By Alex Dunnin
INTEREST rates are on the way back down. That’s the good news. The bad news is that the credit crunch has so decimated the bond market that most banks aren’t expected to lower their mortgage rates by anywhere near the benchmark level.
Some commentators are even tipping that banks might not lower rates at all and instead increase them even higher.
Banks are arguing they need to behave like this because they can’t drop their rates until the people they borrow from also drop their rates, meaning they are at the mercy of the US wholesale bond markets just like everyone else.
However, another reason might be that due to the credit crunch, banks are now more powerful than ever and without strong competition forcing them to lower their rates then why should they bother?
In any case, after the recent scalp of one their top CEOs a few weeks ago, they are under pressure to maintain their huge profits and recover their own sub-prime losses, factors which this month saw bank share prices plunge.
Banks are so powerful again because after years of non-bank lenders such as Aussie Home Loans, RAMS, Resi, Members Equity and others eating into their market share with lower-priced mortgages, the credit crunch has seen funding sources for these competitors dry up.
Greg Medcraft, chief executive of the Australian Securitisation Forum (ASF), said the mortgage market share of the five largest banks, after steadily falling from 65 per cent to 58 per cent between 2004 and 2007, has in just a few months reclaimed 10 per cent, returning them to their glory days.
Because the intense competition from non-bank lenders is what forced down the gap between the official Reserve Bank rate and mortgage rates paid by consumers from nearly five per cent to now be less than two per cent, fears are growing that if mortgage competition keeps reducing, all the effects of interest rate competition could quickly swing into reverse.
What’s stopping the non-bank lenders from competing and forcing them to shut their businesses is that hardly any big institutions are right now prepared to lend them the money for their mortgage bonds that they then lend out to us as mortgages, called Residential Mortgage Backed Securities (RMBS).
Even worse, they may not be able to sustain the mortgages they already have and to keep afloat they have no choice but to keep increasing interest rates regardless of what the Reserve Bank does.
Illustrating the problem, Medcraft said only $2 billion in RMBS bonds were bought in the first six months of this year compared to $47 billion during the same period last year.
“The RMBS market is dying on the vine,” he said.
If this keeps up, consumers may be left at the mercy of the big banks as the only remaining mortgage lenders, with dire consequences for borrowers, said Medcraft. Governments better forget about any of their housing affordability reforms because they just won’t happen.

Alex Dunnin is the director of research and editorial at the Rainmaker Group.