Mortgage madness

Houses and Holes today posted a nice summary of the recently released report from the Senate Inquiry into Competition within the Australian banking sector.

While there are some sensible recommendations in the report, including establishing a broad ranging inquiry into the Australian financial system, there are some absolute shockers aimed at increasing the availability of credit by pushing the risks of banking onto Australian taxpayers.

The following recommendations, in particular, struck a raw nerve with me [my emphasis]:

Recommendation 20

The Committee recommends that, to increase the competitiveness of smaller lenders, the Government immediately standardise the fee for all borrowers under the wholesale funding guarantee to a uniform rate of 70 basis points.

Recommendation 21

The Committee recommends that the financial claims scheme should be retained in its current form pending the outcome of a full inquiry into a deposit insurance scheme, possibly charging risk-related premia. The inquiry should also examine the issue of guaranteeing non-ADI products that are close substitutes for deposits, with a view to being better placed to provide such a guarantee as future need arises.

Recommendation 24

The Committee, having more confidence in the Australian Prudential Regulation Authority’s oversight than in the opinions of credit rating agencies, recommends that the Reserve Bank accept as eligible paper for repurchase agreements long term debt issued by any authorised deposit-taking institution rather than just those rated above A.

Recommendation 25

The Committee recommends that the Australian Office of Financial Management programme be expanded to include asset-backed securities based on assets other than home mortgages and to include securities rated AA or A (rather than just AAA) or issued by a financial intermediary supervised by the Australian Prudential Regulation Authority.

Recommendation 26

The Committee recommends that the Australian Office of Financial Management be given the discretion to purchase residential mortgage-backed securities issued by entities with a substantial bank shareholding where it judges this would promote a more competitive market.

Recommendation 29

The Committee recommends that Treasury develop a plan to introduce a support programme for RMBS similar to that operating in Canada in case a future deterioration in the securitisation market requires its introduction.

Over the past 20 years, competition in the Australian banking sector has increased markedly. In the early-1990s, non-bank lenders like Aussie home loans entered the mortgage market offering ‘innovative’ loan products on far easier terms than the banks. Included amongst these new loan products were low-doc loans (introduced in 1997) and  ‘no-doc’ loans (introduced in 1999). More recently the non-banks were beginning to issue ‘non-conforming’ (sub-prime) loans just before the GFC intervened.

Faced with increased competition, Australia’s banks responded by lowering their deposit requirements from a minimum of 20% to 5%, and significantly increasing the amount that they would lend on a given level of income, with much of the funds borrowed from offshore.

The massive increase in the availability of credit sporn from this increased competition, combined with unresponsive housing supply, has resulted in the housing bubble that Australia experiences today.

However, the increased competition in the mortgage lending market has not improved housing affordability. Rather, the amount of total household disposable income required to service mortgage interest repayments has escalated over the past decade, as evident by the below chart.

Given that previous efforts at increasing competition in the mortgage market have failed to improve housing affordability, yet have reduced financial system stability (necessitating significant government intervention during the GFC and ongoing taxpayer support), what makes anyone think that the recommendations by the Senate Inquiry are desirable from an affordability or financial stability perspective?

As long as Australia’s land/housing supply is constrained, any extra housing (credit) demand arising from these proposals will be met with rising prices instead of new home construction.

What is particularly galling is that the Senate Committee has recommended that Australia introduce a support programme for RMBS similar to that operating in Canada.

As examined previously, the Canadian Mortgage Housing Corporation (CMHC) – the Government-owned guarantor of high loan-to-value-ratio mortgages –  is a disaster waiting to happen. With default risk removed via the CMHC, Canada’s banks are able and willing to lend to people with little money, no savings history and questionable capacity to repay their loans.

In many ways, the CMHC is analogous to the United States government-sponsored Federal National Mortgage Association (Fannie Mae) and the Federal Home Mortgage Corporation (Freddie Mac), which provided insurance against default risk to a large proportion of risky low-deposit loans in the United States and whom required massive taxpayer bail-outs following the bursting of their housing bubble.

Moreover, CMHC is terribly under-capitalised and has the potential to expose Canadian taxpayers to significant losses should Canada’s housing market enter a protracted down-turn. As at 31 December 2009, the CMHC had only $9.3 billion CAD of shareholder capital but a whopping $473 billion CAD of outstanding insured loans – 29% of which had a loan-to-value ratio above 80%.

Should a housing correction occur, and significant defaults take place, there is very little capital available to absorb losses. Rather, like in the United States, Canadian taxpayers would be called upon to stump-up funds to bail-out the banks for their risky mortgage lending.

To add insult to injury, a leading Canadian think tank, the Fraser Institute, released a study in March 2010 highlighting the risks to taxpayers from the CMHC-insured system and suggested a privatised mortgage market structure similar to the one Australia uses. This study also confirmed that the taxpayer risk from a housing collapse is greater in Canada than elsewhere:

…the Canadian government is heavily exposed in the mortgage market because 43 per cent of all residential mortgages (including all loan-to-value mortgages over 80 per cent) are backed by the government through the federally owned Canada Mortgage and Housing Corporation (CMHC). The report recommends that the federal government follow Australia’s example by opening Canada’s mortgage insurance market to full competition including the privatization of the CMHC… The report points out that the Canadian model has the majority of risk concentrated with the Government of Canada, and therefore the taxpayer liability is much greater in Canada than in Australia…

In the wake of the recent financial crisis, American taxpayers are facing an enormous future liability to pay for the government bailout of the financial industry. Canadian taxpayers could face a similar liability because our government is so heavily involved in the mortgage insurance market through the CMHC…

In order to lessen the taxpayer exposure and reduce the likelihood of a Canadian mortgage crisis, the government should emulate Australia and allow the private sector to take total responsibility for insuring and securitizing Canadian residential mortgages.”

So while the Senate Committee has misguidedly recommended that Australia emulate Canada’s mortgage market, Canada is examining ways to become more like Australia’s.

Reflating the housing ponzi:

It is clear from where I sit that the Government’s focus on banking competition is a distraction from the real issue at hand –  that Australia’s housing market has become highly unaffordable due to: easy credit funded, to a large extent, from offshore; investor speculation; and supply-side constraints. And now that house prices are correcting, thanks mainly to households reaching ‘peak debt’ as well as the banks finding it increasingly difficult to expand credit by borrowing offshore, the Government is once again looking to intervene in the market to reflate the credit/housing bubble and delay the day of reckoning.

What you, the reader, needs to ask yourself is whether this is how you want our banking system to operate: borrowing large sums from foreigners and channelling lending towards housing in place of productive enterprises, with the taxpayers picking up the tab if things go wrong? Is such an approach to banking in our national interest?

It’s a shame that our political leaders and mainstream commentators are not asking these important questions.

Cheers Leith

[email protected]

Unconventional Economist


  1. You know I just dont think the govt can really do anything even with these recommendations. Prices are at a level that most people can not afford. The govt can try everything in the power to stimulate but with prices where they are at I dont see the market turning around. You got to laugh though as the govt is determined to keep this ponzi scheme going. I look forward to 5 to 10 years from now reading what the headlines will be.

  2. Dave From Pakenham

    High UE,

    Australia has the least competitive banking system in the world. Not sure how you can state otherwise.

    Competition from Off balance sheet funding, reulted in negative deposit requirements in much of Europe and the US.

    If Australia was truely more competitive, with cost to incomes nearer 50% rather than 40%, with small lenders sourcing a greater percentage of deposits from the local community, funding smaller asset books without access to global wholesale funding, I don’t think we would have seen anywhere near as great a bubble as we have.

  3. I disagree with the statement that CMHC is “terribly undercapitalized”. Mortgage insurers are not akin to, say, auto or house insurers where they are underwriting the entire asset. Mortgage insurance underwrites an asset that has some underlying inherent value. So to claim that $9.3BB is inadequate for $450BB in assets isn’t quite correct.

    Certainly a fall in asset values of, say, 25% nation-wide, will put CMHC close to insolvency but it will only be to the tune of a few tens of billions of dollars net. The real pain comes, like AIG, when the assets insured become illiquid. There we could be talking about $70BB or more in bridge loans to handle increased inventory.

    CMHC is a big problem but Australia is proof that it isn’t necessary to cause speculative bubbles. As a Canadian taxpayer, I certainly would not recommend it for Australians. Backing mortgage loans at banks… well Ireland would probably have something to say about that!

  4. Looks like a blueprint for the creation of a full blown mortgage bond market. It appears to me to be a mechanism to access pension funds and OS investment.

    Aussie,Aussie,Aussie, oi,oi,oi.

    Ponzi, ponzi, ponzi, oi, oi, oi!

    The bond derivative vigalantes should be breaking out the champers on this. At least we know who to back when the SHTF.

  5. Will our banks do a Goldman Sachs and take the otherside on derivatives to recapitalise at our expense?

  6. These people have no idea. On one hand they seem to understand that the best way to stimulate a market is to increase available credit, yet on the other cash insentives are the tool of choice to stimulate the most needing sector (new homes).
    Why not drop the current path and just find a way offer better credit only to new development white booting councils up the backside to rezone/release/process?

    • Exactly….!

      But these supply-induced bubbles create a massive constituency against the needed reform, i.e. all incumbent property owners. “Urban growth containment” could have been devised by quislings in the pay of an enemy power, they are such a dastardly wrecker of economies.

  7. “What you, the reader, needs to ask yourself is whether this is how you want our banking system to operate:”

    A good start would be the practice of mortgage securitisation to be done away with and bring back the lending criteria of 20 years ago.

    Securitisation shifts risk away from lenders and encourages predatory practices. A stricter lending criteria where punters realistically need to prove they can pay off their mortgage comfortably as a percentage of one income is needed.

  8. sometimes truth really is stranger than fiction. it really is like dumb and dumber out there amongst the “experts”.

  9. What the decadent West is in the process of learning the hard way, is the LIMITS to the ability of government to handle a situation. A bubble in property prices is simply FAR TOO BIG for the “present value of future taxation revenue” to bail out in the event of a crash. Government’s powers to deal with any financial crisis IS NO MORE THAN “potential future taxation revenue”. Government is NOT “God”, with omnipotent powers to conjure real wealth into existence with which to fix a financial crisis.

    The Irish are finding this out. How much extra tax is involved, in every man, woman and child having $50,000 to pay off, for NOTHING? It is not as if a whole lot more roads are going to be built, or a whole lot more education funded. It is not as if progressive taxation is not already at its rational limits.

  10. “Government is NOT “God”, with omnipotent powers to conjure real wealth into existence with which to fix a financial crisis.” Tell Bernanke that.

  11. The_Mainlander

    Did you guys not cover a new law over the puddle in NZ where they wrote up that the Kiwi;s would never be responsible for Bank Debt should the market implode?

    Why oh why is Australia any different.

    Sheesh… this is getting corrupt!

    Do we need a GetUp campaign to highlight the madness!

  12. Alex Heyworth

    Apart from the conclusions you drew above, Leith, (which I agree with) the other thing that seems obvious to me is that our politicians do not understand competition. The essence of competition is that there are winners and losers. Politicians seem to think that when winners win, it is not because losers were uncompetitive but because the winners cheated. Thus the winners have to be handicapped by having a bit more lead in their saddlebags so that the losers can be more “competitive”. With the real result that the whole economy is made less efficient and less able to compete with other nations which understand the nature of competition, and back the winners. Dumb.

  13. CharlieChaplin

    Extraordinary! It really is like watching a car crash in slow motion. Why are the main stream media so gormless about the true implications of these policies, and their role in attempting to further inflate housing prices.

    It’s not as though it’s new! It’s a pattern repeated over and over internationally in the last few years. We know with awe up prescience what will happen.

    Hopefully the poh will hit the dan before they have a chance to implement them.

  14. Leith,

    I don’t think any discussion about banking system without limiting the power of RBA with respect to its ability to set interest rates amounts to missing the point.

    We need to move to a market based approach to interest rates without interference from the RBA.

    How can we have an efficient pricing mechanism when the most important price in our economy (interest rates) is not market-based.

    Yes, rates will be volatile… and that’s reality… same as petrol prices, gas prices, bananas etc…

    This will limit how much a bank will lend and how much we will want to borrow.

    If a bank goes broke, the bond holders take the hit and so do the shareholders. Hey if you want to enjoy the fruits in good times then shareholder/bondholder need face the music as well when the $hit hits the fan. (I’ll get to protection for the battlers in 3 below).

    The Govt plays no part in any bailout… the implied put has to be taken away for behaviour to change at banks. They know that they will get bailed out.

    What about the depositors who don’t know/understand risk…you can put the entire country in this category. I don’t think it’s fair that someone who wants access to the utility of a bank to pay for the banks risk-taking, i.e. A place where I can store my wages and withdraw money — why should I lose my hard-earned wages.

    a) Banks offer insured accounts vs. uninsured accounts. Insured accounts get 100% protection in the event of failure. Insured accounts pay a lower rate of interest. These can be insured by insurance companies or govt (less preferred option)

    b) Uninsured accounts pay a higher level of interest and offer a lower level of protection or no protection. High risk/high reward.

    Consumer can choose the level of risk they want… they may even choose a mix of the 2.

    Claw-back provisions for corp bonuses and/or long term vesting periods.

    Not so fast tiger…

    We have to end this monthly budget crap. I make budget, I get a fat bonus… the fact that so much risk has been taken to make budget is irrelevant. How many bad loans were written in US (and soon to be proven here) due to massive bonuses. If you know that even 5-10 yrs from now, you’ll have to pay back the bonus or it’s still hasn’t vested then, I’ll look at credit quality myself.

    This sort of market based system will mean no more socialising of losses… plus I have never given the authority as an Aust citizen for the Govt to bailout private enterprises.

    We don’t need more regulation…

  15. It’s hard not to be an existentialist after reading this:

    “The buyers’ strike of Australian property sought by a tax reform group last month has proven to be a fizzer, precisely because some people don’t like the idea of lower house prices.

    “Online activist group GetUp! decided not to pursue a strike of home purchases to protest at the lack of affordability in the housing market because its own members did not like the idea.”

  16. Like manything this is done out of stupidity or with maliace a forethought. It is not done out of neglect.

    If it is done out of stupidity how come these people can arrive in a position where they can exact their stupidity upon others. I find it hard to believe that the policy makers are stupid, although you could say a platypus is something a committee might build.

    That leaves malice a forethought and the next question then is …. why?