Wallis not Joyris

In recent weeks the dynamic duo of Mark Bouris and Christopher Joye of Yellow Brick Road have argued hither and thither for a dramatic shift in the rules that govern the Australian financial system. They have recently appeared in the ABC, AFR and The Australian (as well as no doubt being the secret “bankers” referred to yesterday by Robert Gottliebsen at BS) to propose that the Australian Budget should be deployed as a guarantor for pools of mortgages aggregated from all banks and non-bank lenders. They propose this as a solution to the competition woes afflicting the current system, which guarantees individual banks, privileging the large over the small.

Here is a sample from their recent AFR article:

The real trouble with this banking system is that it’s based on a flawed paradigm: a purported conflict between stability and competition, which the big banks highlight when justifying their margin expansion.

Yet these two objectives are, in fact, complementary. The financial system would be safer if we had 10 smaller banks worth $25 billion each, so that none is individually big enough to threaten the system’s viability compared with the four too-big-to-fail behemoths, worth about $250 billion combined, that we have today.

In a similar vein, Bendigo and Adelaide Bank chairman Robert Johanson argues, “We went into the crisis with no bank too big to fail . . . Coming out of it, I don’t think that’s the case . . . We’ve ended up with an industry structure that’s far more rigid, and . . . more vulnerable to the next shock.”

Policymakers should accept that government guarantees of banks are a prerequisite for safe “maturity transformation”. But this taxpayer insurance must be properly priced, or you encourage a US-style situation whereby a handful of implicitly government-backed lenders dominate financial intermediation to the detriment of competition and stability.

When extending liquidity and insurance to banks, Treasury or the RBA should not rely on ratings agencies. The Australian Prudential Regulation Authority monitors and controls every bank’s risk, and the cost of taxpayer support should be APRA’s intrusive regulation, and thus priced the same for all institutions.

In preference to guaranteeing nebulous “institutions”, taxpayers should focus on insuring safer assets. If the government offered a credit-wrap of mortgage loss insurance like the Canadians do, it would formally price an implicit guarantee that already exists (generating substantial revenue) while levelling the playing field.

This would allow all banks to raise capital on similar terms and help eliminate the too-big-to-fail advantages that the majors now have. The Australian Securities and Investments Commission chairman, Greg Medcraft, also supports this.

Finally, why not require all banks to publish a regular index of their funding costs and net interest margins to end the asinine monthly RBA rate debate. We’re surprised the majors haven’t offered to do so.

Bouris and Joye have done a great job of describing the distortions of the current system. We at MB agree and recommend you read their articles. What makes us nervous, however, is their proposal to use the Government’s balance sheet to purchase pooled mortgages and resell them to investors as AAA-rated government-backed bonds, thus providing banks and other mortgage lenders with an immediate source of cash that they can re-lend.

As they mention, the approach championed by Bouris and Joye is effectively the system currently in place in Canada via the government-owned Canadian Mortgage Housing Corporation (CMHC), as well as the process employed by Fannie Mae and Freddie Mac, which exposed US taxpayers to huge losses when the US housing bubble burst.

While the proposal is interesting, there are a number of issues that would need to be resolved prior to moving in such a direction. These issues include:

  • First, how will moral hazards be managed under such a proposal, in order to reduce the incentives for banks to reduce underwriting standards in order to sell as many mortgages as possible, in the knowledge that any default risks will ultimately be borne by the taxpayer? The Fannie Mae and Freddie Mac debacle in the US highlighted what can go wrong when lender’s incentives do not align with taxpayers, so moral hazards need to be managed carefully.
  • Second, what controls will be in place to ensure that only the highest quality borrowers receive credit under such a system, in order to ensure that taxpayers are not exposed to low quality mortgages and default risk? Fannie Mae, Freddie Mac and the CMHC have all been embued with ‘affordability mandates’ that requires them to supply credit-enhancement and securitisation services to facilitate the provision of finance to low-income and/or disadvantaged households where there is private-market failure to do so. Some would argue that such mandates exacerbated sub-prime lending in the US, resulting in greater losses to taxpayers.
  • Finally, what sorts of loan-to-value (LTV) restrictions will be in place? Current AOFM requirements on the Government’s budgeted $20b of RMBS purchases are not exactly “conservative”, permitting 95% LTV, $750,000 loan sizes, 10-year interest only loans, and some low doc loans (see below slide).

In fact, the Bouris/Joye proposal really begs the question what is the point of having private banks at all? If credit quality is simply to be enhanced by a government wrap then why bother with credit assessment? If liabilities are to be guaranteed then why bother with balance sheet management? If assets are to be protected by fiscal largesse then why bother with collateral quality?  We at MB may start our own AAA mortgage shop to cash in on the rent seeking. The irony is made all the more palpable when you consider that what is being proposed as a solution to too-big-to-fail is, in fact, that everybody fail equally, and fall together into the lap of tax-payer support.

There is also the law of unintended consequences of which there will be many. Just one is that if you set up a system to provide a government guarantee on only some new mortgages, all other mortgages will be seen to be relatively risky and the cost of funding these must increase over time to very high levels relative to government guaranteed mortgages. This is an analogous problem to that created by covered bonds, where the guarantees of collateral provided to some investors upset the remaining unsecured investors, driving up the price of funding anyway. The Joye/Bouris proposal would risk creating either different borrower classes or forcing those who can to refinance into a government guaranteed mortgage and/or making no difference to bank funding costs anyway.

No, what Australia must do first is return to first principal questions about what kind of banking system we want and need. What kind of financial system is in the national interest? Do we really want another round of mortgage oriented credit creation further displacing business banking skills and issuance?  What reforms are needed to deliver the system we want? And what trade offs are appropriate in constructing it?

As has been argued at MacroBusiness many times before, as well as previously by Christopher Joye himself, what we really need, desperately, is to undertake a wide-ranging inquiry into the financial system to examine all of the stability and competition issues raised by the Yellow Brick Road duo. Their proposal is far too big a structural shift in our financial architecture to be implemented via a media obsessed with the price of mortgages and a panicked government decree.

The previous Inquiry (the ‘Wallis’ Inquiry), completed in 1997, never envisaged systemic risk engulfing financial markets as well as intermediaries, as occurred during the GFC. And it explicitly ruled-out ever guaranteeing any part of the financial system. The patchwork of adjustments that have been made to the architecture since the GFC have rendered it unrecognisable.  This process of policy on the run must stop.

If there was ever a time for strong political leadership on banking policy, it is now.


  1. Let the banks and anyone else who wants to lend money for mortgages raise the money from issuing bonds to private investors or from term deposits.

    They will be a much better judge of what is a reasonable return for the risk of the investment.

    The party lending must always remaing on risk for a portion of the bond to ensure they have some skin in the underwriting process.

    If housing loans are seen as a good investment there will be queue down the street.

    If foreigners want to buy the bonds let them

    But if the bonds go bad no bail outs!

  2. Why do we need all this government interventionism to prop up mortgages at all? Has noone learned anything from the mess in the US?

    • Call me cynical, but I think that Bouris and Joye are campaigning for this because their apparent goal is to turn Yellow Brick Road into a bank, and they want a cheap source of funding to compete with the majors.

      This isn’t Joye’s first attempt at cheaper funding for home loans – he pioneered the Equity Finance Mortgages in Australia. They never really got traction, however – which I think is a good thing.

      And finally – no, we haven’t learnt anything from the US. If we do this, then ultimately suffer our own subprime and/or collapse, the people responsible would all be saying, “well, no-one saw this coming.”

      • Call me cynical, but I think that Bouris and Joye are campaigning for this because …

        You’re not being cynical.

        the people responsible would all be saying, “well, no-one saw this coming.”

        Or the people responsible would be the first ones on the scene, offering to help clean up the mess — for a fee, of course.

      • “Call me cynical, but I think that Bouris and Joye are campaigning for this because their apparent goal is to turn Yellow Brick Road into a bank, and they want a cheap source of funding to compete with the majors.”

        I don’t think there’s any doubt about that.

  3. More moral hazard is NOT a solution for the current moral hazard with the big4 banks.

    Anyway, CMHC only guarantees investment property mortgages that are <= 80% LVR.

    Are the Joyeris chaps willing to accept a similar restriction here?

    No? Thought so. Because that will effectively mean ZERO investment property mortgages.

  4. Well of course the dynamic duo will support taxpayer-support of any scheme that they seem to have positioned themselves to profit from. Let’s be realistic. I’m not saying that’s necessarily a bad thing, but it should be screamingly obvious that altruism is not the sole motivation here.

  5. We already have low to zero RAT rates causing great distortions to the economy. So the solution is to lower rates even further.
    Moral hazard re the Big banks aside. We are using pea and thimble tricks to allow the expansion of our already substantial foreign debt (and accompanying national fire sale) Now we are going to expand that debt even further and spend even more on over-consuming….makes sense to me!!!! 🙁

    • It’s not the solution flawse, its the only non-paradigm changing outcome available. An ever increasing bag of mortgage debt requires, by necessity, an ever decreasing level of interest rates to keep the system intact. OR massive stimulus (ala 2008-2009) either endogenously (first home buyers bribe/$900 cheques, building grants etc) or exogenously (half a trillion of printed Yuan/lowered Chinese rates etc).

      Its not a prescription! Its a realisation. I favour much higher rates, as higher interest rates equals more affordable housing and a more robust system. But it won’t happen without a paradigm change, which is likely to be forced upon Australia, not done within.

      /rant back to flicking through company reports…carry on

      • Yes Prince Agree all the way….unfortunately!
        I just have a lot of Don Quixote in my make-up! I have to keep tilting at these damned windmills at every opportunity.
        In the scale of archetypes, as judged by those around me, I was way over on the warrior side. I’m trying to get to be a lover!! 🙂

          • +10

            How the hell do we get listened to?

            I am doing my bit via social media, tweeting and posting about this since the 2-3 days until I am blue in the face 🙂

    • I’ve been trying to dig it up and can’t find it yet, but after the GFC some boffins from Canada did a study, and recommended that Canada should get rid of its current mortgage guarantee system and adopt a similar system to, of all places, Australia.

      The ironic thing was, this came out around the same time that Joye started agitating for a Canadian-style system in Australia post-GFC (which was a couple years ago now).

  6. General Disarray

    The questions and issues raised by MacroBusiness here are spot on.

    The Yellow Brick Road proposal has some very self-interested backers with political access; this is dangerous as history has shown. Not one of the pieces of “journalism” I’ve looked at from the backers of this plan has talked about a negative – that is a real worry.

    All politicians that consider the YBR proposal need to be asking the same questions raised here today.

    MacroBusiness might need to invest in some Carrier Pigeons if that’s what it takes to get your message across.

    • As you know Rumples I’m not a big fan of Govt control on things but….Yes…these things and all their special privileges should be smashed (let fail)and start again…somehow.
      I couldn’t understand the Govt not taking equity in return for all the bail-out money that was pumped in one form or another.

      • Yep, changing to governement ownership now is not the answer, but it is something we shoul t be afraid if as the evidence shows that the scenario is perfectly functional ( as it was in Australia when the Commonwealth bank was THE bank).

        There should be a premium paid for government insurance of private enterprise, as I have previously argued. Or your alternative of an equity stake is also worth considering carefully.

        • Maybe a little too late now but I do have a belief that either you do complete private banking or complete public banking but not in between. Otherwise you get a lot of interests trying to corrupt the process and the potential for moral hazard/relaxation of the rules.

          The problem with banks is that they effectively determine (or APRA via their capital requirements) where the money of all of Australian’s will end up. This is not a business – government has given incentives for banks to invest in mortgages above any other asset. Pretty much they sealed in stone the use of Australian savings to fund housing above all other assets/projects.

          A business does not have that power. Only a utility does. If you want banking to be a business it needs to live by the sword and die by the sword when it fails with amny participants.

          • Agreed, Mark. And what we’ve been seeing in the US and Europe aint exactly private banking.

            I think handing natural monopolies to privateers involves a donation of our public rents. Viz, bubble-inflated land prices are in effect the private capitalisation (plus interest) by banks of uncaptured publicly-generated rent for a period of some 30 years.

            But I’m sure the Australian sheeple would defeat any Chifley-like move to nationalise the banks again.

            But, please tell me we won’t stoop to bailing our Big 4 out (when our turn comes), as they have o/s? I mean, are we learning anything at all from the nonsensical goings-on in the US and Europe?

          • Bryan I wonder what you call a bail-out? I thought the $55 Billion last time plus the FHOG was a fair start

  7. Try reading this 2008 paper co-authored by Chris Joye (along with Joshua Gans):

    TP: careful AB – you may disagree with the ideas (as do I) but don’t need to resort to that sort of language

    “We propose that the Commonwealth Government sponsor an enterprise – ‘AussieMac’ – that would leverage the Government’s AAA-rating to issue low-cost bonds and acquire high-quality mortgage-backed securities from Australian lenders just as Fannie Mae and Freddie Mac have done in the United States (and the CMHC in Canada).”


    And while you’re reading it, just remember that the latest estimate for Fannie Mae and Freddie Mac losses is between $120 and 200 billion.


    • “TP: careful AB – you may disagree with the ideas (as do I) but don’t need to resort to that sort of language”

      Fair point about one of the adjectives – surely “dangerous” is OK though given the losses for the US GSEs?

      • dangerous was fine AB, rest wasn’t, so whole lot went.

        We can tear apart the ideas – since they are dangerous, ill thought, have a probable vested interest behind them, lack robustness, take no account of systemic or macro risk etc ad nauseam – but leave the personal aside.

        • No problem Prince – I think we have a different interpretation of the word I used but in the end I’m a guest at your house and happy to accept your interpretation.

    • LOL.. Pity that the Internet never forgets!!

      Compare and contrast the statements made by Chris Joye in 2008..

      “We propose that the Commonwealth Government sponsor an enterprise – ‘AussieMac’ – that would leverage the Government’s AAA-rating to issue low-cost bonds and acquire high-quality mortgage-backed securities from Australian lenders just as Fannie Mae and Freddie Mac have done in the United States (and the CMHC in Canada).”

      …to the one he made in the article last week:

      In the US, there were two giant institutions with the highest possible — AAA — credit rating: Fannie Mae and Freddie Mac. Both were private companies listed on stock exchanges, like the majors. Both were regarded by investors as being too big to fail, and implicitly government-guaranteed, like the majors.

      ROFL .. Mr Joye’s “views” have evolved from demanding Aussie versions of Fannie and Freddie 2008 to now equating the Big 4 banks with Fannie and Freddie !!

      So does he still want a Aussie Mac or not? If he does, by his own words, we have already got em in the form of Big 4 majors 🙂

      • I know it’s easy to pick on things that people have written in the past, but I think it’s reasonable to do so when they are still arguing for solutions that have clearly failed elsewhere.

        “In this way, these two GSEs ensure that a continuous, low cost source of home loans is available to consumers whenever and wherever they need them. They therefore serve as a liquidity provider of last resort. As the US regulator of the GSEs, OFHEO, notes, “Fannie Mae and Freddie Mac…help stabilize mortgage markets and protect housing during extraordinary periods when stress or turmoil in the broader financial system threaten the economy.””

    • I’d bet on it! Many here would disagree i know.
      My really wise answer would be ‘Hard to say’ followed by significant silence!

    • Unfortunately if they get it in soon enough I think they could, especially as we have some room to move interest rates downwards thus allowing ever larger loans to be serviced. Also given the source of these suggestions, it could create the environment where exotic products like ‘shared equity’ mortgages could gain favour and drive prices even higher again.
      The housing mania is far from dead in this country, and only needs a bit of fuel to wake it up again, and the politicians on both sides are co-opted and short sighted enough to do it.

      Maybe this sould have been at the Festival of Dangerous Ideas last year…

  8. Great article. Very easy for Bouris and Joye to get lots of traction in today’s bank-bashing environment without anyone looking at potential problems with their solution.

    Agree that they raise some important issues, but like MB said, a wider analysis of what we want our banking system to achieve is warranted.

    • Yeah,thanks bbu…why just the other night after following some stories from the site ‘Bubblepedia ,on the same,you comment..and I looked Mark B up at Wikipedia’
      Seems he’s been around like a wizard and looks pretty good…at that I turned my screen back over to TV and ‘The Avengers’,were on …then I thought of Joye…before turning to the ABC news 24
      Cheers JR

      • JR,

        A bit hard to read, but if you’re saying you looked up Mark B after reading a comment of mine on Bubblepedia, I’m afraid you’re mistaken.

        Prior to just now, I’ve never been on that website or forum. Macrobusiness is my source for the mostly bearish view of the economy. From a quick glance, Bubblepedia doesn’t look like a bastion of open-minded discourse.


        • Yeah,Sorry about that bbu..did I make you feel like you were getting ahead of yourself..i mean if you ain’t been there ..how could i see you’re comment..anyway save all the bastion open minded discourse n Don’t be afraid…problems been solved,see..Joye Boy wonder…Bubblepedia
          Cheers JR

  9. The whole proposal is a joke driven only by self interest. Credit availability is not an issue in Australia.
    And even with 10 new banks, they would be each too big to fail. Or how about: too little to survive in a crisis.

  10. The first challenge is to define exactly what is meant by stability. Most natural systems are not stable at all – they are resilient, and the size of the cycles are generally smaller the greater the diversity. Smaller diversity = larger cycles. Sound familiar?

    I would suggest that proposals to encourage diversity are the key.

  11. The Wallis inquiry could never explicitly envisage systematic failure or bailouts within the context of its review, because such failure is an inherent property of our economic construct. Moral hazard and unintended consequences will be an inherent part of any banking system within a society that strives to achieve some semblance of social equity against ideological precepts of continuous economic growth, freedom of capital and markets, lighter regulation, primacy of shareholders and the privatization of profits. I would suggest it is not possible to eradicate the potential for moral hazard unless you are prepared to forgo some substantive degree of these interconnected elements.

    Will such a fundamental ideological shift result from a new government inquiry ?

    2008/9 was a wasted opportunity – perhaps our best one – to reel in the worst excesses of the banking sector and peg them to more sustainable levels of credit growth and profitability. A smarter, stronger (and more visionary) breed of government would have faced them down; unfortunately ours blinked. The banking sector are now well dug in for a very long and bruising fight against those who might question the legitimacy of their supremacy. The holy grail of a new banking order will not be found in a government inquiry – it will be the cumulative outcome of small battles and slowly mutating common social values. Headlines such as ‘Banks were right to lift rates’, viewed through the prism of the ‘reality’ that our banking sector has worked very hard to construct and maintain, are manna from Heaven for the ABA.

    • Headlines such as ‘Banks were right to lift rates’, viewed through the prism of the ‘reality’ that our banking sector has worked very hard to construct and maintain, are manna from Heaven for the ABA.

      Look at it from another angle – the more greedy the banksters get and lift rates, the more it’ll affect the housing ponzi sentiment and force deleveraging process to continue. Also, this will ensure banks will not be popular candidates to receive a bailout in the future, as any pollie seen helping the banks is toast.

      IMHO, the ideal outcome for Australians is for the RBA to drop the cash rate (bring down the AUD) and for our banks to go in the opposite direction lift their mortgage rates.

  12. MB, when you say their proposal is interesting, I hope you mean “interesting” as in “we live in _interesting_ times”.

    Whatsmore, you say:

    “Bouris and Joye have done a great job of describing the distortions of the current system. We at MB agree and recommend you read their articles”

    It seems pretty dangerous to promote articles like these with such terrible ideas. MB readers have done a good job pointing out some of the other terrible ideas Joye has pushed over the years e.g. shared equity.

    Keep up the good work MB. Australia seems to have lost most of its journalistic integrity and all the investigative journalists seem to be on vacation :). MB is still a breath of fresh air.

    • Thanks for the comments Steven – we are saying the description is good (if a little late and obscured, there is no MacroBusiness Bank or MacroBusiness Building Society….(yet?)), but not the prescription.