Australian Mortgage Industry & the Global Financial Crisis - Case Study Example

Name : xxxxxxxxxxx Institution : xxxxxxxxxxx Course : xxxxxxxxxxx Title : Australian Mortgage Industry & the Global Financial Crisis Tutor : xxxxxxxxxxx @ 2009 Introduction The current global financial crisis has a great economic, social and political significance wherever it is felt. This is because it touches on virtually ever aspect of human life, especially consumption markets. Among the economic sectors that have been worst hit is the financial one, and by extension, the mortgage industry. The effects of the crisis on this industry have been almost similar globally (Stiglitz 2007). In Australia, the government has adopted relevant policy measures to deal with the challenges. This paper discusses the effects of the crisis on the Australian mortgage industry and the measures that the government has developed to deal with them. Origins of the Crisis The global financial crisis of 2008–2009 may be traced back to July 2007 and has its roots in the United States of America. There, investors lost their confidence in securitized mortgages. This led to a liquidity crisis that caused the Federal Reserve, European Central Bank and Bank of England to inject extra capital. The raised levels of credit risk in the world economy. The crisis in Australia mortgage is attributed to several factors that exist in the credit and housing markets. The issues have arisen slowly through time. The causes include an inability of homeowners to pay for their mortgages mainly due to adjustable mortgage resetting rates. There is also the issue of borrowers overextending their repayment time, predatory lending, overbuilding that occurred during the previous boom, development of high risk mortgage products and financial products which distributed and at times hid high personal and corporate debt levels. Others are financial products which spread out and probably hid risks of mortgage default, government regulation or lack of it, inappropriate monetary policy and imbalances in international trade (Spahr 2009). The issues were facilitated by the inflow of funds from banks and the private sector, in addition to the entry of banks into mortgage bond markets. The adoption of predatory lending practices on the part of mortgage brokers, especially adjustable rate mortgages were other issues arising. As from October 12 2008, the Australian Federal Government started implementing a broad range of measures that aimed at supporting the country’s financial system to deal with the crisis. The responses which were developed are generally similar to those in other governments across the world. The main one is to offer reassurance to Australian depositors that the deposits that they make are safe and in so doing raise the degree of investor confidence in the country’s financial system. The measures are also aimed at helping the country’s financial institutions to deal with the prevalent turbulence in global finance and to boost the attractiveness of the national financial institutions as borrowers in the highly dislocated financial markets of the international markets hence mitigate all possible impacts on the institutions’ lending activities and liquidity levels (Plunkett 2008). Effects of the Crisis With the global financial crisis, uncertainty within the Australian property markets has gone up. Refinancing of mortgages has lost its significance has become less important for mortgage brokers. There was for instance a sharp drop in mortgage business during 2008. Mortgage brokers are therefore become less optimistic. As a result, the large Australian banks have become the most dominant. The large banks lowered their levels of commission during mid-2008 (Pearson 2009). There existed a sharp drop in the average level of commissions offered. There is currently a challenge posed in the large number of lenders that are abandoning brokers. A large number of the brokers are not concerned with the consequences of federal government regulations. The 2008 budget was set against the background of a growing financial crisis. The government’s budget was therefore aimed at balancing the domestic inflation challenge that was posed with the requirement that the economy’s degree of productivity be attained while guarding against the chance of a faster decline in economic growth in the future (Lougheed 2008). Although Australian mortgage providers have generally experienced less impact of the liquidity crisis that has been the result of changes in international markets, there have still been considerable impacts on the ability of the firms to gain access to funds in both the local and international markets, in addition to their cost. This has in turn led to a flow-on effect to the entire economy as the lending conditions for mortgage companies and banks have tightened. Yet another visible effect of the financial crisis is the elimination of the possibility of Australia being a two-tier economy. Previously, there could be a boom in the western regions and Queensland while there was either a general slowdown or recession in Sydney and Melbourne. The two have for long experienced high rates of mortgage charges and general inflation. There was therefore the feeling that they were excluded from the boom that was being experienced elsewhere in Brisbane and Perth. With the crisis, there is at the moment an anticipated economic slow-down in Brisbane and Perth (Foster & Magdoff 2009). The Reserve Bank has opted to significantly lower interest rates. This has been anticipated and is indeed proving to be capable of lowering the mortgage rates in Melbourne and Sydney. The future effect of this will be the lowering of inflation rates as well. The main anticipated side effect of the global financial crisis in this respect is an eventual reunification of the country. As at the middle of 2010, it is expected that there is no longer going to be the two tier nature of the Australian economy. There is going to be a single country economically and an essentially identical business cycle across the country. As much as the shocks from the effects of the crisis will have a deep impact on the mortgage and finance industries therefore, one aspect that may be considered to be positive especially from the political perspective is the eventual economic reunification of Australia (United Nations 2004). Steps that are taken to Deal with the Crisis Enacted legislative measures by the Federal Government are generally oriented towards the provision of uncapped guarantees on deposits. There is to this effect, the charging of a fee upon deposits that exceed $1 million in Australian banks. The rule extends to building societies and credit unions for three years beginning 12 October 2008. This is a measure under a Financial Claims Scheme (FCS). In addition, the government sought to provide a guarantee for the general funding usually offered by nationally-incorporated banks and similarly authorized institutions that accept deposit taking institutions, as long as the borrowing institutions have applied for a guarantee and paid necessary fees. The measures also require the mandate for purchase by a government authority, the Australian Office of Financial Management’s (AOFM). There is also the requirement of an extra A$4 billion as Residential Mortgage-Backed Securities (RMBS). This provides a complete investment mandate to a RMBS purchase of A$8 billion (Kee & Khoury 2008). The Australian Reserve bank set up a number of relevant macroeconomic policies to deal with the challenge posed by the financial crisis. The first among these was the cutting back of interest rates by a figure of a hundred basis points. Although as at October 2008 the country’s big four banking groups were part of the ten mortgage providers rated as AA and above, the government took steps to ensure that there was the creation of stability for the national financial system, in addition to securing the credit flows into the economy. Due to the fact that other governments had provided a guarantee for borrowings by their banks, the Australian ones were left in a relative competitive disadvantage although they were actually in a better position than their international competitors. Apart from this, there came up indications of delicateness in the country’s smaller banks (Harrison et al. 2009). The financial stability strategies involved the state taking up the existing risk in order to reduce business and consumer concerns relating to the financial sector. The new business environment that emerged for the mortgage industry may be described as a volatile and high risk one in which there is the potential for unmanageable and irrational behaviour. The government therefore decided to calm the situation through the temporary taking over of risks that faced the private sector (Singh et al. 2007). Another component of the government's policy that was adopted was fiscal action. As soon as the measures for ensuring financial stability were adopted, the government also recommended and put in place $10.4 billion as a stimulus package, calculated as about one per cent of Australia’s Gross Domestic Product (GDP). This package was made up of $8.7 billion to be given to low income earning families and pensioners as cash bonuses, a further $1.5 billion as support for housing construction and a total of $187 million to pay for training. There have also been continuous discussions on possible changes in fiscal policy for a while before the announcement of the package. There was deep thinking into its structure. The eventual package was then allocated to the weaker segments of the economy that were identified as housing and consumption. The two areas represented more than 60% of the entire economy, thus it was considered necessary that the sectors be supported. The mortgage industry therefore found itself at the heart of government protection in the tough times (Shiller 2008). The policy support package also adopted the key elements of an effective fiscal policy because it was generally timely, well focused on the target and temporary in nature. The housing component of the package mainly took the form of a time bound grant that was intended for first home owners or buyers and took effect instantly. The measure was not really the first time when had been given to home buyers as a way of stimulating economic activity. There had been one in the past which brought forth house construction activity during an economic slowdown in the earlier years of the new millennium. In addition, the Government remained aware that there existed a large amount of suppressed demand for houses for occupation by owners upon the end of a period that had a relatively high rate of interest and migration strength. The government realized that if the policy was to be taken away at the right time and appropriately, there was the possibility of it stimulating activity without causing much collapse in transactions upon withdrawal (Laperche & Uzunidis 2008). Through the tough economic times that characterized the period between December 2008 and January 2009, there was the realization that the conditions in the global market had got even worse as compared to projections. From mid –January therefore, the government came to the realization that some additional fiscal policy was required if the financial and general economy was to be sustained. There was therefore the finalization of a package that was to supplement the earlier one. During the first week of February, the Government announced the implementation of a $42 billion worth stimulus package that was referred to as the ‘Nation Building and Jobs Plan.’ Here, there was still the identification of the need to continue supporting the housing and consumption sectors of the economy in order to attain a semblance of recovery (Merrett 2009). Conclusion Australia's attempt by the government to stabilize the economy explains the great role that is to be played by governments in cushioning their economies from challenges posed by global recession. This is especially the case in helping to understand the broad economic and social consequences which may arise from durations of sustained high rates of unemployment. The changes in the global economy have had considerable impacts upon consumer sentiments regarding mortgage settlements and availability of such mortgage funding.  The ability of Australian major institutions to provide adequate lending services, in addition to the different measures adopted by both the government and Reserve Bank of Australia to stimulate the economy have led to an ever-present possibility of the development of a resilient ground to the markets for housing in the near future, hence offering some element of hope for the mortgage industry. The industry is therefore hopeful of better times ahead in spite of the fact that the negative effects of the crisis may actually be said to have originated and been most visible in it. . Bibliography Carapiet, L., 2007, Mortgage Predators Still Lurking; Predators Have Taken Advantage of the Lack of Uniform Rules in the Mortgage Broking Sector for Too Long, Australian Banking & Finance, Vol. 16 Issue(17) p. 5(1). Foster, J & John Bellamy Foster (Author) › Visit Amazon's John Bellamy Foster Page Find all the books, read about the author, and more. See search results for this author Are you an author? Learn about Author Central Magdoff, F., 2009, The Great Financial Crisis: Causes and Consequences, Monthly Review Press, New York. Harrison, L., Bifferato, C & Hammer, M, 2009, The Impact of the Subprime Mortgage Crisis: Leading Lawyers on Understanding the Factors Responsible, Minimizing the Financial Impact for Clients, and Recognizing the Effects of the Recession on Law, Penguin Books, Sydney. Kee, T & Khoury, A, 2008, Breathing Life into the Mortgage Market: The Federal Government Has Taken a Step to Resuscitate Competition in the Australian non-bank Lending Sector, Australian Banking & Finance,Vol. 17 (16)p. 1(2) Laperche, B & Uzunidis, D, 2008, Powerful Finance and Innovation Trends in a High-Risk Economy Palgrave Macmillan, New York. Lougheed, A., 2008, Australia and the World Economy, Queensland, Penguin Books. Merrett, D., 2009, Business Institutions and Behaviour in Australia, Routlege, Melbourne. Pearson, G., 2009, Financial Services Law and Compliance in Australia. Cambridge University Press, New York. Robert J. Shiller (Author) › Visit Amazon's Robert J. Shiller Page Find all the books, read about the author, and more. See search results for this author Are you an author? Learn about Author Central Plunkett, J., 2008, Plunkett's Banking, Mortgages & Credit Industry Almanac 2009, Plunkett Research Ltd, Houston. Shiller, R., 2008, The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It, Princeton University Press, New Jersey. Singh, A, Felman, J, Brooks R, Callen, T & Thimann, C, 2007, Australia Benefiting from Economic Reform, International Monetary Fund Publication Services, New York. Spahr, R., 2009, The Root Cause of the Current Financial Crisis, Effects on Capital Markets and Long-term Solutions, Business Perspectives, Vol. 19 (4) p. 42(4). Stiglitz, J, 2007, Making Globalization Work. Greenwood Press, Westport. United Nations, 2004, World Economic and Social Survey 2004: Trends and Policies in the World Economy. United Nations, New York. Read More