Monday, December 13, 2010

A singular achievement

This blogger will not add to the ubiquitous negativity around Wayne Swan's bank reform package. The larger process around the reforms has achieved something important.

For the past two years, the Australian bank debate has floated on a cloud denial. Beyond the efforts of the "six economists" who called for a Son of Wallis Inquiry, the writing of yours truly in book and media, and the odd piece by odd commentators, there has been a widespread belief in Australian bank exceptionalism.

The failure of the media to address our systemic banking issues may be the result of the banks being large advertisers, but it afflicted the ABC as much as it did private outlets. It may be the media these days is addicted to the same 24 hour news cycle that drives our pollies, so it can't hold an idea in its collective head long enough to genuinely consider ideas of historic national interest. It may be that our media's singular narrative of 'the battler' versus 'the bludger' couldn't interpret events beyond we, the battling nation, being triumphant against a GFC that included epochal bludgers, such as Wall Street.

This blogger doesn't know. What it does know, however, is that the process we have just been through has broken the silence. Three months ago nobody beyond a few esoteric enthusiasts, such as your blogger, even acknowledged that the banks were bailed out on the liability side of their balance sheets during the GFC.

Now, no serious analyst denies it. Nor does any serious analyst deny that the deposit and wholesale funding guarantees that did the bailing continue to exist, one explicit the other implicit. Australia's big five are now known widely to be "too-big-to-fail".

This improvement in the national discourse has begun the education of the public for the battle to re-regulate banks that lies ahead.

Turning to the reform package itself, this is obvious in what it steadfastly refuses to address or attempts to negotiate around.

The elephant in the room is the connection our banks have with global capital markets. Whether it's banks and their reliance on wholesale funding, or non-banks, and their reliance on offshore investors to buy their securities, both channel international savings into Australian assets, most obviously the mortgages that support the Great Australian Housing Bubble.

Many commentators this morning berate the government for being too light-on in its reforms but this is the reason why. The foreign bond-holders of the banks may well be spooked if the government goes too-hard on stimulating competition. Who knows to what extent? As with many things in global capital markets, a large component of any investment is sentiment.

The reform measures that do and don't address wholesale funding are marred by the same consideration. According to the Treasury release, initiatives to promote covered bonds and retail corporate bonds are in part directed at reducing "our reliance on offshore wholesale funding". They do this by fashioning new markets that will be attractive to Australia's trillion plus superannuation funds. In short, the substantive measures in the package look designed to grow Australian banking beyond its current offshore debt addiction by shrinking the relative importance of foreign-held debt.

Will it work?

Covered bonds have worked for hundreds of years in Europe and they're pretty much a foolproof investment. A retail bond market might also draw in more local savings. The initiative to revitalise securitisation through attempting to "...accelerate development of [a] bullet RMBS market" might do so as well. Especially if that "acceleration" is the result of the Australian Office of Financial Management buying early-loss tranches, which is what it did for Bendigo Bank last week.

The problem, however, is that even if all three new markets are attractive, they will also be appealing to international superannuation savings. This blogger cannot see how any will reduce the relative importance of offshore funds. There is no Piguvian element (that is a tax that corrects a market distortion) to any of the initiatives to mitigate the offshore-debt imbalance.

The effort and the spin of the package tells us a couple of things. First, reducing the relative size of our offshore debt - as opposed to reducing the debt - is the same strategy the RBA is using on the economy generally, so it is at least consistent with the central banks' effort in a broad sense.

However, the failure to make any real reforms to push this along suggests the government is much more concerned with funding the bubble than it is helping the RBA.

Second, Canberra is well aware that we have a problem. It's just not ready to take it seriously.


Alan said...

Looking at the ASX release about the Bendigo and Adelaide Bank's RMBS offering confirms these derivatives are way too complex for mere mortals to comprehend.

David Llewellyn-Smith said...

From the link:

"The AOFM invested $395m in the Class A5 Notes and $20m in the Class AB Notes."

And the list of credit ratings for each tranche, with Class AB at fifth:

Class A1v $250m WAL 0.98yrs 1mth BBSW +65bps
Class A2 $150m WAL 1.99yrs 1mth BBSW +105bps
Class A3 $130m WAL 2.99yrs 1mth BBSW +115bps
Class A5 $395m WAL 4.58yrs 1mth BBSW +110bps
Class AB $45m WAL 4.72yrs 1mth BBSW +180bps
Class B 1 $20m WAL 3.52yrs 1mth BBSW +350bps
Class B 2 $10m WAL 7.13yrs Undisclosed

Financial Follies said...

Wow. There's not much credit enhancement in those lower AAA tranches. I was under the mistaken impression that AOFM was buying the supersenior AAA tranches only. Silly me.

David Llewellyn-Smith said...

Subordinated in duration too...

Financial Follies said...

The S&P ratings release cites "Our view that the credit support for each class of notes, which comprises both note subordination and mortgage insurance covering 100% of face value of all loans, accrued interest, and reasonable costs of enforcement, is sufficient to withstand the stresses we apply."

Who writes the mortgage insurance for this stuff? And I wonder what the LVR on this pool is...

Anonymous said...

Thanks for posting this as I just couldn't believe (actually I had expected it) this 'black duck' fix, so we just continue our way to the abyss led by the cartel or the inept.
"Covered Bonds, eh? If it wasn't so damned sad, it would be hilarious the ruling incompetence.

But, it looks like KRudd is attempting a reverse takeover over Gillard? LOL Great MSM entertainment these days!


Anonymous said...

"They do this by fashioning new markets that will be attractive to Australia's trillion plus superannuation funds."

Yes indeed. This is where it begins. Subsequent steps will include legislating an obligatory "investment" of X% of all super in "Govt-approved" "safe" bonds. "For your own good", you understand, perhaps justified by losses to Aussie superholders in a GFC 2.0 event, and the resultant sell-off of these govt-approved bonds by those "international super funds" who were originally "attracted", but cannot be compelled to invest in them. Unlike AU citizens.

The percentage of mandatory contribution will only creep up over time, with both the time and % dependent directly on how badly and how rapidly the economy (thus, govt finances) falter.

The final step will be a la several nations abroad right now. Confiscation of ALL yours and my superannuation by our beloved Govt. The blow of total confiscation perhaps softened by a weasel-worded promise of a govt pension approx. proportional to the total balance of your super so confiscated. A continuation of the welfare state now made possible by the great unwashed masses' selfless (unwilling) "investment" in support of the corporatocracy / "State".

Mark my words.