.
The government assures us that "not one dollar will go to the big banks", but taxpayers should not be any more pleased at the prospect of further subsidising the mortgage securitisation industry.
The government's investment in RMBS could only be justified if there were benefits for retail borrowers in the form of lower interest rates.
The Reserve Bank estimates the program has seen a reduction in average RMBS issuance costs of about 40 basis points, but there is no reason to believe that this has been passed on to retail borrowers in the form of lower interest rates.
The program is undoubtedly of benefit to the industry, but that is not the same thing as helping retail borrowers, for whom the only relevant test of the program is its implications for interest rates.
Even if the cost reduction was passed on to retail borrowers and the program was large enough to have an impact on overall retail lending rates, the RBA would be forced to claw back any resulting reduction in retail interest rates through a higher official cash rate, so it could maintain its desired level of credit restrictiveness.
In August 2006, the RBA raised the official interest rate as part of its pre-financial crisis tightening cycle. One reason it gave was that "compression of lending margins over recent years has contributed to a lowering of borrowing costs relative to the cash rate".
In other words, there is no free lunch on interest rates from increased competition in retail borrowing, so long as the Reserve Bank targets the overall credit conditions in the economy, as it has through the financial crisis and its aftermath.
The minutes of the RBA's November board meeting demolished the populist bank-bashing of both the government and the opposition in noting that the RBA continued to take account of developments in wholesale and retail lending rates in setting the official rate.
The government's claim that its RMBS investment puts "downward pressure on mortgage interest rates" is thus flatly contradicted by the RBA. The government also claims that the program has the support of the RBA, but neglects to mention that the main benefit the RBA sees in the program is that it will be much easier to wind up than the alternative policy proposal of government guarantees of RMBS issuance.
The big decline in Australian RMBS issuance as a result of the financial crisis came from overseas, highly leveraged, structured investment vehicles — a risky business model that was shown not to be robust during the crisis.
The government is trying to plug a hole in capital markets created by a failed business model for which it has shown very little sympathy in other contexts.
There is a danger that government support for RMBS will weaken the incentive for smaller banks and non-bank lenders to develop deeper private markets for their securities.
Instead, the industry now competes to shop its product to the Australian government's Office of Financial Management. The third expansion of the program from its initial $4 billion in October 2008 shows the government is a soft touch and the industry will lobby hard to maintain this support, capitalising on the populist bank-bashing by the government and opposition.
The experience in the US and Canada has been that government intervention in mortgage securitisation has increasingly stifled competition and innovation. The financial crisis would not have been possible were it not for the US government's support of mortgage giants Freddie Mac and Fannie Mae. These government-sponsored enterprises leveraged government guarantees to dominate the US mortgage market, but with very little benefit to consumers in the form of lower interest rates.
Peter Wallison of the American Enterprise Institute estimates that almost two-thirds of all the bad mortgages in the US financial system were bought by government agencies or were required by government regulations designed to extend lending to non-prime borrowers.
There is no suggestion the Australian government's support for RMBS will have the same disastrous consequences, given the program's much narrower scope, but it is ironic that the Australian government, with the support of the federal opposition, should resort to a policy that differs only in degree from policies that were deeply implicated in bringing on the financial crisis.
Dr Stephen Kirchner is a research fellow at The Centre for Independent Studies and a senior lecturer in economics at the University of Technology Sydney.
