Low doc loans, residential mortgage securitisation and mortgage brokers

The US "sub-prime" lending crisis has focussed attention on the securitisation market and the liquidity it provides for Australian lenders, particularly non-ADI lenders, and "low doc" loans.

( The Economist has a good international overview in its articles "Risk and the New FInancial Order" and "Banks in trouble: the game is up".)

The Reserve Bank of Australia has analysed the structure of Australian residential mortgage backed securitisation here.

In his Opening Statement to the House of Representatives Standing Committee on Economics, Finance and Public Administration on 17 August 2007 Glenn Stevens Reserve Bank Governor said:

For some years now, many long‑term observers, market participants
and officials have been troubled by very narrow pricing for risk. In
other words, it has been easier and cheaper than had been normal in the
past for risky borrowers to access funding. Investors were prepared to
take more risk in pursuit of returns in a world of low global interest

Somewhere or other, returns were eventually bound
to disappoint someone. As it turned out, the problems emerged in the US
housing sector. Lenders into the so‑called ‘sub‑prime’ market attempted
to keep the pace of business up as the US housing sector slowed during
last year. But they could do this only by lowering lending standards.
Before long, arrears began to rise as some borrowers struggled to meet
their commitments.      

Once this deterioration in underlying
asset returns had occurred, those with exposures inevitably began to
see losses. Because this type of lending was via securitised structures
sold into global capital markets, losses have been coming to light
right around the world. In most cases, the losses are embarrassing
rather than fatal for the institution concerned. The exceptions have
been where particular funds invested mainly or solely in these types of
risky assets, and especially where leverage was involved. Several hedge
funds have borne large losses, including some in Australia.      

of this created a climate in July and early August in which investors
retreated and pricing of risk started to return to levels that could be
regarded as more reasonable based on historical experience. A number of
capital raisings that had sought to take advantage of the earlier very
generous terms were postponed. Volatility in some financial markets
increased, share prices declined somewhat and a general sense of
heightened uncertainty was evident.      

In considering the
implications of all this for our decision on monetary policy, there
were two questions to ask. The first was whether there was information
to suggest that financial developments were likely to make a sufficient
difference, over the relevant horizon for policy, to the global
economy, and therefore the Australian economy and the inflation
outlook, to remove the macroeconomic case for a 25 basis point
adjustment to cash rates. On balance, we judged that there was not.
Downside risks to the US economy do appear to have increased over
recent months, but in other parts of the world the growth outlook has,
if anything, been marked higher recently.      

The second
question was whether a rise of 25 basis points in Australian cash rates
would, in itself, be financially destabilising. No credible case could
be made for that idea. In fact, it would probably have been more
destabilising to expectations not to have carried out a policy
adjustment that most people could see was needed.      

Accordingly, as you know, monetary policy was  tightened last week, taking the cash rate to 6.5 per cent.      

towards the end of last week there was a period of stress in some major
country money markets. Because the exposures to the mortgage problems
in the US are still coming to light, financial institutions are
uncertain over the standing of other market participants. Objectively,
it is extremely unlikely that the sub‑prime mortgage exposures could
significantly damage the core banking system in any significant
country. The exposures are spread far too widely for that to occur. But
precisely because they are spread widely, and because the associated
financial structures are opaque, information on who is exposed and by
how much is incomplete. Hence people remain wary. At times of
uncertainty, market participants naturally get more cautious and want
to hang on to cash, rather than lending it in the interbank market."

In an interview on Meet the Press on 19 August, Treasurer
Peter Costello called for more progress on licensing of mortgage brokers, who are not prudentially regulated:

PETER COSTELLO: Well, of course, mortgage law is run by the States as is property law. The conveyancing, the transfer of land system, the way you register mortgages and all of those sorts of things. This is a matter for State law. The States themselves have been talking about getting more regulation into this area. The need to license mortgage brokers, to put on them disclosure obligations, the things that they must disclose to borrowers, the things they must take into account. We would want to get a uniform law throughout Australia. In 2006 a ministerial council of the States met to talk about getting a uniform law. It’s time that that’s brought forward. It’s time that the States enact a uniform law, and I am very concerned that some of these low-doc lenders may be pushing money on to people who they know are bad risks – and I want to see that ended.

PAUL BONGIORNO: Now, according to one report today, you’re saying if the States don’t act you will. How can you if they don’t?

PETER COSTELLO: Well, we would say to the States that if they want to refer powers to us, then we would be willing to step in and take their powers and to legislate in this area. I think it’s important that it be done. Let me make this very clear – the Australian Government has responsibility of prudential regulation of the financial system. We do that through APRA, the Australian Prudential Regulatory Authority, but outside of deposit-taking institutions and financial institutions are a whole lot of those originators who are just money lenders, basically, under State law. And if you are going to license and regulate them, then it’s going to have to be done under State law or otherwise the States should refer their powers to the Commonwealth.

PAUL BONGIORNO: In the last couple of days you have repeated your warning to the banks not to take advantage of the situation on global markets and up their interest rates. I’m just wondering, these warning are coming so regularly from you. Do you know something that maybe we don’t?

PETER COSTELLO: Paul, it’s a complicated issue, if I can just explain. I said earlier that the Commonwealth has prudential regulation on the banking system. The banking system is well capitalised and highly profitable. There is no need for any bank in the wake of what is happening in the United States to move its interest rate up. That’s the point I want to make. Outside of the banking system there are what are called mortgage originators. These are not banks. These are not prudentially regulated.

PAUL BONGIORNO: They have provided competition, haven’t they?

PETER COSTELLO: They have, and what they do is they go out and borrow money on the money market and they forward it to borrowers. Now, some of these mortgage originators are actually raising their money in the United States, in the United States where there has been all of this fallout. Now, in order to continue to raise that money in the United States they will have to pay a higher price. If they have to pay a higher price, that may affect their borrowers here in Australia and they may in fact get hit by a credit crunch. They may in fact not be able to borrow it. I am making this point – the fallout will come through some of these originators, but the fallout will not come through the banks and the banks are not entitled to use this as a reason to move their rates.

UPDATE: Treasurer’s Press Release

Print Friendly, PDF & Email

Your Compliance Support Plan

We understand you need a cost-effective way to keep up to date with regulatory changes. Talk to us about our fixed price plans.