I recently made a submission to the Senate Economics Committee on the RBA (Enhanced Independence) Bill, where I argued against the Bill–as did all four public submissions.
After making that submission (which I’ll post here shortly) I thought I’d check out my submission to the Wallis Committee–since I argued that the RBA and the regulatory authorities in general, while they may appear to have succeeded in controlling inflation, have presided over the biggest speculative bubble in world history.
The securitisation of loans was a major part of this bubble, which of course, no-one could have foreseen… or at least that’s the line from conventional economists.
Below is what I sent to the Wallis Committee on December 7th 1996 on the topic of securitisation of loans (in a follow-up letter to my oral submission):
The securitisation of debt documents such as residential mortgages does not alter the key issue, which is the ability of borrowers to commit themselves to debt on the basis of “euphoric” expectations during an asset price boom. The ability of such borrowers to repay their debt is dependent upon the maintenance of the boom, and as the share market reactions to yesterday’s comments by Alan Greenspan reminded us, such conditions cannot be maintained indefinitely.
Should a substantial proportion of eligible assets (e.g., residential houses during a real estate boom like that of 87–89) be financed by securitised instruments, the inability of borrowers to pay their debts on a large scale will not, of course, directly affect liquidity in the same fashion that a failure of bank debtors does. Instead, the impact will be felt by those who purchased the securities, or by insurance firms who underwrote the repayment.
Where this is a government, the impact on liquidity will again be slight, since public debt will replace private.
Where this is a financial institution, such as a bank, it will be in a very similar situation to the State Bank of Victoria (and many others) after the last real estate crash, with similar consequences.
Where this is an insurance company, it could be driven into bankruptcy, with an impact on liquidity via its shareholders and its own creditors. However this would not be as serious as the second instance above.
Where the securities are tradeable, there would obviously be a collapse in the tradeable price, and, potentially, the bankrupting of many of the investors–depending again on their own financing arrangements.
Overall I would agree that direct regulation of securitisers is not warranted. What is needed instead is prudential overview of the extent to which banks, insurance firms and superannuation institutions invest in securitisers and their products. However, I would object strongly to the proposal from Aussie Home Loans (p. 135, paragraph 5.94) that securitisers should be able to call themselves banks.
Is it rude to say “I told you so”?
