Effects Of Sub Prime Mortgage Meltdown On Housing Affordability

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The Politics of Australian Monetary Policy, or bailing out Macquarie Bank when you go to Woolies..

Periodically, Australians overindulge their love of property, but never like now. The number of housing loans granted increased at twice the rate of population growth between 1896 and 1977 and then exploded after deregulation. Twenty years of falling rates and innovation in financial services has ensured not only massive but excessive investment in housing. it’s a mania! Generally in Australia the price of the housing stock has risen as a response to strong demand from family formation and immigration especially when low interest rates allow easy borrowing both for builders and borrowers.

New home inspectionsEarly rises in prices encourage speculative building and the rationale for investing in housing moves from rental yield to capital gain. Investment in cheap rental accommodation to maximise yield is indicated when prices are low but as the possibility of capital gain drives prices the focus of investment up the value chain to that sector of the market delivering the largest gains.

Demand continues until stresses in housing affordability peak and a cyclical recession, sometimes combined with a spike in interest rates cools demand and prices fall, usually accompanied with a financial crisis and institutional failures the commercial or residential markets. Bank profitability falls, credit is restricted and the market bottoms as the lower prices make houses more affordable. This has been the nature of the boom bust cycle in housing.

The arguments against an active industry policy are often framed by the expression that government is not in the business of picking winners. The argument runs that a Free Market Economy is the best means by which capital allocation decisions are made and the large profits of the housing sector have been rationalised by the argument that with market risk comes the possibility of loss as well as reward These arguments support a process of deregulation and privatisation. The winners of those debates have always argued, successfully to date, that the private sector was better suited to make the capital allocation decision.

The ratio of house prices to incomes has recently risen to historically unprecedented levels, driven by easy credit, direct government grants to first home buyers and a taxation system that, via negative gearing, encouraged and advantaged investment in real estate. Furthermore prices were pushed higher by a whole new layer of loan providers and a flood of cheap money that became available when Alan Greenspan stimulated the US with low rates, making US home prices the fulcrum of monetary policy.

chain hoistThe availability of credit has been a function of the long term decline in interest rates, increasing innovation in financial services and massive credit creation in the investment banking sector. This tide of money has reached a peak and now appears to be reversing. The prospect of significant falls in the price of credit going forward is close to zero.

Affordable housing may return as credit becomes less available and more expensive. Sure there will be pain but as we need capital for energy efficiency investments and alternate energy and infrastructure. The only problem is thr Reserve Bank is working hard behind the scene to sustain the unsustainable.

Financial engineering unleashed an explosion of credit which led to an explosion of debt. In part, credit drove up housing priced to a point where housing became unaffordable. In the end, this process transferred an enormous amount of wealth to property developers and baby boomers. Now that the bubble has reached its apogee, the Reserve Bank sees it as part of its charter to bail out the banks that got into this mad scam.

It is the duty of the Reserve Bank Board, within the limits of its powers, to ensure that the monetary and banking policy of the Bank is directed to the greatest advantage of the people of Australia and that the powers of the Bank … are exercised in such a manner as, in the opinion of the Reserve Bank Board, will best contribute to:
(a) the stability of the currency of Australia
(b) the maintenance of full employment in Australia; and
(c) the economic prosperity and welfare of the people of Australia.
(d) bailing out politically connected insolvent banks and property speculators with free money when it(Aug 07 onward)

The announcement by the ANZ Bank that it had “securitized internally A$11.2 billion ($10.6 billion) of residential mortgage loans to give it greater access to liquidity if needed” is Newspeak that it is taking advantage of a change late last year by the Reserve Bank of Australia that made mortgage securities eligible for repos. What the terms and conditions of these arrangements might be is anyone’s guess as RBA simply refuses to disclose those details. It is an measure popular with the banks as Reuters continues:

pre purchase building inspectionANZ is the third bank to adopt the approach, following Westpac Banking Corp which earlier in the year converted A$10.6 billion of mortgages into securities that became repo-eligible with the Reserve Bank of Australia. Bank of Queensland followed suit in March with a A$500 million similar issue. Late last year, the RBA widened the type of assets it would accept as collateral in repurchase agreements to promote liquidity in financial markets. The new list of collateral included certain types of residential mortgage-backed securities. Issuance of RMBS in Australia has slumped to zero in 2008, from A$57 billion in 2007.

St George and Macquarie Securities have also followed this crazy trend to “securitisation not for sale to investors but for passing to the crazy man at the Reserve Bank repo window which has become like a soft touch at the local pawn shop” (a contradiction in terms ), to latch on to the Reserve Bank’s ever generous teats! Robert Gottliebsen noted “Internal securitization in Australia this year now stands at $50 billion, almost as much as the entire volume of RMBS sold to investors last year. Internal securitization consists of converting mortgages into securities that become eligible for repurchase agreements with the Reserve Bank of Australia. Last year, the RBA widened the type of assets it would accept as collateral at its repo operations, including certain types of RMBS, to promote liquidity in financial markets.”

The law of consequences in the free enterprise system has been repealed for borrowers and other bag holders. At the repo rate current Down Under, banks and associated hangers on under the patronage of the Reserve Bank of Australia are having the whole of their annual fund raising requirements effectively provided by the taxpayers at highly concessional rates and without even the spotlight of public scrutiny on this sorry state.

This is the real issue. The property spruikers, and their enablers, when the bubble finally dies, will have offloaded their risks to the Australian taxpayer by way of both inflation of the money supply and the impairment of the balance sheet of the Reserve Bank.

Mr Rudd and his treasurer should not be running off to the USA to learn the art of money printing from Ben Bernanke. Rather Mr Rudd and his treasurer should be making plans for the demise of the US dollar as the reserve currency and focus on rebuilding a monetary system that we have a capacity for actual savings and investment.

Otherwise citizens will have no alternative but to feel this madness into traditional means of preserving wealth, gold, silver, oil and copper.

When money and credit cannot be distinguished, the role of savings in the economy is shortcircuited, idle resources cannot be redeployed into productive uses and the economy morphs from healthy adult to walking zombie.

The Reserve Banks responsibility is to provide for an economy with a capacity to respond to the great changes and challenges of peak oil and climate change, not to freeze by fiat the current pattern of economic activity and put the most foolish players on monetary life support.

GGIM