Socially progressive regulation caused much of the mess that has enveloped the US. In pursuit of the perceived social benefits of home ownership, the mortgage dice has been ridiculously loaded in favour of American borrowers. The American dream of home ownership for all is a fraud. Not everyone can own a home. But politicians pimped this dream, creating an unsustainable mortgage industry whose collapse is surprising only because it didn’t happen sooner.
The US mortgage industry will not recover, or deserve to recover, unless someone somewhere is prepared to challenge that politically unpalatable reality. Eager law-makers in Washington are as much to blame for the financial crisis as the unregulated suits on Wall Street.
Wrong regulation, rather than deregulation, is the problem.
Those genuinely interested in understanding the causes of the meltdown could start by comparing the US mortgage industry with Australia’s. The stark differences explain why our central banker, Glenn Stevens, said a few weeks back that Australian banks were “light years away from what’s happening in other banking systems around the world”.
And why Australia’s four leading banks sit among the 20 AA-rated banks across the globe. And why the most recent International Monetary Fund country report concluded that Australia’s banking sector was sound, with stable profits, high capitalisation and few non-performing loans.
Unlike the situation in Australia, the American dream was founded on a house of legislative cards that deserved to topple. Take non-recourse mortgage loans. When Australians borrow money to buy a house, they know that if they default and the mortgaged property doesn’t cover the debt, they will be responsible for the shortfall and the lender will chase them for it.
It’s a neat way of reminding Australians to borrow responsibly.
In the US, where populist post-Depression laws in many states have mandated loans be non-recourse, the opposite is true. Americans can take out a mortgage loan more or less as a one-way bet.
If you can’t afford the repayments and can’t refinance, you just send the keys back to the bank. The banks collect the jingle mail. Borrowers wipe their hands of liability. So, naturally, an American in financial strife will pay off debts that carry personal liability, such as credit cards, before they pay off their mortgage.
Quite apart from the ugly economic effects of such laws, they are objectionable in a moral sense.
What happened to the US being the land of sturdy individuality and personal responsibility?
This is made worse by the fact that traditionally many American mortgages are typically set at a fixed rate for the 25 or 30-year life of the loan, and the borrower often has the nifty ability to refinance without penalty.
Most Australian mortgages are usually subject to a variable rate of interest. Fixed-rate loans are limited to about five years. So when Australian lenders offer a fixed-rate loan for five years, they fund it by borrowing five-year money. If borrowers want to repay a fixed-rate loan early, sensible economics require that they pay the lender a break fee that compensates the lender for any penalty the lender incurs in breaking their back-to-back borrowing.
Prepayment penalties are prohibited or severely restricted in the US. Thus, an American lender that makes a 30-year fixed-rate loan that the borrower can prepay at any time without penalty is simply making a bet about the average life of a loan. And while it’s true that there are good quality statistics about how long American loans usually last, these are necessarily averages. Averages don’t reflect actual experience and are especially misleading when real outcomes are at the extreme.
If market interest rates fall below the fixed interest rates, borrowers will simply refinance at lower rates. Another fine deal for borrowers. If market rates rise above the fixed interest rates, the reverse applies. So loans are terminated by borrowers when they are profitable for lenders and loans last longer when they are unprofitable. Who would want to be an American lender?
The US has a long and undistinguished history of populist politicians stacking the cards against lenders and in favour of risky home ownership. Proving that good intentions are no guarantee of good policy, Jimmy Carter’s 1977 Community Reinvestment Act, which required banks to make loans to low-income people, was just another legislative leg-up for high-risk borrowers. Socially laudable but economically reckless laws led to entirely predictable problems for lenders. And it’s no surprise that taxpayers are left holding the bill.
The final proof that American social policies have made mortgage lending an unviable industry rests with Fannie Mae and Freddie Mac. If sensible business people don’t get into the mortgage industry because it is fundamentally a bad business, the American way has been to send in a couple of quasi-government agencies to fill the gap.
Fannie and Freddie dominated the mortgage industry because ultimately government was prepared to fund activities that prudent lenders would not. When their implicit government guarantee became explicit, the US system of government-directed lending, promoting socially desirable but commercially imprudent borrowing, stood exposed.
The US mortgage industry will not recover, or deserve to recover, unless someone somewhere is prepared to challenge that politically unpalatable reality. Eager law-makers in Washington are as much to blame for the financial crisis as the unregulated suits on Wall Street.
Wrong regulation, rather than deregulation, is the problem.
Those genuinely interested in understanding the causes of the meltdown could start by comparing the US mortgage industry with Australia’s. The stark differences explain why our central banker, Glenn Stevens, said a few weeks back that Australian banks were “light years away from what’s happening in other banking systems around the world”.
And why Australia’s four leading banks sit among the 20 AA-rated banks across the globe. And why the most recent International Monetary Fund country report concluded that Australia’s banking sector was sound, with stable profits, high capitalisation and few non-performing loans.
Unlike the situation in Australia, the American dream was founded on a house of legislative cards that deserved to topple. Take non-recourse mortgage loans. When Australians borrow money to buy a house, they know that if they default and the mortgaged property doesn’t cover the debt, they will be responsible for the shortfall and the lender will chase them for it.
It’s a neat way of reminding Australians to borrow responsibly.
In the US, where populist post-Depression laws in many states have mandated loans be non-recourse, the opposite is true. Americans can take out a mortgage loan more or less as a one-way bet.
If you can’t afford the repayments and can’t refinance, you just send the keys back to the bank. The banks collect the jingle mail. Borrowers wipe their hands of liability. So, naturally, an American in financial strife will pay off debts that carry personal liability, such as credit cards, before they pay off their mortgage.
Quite apart from the ugly economic effects of such laws, they are objectionable in a moral sense.
What happened to the US being the land of sturdy individuality and personal responsibility?
This is made worse by the fact that traditionally many American mortgages are typically set at a fixed rate for the 25 or 30-year life of the loan, and the borrower often has the nifty ability to refinance without penalty.
Most Australian mortgages are usually subject to a variable rate of interest. Fixed-rate loans are limited to about five years. So when Australian lenders offer a fixed-rate loan for five years, they fund it by borrowing five-year money. If borrowers want to repay a fixed-rate loan early, sensible economics require that they pay the lender a break fee that compensates the lender for any penalty the lender incurs in breaking their back-to-back borrowing.
Prepayment penalties are prohibited or severely restricted in the US. Thus, an American lender that makes a 30-year fixed-rate loan that the borrower can prepay at any time without penalty is simply making a bet about the average life of a loan. And while it’s true that there are good quality statistics about how long American loans usually last, these are necessarily averages. Averages don’t reflect actual experience and are especially misleading when real outcomes are at the extreme.
If market interest rates fall below the fixed interest rates, borrowers will simply refinance at lower rates. Another fine deal for borrowers. If market rates rise above the fixed interest rates, the reverse applies. So loans are terminated by borrowers when they are profitable for lenders and loans last longer when they are unprofitable. Who would want to be an American lender?
The US has a long and undistinguished history of populist politicians stacking the cards against lenders and in favour of risky home ownership. Proving that good intentions are no guarantee of good policy, Jimmy Carter’s 1977 Community Reinvestment Act, which required banks to make loans to low-income people, was just another legislative leg-up for high-risk borrowers. Socially laudable but economically reckless laws led to entirely predictable problems for lenders. And it’s no surprise that taxpayers are left holding the bill.
The final proof that American social policies have made mortgage lending an unviable industry rests with Fannie Mae and Freddie Mac. If sensible business people don’t get into the mortgage industry because it is fundamentally a bad business, the American way has been to send in a couple of quasi-government agencies to fill the gap.
Fannie and Freddie dominated the mortgage industry because ultimately government was prepared to fund activities that prudent lenders would not. When their implicit government guarantee became explicit, the US system of government-directed lending, promoting socially desirable but commercially imprudent borrowing, stood exposed.
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