Monday, November 8, 2010

The 'pay more for stability' meme



There's an argument catching on in media commentary that the Australian banks are right to be ramping interest rates, and the Australian population is wrong to complain about it, because it's the price we must pay for a stable banking system.

Champions of this argument have included a triptych of the smarter commentators, including Michael Stutchbury, Rob Burgess and Annabel Crabb. The argument is also becoming central to the bank defence campaign with Ralph Norris using it over the weekend and the Australian Bankers Association propagating it further in the Herald Sun today.

The argument is more sophisticated than much of the interest-rate related drivel and is a tempting one to draw. After all, it is has worked so far and allowed Australia to flourish as much of the Western world has stagnated. What's more, many Australians are responsible for the housing bubble and it is hypocritical to simply now blame the banks for raising the cost of servicing the beast. Same goes for politicians who allowed the consolidation to happen.

This blogger has five problems with this line of reasoning.

First, the argument ignores the real macro-economic risk that the country faces. The housing bubble came before the resources boom and, as has been argued by this blogger, was also bailed out by it. Without the extraordinary income growth that the nation's households have enjoyed since 2004, the housing bubble would long since have deflated instead of blowing off.

When the resources boom ends, either slowly or, God forbid, suddenly, there is a real chance that the banks will face a Waterloo with their external creditors that will very seriously challenge the Budget's capacity to bail them out with renewed guarantees. This scenario runs a serious risk of depression. It is effectively what Goldman Sachs warned about in its recent report on housing "overvaluation".

So far as this blogger is concerned, that is a ridiculous risk to run.

This perspective also has a decidedly moral dimension in-so-far-as instead of taking the one-off resources income, leveraging it up and blowing it on housing before bankrupting ourselves when the income disappears, we might have saved it for future generations who will no longer be able to rely upon it.

This blogger's second problem with the 'pay for stability' meme is that it ignores moral hazard. Sure, keeping the banks profitable is a good idea, but the banks will not stop. They have declared their intention to become growth stocks and, as NAB recently confessed, even credit growth of just 8% will involve an incredible doubling of their offshore borrowing by 2014. The risk is set to rocket and as Westpac recently stated, it is doing so on the assumption of an implicit government guarantee.

This blogger's third problem with the argument is that it poses a false choice. If we are brave enough to open up the debate with a wide ranging banking inquiry then all sorts of other possible policy solutions will present themselves. This blog has proposed some kind of Federal Bond Insurance Corporation to manage the risk of the banks external portfolios. But there are many other possibilities that address competition, external risk and credit availability.

The fourth problem with the 'pay for risk' meme is that it is policy by default. No conscious policy choices have been made about the kind of financial system we want and need. Instead, we just have the BIG LIE that the banks are good at their jobs and policy-makers mad scramble to cover it up with Invisopower!.

The fifth problem is that so long as we bail out rather than regulate banks as a special case, it is an open invitation to all other vested interests to pursue support whenever they hit trouble. Over time that will exacerbate an already endemic decline in Australian competitiveness.

This blogger doesn't know about you dear reader but that is QED for 'pay for stability' meme as far as it's concerned.

6 comments:

Pallbearer said...

http://www.rba.gov.au/publications/bulletin/2010/sep/4.html

Shows how foreign financial bonds have tripled since 2003 to nearly $400 billion dollars or around 1/3 of total housing debt.

Interesting that the housing price boom had already started before then, thanks to CGT changes in 1999 and FHBG introduction in 2001. Foreign lending by banks then surged from 2003 in response to increasing house prices.

The exponential growth in issuance of Foreign Financial Bonds shows no signs of slowing.

Anonymous said...

The fifth problem is that so long as we bail out rather than regulate banks as a special case, it is an open invitation to all other vested interests to pursue support whenever they hit trouble.

I have a problem with this argument. Why are banks so special?

They don't deserve to be bailed out, nor should have special regulation. The state is not a benign and omniscient entity that will care for the best interest of the people (as we can see currently). It couldn't do that even if it wanted to.

Let the the too-big-to-fail fail once or twice and they will learn the lesson - this includes bank executives, shareholders, bond holders and (yes - OMG) people with deposits. That's the only way to eliminate the moral hazard.

Everybody needs to be responsible for themselves.

(Yes, I also have savings)

David Llewellyn-Smith said...

Anon,

Either I've written unclearly or you've misinterpreted me. I agree with you. Banks must fail. I'm arguing that the regulatory regime must be special to ensure that is a possibility.

David

Anon2 said...

Pallbearer,
The RBA pub. does indeed show the $400 billion, but it doesn't seem to say that it is all in Res Mortgage, or even all in Banks.
It does say "whereas foreign investors hold more non‑financial corporates (which make up 80 per cent of their holdings). " which, to my untutored mind, seems to indicate non-Bank, non-ResMortg.
Against this, Westpac's numbers indicated only about 15% of assets were funded by overseas borrowing.
Care to clarify? The idea of our wonderful "4 pillars" crashing is a little un-nerving.
Thanks

David Llewellyn-Smith said...

Anon,

Australian ADI's owed over $400 billion in offshore bonds last quarter and another $100 billion or so in other instruments, according to the national financial accounts and RBA.

Most of that will be in the big four.

Securitised assets are additional.

David

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