Better to kick banks while they are up

NOW that the banking Royal Commission is under way, it is a good time to reflect on the Australian financial system over the past decade and be grateful that we are kicking the banks while they are up, not down. Far better to have obscenely profitable banks than grotesquely bankrupt ones.

The popular mythology is that Australia was saved from the Great Recession of 2008 by Prime Minister Kevin Rudd and Treasurer Wayne Swan following Treasury advice to increase public spending and to get cash into people’s hands.

But that is only part of the story. Remember, the US Government did a similar thing, pushing $700 billion into the economy, but it did not save the US from recession. Similarly with Britain.

Rudd did the correct thing. It was a necessary thing to save us from recession, but of itself not sufficient. He was able to hand out the cash easily because the Howard Government had not totally squandered the proceeds of the mining boom on tax breaks for the well-off.

But more importantly, the real genesis of Australia dodging the recession was Paul Keating as Treasurer and Prime Minister bucking the US trend of permitting laissez-faire capitalism to capture the banking and financial system.

He made it clear he would not accept takeovers or mergers among the big four banks – the four pillars. He also insisted on liquidity measures to help ensure the banks would stay afloat in the case of high defaults or a run.

Importantly, the banks went along with it. And the regulators, the Reserve Bank and the Australian Prudential Regulatory Authority, while not perfect, at least kept their eyes on the ball and the banks under scrutiny to ensure they had sufficient liquidity.

In the US, on the other hand, Republicans and Democrats laid the groundwork for a financially deadly cocktail – the removal of regulation, as sought by Republicans, and the easing of credit vetting of the poor so they could get into the housing market, as sought by the Democrats.

This in turn led to the creation of a lot of sub-prime mortgages, no-doc loans and NINJA (No Income No Job) loans. The marketers got paid commissions on these so sold as many as possible and in 2005 started writing mortgages with enticing very low interest rates for the first two years before the real rate cut in.

These were on-sold to the banks and financial houses.

Then the newly freed banks entered the bond and derivative markets. They created new bonds by collecting bunches of sub-prime mortgages. The ratings agencies, Moodies and Standard & Poors, then thought that there would not be a lot of sub-prime defaults at once, nor would they default together across the country, so they rated the bonds Triple-A, as risk-free as US Treasury bonds, and charged fat fees for doing so.

The ratings agencies were the most culpable organisations in the whole sorry saga because the defaults did come, and they did at once and they came across the whole country as soon as the sweetener interest rates written in 2005 and 2006 ended in 2007 and 2008

The sub-prime bonds became worthless at once. The crash followed because financial institutions kept too many of these bonds on their balance sheets, thinking they would be profitable, with insufficient liquidity if they went bad. Lehman Brothers went under in September 2008. Others followed. Others were forced to merge or sell to bigger banks.

Pension funds, required to invest certain percentages in Triple-A only, were forced to sell at a loss as soon as the sub-prime bonds were rated lower, if they were lucky to get anything for them at all.

Similarly exposed British banks faced the same fate. But the Australian banks only had mild exposure to the sub-prime market, though they were affected by the subsequent stock market falls. However, the bonds lost up to 100 per cent of value; the stocks less than 20 per cent.

Sure, Australian financial institutions have gouged customers; given them dud advice; and profiteered on commissions. But they did not concoct the delusional, reckless, ignorant, dumb market manipulation on the wholesale scale that the US financial institutions did.

Also, the Australian banks were not bailed out with all their debts guaranteed by the Government, as in Ireland and England. The Australian Government just guaranteed deposits up to $250,000 per account holder. There was no bail-out to save the banks, just a guarantee to depositors to prevent a run on the banks.

The Irish Government foolishly guaranteed to repay the major Irish banks the money they had lent to speculators if the speculators defaulted, which they did, causing a massive blow-out in Irish public debt.

Nor did the Australian Government take over financial institutions or enterprises, as in Britain and the US. Contrary to popular belief there is no de-facto “too big to fail” policy in Australia. At most, it is a policy of “we will save ordinary voters’ deposits if a big bank fails”.

Nor did Australia suffer Iceland’s fate. Its banks lent vast amounts of money, much of it in foreign currencies, for people to buy assets (land, cars etc) at inflated prices. When land prices and the local currency fell, there were multiple defaults and the banks went bust.

Australian banks, on the other hand, did not make so many foolish loans way beyond what their balance sheets could bear.

True, Australian banks were not angels. They made some risky loans and they advised people to buy things which were not good investments.

Their fees are still way too high, reflecting their oligopoly. A good example is the usurious credit card interest rates charged customers who have mortgages which are written in a way that secure ALL money owed to the bank. Twenty per cent interest on what is in effect a secured loan is almost theft.

So during the Royal Commission (and by the way, can’t we call them Federal Commissions of Inquiry), let’s have a good look at bad bank behaviour and let’s look at the imprudent behaviour of superannuation funds which took the agency ratings unquestioningly.

But let’s be thankful for the wisdom of earlier governments not to remove crucial parts of the regulatory regime as other countries did; the prudence of the regulators and administrators in applying those regulations; and the acceptance of the major Australian banks that they could not join the international banking cowboys.

At least our federal commission of inquiry has more than just the entrails to pick over.
This article first appeared in The Canberra Times and other Fairfax Media on 17 February 2018.

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