Friday, October 1, 2010


There are a couple of breathless reports today, one from Eric Johnston and another from David Uren, on yesterday's announcement that the RBA now has financial stability as an official part of its mandate.

Both are at pains to report that not only has the remit been expanded it's been limited too. Uren quotes from the RBA release:
The Reserve Bank's mandate to uphold financial stability does not equate to a guarantee of solvency for financial institutions, and the bank does not see its balance sheet as being available to support insolvent institutions.

Whilst it is encouraging that our financial overlords still bother with the quaint notion of moral hazard, we should take a quick look back at whether or not such clear distinctions are actually applicable to the RBA's role.

In order to facilitate such a glimpse, this blog has gone to the God awful trouble of aggregating and graphing in monthly increments the history of RBA repo transactions since 2004, before which there were none (at least, no record of such). Repos are short-term cash loans from the RBA to banks secured against collateral. In other words, they provide liquidity.

It is pretty clear in the graph that what transpired for eighteen months between late 2007 and early 2009 cannot simply be described as a liquidity crisis. If banks require the kind of support apparent in the graph - with many months above and around $20 billion and, in the heat of the crisis, approaching $50 billion - then the notion that the RBA will never support insolvent institutions looks rather silly.

Indeed, it is only the arrival of the government guarantee in December 2008 (not a bailout, either!) that turns the gushing RBA tap off.

Now, there are a couple of problems with this blogger's argument. If you examine the graph closely, you will see that in late 2007, right around the time the French declared the US asset-backed market a circus, the RBA suddenly begins accepting some new forms of collateral for repo loans: asset-backed securities (ABS) and residential mortgage-backed securities (RMBS). Prior to this time, such assets were not considered of sufficient quality for the RBA to accept them as collateral. Then, having suddenly been allowed, they mysteriously disappear - poof!

No, the assets did not enter a wormhole. Rather, the RBA changed the rules by which it categorises repo collateral so that from late 2008 all are recorded equally as "private securities". So, having torn up its rule book, the RBA replaced it with a shiny new one, with no pages in it.

The problem, then, for this blogger's argument, is that we have no idea who, why or what is being provided liquidity.

Add to this that we don't know the who, why or what for banks that used the government guarantee and we have very little to go on.

Except, of course, the deep sense of suspicion that this Invisopower! leaves behind.

P.S. Since I stayed up very late putting together the damn data for the graph, the least you can do is forward the link to absolutely everyone you know!


homes4aussies said...

Nice work, David. I was directed here by delusional econonomics so nice to see Simon took your advice so thoroughly and promptly.

Just wondering if you've had a chance to read the latest RBA Financial Stability Review? (Of course not he says, did you not read that I was busy frying other fish ;-)

Again the document is being interpreted by the media as things being rosy - but some graphs tell some interesting stories, and there are some interesting comments.

In Graph 31 there is a strong uptick in "past due" mortgages in the banks' loan books, and note the banks are not calling them impaired essentially because of the bubble, in RBA speak "implying that they continue to be well collateralised – an unsurprising result given house price gains in recent years".

Then in Graph 70 - of Loan to Valuation Ratio (for bank mortgages) - it is hardly "historical" including data for just the last 3 years. Importantly, it shows that at the peak of the boost-induced mania over 25% of ALL owner occupier borrowers (undoubtedly almost all FHBs) had a deposit of less than 10%, and a further 16/17% had deposits of 10 to 20% - so at least 42% of ALL owner occupiers were borrowing at LVRs of greater than 80% (and actually the situation still remains high with proportion around 33%, though more now in the lesser LVR of those two categories). A fairly high proportion of investors also have high LVRs, too. Moreover, a lot of owner occupiers are in interest only loans (though the footnote says this also includes mortgages with 100% offset accounts?).

Research by Fitch Ratings shows that in recent times such heavily leveraged borrowers are at least 4 times more likely to default - see

Graph 67 shows the trend of bank mortgage assets worsening while securitised mortgages are not (the scaling tends to downplay the degree of uptick in troubled bank mortgages as shown in graph 31).

But, importantly, Graph 43 shows just how little RMBS paper has been issued since 2007, confirming that the bulk of the lending during the boost-induced irrational exuberance remains on in the banks loan books on their balance sheets.

This is of relevance to the stress test which was announced yesterday by Fitch Ratings. While it will assess the stress on Australian RMBS, these are now more "seasoned", and it will not be a good indicator of likely stress on bank balance sheets and the growing divergence between securitised and non-securitised mortgages is clear.

Adjacent to Graph 70 - showing the proportion of high LVR mortgages over recent years - the RBA states "some lenders have begun to raise their maximum LVRs again, so any further improvement in the average quality of new loans could be fairly modest."

These graphs suggest in reality there was no improvement in any case. But perhaps the RBA is indicating it is not pleased about the potential for lendings standards to deteriorate from here - hence the jawboning and other activities straight out of the "Bloxham Manual for Leaning Against Bubbles" published last week.

Bear Feller said...

This is excellent.

Anonymous said...

David, I miss you at BS - instead they seem to have ramped up the BS, from the usual suspects....(not KGB, you know who they are).
Excellent work - keep it up.
The average bloke on the street has no idea how close our banks came to failing, and that that risk still remains - in fact, its now in 6th gear after gearing levels passed the $1 trillion level....