Welcome Guest [Log In] [Register]


Reply
Moral Hazard - Laying the groundwork for an Australian subprime crisis - Christopher Joye; Governments should man up and force banks to take their own medicine
Topic Started: 7 Sep 2014, 11:04 AM (1,056 Views)
Admin
Member Avatar
Administrator

Quote:
 
Bank plan sets scene for next subprime crisis

Christopher Joye
05 Sep 2014

One of the dumbest policy solutions to emerge from the ashes of the global financial crisis is non-recourse “bail-in” bonds, which David Murray’s financial system inquiry is thinking about recommending.

This proposal, which has for self-interested reasons been embraced by banks everywhere, requires a bare-bones explanation to understand the strife it could cause down the track.

Imagine if all residential borrowers convinced the government to adopt the following brilliant way to avoid future housing crises. If it looks like you will not meet your monthly mortgage repayments – so you might default – the government has the ability to step in and make your debts disappear. (This is precisely what the banks are advocating.)

More specifically, the government has the unilateral right to swap your lender’s once safe loan into highly risky and perpetual equity in your home. All your repayment obligations conveniently vanish. It is, therefore, impossible for you to default and lenders can never take possession of your property and effect a distressed sale at a fire-sale price.

Genius, right? If you fail to save enough, spend too much money or just take on excessive debt, the government can bail you out. Borrowers never default and asset prices always go up.

The plan is not marketed this way, of course. Working together, home owners and governments tell lenders that their loans are now “loss-absorbing” capital that – wait for it – actually avoid public bailouts. You see, taxpayer money is not being burned. Only lenders wear the pain. But who is deciding whether these borrowers are good or bad credits? Who unilaterally converts their debts into equity in a manner that no other industry can avail itself of? Who is subsidising shareholders? Certainly not the private sector or free markets.

Lenders might reasonably wonder why hundreds of years of commercial and legal history that dictates that debt ranks ahead of equity, and gives debt the power to require owners (equity) to meet their obligations, is being thrown out the window. In the rest of the commercial world, when you fail to repay your debts lenders have rights and recourse under our insolvency laws to the assets you offer as security – like a home, a company and/or your personal wealth.

But in its desire to never let a borrower fail, the government is giving itself the option of writing off their debts as if they never existed. Under this scheme, the worst-case scenario for the lender is that the debts are zeroed completely. The best case is they’re stuck with much riskier and more illiquid equity in the asset the borrower used as security at the worst imaginable time.

By letting borrowers continue to take on significant debts, but simultaneously offering to bail them out by eliminating these liabilities when they get into trouble, governments implicitly present them with incentives to make even riskier bets, which is called “moral hazard”.

The alternative is to let bad banks fail when they make mistakes, as happens with companies in all other industries. It seems, however, that governments want to do everything possible to make banks impervious to the disciplines of free-market capitalism.

The financial system inquiry is rumoured to be thinking about going a step further by allowing the government to bail in even the safest, “senior-ranking” bonds into equity if a bank needs support.

Yet if we are trying to de-risk banks, and reduce the chance they default on their debts, why not simply do what every borrower has done for the past 500 years? What’s wrong with just forcing banks to hold more equity and less leverage, thereby reducing their dependency on debt in the first place?

After all, this is what banks have asked individual and corporate borrowers to do since the GFC. These days most banks require home buyers to have minimum equity of 5 per cent to 10 per cent in contrast to the zero-down deposits available before 2008. We’re still buying properties – just the mix of debt and equity has changed.

The government already guarantees bank deposits and is prepared to step in and provide $300 billion of “emergency” loans to banks at an insanely low annual interest rate of 2.9 per cent via the Reserve Bank of Australia’s new Committed Liquidity Facility. This bailout program was expressly designed to ensure banks don’t trade insolvent in a liquidity crunch that would kill most normal businesses.

Given the banks’ explicit government backing, equity investors should be prepared to accept total returns that provide a still decent, say 4.5 per cent to 5.5 per cent, risk premium above long-term government bond yields (or 8 per cent to 9 per cent in total today). Instead, Commonwealth Bank’s return on equity is north of 18 per cent.

Contrary to popular rhetoric, cutting bank leverage would actually help them raise debt and equity capital more cheaply, and would certainly make it easier to access funding during crises.

What the community does not need is Treasurer Joe Hockey letting the banks off the deleveraging hook by establishing non-recourse loans that ironically embed higher moral hazards than the “jingle-mail” products that caused so much havoc in the United States. (The mail jingled with the keys to the equity that borrowers were giving lenders as a substitute for repaying them.)

Governments should man up and force banks to take their own medicine. During the GFC banks furiously resisted government interference with the loans they had given to borrowers. Since then they have required corporate and residential borrowers to protect them by stumping up with more equity and less leverage. That sounds like a sensible idea.

Read more: http://www.afr.com/f/free/blogs/christopher_joye/sowing_seeds_of_new_sub_prime_crisis_3fQbeBtAcOdain8H2FoBuK
Follow OzPropertyForum on Twitter | Like APF on Facebook | Circle APF on Google+
Profile "REPLY WITH QUOTE" Go to top
 
ThePauk
Member Avatar
Diamond Member
Dear God, if CJ keeps speaking the truth, no one will believe him.
Profile "REPLY WITH QUOTE" Go to top
 
miw
Member Avatar


ThePauk
7 Sep 2014, 12:47 PM
Dear God, if CJ keeps speaking the truth, no one will believe him.
Yeah. I wonder why the oz govt isn't taking the US regulatory approach to "too big to fail" which is to make it possible to fail anyone without unduly damaging the economy. They basically now have a chainsaw idling constantly, designed to chop a bank that becomes insolvent into little pieces in a matter of hours and distribute the pieces. "you fuck up, you won't have a job next week, let alone bonuses."
The truth will set you free. But first, it will piss you off.
--Gloria Steinem
AREPS™
Profile "REPLY WITH QUOTE" Go to top
 
Foxy
Member Avatar
Zero is coming...

there is probably no other option.
does anyone want to see empty homes and Australians on the street, i know i do not.
Peter
http://www.afr.com/content/dam/images/g/n/2/1/u/8/image.imgtype.afrArticleInline.620x0.png/1456285515560.png
Profile "REPLY WITH QUOTE" Go to top
 
1 user reading this topic (1 Guest and 0 Anonymous)
« Previous Topic · Australian Property Forum · Next Topic »
Reply



Australian Property Forum is an economics and finance forum dedicated to discussion of Australian and global real estate markets and macroeconomics, including house prices, housing affordability, and the likelihood of a property crash. Is there an Australian housing bubble? Will house prices crash, boom or stagnate? Is the Australian property market a pyramid scheme or Ponzi scheme? Can house prices really rise forever? These are the questions we address on Australian Property Forum, the premier real estate site for property bears, bulls, investors, and speculators. Members may also discuss matters related to finance, modern monetary theory (MMT), debt deflation, cryptocurrencies like Bitcoin Ethereum and Ripple, property investing, landlords, tenants, debt consolidation, reverse home equity loans, the housing shortage, negative gearing, capital gains tax, land tax and macro prudential regulation.

Forum Rules: The main forum may be used to discuss property, politics, economics and finance, precious metals, crypto currency, debt management, generational divides, climate change, sustainability, alternative energy, environmental topics, human rights or social justice issues, and other topics on a case by case basis. Topics unsuitable for the main forum may be discussed in the lounge. You agree you won't use this forum to post material that is illegal, private, defamatory, pornographic, excessively abusive or profane, threatening, or invasive of another forum member's privacy. Don't post NSFW content. Racist or ethnic slurs and homophobic comments aren't tolerated. Accusing forum members of serious crimes is not permitted. Accusations, attacks, abuse or threats, litigious or otherwise, directed against the forum or forum administrators aren't tolerated and will result in immediate suspension of your account for a number of days depending on the severity of the attack. No spamming or advertising in the main forum. Spamming includes repeating the same message over and over again within a short period of time. Don't post ALL CAPS thread titles. The Advertising and Promotion Subforum may be used to promote your Australian property related business or service. Active members of the forum who contribute regularly to main forum discussions may also include a link to their product or service in their signature block. Members are limited to one actively posting account each. A secondary account may be used solely for the purpose of maintaining a blog as long as that account no longer posts in threads. Any member who believes another member has violated these rules may report the offending post using the report button.

Australian Property Forum complies with ASIC Regulatory Guide 162 regarding Internet Discussion Sites. Australian Property Forum is not a provider of financial advice. Australian Property Forum does not in any way endorse the views and opinions of its members, nor does it vouch for for the accuracy or authenticity of their posts. It is not permitted for any Australian Property Forum member to post in the role of a licensed financial advisor or to post as the representative of a financial advisor. It is not permitted for Australian Property Forum members to ask for or offer specific buy, sell or hold recommendations on particular stocks, as a response to a request of this nature may be considered the provision of financial advice.

Views expressed on this forum are not representative of the forum owners. The forum owners are not liable or responsible for comments posted. Information posted does not constitute financial or legal advice. The forum owners accept no liability for information posted, nor for consequences of actions taken on the basis of that information. By visiting or using this forum, members and guests agree to be bound by the Zetaboards Terms of Use.

This site may contain copyright material (i.e. attributed snippets from online news reports), the use of which has not always been specifically authorized by the copyright owner. Such content is posted to advance understanding of environmental, political, human rights, economic, democratic, scientific, and social justice issues. This constitutes 'fair use' of such copyright material as provided for in section 107 of US Copyright Law. In accordance with Title 17 U.S.C. Section 107, the material on this site is distributed for research and educational purposes only. If you wish to use this material for purposes that go beyond 'fair use', you must obtain permission from the copyright owner. Such material is credited to the true owner or licensee. We will remove from the forum any such material upon the request of the owners of the copyright of said material, as we claim no credit for such material.

For more information go to Limitations on Exclusive Rights: Fair Use

Privacy Policy: Australian Property Forum uses third party advertising companies to serve ads when you visit our site. These third party advertising companies may collect and use information about your visits to Australian Property Forum as well as other web sites in order to provide advertisements about goods and services of interest to you. If you would like more information about this practice and to know your choices about not having this information used by these companies, click here: Google Advertising Privacy FAQ

Australian Property Forum is hosted by Zetaboards. Please refer also to the Zetaboards Privacy Policy