AOFMac

The parallel universe that is Australian banks and houses took a new turn yesterday when Glen Stevens warned of the consequences of US-style intervention to support housing markets. According to the SMH:

In the first hearing of a Senate inquiry into banking competition yesterday, the Reserve's governor, Glenn Stevens, maintained that competition was more fierce today than 15 years ago.

Consumers now had greater choice and banks were under greater competitive pressure, he said, although higher funding costs had made life difficult for small lenders.

However, as the government strives to support a ''fifth pillar'' to compete against the big banks, Mr Stevens said it needed to be wary of any unintended consequences of helping smaller lenders, citing examples from the US subprime crisis.

"A number of proposals that one sees extend guarantees to this or that, or you know, help this market or that in some way,'' Mr Stevens said in Sydney. ''Those really amount to taxpayers taking some more risk.''

This could be worthwhile, he said, but such moves needed to be treated with ''great care''.

For example, he said providing a government guarantee to mortgage bonds - an idea favoured by non-bank lenders and supported in part by the opposition - should be treated with ''great care''.

''When you think about extensive public intervention in housing markets, we don't need to look any further than the United States to see that that can go wrong if we're not very careful with the way incentives are designed.''

Mr Stevens said his warning did not apply to the government's plan to spend an extra $4 billion on mortgage-backed securities, but was reluctant to comment on other aspects of its banking reforms.

Presumably the good Gov is pointing to the US Government Sponsored Enterprises (GSEs), Fannie Mae and Freddie Mac, whose creation of and support for securitisation led ultimately (over many years) to the proliferation of dodgy lenders and the subprime crisis.

This blogger could not be more grateful for the Governor's negative view on the idea of guaranteeing RMBS. As this blogger argued when the idea was first mooted, it is the mother of all bad ideas.

However, one wonders why the Gov makes a distinction between the tossed idea of guarantees and AOFM direct purchases, which are now ongoing with no end in sight, when the AFOM activity looks much more like the GSE's than guaranteeing RMBS would have done.

GSEs didn't guarantee anything, they bought MBS.

No doubt, the Gov would respond that the AOFM is not government sponsored, it is government. And that the AOFM program is clearly designed to keep secutirisation alive only until it can once again fend for itself. It is a transparent and temporary intervention, not an opaque structural distortion like the GSEs.

But is that the case? It's anybody's guess when AOFM purchases will cease. If we set them against the backdrop of government bank reforms that have by-and-large reinforced the status quo of the dominant four, the AOFM purchases are one of the few policies the government can point to to defend its record of supporting competition with the banks. The purchases therefore have a strong political underpinning to continue.

If this blogger can figure this out, so too can the market. And given the new range of other very solid fixed interest products like covered bonds, why bother buying RMBS unless the AOFM does? Not unless we get some new race for yield are RMBS likely to bounce back. And that is only likely to happen at the feverish end of this current cycle, meaning the AOFM could bow out for a month or two only to plough back in as the cycle busts.

Bullet securities don't seem to change this dynamic.

One wonders if we don't have the germ of a GSE-like entity developing right under our noses.