CONCRETE DETAIL
by Christopher Joye
Posted 1 Jul 2009 9:44 AM
Joe Hockey jumps on the bandwagon
Well, well, well… the plot certainly thickens. On the final day of a two-part series arguing for the government to support the liquidity of the RMBS and CMBS markets, which I co-authored with the formidable Sharan Burrow, who is President of the ACTU and the two key international labour union bodies, the Shadow Treasurer, Joe Hockey, gave a speech backing the idea. Of course, the timing was coincidental, since I had written the first detailed article sketching out this proposal for Business Spectator back in April. In any event, this is an excerpt of what the AFR’s long-time warrior, Laura Tingle, had to say about big bad Joe’s speech:
“The federal government should provide a guarantee for "investment grade" mortgage-backed securities in place of the "RuddBank" fund rejected by the Senate in June, shadow treasurer Joe Hockey said yesterday…Mr Hockey said the lack of liquidity in these markets constrained the capacity of smaller financial institutions to raise funds and kept them reliant on funding raised using the wholesale bank guarantee. This in turn made it more difficult for the government to unwind the guarantee. The opposition call could open the way for Prime Minister Kevin Rudd to guarantee mortgages, a move that is being pushed by Bendigo, Adelaide Bank and Challenger Finance Services Group. It is understood Treasury officials are already considering options to increase assistance to the mortgage market, including giving a government guarantee over mortgage securities with a AAA rating.”
Laura is spot-on. The Coalition’s support for this initiative, which I must admit is a surprising development, really removes the bulk of the political risk for the government. If the government does run with the idea, the Coalition will not be able to criticise it.
Malcolm Turnbull had previously landed blows on both RuddBank and the unanticipated consequences of the original bank guarantees, and the government would be anxious to avoid a repeat of these experiences. Naturally, there will be the small and quickly forgotten cost of Joe being able to claim that he first came up with the idea. But I suppose the government could argue that it had been looking at this for ages. Either way, the media storm will focus on the policy initiative and spend next to no time trying to work out where it originally came from (based on past precedents).
One bizarre snippet I have heard from industry sources is that the Treasury may prefer an expansion of the existing $8 billion AOFM facility. This is extremely odd because when Joshua Gans and I originally came up with the idea both Treasury and the RBA were rabidly opposed to it. And this opposition has been repeatedly reaffirmed to me in many conversations since the government announced the initiative.
Yesterday we noted that while the $8 billion has directly helped out the lenders who have benefited from the capital, it has had no effect at all on the overall cost of RMBS funding (or the so-called ‘spreads’) because it is being undermined by the government guarantees of bank debt, which have massively increased the supply of AAA-rated securities and created two-tiers of investment – those AAA assets with and without a government guarantee (RMBS and CMBS obviously fall into the latter category). Indeed, as the RBA (in its Statement of Monetary Policy) and the Treasury’s David Gruen have recently observed with some bewilderment, RMBS spreads have actually increased markedly to more than 200 basis points over the swap rate since the AOFM started investing its money notwithstanding their incredibly low default rates (again because of the dysfunction indirectly introduced by the government guarantees of bank debt). In the ten years prior to the advent of the GFC, Aussie RMBS spreads averaged 20-30 basis points over. And today, the 90 day mortgage default rate sits at about 15 per cent and 25 per cent of US and UK levels, respectively, or roughly 0.6 per cent.
I have absolutely no idea why Treasury would prefer to expand the AOFM facility, which will significantly increase the government’s debt with no tangible impact on the cost of mortgage funding (which is the objective of this exercise) in favour of a much more efficient commercial guarantee of RMBS and CMBS. The latter is far more scalable (ie, many more lenders could use it), does not increase the public debt, will be immediately revenue positive for taxpayers, and, importantly, should quickly reduce spreads or the cost of funding in the RMBS and CMBS markets by removing the asymmetry that these securities face vis-ŕ-vis government guaranteed bank and state government debt.
My only conclusion is that the Treasury’s deep institutional risk-aversion and fear of anything remotely new or innovative has meant that it is far more comfortable continuing with an existing policy initiative that it originally advised government not to pursue (ie, the AOFM scheme, which it has now implemented against its wishes and recruited human resources to run) than it is embracing a demonstrably superior solution that is, critically, foreign to it. Go figure.
Here are some excerpts directly from the Shadow Treasurer’s speech, which I thought was quite good:
“The Coalition does not believe in executive government becoming intimately involved in commercial business deals.
History shows that governments are not successful at running business ventures. They lack sufficient commercial experience and acumen.
Being in a position to influence the fate of a business venture opens up the possibility of improper influence or deals for mates.
We have seen that revealed over the past few weeks with OzCar.
It is our contention that Treasurer Swan afforded special privileges to a political mate, 1 car dealer out of 240, facilitating a line of contact through to himself, Treasury, and a financier, that was not afforded to any other car dealer in Australia. And it was about seeking an advantageous financing arrangement.
We will continue to press for a full judicial enquiry into the OzCar debacle.
The possibility for these sorts of deals for mates was one of the reasons and a pretty significant reason why we opposed the Rudd Bank legislation.
There is a more fundamental philosophical reason why we do not support these types of government/commercial arrangements.
Direct government intervention in this way injects the government into areas of the economy where it has no place. The growth of a “corporate state” gradually, but surely, distorts the workings of the market because decisions can take into account the preferences and biases of the state rather than being made on purely commercial grounds. And you’ve seen that with the bail-outs of General Motors and Chrysler in the United States.
In the end, elevating the power of the state can only mean weakening the power of the market. This would be to the detriment of all Australians.
The Coalition will assist business when it needs it, and it always has done so. But we will do it in a way which is at arms length, where the government and the bureaucracy do not have a say in or interfere with commercial decisions and the workings of the market.
Our view is that a Government should intervene only where there is a market failure, not a business failure.
There is an issue today in Australia with the operation of market financing arrangements for housing and for commercial property investment – they are in a state of disrepair.
The development of the securitised asset markets for residential mortgage backed securities (RMBS) and commercial mortgage backed securities (CMBS) have been successful market initiatives to provide increased flows of non bank finance to these sectors.
These markets today, particularly the CMBS, are not working as well as they should because of wariness among investors stemming from the difficulties with US sub prime.
The Coalition believes these markets deserve support. Such support can be provided in a way which restores investor confidence in purchasing RMBS and CMBS but which does not involve the direct use of government money or provide for the possibility of state interference or influence in the markets.
Our solution – in stark contrast to Rudd Bank – is to provide a government guarantee for investment grade RMBS and CMBS in the same way that the government has offered a guarantee for bank wholesale security issues and state government bonds.
Alternatively, or perhaps in addition, we would suggest that there is a justification for the Future Fund, with additional funds being provided by the Government, to be in the market, even aggressively looking for particularly Triple A rated issues.
The issuers would need to put in place the necessary protections to ensure an investment grade rating.
The government enhancement would promote investor confidence, improve demand, and lower yields (spreads to the government curve would narrow). The government guarantee would be a contingent liability which we believe would be unlikely to be drawn upon.
This approach will assist the operation of the market rather than seeking to replace it.”
COMMENTS ON THIS POST
Loading...
