The credit crisis

Current RBA practice addresses the short term problem of liquidity for banks - but exacerbates the long term damage the collapse of primary securitisation markets is causing to the competitiveness of the home loan sector and beyond. Banks have stepped into the vacuum expanding their market share. But with limited capital they’re starving other customers for credit.

Christopher Joye and Joshua Gans’ “Aussie Mac” proposal involves extending this government function in the way that Fannie Mae has done in the US since 1938 and the Canada Mortgage and Housing Corporation, which has done so since it first helped returned soldiers into homes in 1948. “Aussie Mac” would involve government doing what the RBA is now doing for banks - effectively guaranteeing high quality mortgages - but on a larger scale and with competitive neutrality.

Naturally, as in the days of Smith, any “intervention” is looked upon askance by some and slated by some as “government assistance”. It is not. Government guaranteed involvement in vouchsafing liquidity in the market should be seen as a trade in which the state agrees to bear a risk that those in the private sector have, by their withdrawal from the market, indicated they cannot or will not bear. At the same time Government should charge an appropriate premium for its insurance, reflecting its unique position in the marketplace as the least cost bearer of such risk.

In its role as lender of last resort the central bank is in a fine position to price its own services at a healthy profit and it should do so. And just as the RBA is currently charging banks a healthy margin for lending against their residential mortgages, so too the government should charge a healthy premium for insuring residential mortgage securities during times of extreme dislocation. And as is generally the case with trade, it doesn’t take place unless both parties gain from it. Only in this case, in addition to the Government expecting to come out ahead financially, we get a powerful economy wide benefit of the perseveration of liquidity in the financial markets.

In short, if done right, as with the opening of a new trade route, everyone could expect to be a winner including a government eager to deliver a higher surplus.

One final thought: right now the credit crunch is acting in concert with higher interest rates to produce a desired slowing of our economy, but rising bank margins are building costs into our economy which we’ll rue once this tightening cycle is over and our economy needs to pick up steam.

So let’s get on with innovating the tools we’ll need to fight this, and future wars, rather than honing instincts we developed during the last one.