Even without Fan and Fred, American mortgage rules are unusually lax.Maybe only a friendly foreigner could say this. But America needs to realize that not everyone can own a home. The American Dream of home ownership for all is a fraud. Politicians who pimped this dream created an unsustainable mortgage industry whose collapse is only surprising because it didn't happen earlier. America's mortgage industry will not recover, nor deserve to recover, unless it is prepared to challenge this politically unpalatable reality.
Why listen to an Australian like me? For starters, as our central banker, Glenn Stevens, said a few weeks back, Australian banks are "light years away from what's happening in other banking systems around the world." Australia's four major banks sit amongst the 20 AA rated banks around the globe. And as the Sept. 23 International Monetary Fund Country Report on Australia concluded, Australia's banking sector "is sound with stable profit, high capitalization and few non-performing loans."
The reasons go directly to regulatory differences that should interest Americans. Take nonrecourse 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 America, where populist post-Depression laws in many states have mandated loans be nonrecourse, the opposite is true. Americans can take out a mortgage 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. 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 ugly economic effects of such laws, they are objectionable in a moral sense. America is meant to be the land of sturdy individuality and personal responsibility. Instead, nonrecourse lending laws mean that mortgages, as an asset class, are of dubious value.
This is made worse by the fact that traditionally many American mortgages were 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 around 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, which compensates the lender for the lost interest the loan would have brought in had it been carried to term.
Prepayment penalties are either prohibited or severely restricted in the U.S. Thus, an American lender who 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, borrowers will stand pat. So loans are terminated by borrowers when they are profitable for lenders and loans last longer when they are unprofitable for the banks. Who would want to be an American lender?
America has a long and undistinguished history of populist politicians stacking the cards against lenders and in favor of risky homeownership. Proving that good intentions are no guarantee of good policy, President 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. If socially laudable but economically reckless laws cause entirely predictable problems for lenders, don't be surprised if taxpayers have to bail them out.
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, America's system of government-directed lending on socially desirable, but commercially imprudent, lending stood exposed.
Now, Australians -- and others -- place a high value on homeownership too. But they are aghast at the dumb things America has tolerated in pursuit of that goal. Even more dumbfounding is that nobody in Washington seems to be talking about fixing it.
By: Janet Albrechtsen
Ms. Albrechtsen writes a weekly column for The Australian.
Wall Street Journal; October 8, 2008
