Monday, November 8, 2010

Innovation can't save failed innovation

Amidst the ongoing banking furor, one innocent little paragraph leapt out at this blogger over the weekend: "A secret briefing note obtained by The Sun-Herald confirms Treasury is working on a plan to allow customers to carry account numbers from one financial institution to another."

We already know that a key plank of Labour's new measures to increase bank competition will be mortgage portability. Although not much to go on, the above story hints that Canberra may be considering some kind of new clearing system for mortgages.

At Business Spectator recently, housing speculator Chris Joye argued for just such a system.

Joye argued for the creation of a National Electronic Credit Register (NECR) which did, among other things, allow for greater account portability:
1) A unique loan identification code (so that NECR can track the loan);
2) The loan amount;
3) The loan type (eg, 3- year fixed)
4) The interest rate;
5) The settlement/discharge date;
6) The collateral value (eg, property value);
7) The collateral address; and
8) Importantly, a nationally-defined debt serviceability standard measuring the ability of the borrower to meet the repayments on the loan (all lenders use these in one form or another, so it should be easy to define a standard metric that they have to supply, which in turn would allow us to make cross-sectional comparisons of ex ante credit quality for the first time).

He went on to argue that this would:
NECR would also revolutionise the RBA and APRA’s approach to risk-management. Allow me to illustrate a few examples. In the shadow of the GFC, regulators are understandably worried about system-wide debt levels (or ‘leverage’) and the rate of change in credit over time (ie, the process of gearing up, or, conversely, deleveraging).

These concerns are made all the more acute given the recent tapering in national house prices combined with the spectre of further rate rises. But what arguably gets regulators most energised is the so-called ‘distribution’ of these risks. That is, those borrowers sitting in the far tails of the distribution that carry the highest hazards. But disaggregating this information when banks are sending you summary statistics is an arduous task (obviously the regulators insist on some disaggregated data).

So rather than simply calculating a system-wide loan-to-value ratio (LVR) by dividing the total amount of mortgage debt (ie, circa $1 trillion) by the total amount of residential property outstanding (around $3.5 trillion), or for the pedants, the amount of property with mortgage debt held against it (about half based on the 2006 Census), the regulators would be able to measure the individual LVRs of every single loan in the country. And they would get live updates on changes in those LVRs as loans were regularly refinanced, which they are.

Since the average home loan’s life is only around 4 years (due to refinancing), it would not be long before they had individual records on all outstanding debt.

More significantly though, real-time information on the specific lending criteria employed by institutions (as proxied by, for example, LVRs and a standardised debt serviceability metric, which does not currently exist) would allow authorities to act assertively in the upswing of concurrent asset price and credit booms rather than picking up the pieces after the bubble has burst.

This argument strikes this blogger as odd. Central banks have had plenty of data in the past to identify housing and other asset bubbles, they have either chosen to ignore the signs or been ideologically blinded to them.

One example is the story of how FOMC governor Ed Gramlich lobbied Alan Greenspan to investigate mortgage fraud in the early 2000s. From The Great Crash of 2008, this blogger's co-authored book with Ross Garnaut:
According to the Wall Street Journal, even as unease about mortgage fraud grew among some Federal Reserve governors around 2000, Greenspan prevented action. This extended to proposals by Edward Gramlich, Federal Reserve governor from 1997 to 2005, to use the Reserve’s discretionary authority to crack down on predatory lending. Even in late 2004, when enthusiasm for the US housing bubble reached fever pitch, Greenspan found a favourable interpretation for events, remarking that improvements in lending practices driven by information technology have enabled lenders to reach out to households with previously unrecognized borrowing capacities.

In short, all the data in the world is useless if its interpreted though a corrupting prism.

Moreover, how exactly is the RBA going to use the blunt tool of monetary policy to dynamically manage risk in the mortgage market? It isn't.

Perhaps, if new macro-prudential tools were embraced, Joye's system could be useful, raising lending standards in a nip/tuck kind of fashion. But, in reality, this can't and won't happen. Given central banks (and other regulators) have watched bubbles build and bust for over thirty years without doing much, it is a huge stretch to think that they would ever conclude that they could dynamically manage particulars of bank portfolios better than the banks.

And in truth, why would they? Surely this represents a kind of technical moral hazard the effect of which on bankers is not difficult to imagine: I'll lend my arse off until the RBA tells me otherwise.

Another potentially destabilising feature of a central electronic clearing system is that it may make the shifting and packaging of mortgages easier, thus encouraging securitisation.

As this blogger has outlined before, Australia is yet to confront the fact that it is was securitisation that sat at the heart of the wholesale collapse of US banks, as well as the mid-tier and non banks that made up 40% of our financial services competition in mortgages.

In the US, securitisation is still being discredited by the ForeclosureGate scandal and their own version of a central electronic clearing house, the MERS, is under intense legal strain.

Do we really want to do go down this same path again?

This blog is, of course, a fan of more data for regulators, as well as greater mortgage portability to enhance competition. But continuing the practice of ad hoc innovations to the financial services regime that began with crisis measures during the GFC is eating your own tail. The overall system needs to be stabilised first.

A far better approach is to go back to first principles and ask: What kind of banking system do we want in ten years? We should be discussing such measures as dramatically increased reserving levels, breaking up too-big-to-fail banks, mitigating the wholesale funding addiction, restrictions on bank bonuses and other measures to restore a conservative banking culture, as well as how to raise new banks.


jonathon smythe said...

reading joye's paper, he did, in fact, argue for NECR to be used in a macro-prudential sense. you seem obsessed with this boy.

David Llewellyn-Smith said...

You're right, Jonathon, and have amended.

As for obsession, probably, yes. I do my best to keep it rational and my goal is accountability but it ain't easy...


Anonymous said...

And what the Banks can't do in Australia, they'll go to their subsidiaries in New Zealand, and do.(although our IRD did recently ask for hundreds of millions of dollars back from a collective, them!) The recent 'discovery' here of the Covered Bond market ( that isn't allowed in Australia, I'm told) smacks of The Big 4 securitising through the back NZ door.

homes4aussies said...

Good stuff, David.

I think you are spot on about the portability issue over to securitisation.

I can't help but feel that the taxpayer is being set up big time here. I think we are starting to to see the outline of the strategy that has been developed between the big vested interests (the banks, those with a lot of skin in the game like our Joyous one, and the Government).

The formula goes something like this -

increase RBA rates + Ralph's 20 = public outrage

- exit fees = hoards of people (especially the over indebted) looking to flee the banks, but to where?

+ portability + "competition" (in the form of the taxpayer bankrolling the entire RMBS market) = risk moved almost entirely to the public purse

And poor old taxpayer is none the wiser....

Scarey... time to consider migrating.... nah, I've spent a bit of time out of the country and I reckon this place has the potential to be the best place in the world to live if we could just get some real leaders.... so I'm gunna stay and fight.... just waiting to see what Swan/Gillard come up with this week and will see if I can mobilise some protesters.... no joke....

I went to the 2020 summit (in Rudd's own electorate, actually) and the public feeling on display with regards the housing affordability crisis was incredible.... from a wide range of groups.... from obviously the social services dealing with people/families on the brink of homelessness, to disability services, to migrant services - they all were struggling with the impacts of the bubble.... I'm sure there will be more.... general concerned citizens... and then add students concerned about the future of the country and about their ability to buy a home.... I expect that it should be possible to mobilise a large number of people.....

Pallbearer said...

Just to update Mr Joye's data, according to the RBA as of Sept 2010, housing debt is now 1.15 trillion dollars.

Total house value harder to determine, but if we take out houses without a mortgage, say close to 40% or around 1.5 trillion in value.

That debt is borrowed against about 2 trillion dollars worth of housing.

Not quite as impressive sounding as his claim of 1 trillion debt out of a 3.5 trillion housing market.

Anonymous said...

PallBearer, if you look at ABS 5204.041 and 5204.061. Dwelling and residential land values combined are valued at $4.25T. Joye Boy is actually too conservative in his estimate.

Leith van Onselen said...

Guys. RBA Statistical Table B20 has total residential housing value, whereas total housing debt is found in table D2. Go here for the stats:

As at June 2010, the total value of housing assets was $4066 billion. Whereas the total value of housing debt was $1126.3 billion (27.7% of assets).

Pallbearer said...

Thanks for those Leith. I like how dwelling values increased from 3.3 billion in March 09 up to 4 billion in March 2010. Lucky we are not in a housing bubble. :D

This from notes on B20

"The dwelling stock is estimated by combining Census data and the number of new dwellings completed each quarter (sourced from the ABS) with an adjustment for estimated demolitions. The dwelling price series is constructed from a number of sources."

Any ideas as to the those data sources ? The ABS only publish established capital city prices. Then we have RP data and APM.

Hopefully not the dodgy CBA figures, where they compared median dwelling prices to average income.

Australia wide median for housing to average income was 4.3

They used an average income of $98000 per household.

Using that data gives us an approximate Australian median house price of $421000 and about 9.5 million dwellings.

Does anyone have any more accurate data?

Any data on LVR for mortgage holders only?