Monday, November 15, 2010

March of the rent-seekers

Yesterday on the ABC's Inside Business, Alan Kohler interviewed David Gruen, CEO of Lateral Economics and Peach Financial.

Kohler introduced Gruen as " independent economist who's currently studying the issue and also has skin in the game, running a small mortgage broking business" which, this blogger supposes, scrapes home as disclosure. Peach is a mortgage broker and would obviously benefit if the government guarantees RMBS issuers. Precisely what Gruen argued they should do.
ALAN KOHLER: Ok, so if the answer is not removing exit fees, entirely - that may be part of the answer - what is the answer? What needs to occur for there to be proper competition in Australian banking?

DR NICHOLAS GRUEN: I think we're sort of 75 per cent of the way there before the GFC, realising that securitisation - this alternative source of funding - can be a powerful competitor with the banks.

What we did wrong... And I might say I was one of the people right at the time who were saying we were doing it wrong. We - almost all the things the Government did, it did right and the mistakes that it made are understandable in the rush that it was in.

But from, I think it was about June or so 2008, me and a number of other people were saying that the securitisation market is simply collapsing, and you're propping up the banks - help provide a support to securitisation which enables it to continue functioning and then over time try and make sure that these things are on a level playing field.

Like The Australian's coverage of the securitisers last week, this is a seriously Panglossian view of their history. The Australian securitisation market received plenty of support, no less that $16 billion to date.

Despite this gift from tax-payers, Mr Gruen thinks the government did it wrong. This blogger must ask, how exactly is that? Should the government rather have leapt into the market guaranteeing the same securitisers that had brought on the crisis? Protecting the core of the banking system and getting everything back onto transparent balance sheets was the right thing to do. Back to the interview:
ALAN KOHLER: Are you saying that since the Government guarantee, either implicit or explicit, can't be removed from the banks, then the securitisers or the securitised mortgages have to be guaranteed?

DR NICHOLAS GRUEN: Yes I am saying that, but obviously then you have to say "Well guaranteed by how much? And in what way?"

It's too simplistic to just say, "Oh, the Government's going to charge off and guarantee all mortgages".

But for instance in Canada, there is a government owned mortgage insurer and if a bank holds a mortgage on its balance sheet, that counts as equivalent to holding a government bond.

One way of looking at that is they've taken prudential regulation of home loans - they've set up prudential regulation of home loans before the loan ever appears on anyone's balance sheet.

ALAN KOHLER: Are we suggesting a national scheme of mortgage insurance, focused on the mortgages themselves rather than the institutions?

DR NICHOLAS GRUEN: Exactly. If you ask yourself the question "How do we get competition in mortgages?" You might solve those problems out by looking at the mortgages rather than the institutions.

Once you've done that, then it doesn't matter what institution ends up funding the mortgages.

Of course it doesn't matter any more, because nobody is on the hook for anything, except you dear reader. Mr Gruen is describing a level playing field of economic rent-seeking, with the two halves of Australia's dated Wallis architecture - banks and non-banks - fastened at parallel public teats. This blogger suggests taking a moment to ask: What happens when/if the Budget loses its AAA rating? What price are we paying in reduced services by making it impossible to run deficits? Where next will this take the credit bubble?

If we really want to use securitisation to boost competition, and this blogger is dead against it, then we at least have to ask who it is that we want to back to use it.

Do we want the same crop of non-bank cowboys that don't lend to business, or do we want to enable mid-tier banks so its use frees other funds to be directed at productive investment instead of more housing bubble waste? In this vein we can turn to The Australian and an interview with BOQ CEO, David Liddy:
BoQ's challenge is to re-establish the 15-20 per cent market premium it enjoyed before the financial crisis, when securitisation, accounting for almost one-third of its funding, was the great equaliser that enabled regional and non-bank lenders to compete with the majors.

But now, with securitisation closed off as a source of competitive funding, BoQ's premium has been transformed into a discount of the same magnitude.

In the brutal economics of the market, the bank's 9.6 per cent return on equity is inadequate, which is why Liddy has to clear a pathway to the 15 per cent benchmark enjoyed by the majors.

The BoQ chief has guided analysts to a 2011 cash profit in the range of $220-$250 million compared with last year's $197.1m, up 5 per cent.

While a 15 per cent ROE (return on equity) is achievable, it requires difficult structural changes in regulation and funding.

Liddy's two biggest concerns are the bank's elevated cost of funding and the drag on its net interest margin and the profit-sapping impact of the next wave of bank regulation.

On funding, the top priority for the BoQ boss is to get some traction in Canberra -- elusive so far, to say the least -- to slash the 150 basis-point fee for BBB-rated banks like BoQ for using the wholesale funding guarantee.

BoQ will continue to pay the fee until 2015 when its government-guaranteed debt expires.

But the bank would make substantial progress -- about 3.3 percentage points -- on the long march to a 15 per cent ROE, if it only paid 70 basis points like the AA-rated majors.

Stuck at BBB+, BoQ faces a $36m extra cost burden in 2011 compared with a big four lender in the same position.

Canberra's deaf ear to calls for a flat fee, regardless of a bank's rating, relates to the original purpose of the guarantee as a crisis measure to secure bank funding, not to tilt the competitive landscape.

If the desire for policy consistency persists, BoQ can still achieve a large part of those savings - an estimated $20m - if Standard & Poor's bumps the bank up to an A rating.

"I don't think we're far away from being an A-rated bank," Liddy says, noting CUA was recently upgraded to BBB+, yet BoQ has a larger balance sheet and distribution.

We might also ask if want more banks spouting 15% plus ROEs. This blogger for one, would rather see ten banks running at ROE's of 10%, yoked to tight reserving and liquidity requirements. The GFC proved that high speed banks competing with non-banks is an unsustainable bubble machine.

This is ridiculous. We now have a march of rent-seekers through Canberra, through our media, through this blogger's head, when we should be having an open and honest Son-of-Wallis Inquiry where everything is transparent and discussion focussed on what kind of banking system we want in light of the failings exposed by the GFC.

Labor is setting a new low in its appalling recent history of blundering public policy process.


Anonymous said...

Regarding Gruen's comments, didn't a recent post at The Unconventional Economist question the wisdom of going down the Canadian route re mortgages?

Anyway, I often think that Kohler's selection of 'experts' are a curious choice, at best.

Peter said...

Gruen's recommendation would be an absolute disaster. If the collapse of the financial system is viewed from the context of a Minskian analysis, which attributes the majority of the cause of the collapse to the breakdown of underwriting standards due to the rise of Originate and Distribute model of credit allocation.

It would create the worst of all moral hazard for the Australian nonbank finance industry to give loans to any non-credit worthy recipients without incurring any liability on their own balance sheet with the loans backed up by the Australian government and taxpayer.

Try again David.

Peter said...

Sorry meant to say Gruen should try again

Aaron said...

Nice article David.

It's amazing how the voices of self-interest rise above the din...

Anonymous said...

Spot on - they are demanding a 15% ROE for a Government insured business. Ridiculous.

The Lorax said...

Nick Gruen not David Gruen, and where's my hat tip?

Torchwood1979 said...

And just when you thought it couldn't get any worse!

If we're sensitive enough to an out-of-step 0.2% rate rise that the Government is thinking of this madness then we've taken on too much debt. Simple. Time to take a big dose of that disgusting medicine and get back on our feet. Because constantly popping even higher doses of pain killers will only end in an even worse illness.