Monday, October 6, 2008

An International Perspective on the US Financial Crisis

In today's Wall Street Journal, columnist Janet Albrechtson of the Australian discusses the how bias towards "home ownership for all" helped to create a fast and loose environment with home loans in the US. She notes that Australia's banks are still sound, and that the relatively small country's 4 largest banks are among the only 20 AA rated banks around the world and that the International Monetary Fund's (IMF) latest report gives the Australian banking industry a clean bill of health.

First, US laws in many states give homes inordinate protection against debt collectors. Such loans are "non-recourse" meaning that the borrower can only be held liable up to the home's value. If the home proves to be worth less than the loan, there's little the lender can do to make up the difference. If that's the case, it certainly gives people a strong incentive to borrow more than is prudent, knowing that they can, at worst, only lose a home they couldn't afford anyway. Why not take a risk?

Next, mortgages in Australia tend to be fixed only for a short term, which protects banks from a situation where it makes a lot of long term fixed loans, but needs to finance them with shorter term loans more subject to variable interest rate markets. Banks won't find themselves having low interest streams of income from 30 year fixed mortgages while needing to pay high interest rates themselves. Further, US laws in many states prohibit lenders from charging home owners from pre-paying their mortgages. Banks are in a heads I win (interest rates go up and home owners keep their fixed rates), tails you lose (interest rates go down so home owners refinance) situation.

Finally, if bundling home loans and turning them into securities, getting them off the books of banks was such a prudent way of doing business, why did the government need to set up the operation by creating Fannie and Freddie? Apparently, this wasn't such a hot idea in the view of the private sector.

Frankly, I don't know whether her assessment is accurate, but it is very interesting, and its worth exploring whether the roles of these state laws in the US that protect home debt and fix mortgage terms have played a role in this mess. As I have stated below, I think there's a lot of causes to be examined, which is why we need a commission to thoroughly investigate before we regulate / re-regulate or deregulate further.

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