Australia Needs a Comprehensive Financial System Inquiry

Christopher Joye rang me recently and asked if I’d sign a statement supporting a comprehensive financial system inquiry. I agreed for reasons that are explained in the statement.  So did Joshua Gans, Stephen King, John Quiggin and Sam Wylie.

In short, as people with a bit of nous including those in government know, it’s scary how much dumb luck was involved in our not gettting as badly bruised by the financial crisis as some other countries.  Since the crisis struck, the Government has done most of the big things right. It’s stabilised the financial system with guarantees.  There were some hiccups as one would expect given the speed with which policy had to be made and the magnitude of the issues. And it’s been very vigorous in keeping the economy going with fiscal policy all against easy attack lines from the Opposition. (I’m fairly bipartisan about Oppositions by the way – any old scare campaign will do whether they believe it or not. The ALP didn’t believe the scare campaign it ran on the GST and the current Opposition, I like to think, doesn’t believe it’s own scare campaign on debt.)

In any event, I support the statement and think that we shouldn’t let our own luck condemn us to complacency.  There’s plenty of things that need attending to, and plenty of ways that we can get much better value out of our financial system.  The statement is over the fold.

Ever since the severe market failures in Australias securitisation industry were identified in 2008, we have been concerned that these problems were partly attributable to more fundamental flaws in Australias ageing regulatory architecture and the inadequately defined role of government in dealing with such crises.

The shortcomings within our governance system have been exacerbated by the relentless changes that have occurred in financial markets since the essential elements of our regulatory infrastructure were put in place decades ago. One example of this is the 1996 Wallis Inquirys rejection of the use of deposit guarantees, which have been critical tools for maintaining stability during the current crisis. Following the lessons that have been learned during the global financial crisis, and the 12 years that have elapsed since the last such exercise, we believe that a broad-based inquiry into the integrity of Australias financial system is now warranted.

While the $40-50 billion per annum residential mortgage-backed securities (RMBS) market supplied the funding for up to a quarter of all Australian home loans it did so with little-to-no government oversight or support. The growing depth and liquidity of this market enabled the emergence of significant alternatives to the major banks in the form of empowered regional banks and building societies, and smaller non-bank lenders. When this market disappeared due to an entirely external shockthe US sub-prime crisismany of these institutions were brought to the brink of collapse and forced to withdraw from lending altogether or merge with competitors. At least one smaller Australian bank would likely have failed had it not done so.

The biggest beneficiaries of this chaos have been the four major banks that receive the most favourable regulatory treatment under the existing system, which was not conceived with many of their smaller rivals, and the new markets that they rely on, in mind. Yet the forced reintermediation of the major banks into the residential lending arena has had other unintended effects, with the pressure placed on their balance-sheets in turn compelling them to ration credit to the higher risk small business, corporate, and commercial property sectors.

We are still in the midst of understanding the consequences of the global financial crisis and the actions of governments (including Australias) in response to it. Importantly, it remains uncertain to what degree Australias comparatively successful performance in navigating through this catastrophe has been due to our own regulatory foresight or just good luck. We would do well not to discount the possibility that a ‘good roll of the dice’ left us without more significant system failures such as those seen in the UK. In future crises, we may not be so lucky.

This cataclysm was imposed upon us by the increasingly interconnected and globalised nature of capital markets. These interdependencies also extend to government policy. The catalytic event that was US sub-prime borrowers defaulting on home loans that barely exist in Australia pushed the world into a deep recession and has subjected Australia to a marked slowdown accompanied by significant job losses. As a nation with a large foreign debt that has continually increased its liabilities via enormous current account deficits, Australias vulnerability to foreign shocks is in many respects greater than most of our peers.

It is, therefore, critical that policymakers take this opportunity to thoroughly review the existing system and evaluate whether changes need to be made to it. Although the dependence of financial institutions on national governments has been reinforced by the crisis, global capital market integration is not going away. We have little comprehension of the consequences of the raft of new policies that are being implemented by other nation states. What effect will the whole or partial nationalisation of banking systems around the world have on Australian institutions and, more specifically, our ability to source foreign credit? Will the UK Governments recent decision to guarantee securitised home loans along the lines of the Canadian model place Australian lenders at a competitive disadvantage in a global capital raising context? What are the long-term ramifications for Australia of the new regulatory regime being instituted by the Obama Administration?

These linkages cannot be ignored and should be examined under the auspices of a first-principles system review process similar to that undertaken by Campbell in 1981 and Wallis in 1996 with the benefit of new insights.

If there is any doubt as to why Australia needs to urgently revisit the foundations of its financial architecture, and evaluate what renovations might be required in light of the current crisis, consider that the following questions remain unanswered:

    • Will the Australian government seek to establish a regulated clearinghouse for the hundreds of billions of dollars worth of over-the-counter derivatives contracts that are otherwise beyond the remit of policymakers;
    • Should banks be subject to a systemic capital charge to account for the risks associated with the correlation between bank balance sheets given that current capital charges reflect the idiosyncratic risks to the institution itself, and may not be collectively large enough to compensate for system-wide catastrophes;
    • Will the deposit and/or wholesale funding guarantees be phased out and, if so, what new policy guidelines will explain how they might be redeployed when capital markets seize up again in a manner that minimises disruptions to other sectors (such as the knock-on effects seen in non-guaranteed areas like the commercial paper debt markets, the mortgage trust industry, and the CMBS and RMBS markets). If they are not phased out, how will the terms and price of these subsidies be determined and what regulatory constraints will be applied to prevent the emergence of moral hazard risks. More broadly, what parts of the credit markets will or will not be guaranteed in the future;
    • Should APRA impose automatic stablisers that require banks to accumulate capital in good times to serve as insurance against the bad;
    • Has this crisis reminded us that Australias major banks fulfill a unique community role akin to public-private utilities that warrant special controls to guard against system stability risks? Here it is odd that weve been repeatedly told that our banks were lucky not to have had substantial overseas exposures and yet they now appear to be rushing offshore to obtain exactly these;
    • What new regulations will govern executive compensation at banks and securities firms to mitigate the call-option like payoffs that have tainted these arrangements in the past and how might these be tied to prudential supervision (eg, higher risk-weightings for firms that have short-termist structures and/or claw-backs on remuneration for executive negligence and adventurism);
    • Can real competition emerge while consumers face significant costs in switching between financial institutions? Does a government-regulated securitisation market provide an opportunity to consolidate mortgage account standards and more effectively enable switching;
    • Where government guarantees are deemed necessary is it preferable for them to be offered against complex institutions like banks, or against tangible portfolios of assets the characteristics of which can be relatively easily assessed by independent experts;
    • Should citizens who feel unsure and unqualified to shop wisely in our financial markets be able to access basic savings, payments, and wealth management products that have been vouchsafed by governments as being safe and professionally managed (eg, why cant Australians invest with the Future Fund)? In this regard, is there a role for a publicly-owned entity, akin to KiwiBank in New Zealand, to offer essential services in Australias finance sector that leverage off unique government infrastructure (eg, Australia Post, the tax system, and the government bond market);
    • How will policymakers remedy the regulatory asymmetry between institutions like the larger banks that rely on short-term retail deposits as their primary source of funding (in combination with wholesale debt) and many of their competitors that depend on the longer-term and (ironically) matched funding furnished by the RMBS market? Whereas banks benefit from a range of government subsidies (implicit and explicit deposit guarantees, term funding guarantees, RBA liquidity support, etc), which glue together the enormous asset-liability mismatch created by funding 30 year loans with at-call deposits, Australias regulatory architecture does nothing to maintain the liquidity and integrity of its securitisation market. This contrasts with the Canadian system, which has remained open and functional throughout the crisis (and displayed lower default rates than Australia);
    • Should the RBA lean against incipient asset-price booms fuelled by increases in system-wide leverage;
    • Should Australias global foreign debt position be the subject of any general policy oversight and, if so, what measures should be pursued to ensure that these exposures are prudent;
    • What position should Australia take in relation to the restructuring of the global financial architecture? This will begin in earnest once it is clear that the worst of the crisis has passed. We need to be prepared for the negotiations that lead to new organisations, treaties and the global regulation of finance. For example, European states appear to favour a global super-regulatory body. The US has not embraced this approach. Where should Australia stand? And what will Australias views be on other key issues, such as the uniform global reform and regulation of rating agencies and hedge funds; and finally
    • What does Australia want to achieve from trade negotiations relating to the opening of foreign financial systems to overseas firms? Australia should be able to expand its supply of global financial services because of its location, political stability, resilient financial infrastructure, skilled workforce and competitive institutions. What steps will be taken to optimise Australias ability to both import and export financial services?

These are but a small subset of the many profound policy questions facing Australia and its financial system. Our relatively strong economic position offers an opportunity to review, investigate, consolidate and reform (if necessary). We need to take active steps to avoid the temptation of complacency and accept the lure of challenge. Only a full-scale independent commission on the financial systemroots and branchcan put us on a path to continued stability and insulation against the unpredictable. Following in the footsteps of Campbell in 1981 and Wallis in 1996, such a reviews time has now come.

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39 Responses to Australia Needs a Comprehensive Financial System Inquiry

  1. Patrick says:

    Hopefully they finish the Henry review first!

  2. Patrick says:

    I think also there is virtue in being engaged now in the global and regional initiatives being developed, but in waiting for them to take shape before concluding on the best path for us. Which suggests a convenient time-frame of after the next election for such an enquiry to deliver its results!

  3. derrida derider says:

    The banking oligopoly in Australia is costing us dearly over the long run in reduced innovation and customer ripoffs. They raise the cost of doing business and reduce incentives to save.

    But in the circumstances of last year it was just what we needed. Policy coordination (ie jawboning and monitoring) was exceptionally easy. And the rents those ripoffs have generated let the banks accumulate lots of lazy capital that they could draw on.

    So maybe be careful what you wish for …

  4. Fyodor says:

    By all means let us have another interminable inquiry. No doubt it’ll be as impartial and productive as Rudd’s other recent efforts.

    Some of the questions asked in the letter are reasonable, others are thinly veiled bank-bashing or special pleading. Did any of you blokes consider disclosing your personal interests in the securitisation vs. major banks “problem”, e.g. Peach Home Loans and Rismark?

    I have to say I laughed out loud at the tin ear and hubris required to write the following:

    Where government guarantees are deemed necessary is it preferable for them to be offered against complex institutions like banks, or against tangible portfolios of assets the characteristics of which can be relatively easily assessed by independent experts;

    What? You mean like asset-backed securities rated by credit agencies? The kind of paper that blew up on its owners last year? The kind that Peach and Rismark want to flog, but can’t because the government won’t subsidise them? Jaysus.

  5. Fyodor,

    Peach doesn’t flog asset backed securities.

  6. Fyodor says:

    Peach doesnt flog asset backed securities.

    Is that right? What do you call it when Peach brokers home loans funded by securitisation?

  7. I call it flogging mortgages (lending) not borrowing. Anyway F, I can write your next line. If you feel like writing it be my guest.

    If I were acting according to my pecuniary interests I’d keep my mouth shut. Your assignment, should you decide to accept it, is to work out why.

  8. Fyodor says:

    Anyway F, I can write your next line. If you feel like writing it be my guest.

    You’re too kind. OK, here goes…

    “Quibblesticks”.

    Your assignment, should you decide to accept it, is to work out why.

    Ooh, I love a challenge. Is it because you want to chair that inquiry too, and setting out your policy prescriptions before the review’s even started might make you look a tadge biased?

  9. Actually I’m busy F. So that’s not the reason. It hadn’t occurred to me.

  10. cjoye says:

    for the record, Rismark is not involved in securitisation in any way whatsoever. nor, F, does Rismark provide home loans or mortgages in the manner referred to in this letter. Rismark does fund a shared equity loan, but that has nothing to do with securitisation or the initiatives discussed in the letter. nor could Rismark benefit commercially in a direct manner from anything in the letter, at least in ways that are immediately obvious to me! thanks

  11. Fyodor says:

    for the record, Rismark is not involved in securitisation in any way whatsoever.

    Even though Rismark’s partners and shareholders, Bendigo & Adelaide Bank (the bank partner for your “shared equity” product) and Liberty Financial, most certainly are? I note also that Joshua Gans appears to be “not involved whatsoever” with Rismark.

    In fact, having a bit more of a dig of Rismark’s website reveals that the Mortgage & Finance Association of Australia went so far as to award Rismark the “MFAA Mortgage Manager of the Year” award in 2009 and “MFAA Non Bank Lender or Mortgage Manager of the Year” award in 2008. I liked the citation on the 2009 award:

    “the MFAA recognised Rismark’s “outstanding overall achievement” in managing a multi award-winning, revolutionary shared equity mortgage product that has no interest rate and assisting the broader industry during the global financial crisis by developing a policy that the Federal Government backed by investing $8 billion into the mortgage securitisation market.”

    With this letter I’m sure Rismark will be a podium chance for 2010.

    Is that what you mean by “whatsoever”, C?

  12. cjoye says:

    Fyodor, I don’t like having to repeat myself, but for the record:
    1) Rismark is not involved in securitisation in any way whatsoever;
    2) Rismark does not fund through RMBS;
    3) Rismark does not issue bonds or debt;
    4) Rismark has nothing to gain directly from anything I have proposed in relation to securitisation other than having a healthy housing market.

  13. Ingolf says:

    Well, that’s certainly managed to (at least temporarily) derail what might have been an interesting discussion.

    I’m not sure why you’re so fierce on all this, Fyodor, but I don’t see how Nicholas and Christopher being involved in their respective parts of the financial industry is a problem. After all, it’s hardly a secret, is it?

    Both have chosen to take an active and fairly high profile role in public life; anyone’s entitled to wonder why (no doubt they often do themselves) but I find the notion that their motivation is somehow deviously pecuniary laughable.

    That said, perhaps both (Nicholas in particular) might have been better to react a bit less defensively.

  14. Fyodor says:

    Thanks, Chris, that repetition clarified things tremendously.

    Im not sure why youre so fierce on all this, Fyodor, but I dont see how Nicholas and Christopher being involved in their respective parts of the financial industry is a problem. After all, its hardly a secret, is it?

    No, it’s not a secret, Ingolf, as I demonstrated, but you’ll note that amongst the slather of MSM coverage the letter received – we can guess why it was so widely covered – the signatories were identified as “economists” and their respective interests were not disclosed.

    Now, your hypothetical average person reading the paper may well conclude that these economists are relatively impartial observers of the financial sector, and in some cases (e.g Quiggin, Wylie and King) that’d be a fair assumption, IMO. In the case of the other three, given their associations with companies affected by the scope of the proposed inquiry and track record on the “Aussiemac” proposal, I’m not so sure. Still, it’s just an opinion – feel free to write it off as “laughable”.

  15. Ingolf says:

    Thanks, Fyodor. Just to be clear, I agree with your more general point about disclosure (as no doubt Nicolas and Christopher do as well).

    I only waded into this for two reasons. First, I felt your tone was kind of disdainful and effectively cast both of them as villains of a sort. It didn’t seem to easily allow for the possibility (near certainty in my view) that they were putting forward ideas they truly believe in, quite apart from any business interests, and that any failure to disclose was innocent.

    Which brings up the second thing. Perhaps I’m reading you wrongly, but in a more general sense you don’t seem to allow much room for the possibility of people engaging in public debate in good faith whilst also having some business involvement in the area under discussion. To my mind, this is too cynical (even though, Lord knows, recent events around the world have given us plenty of reasons for that to be the default position).

    I know this is the very thing disclosure is meant to take care of but I guess I’m trying to get at the question of one’s deeper stance, well before considering any specifics.

  16. melaleuca says:

    I suppose a general disclaimer is important in order to ward off sleazy attacks such as the one we are witnessing here. Sadly, mud sticks even if the chucker is a mendacious oddball.

    More importantly, an inquiry such as the one proposed above sounds like a good idea.

  17. Fyodor says:

    Perhaps Im reading you wrongly, but in a more general sense you dont seem to allow much room for the possibility of people engaging in public debate in good faith whilst also having some business involvement in the area under discussion. To my mind, this is too cynical (even though, Lord knows, recent events around the world have given us plenty of reasons for that to be the default position).

    I apologise if I gave that impression, as I have no issue with people advocating policies in which they declare a personal interest. As long as those interests are disclosed everyone knows where they stand and democracy can take its course. If a person identified as Chairman of XYZ Home Loans were to advocate subsidising the securitisation industry I’d have no issue with his participation in the ensuing debate. I might oppose the policy, but not his voice.

    I know this is the very thing disclosure is meant to take care of…

    Exactly.

  18. Ingolf says:

    Fair enough, Fyodor, although I’m still puzzled about why you felt the need to go in so hard, and apparently without provocation.

    One small side matter. When the letter talked about “tangible portfolios of assets the characteristics of which can be relatively easily assessed by independent experts”, I imagine the signatories had something far more plain vanilla in mind than the esoterica that blew up in the US and elsewhere. The “hubris and tin ear” bit may therefore have been somewhat over the top.

  19. cjoye says:

    yes ingolf. the simple point is that a standard AAA-rated RMBS portfolio that comprises of just, say, 10,000 home loans is a helluva lot easier to assess the risk of than a $10-20 billion AA-rated bank run an autocratic CEO.

  20. Ingolf says:

    Understood, Christopher, as I hope was plain from my comment (this may have been one of the times when I overdid the understatement).

  21. Tel_ says:

    The banking oligopoly in Australia is costing us dearly over the long run in reduced innovation and customer ripoffs. They raise the cost of doing business and reduce incentives to save.

    I’m yet to see evidence that “innovation” in the financial services world delivers a real world benefit. Mostly it is about making products that look great on paper but are too complex to evaluate for risk. Profits are made in the physical world, the financial world merely keeps track of that.

    As an example, suppose someone started espousing the amazing innovations they had come up with in timekeeping — every third day has extra hours, and daylight minutes are shorter than nighttime minutes. Then they claim the productivity to be gained from having more time available right where we need it most. But of course, that’s just nuts. The day is what it is, clocks merely count the time that passes, they don’t create time. The best possible timekeeping system is something completely consistent, easy to understand that never innovates!

    As for reduced incentives to save, the obvious one is inflation coupled with capital gains tax. If you hold cash, the value decreases, if you hold assets you are taxed on the nominal increase which is really just a constant valued asset floating on a sea of devaluing dollars. The only saving options for the average Australian are buying bigger and bigger homes, or watching their superannuation get juggled by investment managers who are expert at ticking boxes on forms but very average at investment decisions. I don’t see how any of the banks can be blamed for this situation.

    I remember a story about occupied Europe during WWII where two guys each had bicycles and one of the guys cut up the tyres on his bicycle and tied hosepipe to the wheels making a lumpy, bumpy ride but serviceable. The other guy laughed about it until the occupying forces decided that bicycles were needed for the war effort so they took the good one, and left behind the one with lumpy, bumpy wheels. That’s my picture of why Australians don’t bother saving or investing.

  22. JC says:

    Im yet to see evidence that innovation in the financial services world delivers a real world benefit.

    Really tel…

    Mortgage backed securities around for decades and helped people buy homes.

    Credit cards. Debit cards.

    Adjustable rate loans.

    Mutual funds

    Interest rate swaps and many other variations that have certainly helped finance smaller firms with stable long term debt.

    Option markets that allow corporations to hedge risk.

    Advance of private equity that allows good ideas to find financial partners to help grow the firm. We wouldn’t have a tech world without these firms.

    I could go on, however it would run out the site.

  23. Fyodor says:

    When the letter talked about tangible portfolios of assets the characteristics of which can be relatively easily assessed by independent experts, I imagine the signatories had something far more plain vanilla in mind than the esoterica that blew up in the US and elsewhere. The hubris and tin ear bit may therefore have been somewhat over the top.

    Too harsh? The near total collapse of investor support for Australian “plain vanilla” securitisation issues belies your and Chris’ assertions. You must know something about assessing credit risk that debt investors don’t.

  24. Ingolf says:

    Fyodor, from Chris’ comment he’s talking about exactly the same assets that populate the greater part of banks’ balance sheets. So far, I haven’t noticed anyone worrying too much about how to value these things (this may of course change if, as I think is quite likely, the downturn continues and steepens).

    If that’s correct, then the reason for the “near total collapse of investor support for Australian plain vanilla securitisation issues” is probably some combination of generic investor revulsion after all the recent unhappy experiences, continuing (albeit much reduced) financial markets turmoil and perhaps relative value considerations (i.e. there are juicier deals around).

    Someone more well versed than me in the mortgage and securitisation markets will hopefully step in with any necessary corrections or additions.

  25. cjoye says:

    That is correct, Ingolf, and a nice way of putting it. Interesting article in Crikey today on this issue…

  26. Ingolf says:

    Chris, would you mind posting a link? I had a quick look on Crikey and didn’t see any likely candidates.

  27. Fyodor says:

    Fyodor, from Chris comment hes talking about exactly the same assets that populate the greater part of banks balance sheets.

    No, he isn’t. He’s comparing a bond backed by the cashflows on a pool of assets with a bond backed by corporate credit. They’re not “exactly the same”; they’re different. As evidenced by the fact that investors are still buying corporate credit, and not ABS.

    If thats correct…

    It isn’t.

  28. Ingolf says:

    Fyodor, you’re slipping back and forth between two different things, I think:

    – In the letter, Chris and his fellow signatories were indeed comparing the merits of guaranteeing banks directly versus guaranteeing pools of tangible assets. FWIW, I’m agnostic on this question, not being particularly in favour of either (with the probable exception of guaranteeing retail deposits).

    – The point I initially raised with you was a narrower one . In your initial comment, you assumed the sorts of asset pools they had in mind were similar to the kind of exotics whose failure initially triggered the meltdown. I didn’t think it was; I figured they had something far simpler in mind, namely pools of plain vanilla high-quality mortgages, fairly homogenous and transparent.

    – Chris, in his comment (#18), confirmed that was exactly what they’d intended. You then wondered why, if that were so, there was little or no market for these securities.

    – I suggested that asset quality issues were unlikely to be the problem, since the exact same kind of assets comprise a big chunk of banks’ balance sheets (about a third in fact) and then put forward some possible explanations for why the RMBS market here is still pretty dead.

    Hopefully that’s removed any possibility of misunderstanding.

  29. cjoye says:

    How the media trash important stories when their rivals scoop them
    Canberra correspondent Bernard Keane writes:

    When does a media outlet judge an important story not to be an important story? When it appears as a scoop in a rival media outlet.

    Exhibit 1: the way Fairfax (who got the scoop) seriously treated this weeks call by six well-respected economists for a new inquiry into the financial system, while and News Limited (who didnt get the scoop) almost totally ignored or dissed the story.

    This isnt a partisan or ideological issue. The economists hail from across the political spectrum. The issues they raise go well beyond the simplistic Left-Right debates that have marked much of the commentary on the economic crisis. While John Quiggin and Nicholas Gruen are perceived to be from the Left, the likes of Christopher Joye and Sam Wylie are not exactly bomb-throwing socialists. All are widely-respected. And all, contra Terry McCrann (and more of him in a moment), are influential.

    Gruen is chair of the Government 2.0 Task Force; Stephen King was an ACCC commissioner. Quiggin is a world-class academic researcher. Wylie (who incidentally used to work for ASIO), is a former Dartmouth professor and a Senior Fellow of the Melbourne Business School. Gans and Joye were responsible for convincing the government to invest $8 billion in the securitisation market last year. Joye ran John Howards home ownership task force and has been a frequent op-ed contributor to The Australian. If theyre not influential, I dont know who is.

    And Ian Harper, a member of the Wallis committee and still a pin-up for the Right, lent strong support for the idea.

    But, perhaps because the economists gave Fairfax papers the drop rather than News Ltd, the letter was barely covered by the latter. Jennifer Hewett, while barely mentioning the letter, attacked the peoples bank idea, as did John Durie.

    The peoples bank proposal was one of fourteen issues raised by the economists, and the letter does not recommend the idea (although John Quiggin in the past has been a strong advocate).

    The substance of the letter was ignored by the non-Fairfax mainstream media. Online media like Crikey and Business Spectator both gave serious coverage to the letter (we didnt get the drop either).

    And then there was Terry McCrann, who launched a vitriolic attack in the Herald Sun involving obscure allusions to can openers, a critique of the peoples bank proposal (again), and the argument that there was no problem with the current financial system that merits any sort of inquiry.

    Quite which part of the banking oligopoly, or the punishingly high interest rates faced by business, is not a problem in the view of McCrann?

    The McCrann logic seems to be that because Australia dodged a bullet from last years financial crisis we can dodge the next one with equal skill with a financial system grown even more cartel-like in the interim.

    Joye told Crikey he was bewildered by an evidently coordinated News Limited attack.

    It appears to be a case of expedient and ideologically motivated journalism that has manufactured an utterly artificial strawman to tear to shreds the Peoples Bank that we never endorsed nor described as such, he said.

    I was very disappointed with their coverage of this matter and have written directly to Jennifer Hewett and Chris Mitchell communicating this fact.

    But we might look at Martin Place for the real motivations behind McCranns attack on the economists. It has long been considered, including by market analysts, that the Reserve Bank notionally committed to greater transparency has a handful of commentators such as McCrann and the AFRs Alan Mitchell on the drip regarding interest rate recommendations to the RBA Board. This enables them to appear to accurately anticipate interest rate movements. In return, the RBA gets a sympathetic ear in the commentariat useful when youre holding interest rates too high, for example, as the Bank did early last year.

    The RBA may have encouraged McCrann in his attack. Or, possibly, McCrann merely acted in the way he thought his RBA information partners would have appreciated.

    But Crikey understands that senior RBA figures consider that the economists letter raises a number of interesting ideas and that there is a case for a review of the financial system although, in their view, now is not the time for it, given the Government is still wading through a number of other major reviews and has the Henry tax review arriving at the end of the year. Further, one senior bank official indicated that they hoped policy-makers would listen to the case made by the economists.

    There appear to be splits within the RBA itself over some of the issues raised by the economists. Governor Glenn Stevens and Assistant Governor Phillip Lowe are not opposed to the idea of the RBA leaning against asset-price bubbles. But Assistant Governor Guy Debelle, in a speech in Brazil in May, savaged the concept. Debelle and Lowe are the two primary internal candidates to succeed Stevens.

    There is nothing but opposition in the RBA, however, to a publicly-owned bank of any kind. And the economists might have erred in providing such an obvious hook for attacks like those of McCrann, who used it to ridicule the entire letter although it is hard to see how they could have downplayed the proposal any further than they did in the letter, where it got 42 words out of 1700.

    The fact that Australias financial system emerged relatively unscathed from last years ordeal by fire doesnt reduce the case for an inquiry, it strengthens it. Unlike the Americans and the British and others, who are overhauling their financial systems in the heat of battle, Australia has the luxury of being able to take a step back, look at what went right and wrong, and try to ensure we can deal with future challenges.

    Too bad some in the media apparently arent up to that kind of debate.

  30. Fyodor says:

    The point I initially raised with you was a narrower one . In your initial comment, you assumed the sorts of asset pools they had in mind were similar to the kind of exotics whose failure initially triggered the meltdown. I didnt think it was; I figured they had something far simpler in mind, namely pools of plain vanilla high-quality mortgages, fairly homogenous and transparent.

    In my initial comment (#4) I did not differentiate between “exotic” and “plain vanilla” ABS, as no differentiation was necessary – the markets for both collapsed. The assumption was yours, at #18.

    – Chris, in his comment (#18), confirmed that was exactly what theyd intended. You then wondered why, if that were so, there was little or no market for these securities.

    No, I did not wonder at #23. I wrote:

    “The near total collapse of investor support for Australian plain vanilla securitisation issues belies your and Chris assertions. You must know something about assessing credit risk that debt investors dont.”

    That is, I noted that the evidence contradicted your and Chris’ assertions.

    – I suggested that asset quality issues were unlikely to be the problem, since the exact same kind of assets comprise a big chunk of banks balance sheets (about a third in fact) and then put forward some possible explanations for why the RMBS market here is still pretty dead.

    And I noted at #27 that this point was irrelevant, as the nature of securitised credit is different from corporate credit.

    Hopefully thats removed any possibility of misunderstanding.

    On your part or mine? I don’t say this to offend, but I don’t think you understand securitisation.

  31. Fyodor says:

    Joye told Crikey he was bewildered by an evidently coordinated News Limited attack.

    It appears to be a case of expedient and ideologically motivated journalism that has manufactured an utterly artificial strawman to tear to shreds the Peoples Bank that we never endorsed nor described as such, he said.

    I was very disappointed with their coverage of this matter and have written directly to Jennifer Hewett and Chris Mitchell communicating this fact.

    Chris, I’ve read your letter and agree that media coverage of it was highly distorted with excessive and inappropriate focus on the so-called “People’s Bank”. However, IMO the fault doesn’t lie with News Ltd, but with the SMH, for its initial coverage: the front page article of the SMH was titled “People’s bank to break the Big Four”. Unfortunately that hyperbolic tripe set the media agenda for your letter thereafter, and it’s consequently not surprising that that is what drew the fire of News Ltd journalists.

    You can’t control how the media will manipulate a “story”, but perhaps you should have anticipated the reaction to some of the more controversial elements.

  32. cjoye says:

    More media follow-up today…

    Cornell: Systemic intervention must be softly, softly

    Andrew Cornell

    The Australian Financial Review | 13 Jul 2009 | Page: 45 | Financial Services

    Having raised the idea of a Kiwibank-style competitor for the major banks in this column a month or so ago, it’s worth adding a few points following last week’s “people’s bank” kerfuffle.

    A people’s bank was alluded to in an open letter drafted by a wad of eminent economists – who must have been rapt with the response – although it was by no means the point of their proposals.

    Kiwibank is an offshoot of New Zealand Post, forced into being by NZ Labour’s junior coalition partner. The first branch opened in 2002 and the bank has run like a dream, although of late its role as price-setter has been reined in a tad. And it is small – about 3 per cent of deposits and 6 per cent of mortgages – and no-frills.

    NZ banking is dominated by the same oligopoly as here, and the bank happily runs the slogan: Kiwibank: It’s Ours.

    But Kiwibank is the least worst approach for interventionist government. If the Rudd government, as form suggests, is intent on showing it is truly worried by the cyclical exaggeration of the Big Four’s market dominance, prodding Australia Post to do more with its financial services capability is a good option.

    Australia Post moved into financial services more than a decade ago and has an extensive, product-hungry branch network, some of which is franchised.

    Basic banking products, white-labelled through companies such as Citibank or GE Capital, could be added to its mix.

    But a more vital [email protected] should be driven by Australia Post, rather than by government.

    The last thing the government should do is get back into banking. Governments are appalling bankers. The late RuddBank, a worthy idea for a back-stop in commercial property if and when a credit squeeze emerged, would have used private-sector bankers to make credit judgements.

    State Bank Victoria and State Bank of South Australia failed, losing more than $6 billion between them and costing taxpayers about $5 billion. Other state banks were rightly sold to the private sector – Commonwealth Bank also – as governments don’t have the skills or capital to provide competition. Nor should they try to get them; the focus should be removing barriers to entry and ensuring any competitor is properly capitalised.

    Moreover, inherent conflicts of interest for state financial institutions are enormous: one issue with Fannie Mae and Freddie Mac, two sub-prime crisis bogies, was they became instruments of government policy and distorted the market.

    This financial crisis is not the result of capitalism not working. It is because the return-on-investment signals that drive capitalism have been wrong. Salesmen and traders had no long-term interest in the viability of what they were selling; senior executives saw the risk-reward structure of their remuneration favoured making big bets that could destroy their institution and the financial system.

    It would be wrong and disastrous to assume the lesson of the crisis is that governments are better at running financial institutions. Rather governments should be looking at such issues as pro-cyclicality in prudential and accounting standards – rules which actively prevent financial institutions building up capital buffers in good times.

    Remuneration is a proper area of scrutiny, enforcing that the returns of both institutions and executives be linked to the long term. For example, institutions that originate loans should probably be required to maintain some exposure to them.

    Another crucial element of this crisis, and one last week’s open letter also canvassed, is the nature of the social contract between the banks and taxpayers. One economist, Rismark’s Christopher Joye, quite rightly argues that simply because Australia and its major banks have come through this crisis relatively well, so far, doesn’t mean everything is fine.

    There are significant issues from the 1997 Wallis Financial System Inquiry still alive, including the issue of government guarantees. That deposits had to be guaranteed was a response to the global situation. But the average depositor assumes they will be bailed out.

    Some element of moral hazard is inevitable in a financial system. The private sector is best placed to mediate the capital in the system and shareholders and depositors should be aware of the risk. But at some point it is more damaging to society to make those who took the risk pay than it is to keep the system afloat.

    That point was reached in Britain and the US in this crisis. It wasn’t here, and we should understand exactly why.

    Unions to push for 15pc super contribution
    Sid Maher | July 13, 2009

    Article from: The Australian

    THE Rudd government has left open the idea of lifting the compulsory superannuation contribution above its current 9 per cent rate as unions prepare to push for their long-held goal of 15per cent contributions by 2015 at this month’s ALP national conference.

    Superannuation Minister Chris Bowen said yesterday that raising the compulsory superannuation contribution above 9per cent was being examined as part of the Henry tax review and the Harmer retirement review.

    “Obviously higher post-retirement incomes are better than lower post-retirement incomes but there’s a trade-off with pre-retirement incomes and we need to strike that balance,” Mr Bowen told the Ten Network’s Meet the Press program.

    His comments came as ACTU secretary Jeff Lawrence told The Australian that unions would push their long-held goal of lifting compulsory contributions to 15per cent by 2015 at the ALP national conference in Sydney later this month.

    Unions would also be arguing for reforms to superannuation tax and the treatment of casuals in relation to superannuation.

    The government has faced pressure to review retirement contributions from the funds management industry and from former prime minister Paul Keating, who has long been an advocate of pushing the compulsory contribution towards 15 per cent.

    Superannuation has been championed as one of the solutions to funding the retirement of Australia’s ageing workforce.

    The review comes as retirement incomes have been battered by the global financial crisis with median returns on balanced investment funds averaging losses of more than 13 per cent in the past financial year.

    Superannuation funds in the 12 months to June 30 recorded their worst financial year performance since the introduction of compulsory superannuation in 1992, according to Super Ratings.

    Last month Perpetual chief executive David Deverall called on the government to lift compulsory superannuation contributions and improve incentives for voluntary payments to boost retirement funding.

    While aged pensions would continue to provide retirees with a guaranteed basic income, there was a long-term argument to sustainably increase the superannuation component, Mr Deverall said.

    Mr Bowen said he was also open to a review of the Australian banking system “at the appropriate time” after calls from leading economists to overhaul the system.

    Rismark International managing director Christopher Joye, who chaired former prime minister John Howard’s 2003 Home Ownership Task Force, said the big four banks had gained significant increases in market power during the global financial crisis.

    “Outside of the big four banks, there is no effective competition and the regional banks have made appeals to government to level the playing field,” said Mr Joye, who was one of six economists who wrote to the government last week asking for the review.

    He said the government also needed to examine a regulatory regime to cover the securitisation market, which had provided funding for up to a quarter of the home loan market before the global financial crisis.

    Koala Bank stillborn: still a case for an inquiry
    The Sheet

    13 July 2009 7:02am

    Six prominent economists released an open letter to the Prime Minister and Treasurer last week. Included in the letter was a question that asked whether there might be a role in Australias financial system for a publicly owned bank akin to Kiwibank in New Zealand that could offer basic savings, payments, and wealth management products and leverage off unique government infrastructure such as Australia Post, the ATO and the government bond market.

    The proposed bank was dubbed Koala Bank by some. As it was, Koala Bank went off quicker than a dead dingo. Given the recent demise of the Australian Business Investment Partnership (and dubbed RuddBank by the media) this was hardly surprising, although if it had been dubbed RuddBank MkII it may have received some initial support from the government.

    However, while Koala Bank may have been a dozy idea, it was what the media picked up on, somewhat overlooking the real thrust of the letter, which set out why Australia needs a comprehensive financial system inquiry. The Koala Bank question was the ninth among 14 that were suggested for examination by an inquiry.

    Given that we are in the midst of the GFC, which has devastated the global financial system; the US and UK are reviewing their own financial systems; we will soon be confronted with recommendations from the G20 on the overhaul of the global financial system; and that the last inquiry we had was the Wallis inquiry completed in 1996; such an inquiry would seem to be a very good idea much has changed in the last 13 years.

    Political leaders at the Federal level appeared to be supportive of the call for an inquiry, but not the government. Presumably, they are happy with the policy that they have made on the run and the unintended consequences that have flowed from it (such as having to guarantee just about everything that moves in the financial market), and have more important matters to deal with.

    Events may move ahead of the government anyway, with Graeme Samuel threatening to hold his own inquiry into the financial system, if he receives another bank merger proposal. Such an inquiry into the competitive position of our financial system would likely address many of the questions that have been put forward anyway.

    But added to the list of questions could be added one on why we have failed to develop a viable corporate bond market in Australia. All the necessary infrastructure is in place with supportive legal, regulatory and taxation environments, and we have a sizeable corporate sector and institutional funds management industry.

    Yet for the last half of this decade our market has looked more like a wholesale bank deposit market, denying institutional investors the opportunity to demonstrate their credit risk assessment skills, and now the market is morphing into a government bond market.

    Many academic studies have pointed to the usefulness of well developed corporate bond markets in mitigating the effects of a credit crunch.

    But the big question, which is beyond the scope of an ACCC inquiry, is what is the post G20 restructured global financial system going to look like and do we want to have a say in this or have it thrust upon us? For those who believe we have or will have no influence in the G20, the question is irrelevant: dont worry about it.

    For the rest of us, an inquiry would have us better prepared to meet the challenge. We are also in the fortunate position of being able to review our financial system from a position of strength.

  33. Ingolf says:

    Fyodor, we still seem to be talking past each other. Let me try to make my position clear.

    – Agreed, you didn’t distinguish between different types of ABS in your initial comment.

    – No argument that excuses are often made for the underperformance of various securities, all in one fashion or another claiming that the market’s got it wrong. I don’t generally pay much heed because it’s almost always just special pleading and, in any case, markets tend to pick up free money if it’s simply lying there in the street.

    – I’m not (as noted earlier) in favour of government intervention in these markets.

    – I accept that all ABS markets have been hit pretty hard, some more than others of course, and also that the RMBS market here in Australia is still pretty much dead. Without government support, the current very low level of new issuance would probably dry up almost completely.

    The only point I was trying to make is that the underlying assets of top quality RMBS here in Australia are essentially the same kind of mortgages as those found on bank balance sheets and that concern with asset quality probably therefore wasn’t the real cause of these securities’ woes. In other words, I thought this might be one of the rare exceptions where structural market issues may be impeding “rational” pricing.

    I’m not suggesting the RBA is the ultimate arbiter on these things, but FWIW this is what they had to say in the May 2009 Statement on Monetary Policy:

    The elevated spreads on RMBS in both primary and secondary markets do not appear to reflect investor concern about the credit quality of Australian RMBS. While losses on prime RMBS (after the proceeds from property sales) increased slightly in the December quarter 2008 the latest data available they remained quite low as a share of outstanding loans (at less than 2 basis points) and were predominantly covered by lenders mortgage insurance. Losses on non-conforming RMBS were higher (around 25 basis points of outstanding loans), with the bulk continuing to be covered by RMBS credit enhancements (mainly the profits of securitisation vehicles). No investor in a rated tranche of an Australian RMBS has suffered a loss of principal stemming from default on the underlying mortgages.

    As to why these securities nevertheless remain under such pressure, they’ve offered a number of comments in the last 12 to 18 months, but I’ll quote just one from the same May 2009 SMP:

    This is in contrast to prior years when there was strong offshore demand for Australian RMBS, partly reflecting the high quality of Australian mortgages. Recently, many of these offshore investors have been selling these RMBS as they attempt to reduce their leverage, and this has kept spreads on RMBS elevated, with recent issues at spreads to the bank bill swap rate of around 110130 basis points, compared with less than 20 basis points immediately prior to the market turbulence (Graph 34). At these spreads, funding mortgages by issuing RMBS is unlikely to be profitable for many types of loans at existing mortgage rates. As discussed below, the difficulties in the RMBS market are having a noticeable impact on those lenders whose business models are centred on securitisation.

    This thread has dragged on more than either of us probably wanted it to, Fyodor. I will of course read any response from you with interest but am otherwise inclined to let it go. I don’t in any case think I can put the small point I was trying to make any more clearly.

  34. Tel_ says:

    Mortgage backed securities around for decades and helped people buy homes.

    The older concept (really old) was that everyone in the village chipped in to build a house for one family, and that family was expected to chip in when building more houses. Mortgages just codify the same thing and allow for finer distinctions as to the size of the house, etc. Exactly when one turned into the other I can’t say but hardly a recent Eureka moment. I guess a lot of the “innovation” at work was the long agonising over usury that took place to finally get us where we are (doing the same thing we have always done, but with numbers attached).

    Credit cards. Debit cards.

    These are really advances in communication, and a convenient method of identification. I’m awarding points to electrical engineers rather than economists on this one.

    Adjustable rate loans.

    A backward step IMHO, and heavily rigged in favour of the banks. My feeling is that all loans should be fixed rate but you can pay out the loan early if a better deal comes along. I’ll point out that if you believe in a rational market (which everyone pretends to but nobody does, I’m continuing the pretence for the sake of politeness) then the details of variable or fixed loans merely shift the risk onto the borrower or the lender but don’t improve the overall efficiency of that market.

    Mutual funds

    It has been possible for a group of people to buy shares into a company for a long time, and this newly created company can perform various activities including investment in other companies. Mutual funds probably streamline the process but they don’t create a new design. In some ways, streamlining the process too much just results in shareholders not paying attention to where their money is going (which is the classic problem of mutual funds).

    Interest rate swaps and many other variations that have certainly helped finance smaller firms with stable long term debt.

    Yeah, probably interest rate swaps are genuine innovation. I remain to be convinced that small firms should run with a substantial debt over the long term. If the small firm can attract investors then it just sells shares, it if can’t attract investors then obviously no one has confidence in the idea so maybe that should be a hint that the idea is not going anywhere. If someone really wealthy wants to start pursuing crazy ideas then they don’t need debt.

    Option markets that allow corporations to hedge risk.

    Insurance companies have been buying and selling risk for a very long time. Option markets allow regular Joe Public to do the same, fair enough I suppose. OK, I’ll give you points for options trading. Genuine democratisation of the insurance industry. Also allows terrorism to be self-financing.

    Advance of private equity that allows good ideas to find financial partners to help grow the firm. We wouldnt have a tech world without these firms.

    This is really as old as the double-entry bookkeeping that I mentioned above. Handling split equity in joint ventures was one of the reasons bookeeping was invented. However, the tech world was moving forward quite steadily even before that. Stonehenge was not built by accountants, it was built be people who had a genuine interest in accurately tracking the sun (yeah, and maybe they were also religious loonies). The fine art of steel smithing was not driven forward by investors, it was driven by professional killers who wanted to increase their chance of seeing the end of their next day’s work. Indeed tech and war go hand in hand right to the present day, just take a peek at what Obama is funding, and how is he finding that? Why the good old fashioned way — tax the peasants by force.

  35. Fyodor says:

    The only point I was trying to make is that the underlying assets of top quality RMBS here in Australia are essentially the same kind of mortgages as those found on bank balance sheets and that concern with asset quality probably therefore wasnt the real cause of these securities woes. In other words, I thought this might be one of the rare exceptions where structural market issues may be impeding rational pricing.

    Again, you are repeating an irrelevancy. Please read this article on securitisation.

    The fact that a residential mortgage-backed security (RMBS) is backed by the cash-flows from an underlying pool of home loans very similar to those held by a bank does not make the credit risk of that RMBS equivalent to the credit risk of the bank’s own bond issues. Why? Because the bondholder of a bank is supported by the earnings power and, importantly, shareholders’ equity of the bank. RMBS structures rely upon the pass-through of cash flows from underlying home loans to fund their coupons and principal repayments; there is typically little, if any, equity backing the structure. This becomes critical when the underlying home loans default at rates higher than planned – there is minimal buffer in the structure to absorb these losses. As I keep saying to you, the credit risk profiles of these bonds are very different.

    Now, the RBA is correct in noting that the rate of default on home loans supporting Australian RMBS issues has been low. However, the yield premium required by debt investors on such issues has blown out, to levels where it is no longer economic to issue RMBS in traditional structures. Why? Because debt investors want higher yield for the risks they perceive in these structures, and home loans cannot be originated at yields (i.e. the interest rate on the home loan) high enough to meet that investor expectation. Why is this? Because the major trading banks are able to fund home loans at much lower yield due to their superior access to deposit funding and wholesale funding. Non-bank mortgage originators currently cannot fund home loans at a rate competitive with the banking sector. That is why the securitisation industry has collapsed.

    We hear quite a lot of blather these days about how the Commonwealth Government guarantee allegedly provides banks with an unfair advantage relative to securitisation, but this is a furphy: the banks were out-competing securitisation vehicles for months (if not a year) before the guarantee was put in place. The securitisation funding structure is, in the main, no longer viable in the current market environment. If and when it does come back it is likely, IMO, to play a much less prominent role in mortgage funding in this country.

  36. Fyodor says:

    Oh, come on. Moderation?

  37. cjoye says:

    More progress…

    Greens move to establish banks inquiry in Senate

    If the Government fails to act, the Australian Greens will move to establish a Senate Inquiry into Australia’s banking system when the Senate resumes in August, Australian Greens Leader Senator Bob Brown announced today.

    “The market-share figures for May show that banks are increasing their dominance of the financial system at the expense of smaller non-bank institutions, with their share of loans up to a record 89.4 per cent compared with 85 per cent a year ago.”

    “At a time when we need robust diversity in financial systems, we instead are seeing a concentration in favour of banks and especially the big four banks which are benefiting the most from the Rudd Government’s Guarantee Scheme for Large Deposits and Wholesale Funding.”

    “I’m mystified as to why Finance Minister Lindsay Tanner can say that the pace of financial innovation has ‘outstripped the capacity’ of regulators to keep up.”

    “The Government showed no such inability when it moved with great speed to provide access for banks to billions of dollars of government underwriting through the Guarantee Scheme.”

    Senator Brown said a Greens’ inquiry would encompass the concerns raised recently by leading economists, and would also look at a range of other issues, such as low or no-fee accounts and mechanisms to ensure that interest rate cuts are passed on directly to customers.

    The last inquiry into the financial system was held in 1996-97.

    Further information: Russell Kelly 0438376082 ends

  38. JC says:

    At a time when we need robust diversity in financial systems, we instead are seeing a concentration in favour of banks and especially the big four banks which are benefiting the most from the Rudd Governments Guarantee Scheme for Large Deposits and Wholesale Funding

    Chris, surely this shouldn’t be a mystery. The government wrapped the banking system, or rather all deposit taking institutions with a larger guarantee while leaving everyone else out in the cold. So who other than Bob Brown would be surprised that the public is shunning the outsiders, as the effect is that government policy is promoting concentration?

    In point of fact the smaller banks are the ones who benefited the most as the effect was it immediately placed them on a similar risk footing as the larger banks on their liability side. Most of the smaller banks and the “colorful banking identity” would almost certainly failed if it wasn’t for the intervention.

  39. Tel_ says:

    Just in case anyone is still struggling with the belief that the banking and investment market drives the tech industry… as if on cue, Defence and Science Minister Greg Combet sets the record straight.

    http://www.abc.net.au/news/stories/2009/07/13/2624387.htm

    Mr Combet said the competition aims to fill the need for an autonomous robot operating in urban environments.

    Oh yes, I ran into that exact same problem. Here I am, living in an otherwise upmarket urban environment, but where are the highly lethal, heavily armed autonomous robots? None to be seen! Glaring need to be filled right there. Obvious example of a market failure that they aren’t selling in Jaycar already.

    Ah well, now is the time to move your investment dollars into landmine and spraypaint manufacture. Maybe give George Lucas a pat on the head for doing it first. Certainly Greg Combet never thought it up, someone must be standing behind cranking his handle.

    Rattenkrieg… :-(

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