Malfeasance evolves with booms and busts

by on April 27, 2018

THE banks will behave badly again. The only questions are how long it will take and what form will it take. In the 2011 film “Margin Call” an investment bank CEO played by Jeremy Irons rattles off the years of financial busts from the late 17th century to the 2008 crisis that he is dealing with in the film.

The bank had discovered (before anyone else) that its vast portfolio of triple-A-rated mortgage-based bonds were in effect worthless. So the bank knowingly dumped the lot on to an unsuspecting market which thought it was snapping up bargains by buying the worthless bonds at below market price.

Irons dismisses the ethical qualms of a more junior executive played by Kevin Spacey saying that the buyers paid the market price at the time. He dismisses Spacey’s warning that the panic sale would trash the bank’s reputation and no-one would buy anything from it again by saying, “Being the first out the door is not a panic”.

In Australia in the early 1990s we saw similar behaviour with the Westpac foreign-loans scandal, documented in Senator Paul McLean’s book “Bankers and Bastards”.

Westpac organised large foreign-currency loans for some of its customers at much lower interest rates than were prevailing in Australia. Alas, the value of those currencies rose and the value of Australian dollar fell, but the customers had to repay the loan in the foreign currency so they were much worse off than if they had taken a higher-interest-rate Australian-currency loan.

The bad advice was bad enough. The attempted cover up and the legal advice on how to do it was worse.

Westpac got an injunction in the NSW Supreme Court to stop The Sydney Morning Herald and others publishing what became to be known as the Westpac papers. So The Canberra Times published them in an ACT-only edition – beyond the reach of the NSW courts.

That made the NSW injunctions rather silly and they were lifted.

All booms and busts attract malfeasance of one kind or another. In 2008 it was the packaging of sub-prime mortgages into bonds and giving them triple-A ratings they did not deserve. In “Margin Call” it was selling bonds the bank knew to be worthless. In booms the malfeasance has been insider trading, such as the Poseidon bubble of the late 1960s.

These scandals usually result in inquiries, sometimes parliamentary, sometimes special commissions of inquiry or Royal Commissions. The rules are changed to make the malfeasance criminal, easier to uncover or attract higher penalities – only for a new form of malfeasance to emerge with the next boom or bust.

No doubt after this Royal Commission the rules will be changed to deal with conflicts of interest and commission gouging. But the finance industry will no doubt find new ways to extract money unethically in the next boom or bust.

You cannot legislate against greed and you cannot protect against fear.

Moreover, this Royal Commission has not (and may not) address the excessive profits of Australian banks. There is little real competition. The big four are as bad as each other, as the Royal Commission is revealing. Further, even if one stood out as slightly better value, it is far too difficult and costly to change banks.

Perhaps one of the main financial institutions unscathed by the Royal Commission, the Reserve Bank, could set up its own retail arm to keep the big four honest.

Unjustifiably high interest-rate charges contribute to the excessive profits. Typically, banks do not give enough credit for lower risk loans. It is absurd that a homeowner with, say, a mortgage of just 50 per cent of valuation gets charged the same interest rate as someone with a mortgage of 85 or 90 per cent of value.

In the former case, there is virtually no risk. In the latter case, the costs of foreclosure and default might result in a loss. So surely the former mortgage should attract a lower rate.

This used to be the case in the 1970s. Then, a first mortgage of 60 or 70 per cent of value attracted a lower rate than the second mortgage which ranked after the first mortgage was fully paid out in the case of foreclosure. These days the banks gouge the highest rate they can for the total owed, irrespective of very different risk.

They also get away with massive interest rates on credit card debt held in the name of customers over whose property the bank has security. Again, in those cases there is virtually no chance of default and loss, yet the banks gouge the same interest rate from them as they do from high-risk clients.

Whatever the result of the Royal Commission, expect these practices to continue and new forms of financial malfeasance long after it has concluded.

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This week the head of the Australian Energy Market Operator, Audrey Zibelman, noted something this column has been prattling on about for some time: the inequity of well-off home-owners being able to invest in solar panels to cut their power bills while renters and those in high-density housing miss out.

Her answer was a plea for home solar generators to stay on the grid because the more people leave the grid, the fewer there are to pay for its fixed costs and so the higher power bills will have to be.

But this is a Catch 22. The higher the power bills, the more people will want to get off the grid.

The answer is not to condemn renewable generation, but to acknowledge that households and businesses are going that way because it is the cheapest way to generate electricity.

That being the case, governments and industry must get their heads out of last century’s fossil mentality and encourage investment in battery storage; pay higher prices for feed in from home panels to encourage people to stay on the grid; and to address the rental and high-density problem.

To do the last, tenancy laws should be change to require landlords to supply a base amount of electricity to every household. They are required to have the power and water on and they are required to provide a habitable dwelling, so an electricity requirement is only a small step. It could be phased in with some balancing rent increases so no-one loses out.

The upshot would be more panels on apartment blocks and rented dwellings and probably more battery storage to take advantage of those higher feed in prices and a cheaper and more reliable electricity grid.
CRISPIN HULL
This article first appeared in The Canberra Times and other Fairfax Media on 28 April 2018.

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