My submission to… the Wallis Committee

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I recent­ly made a sub­mis­sion to the Sen­ate Eco­nom­ics Com­mit­tee on the RBA (Enhanced Inde­pen­dence) Bill, where I argued against the Bill–as did all four pub­lic sub­mis­sions.

After mak­ing that sub­mis­sion (which I’ll post here short­ly) I thought I’d check out my sub­mis­sion to the Wal­lis Committee–since I argued that the RBA and the reg­u­la­to­ry author­i­ties in gen­er­al, while they may appear to have suc­ceed­ed in con­trol­ling infla­tion, have presided over the biggest spec­u­la­tive bub­ble in world his­to­ry.

The secu­ri­ti­sa­tion of loans was a major part of this bub­ble, which of course, no-one could have fore­seen… or at least that’s the line from con­ven­tion­al econ­o­mists.

Below is what I sent to the Wal­lis Com­mit­tee on Decem­ber 7th 1996 on the top­ic of secu­ri­ti­sa­tion of loans (in a fol­low-up let­ter to my oral sub­mis­sion):

The secu­ri­ti­sa­tion of debt doc­u­ments such as res­i­den­tial mort­gages does not alter the key issue, which is the abil­i­ty of bor­row­ers to com­mit them­selves to debt on the basis of “euphor­ic” expec­ta­tions dur­ing an asset price boom. The abil­i­ty of such bor­row­ers to repay their debt is depen­dent upon the main­te­nance of the boom, and as the share mar­ket reac­tions to yes­ter­day’s com­ments by Alan Greenspan remind­ed us, such con­di­tions can­not be main­tained indef­i­nite­ly.

Should a sub­stan­tial pro­por­tion of eli­gi­ble assets (e.g., res­i­den­tial hous­es dur­ing a real estate boom like that of 87–89) be financed by secu­ri­tised instru­ments, the inabil­i­ty of bor­row­ers to pay their debts on a large scale will not, of course, direct­ly affect liq­uid­i­ty in the same fash­ion that a fail­ure of bank debtors does. Instead, the impact will be felt by those who pur­chased the secu­ri­ties, or by insur­ance firms who under­wrote the repay­ment.

Where this is a gov­ern­ment, the impact on liq­uid­i­ty will again be slight, since pub­lic debt will replace pri­vate.

Where this is a finan­cial insti­tu­tion, such as a bank, it will be in a very sim­i­lar sit­u­a­tion to the State Bank of Vic­to­ria (and many oth­ers) after the last real estate crash, with sim­i­lar con­se­quences.

Where this is an insur­ance com­pa­ny, it could be dri­ven into bank­rupt­cy, with an impact on liq­uid­i­ty via its share­hold­ers and its own cred­i­tors. How­ev­er this would not be as seri­ous as the sec­ond instance above.

Where the secu­ri­ties are trade­able, there would obvi­ous­ly be a col­lapse in the trade­able price, and, poten­tial­ly, the bank­rupt­ing of many of the investors–depending again on their own financ­ing arrange­ments.

Over­all I would agree that direct reg­u­la­tion of secu­ri­tis­ers is not war­rant­ed. What is need­ed instead is pru­den­tial overview of the extent to which banks, insur­ance firms and super­an­nu­a­tion insti­tu­tions invest in secu­ri­tis­ers and their prod­ucts. How­ev­er, I would object strong­ly to the pro­pos­al from Aussie Home Loans (p. 135, para­graph 5.94) that secu­ri­tis­ers should be able to call them­selves banks.

 Is it rude to say “I told you so”?

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About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.