Mac Attack II: Gans Responds

Joshua Gans has responded to my CIS paper, Government Intervention in Mortgage Finance: The Case Against ‘AussieMac.’

Gans suggests that the main difference between us is that I don’t ‘believe that markets work imperfectly.’ In fact, all markets are necessarily imperfect to some degree and I do not know of many economists who argue otherwise. The issue is whether government intervention can improve on market-based outcomes.

We probably do have different interpretations of the credit crisis, reflecting a somewhat different view of the functioning of markets. Market efficiency does not mean that markets never make mistakes. What matters is whether they are ultimately self-correcting. We may not particularly like the price signals generated by this process, but that does not mean that the price signals are wrong.

Gans suggests that ‘to spend time attacking Freddie and Fannie is not particularly useful for the Australian debate.’ Since AussieMac was explicitly modelled on Freddie and Fannie (hence the name), the US experience must be relevant, unless one can point to significant differences between AussieMac and the US GSEs.

Gans correctly singles out the implicit government guarantee as the main problem with Freddie and Fannie, but making the guarantee explicit, as the US has done now, does not entirely solve the problem. As Gans concedes, this still leaves taxpayers on the hook, which may create perverse incentives. Gans says ‘Kirchner appears here to be arguing that the government should come out and say that it will not bail-out any Australian bank or large non-bank should it get into financial difficulty.’ My view is that government should if anything guarantee certain classes of depositors rather than financial institutions. Policymakers should aim to keep private financial risk off the government’s balance sheet. Gans wants Australian taxpayers to take effective ownership of 5-10% of the market for residential mortgage-backed securities, but with no mechanism to ensure that the government’s funding advantage in capital markets would be passed on to consumers.

On housing affordability, Gans says that:

Kirchner also argues that our proposal will increase the demand for housing and therefore, not improve housing affordability. This is a common mis-conception. Put simply, the ONLY way our proposal will increase the demand for housing is by making the financing of that housing more affordable.

I should have been clearer on this point. Lower lending rates would only add to demand all else being equal. But as Gans correctly points out, all else is not equal. Lower rates would likely feed through to house prices, with adverse implications for both housing affordability and demand. Housing affordability is really a function of the supply and demand for houses rather than the supply and demand for housing finance.

Gans says of the US rescue plan for Freddie and Fannie that ‘the big losers will be shareholders in Fannie and Freddie, the very people Kirchner were arguing were the big winners in this game.’

It is quite likely that shareholders in Freddie and Fannie will be wiped-out, but only after decades of using public guarantees to secure private profits. The fact that shareholders may ultimately be wiped-out is of no comfort to anyone. Gans has not addressed the issue of the failure to pass through their funding advantage to consumers.

He has also not addressed the issue of whether the Reserve Bank would trade-off any reduction in retail lending rates against changes in the official cash rate. The calculator on the AussieMac web site, which purports to show the cost of not proceeding with AussieMac, actually works against the proposal. Could the RBA ignore an easing in credit conditions of the magnitude suggested by their calculator? I doubt it.

posted on 08 September 2008 by skirchner in Economics, Financial Markets

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Mac Attack

CIS has released my paper on Government Intervention in Mortgage Finance: The Case Against ‘AussieMac.’ Coincidentally, the US government is in the process of announcing a rescue plan for Freddie Mac and Fannie Mae, a timely reminder of the dangers associated with government-sponsored housing finance institutions.

Joshua Gans has actually been using the problems with Freddie and Fannie as an argument in favour of AussieMac. Following Robert Shiller, he suggests that:

the privatised Fannie and Freddie cannot do the job of ensuring liquidity in home mortgage markets and a new government owned and operated entity is required. Thus, despite all that has happened in the US this past year, it looks like they might need an AussieMac too.

The issue is not whether Freddie and Fannie should be privately or publicly-owned. Their implied government guarantee meant that Freddie and Fannie were always effectively part of the balance sheet of the US government.

The problem with the two US GSEs has been that their formerly implicit, and now explicit, government guarantee blurred the lines between private and public risk-taking. Their enormous profits earned at the expense of consumers may have accrued to private shareholders, but it was always understood by those who invested in Freddie and Fannie’s debt and equity that taxpayers were backstopping the two GSEs. This created incentives for excessive risk-taking, which is what ultimately brought them unstuck.

Joye and Gans have set up a web site devoted to debating their AussieMac proposal, where you can find their original and follow-up papers.

posted on 07 September 2008 by skirchner in Economics, Financial Markets

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Protectionism’s ‘Barren Truth’

I have a piece in the Business Spectator, which discusses the terms of trade argument for tariff protection in the context of the Bracks review of the car industry.

posted on 16 August 2008 by skirchner in Economics

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RBA Did Not Go Far or Fast Enough

I have an op-ed in today’s Age, arguing that:

TURNING points in the official interest rate cycle are usually accompanied by claims that monetary policy has gone too far. But if there is any criticism to be made of the Reserve Bank’s most recent tightening cycle, it is that it did not tighten far or fast enough.

The August Statement on Monetary Policy released yesterday contained this observation:

the increase in CPI inflation in Australia is not due only to energy and food prices. Measuring ‘core’ inflation in a broadly similar manner to that used in other industrial countries, inflation excluding food and energy and financial services has increased from around 2 per cent to 3 per cent over the past few years in Australia. This calculation indicates that inflation pressures here have been more broadly based over the past couple of years than in other countries. Indeed, inflation in Australia is now higher than the median of comparable countries in nearly all of the 11 major CPI categories.

posted on 12 August 2008 by skirchner in Economics, Financial Markets

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New Role

I have a taken up a new position as a Research Fellow with the Centre for Independent Studies. I will still be using the blog to highlight the work I’m doing at CIS, so stay tuned. The weekly newsletter has been discontinued. The Business Spectator column will also be discontinued in its current format.

Part of my role is to involve other economists in the work of the Centre. If you are interested in contributing to the CIS research program, I would encourage you to get in touch (skirchner-at-cis.org.au). CIS has several formats for publishing economic and other research, ranging from short journal articles to Occasional Papers and Policy Monographs.

The easiest way to stay across the work of CIS is to become a member, which entitles you to receive all CIS publications by mail, including my output. Donations over and above the annual membership rate are tax deductible. You will be helping to ensure that some of the ideas developed on this blog over the years are given increased prominence.

posted on 05 August 2008 by skirchner in Economics

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Business Spectator Column

This week’s Business Spectator column.

posted on 26 July 2008 by skirchner in Economics, Financial Markets

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Business Spectator Column

This week’s Business Spectator column.

posted on 19 July 2008 by skirchner in Economics, Financial Markets

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Business Spectator Column

This week’s Business Spectator column. If you would like to receive an unedited version by email on Fridays, let me know and I will put you on the distribution list. Email info at institutional-economics dot com.

posted on 12 July 2008 by skirchner in Economics, Financial Markets

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More of the Same for the RBA Board

The new Labor government’s changes to the appointments process for the RBA Board are seen by the RBA and Treasury as preserving the status quo:

Documents obtained by The Australian under Freedom of Information laws show Reserve Bank governor Glenn Stevens and Treasury secretary Ken Henry began discussing Labor’s promised register of nominees in early December last year.

Mr Stevens had some names to suggest early on, as did Dr Henry, but did not regard Labor’s pledge as a bid for radical change.

“I have already had a question on whether this process will result in more economists on the board, to which my answer was that as far as I knew, the idea wasn’t to change the nature of the board, simply to ensure that the best people could be approached,” Mr Stevens told Dr Henry on December 12.

In reply, Dr Henry agreed “the intention is not to change the composition of the board”.

As I predicted here, the new arrangements serve primarily to entrench bureaucratic influence over monetary policy.

In another triumph for transparency and accountability, the names on the register have been suppressed:

The names on the register were deleted in the documents released by Treasury, with the decision-maker ruling their publication would undermine the appointment process.

The documents concede the argument I make in the linked article above, that the composition of the RBA Board ‘was unusual by international standards,’ but maintain that the existing arrangements ensure that Board members ‘operate in, and are seen as representatives of the broader national interest, rather than representing a specific section of the Australian economy.’

Unfortunately, the RBA also argues that the only way in which external Board members can be expected to represent the national rather than their own sectional interests is if the contributions of individual members are suppressed from the minutes of Board meetings. In any other context, the idea that a conflict of interest can be resolved through increased secrecy would be considered absurd. The RBA’s defence of the existing Board arrangements shows they are incompatible with modern demands for central bank transparency and accountability. It says a lot about the RBA that most of our insights into the official rationale for the current governance arrangements come via Freedom of Information requests.

posted on 09 July 2008 by skirchner in Economics, Financial Markets

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Business Spectator Column

posted on 05 July 2008 by skirchner in Economics, Financial Markets

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Alan Wood Tributes

George Megalogenis and Stuart Rintoul round-up tributes to The Australian’s retiring economics editor, Alan Wood:

It is said around the pointy end of the media, and in the halls of the economic bureaucracy, that Wood called every recession correctly in his 45-year career. But Wood admits he can’t remember if that boast is strictly true.

posted on 03 July 2008 by skirchner in Economics

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The Ever Receding Doomsday Cult Trade

For those of you who have given up on a US recession in 2008, Intrade has rolled out a contract for a US recession in 2009. A 2008 recession is still priced at around a 30% chance, with the contracts for individual quarters still implying a better than even chance that growth will be positive for every quarter this year.

Intrade has also rolled out recession contracts for Japan, Germany, the UK, France, Italy and Ireland for 2008 and 2009. Like the contracts for the US, the bids and offers suggest little real conviction behind the idea of a global recession.

Intrade is also running contracts on who will be the next leader of Australia’s federal parliamentary Liberal Party.

posted on 02 July 2008 by skirchner in Economics, Financial Markets

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Alan Wood Retires

The Australian’s economics editor, Alan Wood, retires:

After more than 40 federal budgets and 50 state ones, I have decided enough is enough. The last straw was when Wayne Swan put a coloured cover on this year’s Budget Paper No1. What next, his photograph? So I am retiring, and this is my final column as The Australian’s economics editor. However, after a break I will be contributing a weekly opinion page piece. See you then.

posted on 02 July 2008 by skirchner in Economics

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