The sub-prime mortgage crisis in the United States that began in August 2007 has had far-reaching consequences for global capital markets. For a small and open economy like Australia’s, the price of capital is largely determined in these global markets, so wholesale funding costs for Australian financial intermediaries have increased as a result of the crisis. Both bank and nonbank lenders have raised their retail lending rates, reflecting this higher cost of funds. Nonbank lenders have been hit particularly hard, as they rely more heavily on capital markets for funding, whereas the larger banks can also access funding from their retail deposit base.
Prior to the onset of the credit crisis, nonbank lenders were able to obtain wholesale funding through the market for residential mortgage-backed securities (RMBS). The credit crisis has seen a sharp reduction in the issuance of RMBS, reflecting reduced investor appetite for these instruments and making it difficult for nonbank lenders to originate new mortgage finance at competitive rates. There has been a reduction in mortgage lending by nonbank financial institutions, and a loss of market share to the major banks.
These developments have raised concerns about an apparent reduction in competition in retail mortgage lending. While the credit crisis is temporary, it may take some years before the market for RMBS fully recovers. This has led to proposals for government intervention in these markets. In particular, it has been suggested that the federal government should sponsor an institution, dubbed AussieMac, to acquire RMBS to promote the continued functioning of these markets. The acquisition of these securities would be funded by issuing government bonds, taking advantage of the government’s ability to access capital markets on more favourable terms. These proposals are explicitly modelled on similar government-sponsored enterprises (GSEs) in the United States, known as Freddie Mac and Fannie Mae.
This paper argues that the AussieMac proposal is unlikely to deliver significant benefits for Australian homebuyers, and that government intervention in the market for mortgage-backed securities is an inefficient way of promoting housing affordability. Australia cannot insulate itself from developments in global capital markets, which convey important price signals to lenders and borrowers. The international and cyclical influences on Australian mortgage interest rates are very large relative to the contribution from lending margins. Narrower lending margins may be fully offset by the monetary policy actions of the Reserve Bank of Australia (RBA) in maintaining its desired level of credit restrictiveness. To the extent that lower mortgage interest rates could be realised, this would be capitalised into house prices, with adverse implications for housing affordability.
The proposed institution would amount to an indirect government subsidy to the mortgage securitisation industry, which could ultimately damage competition in the provision of housing finance. Experience with comparable institutions in the US and Canada suggests that little of this subsidy is passed on to home borrowers. Lower wholesale funding costs could only be achieved by exploiting implicit or explicit government guarantees and the government’s power to tax. Overseas experience shows that there are significant risks associated with government-sponsored housing finance enterprises even when they are in private ownership. As a government-sponsored institution, taxpayers would be exposed to any losses on the proposed institution’s portfolio. The two housing GSEs in the US, Freddie Mac and Fannie Mae, have exerted a destabilising rather than a stabilising influence on US housing finance, financial markets, and fiscal policy.
Dr Stephen Kirchner is a Research Fellow at The Centre for Independent Studies.
