SOS: Can the government help?

As the sub-prime crisis lumbers on, dragging down several Australian non-banks lenders in the process, experts both here and in the US are looking at ways the government could help ease the impact of the crisis. Australian Broker's Kate Carr combs through some of these proposals and their implications for brokers and lenders.

AussieMac

In the US, government sponsored institutions Fannie Mae and Freddie Mac buy conforming home loans, and package them into mortgage-backed security bonds for sale to investors. This process allows lending institutions to sell-off existing loans, in the process generating new funds for more loans.

In Australia, this process is left purely in the hands of the market, a fact which has left many non-bank lenders unable to securitise their existing loans and consequently unable to service new borrowers.

According to Melbourne Business School's professor of management Joshua Gans and Rismark International's managing director Christopher Joye this is a state of affairs which could have been prevented if Australia had an 'AussieMac' institution playing the role of Fannie and Freddie in the US.

"If we had an AussieMac right now, non-bank lenders would be able to securitise, Macquarie wouldn't have gone out of business, ANZ's Origin wouldn't have shut up their books, [and] RAMS probably wouldn't have had the problems it encountered," Joye says.

"Thus far the Australian securitization market developed without a government-sponsored enterprise like Fannie Mae or Freddie Mac in the US or what is called the CMHC (Canadian Mortgage and Housing Corporation) in Canada," he explains.

"So those markets have benefited from a government agency, we haven't, and as a result liquidity in the mortgage-backed securities market, has disappeared whereas liquidity remains in the Canadian and US markets."

According to Joye, this is particularly unfair from an Australian point of view given that the scarcity of liquidity stems from problems which originated in the US.

"We have very low default rates, extremely high quality mortgages that have performed incredibly well and yet Australian non-bank lenders have suffered from the closure of the securitisation markets for reasons that are totally unrelated to Australia," he says.

"It makes no sense that Australian non-bank lenders can't securitise.

"Australian households and Australian non-banks are the casualties of irrational investor behaviour..."

Markets misbehaving?

Gans says the right time for the establishment of AussieMac was several years ago, before the hint of any crisis. However, with the previous Howard government firmly in the thrall of free market economics such a scenario was unlikely.

"For the past decade we have had a government who put its faith in the efficiency of financial markets but during that time it was only in the last 12 months that problems appeared," Gans explains.

"Sometimes it takes a shaking of faith and a non-ideological driven government to consider real institutional change."

Sometimes it takes a looming catastrophe too, and it seems as the fallout from the US sub-prime crisis continues more economists, bureaucrats and politicians are beginning to question the inherent wisdom of the market's 'invisible hand'.

"For the last 20-30 years most economists and policy makers and governments have been of the view that we should minimize government interference in markets and we should allow markets to develop in an unfettered fashion," Joye says.

"However, what we've started to see is that in an increasingly integrated world, markets do occasionally fail and when markets fail, whether it's through a bank run or the closure of securitisation markets... I believe that there is a role for government to intervene and provide, on a temporary basis... a minimum level of liquidity, because these markets are shut for completely irrationally reasons."

The sub-prime crisis poses a particular challenge for market based theories due to the fact many are based on the assumption of readily available liquidity, Joye notes, adding that we could be on the brink of ushering in a new orthodoxy in economics.

"Economics over the next ten years will undergo some changes as a result of what we are observing today and I think we are in an inflection point of sorts in terms of the approach government and economists take to markets," he says.

According to Joye, the view that investors in aggregate always behave rationally has taken a particular battering in recent times.

"In fact we've learnt that in investors aren't rational all the time," he says.

"Occasionally you do get irrational exuberance, markets over-react. Hence the tech boom and then the tech wreck; both were over-reactions.

"Because of the frailty of the human condition markets will be occasionally prone to failing."

Hillary and Obama search for an edge

This shift in economic thinking is particularly underlined in the presidential preselection campaigns of both Hillary Clinton and Barak Obama. Clinton has declared she will devote US$30bn to help homeowners at risk of foreclosure, while Obama has earmarked a more modest $10bn for the cause.

Clinton has also proposed the establishment of "high-level emergency working group" to recommend ways to restructure at-risk mortgages to help avert more foreclosures, while Obama has declared he will hold a "homeownership preservation summit" to brainstorm ways to prevent more Americans losing their homes. Furthermore, Clinton endorsed federal legislation aimed at bolstering the government's ability to guarantee restructured mortgages, as well as new laws aimed at protecting mortgage servicers from litigation when they modify mortgages.

According to Gans, while the situation in the US is different to that in Australia, there is a case to be made for such aggressive intervention.

"In a proposal distinct in rationale from AussieMac, myself and Stephen King (fellow professor at MBS) proposed a 'housing lifeline'," he notes.

"That would be a government line of credit provided instantly to households that find themselves in housing stress (whether through mortgage payments or rents).

"The debt would then be paid back in a HECS-style manner through the tax system when their incomes rise again."

First developed by Gans in 2003, and ignored by the previous government such a proposal could find itself back in the spotlight given the recent spate of rate rises.

Why should brokers care?

Although distressing to those involved, does it really matter to brokers if more borrowers are defaulting and non-bank lenders are going bust? According to AFG's general manager for sales and operations, Mark Hewitt it surely does.

"Competition is obviously really important, as is access to funds for borrowers," he tells AB.

"We've seen the last couple of weeks a number of the smaller players pull out. Savings and Loans has pulled out, Home Building Society in Western Australia have advised they are pulling out of the market...plus Bluestone and Macquarie."

According to Hewitt, the withdrawal of such players threatens both brokers' commissions and their ability to compete with bank staff.

"I suppose there is the ever-present concern about commissions," he states, emphasizing that the fewer players there are in the lending sector the easier it would be for commissions to be reduced.

"It's like any situation where you have an oligopoly or duopoly the parties remaining in the business can dictate terms," Hewitt claims.

A diverse product range is also particularly important to brokers, Hewitt says. "If [a broker] is competing with a provider of only one product, such as a bank employee, it's important they have a broad range of products to be able to offer the consumer."

"If you take away choice, the broker proposition diminishes."

What industry players are saying about government intervention in the mortgage market:

"[If I was the RBA governor] I'd consider establishing a government-sponsored agency similar to Freddie Mac and Fannie Mae... to improve the liquidity of mortgages and mortgage backed securities." Alistair Jeffery chief executive Bluestone.

"We've already made a submission to the treasurer and to the housing affordability enquiry urging the federal government to put in place some sort of a scheme like the Canadian scheme or the US scheme, we haven't necessarily supported AussieMac as such but that general principal we are in favour of and supportive of" Phil Naylor CEO MFAA.

"If you don't transfer securities from one part to another at market rates, you get moral hazard risk. Lenders will continue to lend aggressively. [AussieMac] doesn't fix the problem that in this country lending has been growing faster than retail deposits. We're country of borrowers, not savers." Brian Johnson banking analyst JPMorgan Chase.

"The [AussieMac] plan is an interesting idea. However, it will take time for such an institution to be developed," Ed Thian head of marketing and product Pepper Homeloans.

"The idea that the international banks will themselves provide enough competition for the big four banks isn't quite right. Credit markets are closed down tight for anything to do with mortgages so HBOS, Citibank and the like have got their own problems at the moment. These banks are fighting to make sure that they can survive this vicious credit crunch and the last thing they want to do is use their actual balance sheet to fund the 20 or 30 year housing loan at a margin of 100 basis points. Its time that we saw some form of intervention to make these markets liquid again," John Symond chairman and CEO of Aussie Homeloans.