A Financial System Cannot Operate Without Trust

The report of the Campbell Committee* on Australias Financial System (1981) paved the way for financial deregulation of credit flows, interest rates and exchange rates. But it also recognized that a financial system could not operate effectively, let alone efficiently, unless investors at large had confidence in the underlying solvency of financial institutions and in the overall stability of financial markets. So it insisted on adequate prudential disciplines. Two subsequent Inquiries into the financial system reinforced this message. And tough prudential safeguards were implemented. As a result, we should have one of the strongest financial systems in the world. So whats going on?

We are seeing a serious breakdown in trust (even banks dont trust each other) and questions are being asked about the role played by hedge funds, margin selling and short-selling in the recent share market debacle (our share market has fallen at twice the rate of Wall Street), the adequacy of the capital backing requirements of banks and other major financial institutions, the effectiveness of the surveillance and monitoring role of the ASX, APRA and so on.

All the traditional methods of government intervention cannot work when trust has broken down. The good work being done by the Federal Reserve and other central banks, the proposed fiscal US stimulus and the ad hoc attempt to bail out insurance brokers in the USA will all help but cannot fully address a breakdown in trust.

Is it time for another comprehensive review of the functioning of capital markets in Australia? Apart from the specific concerns about margin selling etc., the Inquiry could also consider whether the financial system needs a reliable safety net for risk-averse investors and depositors (small and large) such as through a collective financial lifeboat which insures all approved financial institutions with strong balance sheets (not just banks). It could be funded by an annual levy raised from institutional members and from an initial large investment from the Future Fund. The scheme would have to be structured so as to minimize the risk of encouraging moral hazard or stifling competition in the financial system.

I am not mounting panic stations. The options are limited in a globalised capital market and an inquiry will do nothing to relieve present tensions (and may indeed alarm investors). But I do believe that once the present dust settles we will need to do something to reduce the risk of regular bouts of financial market instability.

Incidentally, in this nervous climate, and having regard for the fact that we have had three interest rate rises in the last 12 months and that the full impact of these rises have not yet been felt, I question the need for a further interest rate rise in February or March.

============
*I was Secretary and signatory to the report presented by Keith Campbell to John Howard in September 1981

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Jc
Jc
13 years ago

Fred

Concerns about trust etc. always shows up when there’s financial tensions. In fact by definion there wouldn’t be financial tension otherwise.

There are no problems with the financial system functionally speaking and hedge funds are no the big bad monsters of the market. It would be good thing next time round if the Fed normalized rates a lot sooner.

More to the point, the markets are doing exactly what they are supposed to be doing which is repricing a new set of expectations.

Fyodor
13 years ago

Have to agree with JC on this one – our financial system seems to be working fine so far.

Fred, I wasn’t aware you’d worked on Campbell, possibly one of the most effective and far-reaching government inquiries ever conducted in this country. Any chance of writing up your experiences on it some time? Yes, I know the subject will be dry and boring for many, but few people realise how influential the report was in this country and an insider’s view would be fascinating to those – like me, f’rinstance – who have an interest.

Patrick
Patrick
13 years ago

I also agree with JC I admit. I don’t see anything particularly worrisome about this. People who took excessive risks are paying for it, basically.

Nicholas Gruen
Admin
Nicholas Gruen(@nicholas-gruen)
13 years ago

“More to the point, the markets are doing exactly what they are supposed to be doing which is repricing a new set of expectations.”

There might be more to it than that. We’ll see.

Patrick
Patrick
13 years ago

One can act ‘rationally’ on irrational impulses, Philly.

The idea of rational action is not as horrible as some seem to think – once you accept my first line you should understand that it is pretty fundamentally ingrained in our modes of thinking and interacting – in other words in our culture.

If you don’t believe me ponder why you expect certain reactions from people in certain situations.

Jc
Jc
13 years ago

Oh. I see. The markets are rational and conform to human needs, which of course are rational, and so all – markets and people – are happy.

Pollyanna lives.

Was Polly good looking, Philly? Just kidding, so settle down.

Markets is the term used to describe how people organize themselves to satisfy their needs and wants through mutual exchange. There’s nothing irrational about this important part of human behavior. There are times you may simply not like what is happening in markets but that’s more to do with your own personal preferences.

———————-
Nic:

There might be more to it than that. Well see.

Quite true, Nic. But let me say this. Stocks are generally not expensively priced around the world on an historical basis. The credit spread LIBOR to govies has actually settled down of late if a little wider and US banking system although battered and bruised may be through the worst of it. Don’t forget that there was ample capital to go around in terms of bank recapitalizations. CPI based Inflation doesn’t look like it’s much of a problem around the world. The Fed is easing and the pigheaded ECB will too by mid to late spring. Moreover the US yield curve is actually beginning to normalize.

Look it isn’t a roaring boom around the world but when you have almost every single important media outlet with doom and gloom on its front cover and when every pundit is talking in negative terms, it’s probably the end of the cycle.

There could be a freight train headed our way… but how knows.
———————

Fyodor:

Fred, I wasnt aware youd worked on Campbell, possibly one of the most effective and far-reaching government inquiries ever conducted in this country. Any chance of writing up your experiences on it some time?

That true Fred? Wow. Fred you unwittingly got me a job, as Im sure I would never have been good at anything else. You’re now a hero of mine. Yea write something up on it. It would be great to hear what was also going on in the background like any horse-trading etc. Please.

Bring Back CL's blog
Bring Back CL's blog
13 years ago

yes the financial system is working well here but it still seems mucked up in the US and Europe.

Jc
Jc
13 years ago

Europe has a strucural problem, Homer. From what i understand the ECB does not lend directly to problem banks or has direct supervisory control the way the Fed does. I can’t recall exactly what the issue is, but some important functions are still done at the national level by the legacy central banks in each EU nation.

It was insane watching what was going on during Xams over the turn of the year. Ground zero was the US but the ECB had to lend close to 1/2 trill Euros to keep the system liquid as the Euro banks weren’t lending to each other.

Fyodor
13 years ago

Europe has a strucural problem, Homer. From what i understand the ECB does not lend directly to problem banks or has direct supervisory control the way the Fed does. I cant recall exactly what the issue is, but some important functions are still done at the national level by the legacy central banks in each EU nation.

The ECB does lend directly to banks in the Eurosystem in its role as monetary authority. Bank supervision is still conducted by the national central banks, e.g. the Bundesbank.

I don’t think Europe has a structural problem. The problem is a globe-wide liquidity shock emanating from the underlying problems in the US debt market due to the ongoing collapse of its housing markets and aftershocks in the structured credit markets. What we’re seeing is the correction after a prolonged and extreme bull market in credit.

European banks were active participants in US credit markets and are paying for it now, but it’s difficult to identify Europe-specific structural problems. Unfortunately, the dominance of US and European financial markets means that the liquidity shock (i.e. banks and other money market participants hoarding cash and capital) has global consequences.

Fred Argy
Fred Argy
13 years ago

Yep it’s true JC. As Secretary to the Inquiry, I drafted at least half of the Campbell report for the Committee’s consideration. But I had a team of wonderful assistants helping me of course. Campbell insisted I should be one of the signatories to the final report. John Howard gave me an OBE because of it. Ah, memories! memories!

Fyodor, I have done very little work on the financial system since the mid 1990s. Instead I have been writing on JC’s pet hate – social policy and its interaction with economic efficiency. Still, it would be nice to write something on the 1979-81 Financial System Inquiry processes – and on the remarkable Keith Campbell, surely one of Australia’s great unsung heroes! Who knows?

It is good to see so much confidence from bloggers regarding the underlying strength of Australias financial system. I share this confidence but I have some concerns (related to all the new financial technology) which I feel need regulators attention at some stage.

In the meantime, let the cartoonist Kudelka have the last word on our stock markets. http://www.theaustralian.news.com.au/opinion/cartoons/

Jc
Jc
13 years ago

Fred:

It is good to see so much confidence from bloggers regarding the underlying strength of Australias financial system.

Here’s what i think, for what it’s worth.

The US basically runs a semi socialist house financing market with Freddie Mac and Sallie Mae (I think it’s them) which we don’t. Our banking system is in better shape in terms of the quality of assets on board.

Our banks didn’t seem to get caught up in it like Europes etc. so that a good sign.

It doesn’t mean they don’t hit if a downturn comes, but our big name banks seem in pretty good shape.

It doesn’t mean that say Mac bank’s special purpose funds couldn’t go down the gurgler. But Mac bank’s balance sheet would be ok.

Please write a little history. Wow , you’re now my new found hero.

Seriously Fred, you indirectly gave meaning to my life. I don’t know what i would have done if I didn’t go into currency trading.

as an aside:
What’s astounding is that Japanese banks have taken a pretty big clip over the head in the recent stock market downturn and these guys don’t have any exposure to sub lending ……possessing some pretty resilient balance sheets.

————————

Fyodor

The ECB does lend directly to banks in the Eurosystem in its role as monetary authority. Bank supervision is still conducted by the national central banks, e.g. the Bundesbank.

Yea, I think your right on that one after I went back.

The piece I was reading mentioned structural problems causing distrust as a result of local supervision rather than ECB. In other words would one trust the Bank of Italy over the Bundesbank?

This is a pretty big problem, don’t you think?

Fyodor
13 years ago

The piece I was reading mentioned structural problems causing distrust as a result of local supervision rather than ECB. In other words would one trust the Bank of Italy over the Bundesbank?

This is a pretty big problem, dont you think?

Not really.

It’s debateable whether Buba or BoI is a better regulator – the experience of IKB contradicts your implication. There is some discussion about harmonising prudential supervision in Euroland, and that’ll probably be a good thing, but it won’t stop bankers from being greedy or over-optimistic in the next bull market.

As you would yourself admit, it happens every cycle and I have much greater confidence in the market’s ability to teach the necessary hard lessons in basic risk management than I have in regulators’ ability to anticipate the next crisis.

The US basically runs a semi socialist house financing market with Freddie Mac and Sallie Mae (I think its them) which we dont. Our banking system is in better shape in terms of the quality of assets on board.

Sallie Mae provides student loans; it’s not involved in housing. Freddie Mac is a publicly-owned corporation that has no explicit guarantee from the US government. I fail to see how its role as a trader in secondary mortgages caused the US housing boom or subsequent bust, let alone the second- and third-order problems in the debt markets.

The key difference in credit terms, aside from socio-demographic factors, between US and Australian home loans is that US home loans are typically non-recourse, i.e. if you default on the loan, the bank takes the house and you walk away. In Australia, banks lend on full recourse, i.e. if you default on the loan, the bank goes after everything you own. Not surprisingly, this has a material impact on the relative propensity to default, with Australian home loan default rates materially beneath the experience in the USA.

That fact, and the fact that Australian banks simply weren’t in a position to “play” the US credit markets over the last few years, explains why our banks aren’t disclosing multi-billion dollar losses at the moment.

Jc
Jc
13 years ago

Sallie Mae provides student loans; its not involved in housing. Freddie Mac is a publicly-owned corporation that has no explicit guarantee from the US government. I fail to see how its role as a trader in secondary mortgages caused the US housing boom or subsequent bust, let alone the second- and third-order problems in the debt markets.

I couldn’t recall the exact names or who did what…

As far as I understand Freddie M doesn’t just trade loans but actually acts in some originating capacity and offers a partial sort of guarantee for a part of a loan… ???

It doesn’t have a US government guarantee but no one would think this agency would ever be allowed to default before the US gov stepped in.

Aren’t there two of these agencies?

If there are then it is pretty distortive.

Jc
Jc
13 years ago

Yes, you point is a good one regarding the default differences.

Fyodor
13 years ago

Freddie Mae acts as a secondary trader/intermediary in mortgages. That is, it buys mortgages off originators (i.e. banks and non-bank originators) and either holds them or – more typically – on-sells into securitisation vehicles. While it plays a major role in facilitating the shuffling of mortgages around the market and into RMBS, it faces the same constraint as anyone else in that space, i.e. the willingness of RMBS investors to finance its securitisations. Yes, it’s often considered to be “too big to fail”, but it’s drawing a long bow indeed to imply as you did that it’s somehow “semi-socialist” or the root cause of the problems in US housing and debt markets.

The other one you’re probably thinking of is Fannie Mae, which does pretty much the same thing, and possibly the Federal Home Loan banks, which are actually privately owned.

Paul Frijters
Paul Frijters
13 years ago

Fred,

sinse the Australian stock market has been going up more than the US stock market before the correction, its not that strange or worrying that it went down more as well during the correction.
Also, I was told by my colleague Anup Basu (who got his PhD in Finance today) that there is apparently no moment in the last 150 years or so that you would have had a better return in bonds than on the stock market if you put your money on the stock market and left it there for the next 30 years, compared to buynig bonds and sticknig to that for 30 years. Hence from the long-run perspective stock markets are less volatile (less chance of low returns) than the supposedly ‘safe and trusted’ government bonds. Who then exactly needs to be protected from this supposed stock market volatility? It could only be short-term investors, which is not Joe average and his pension fund!
I of course do agree that financial markets cannot operate without trust in the system. You cannot have mass trade between fairly uninformed traders without trusting that someone or something ensures you are not being taken advantage of.

SJ
SJ
13 years ago

Cambria: Arent there two of these agencies? If there are then it is pretty distortive.

What kind of gibberish is this?

Fannie Mae (Federal National Mortgage Association) was set up in 1938 to provide liqudity in the secondary market, i.e. to act as a market maker. It was never an originator. It enlarged the bid/ask spread by offering a guarantee on the loans it on-sold. Until 1967, that guarantee was government backed, but it in 1968 Fannie Mae was sold off. As Fyodor notes, there’s no government guarantee, and there hasn’t been one for 40 years.

Freddie Mac (Federal Home Loan Mortgage Corporation) was created just after the sell-off of Fannie Mae, and is essentially a clone of Fannie Mae. Its purpose was to provide competition to Fannie Mae. It never had a government guarantee, and was never an originator.

The U.S. government did, however, originate loans, and still does. It does this through Veteran Affairs, Indian Housing, Rural Development and similar departments. None of these government originated loans have anything much to do with the current situation.

For some reason, these government loans are (seemingly redundantly) guaranteed by government agency called Ginnie Mae (Government National Mortgage Association), but this may be a persistent hang-over from the 1930s, because Fannie Mae used to perform this function until 1968. I’m not sure why Fannie Mae was given this role back in 1938.

SJ
SJ
13 years ago

Paul Fritjers Says: there is apparently no moment in the last 150 years or so that you would have had a better return in bonds than on the stock market if you put your money on the stock market and left it there for the next 30 years, compared to buynig bonds and sticknig to that for 30 years. Hence from the long-run perspective stock markets are less volatile (less chance of low returns) than the supposedly safe and trusted government bonds. Who then exactly needs to be protected from this supposed stock market volatility? It could only be short-term investors, which is not Joe average and his pension fund!

Paul, volatility does not mean what you seem to think it means. Volatility refers to variability as measured by things like standard deviation, variance, range, etc. Stock market returns simply are more volatile than bond returns. There’s no way to argue around this.

The other side of the coin is expected return. What your colleage has told you is that the expected return on stocks is greater than that of bonds, and that the actual return for stocks has been greater than that of bonds over any 30 year period in the last 150 years.

This is not entirely unexpected, as the higher expected return is why we tolerate the greater variability in the first place. Also, it’s usually possible to construct a statistic that will show what your colleage wanted, e.g., if it didn’t work out for the 30 out of 150 years, you could try 35 out of 150 years, or 25 out of 100 years, etc.

The case you presented is only really useful in a scenario where you’re 30 years old or less, expect to retire at 60, and won’t be able to save any more money until you reach 60.

If you’re, say, 55, have $x already invested, and expect to have another $y available to contribute before you retire, how does your colleague’s advice help you?

Jc
Jc
13 years ago

I have leather gloves on SJ, so it’s ok to come of the cage now.

as Fyodor pointed out, angry andrerson, there is no explicit guarantee, but there is very strongly held belief that the Federal government would never allow that agency to go down the spout. US banks limit deposit insurance to basic accounts, but the chances of allowing Citibank to go under is about -10. Agency buyers would rate this agency going under at -40 out zero.

Here’s Fannie Mae’s balance sheet.

It operates on a leverage of around 20:1. (that’s assets over equit, SJ) It couldn’t ever do this unless investors had some implicit comfort that the US government would step in.

http://finance.yahoo.com/q/bs?s=FNM&annual

It enlarged the bid/ask spread by offering a guarantee on the loans it on-sold. Until 1967, that guarantee was government backed, but it in 1968 Fannie Mae was sold off. As Fyodor notes, theres no government guarantee, and there hasnt been one for 40 years.

I assume you went to wiki for the background info. However you seemed to have left this part out.

There is a wide perception that FNMA securities are backed by some sort of implied federal guarantee, and a majority of investors believe that the government would prevent a disastrous default. Vernon L. Smith, 2002 Nobel Laureate in economics, has called FHLMC and FNMA “implicitly taxpayer-backed agencies.” [1] The Economist has referred to “[t]he implicit government guarantee”[2] of FHLMC and FNMA.

I wasn’t quite certain about how/where this distortion was occuring but I do also recall there was also direct government intervention in the loan market. HUD and one of it’s affiliates offers insurance guarantee programs on lower income home buyers
Here’s some back ground.

http://www.mortgage-x.com/library/fha.htm

The Department of Housing and Urban Development (HUD) is the federal agency responsible for national policy and programs that address America’s housing needs. The Federal Housing Authority (FHA) which is part of the HUD plays a major role in supporting homeownership by underwriting homeownership for lower- and moderate-income families. FHA assists first-time home buyers and others who might not be able to meet down payment requirements for conventional loans by providing mortgage insurance to private lenders. Everyone, who has a satisfactory credit record, enough cash to close the loan, and sufficient steady income to make monthly mortgage payments can be approved for an FHA-insured mortgage. To get a FHA-insured loan, you need to apply to a HUD-approved lender.
FHA-insured loans are available in urban and rural areas for single family homes, for 2-unit, 3-unit, and 4-unit properties, and for condominiums. Interest rates on FHA loans are generally market rates, while down payment requirements are lower than for conventional loans. Down payments can be as low as 3 percent, and closing costs can be wrapped into the mortgage.

With an FHA-insured mortgage, you can make extra payments toward the principal when you make your regularly monthly payment. By making extra payments, you can repay the loan faster and save on interest. You can also pay off the entire balance of your FHA-insured mortgage at any time.

FHA loans cannot exceed the statutory limit.

Jc
Jc
13 years ago

This Hud program is a little complex as the amount of loan insurance and other stuff varies depending on the geographic location of the house. In other words eg you may reach the ceiling at 200g in parts of Texas but it would be 450G in california.

Under the current support package this ceiling is going to be raised to a level that would allow a good the bottom end of jumbo mortgaes to get HUD relief. So yes there is government intervetion in the US home market that could actually be quite distortive.

Jc
Jc
13 years ago

Paul says:

that there is apparently no moment in the last 150 years or so that you would have had a better return in bonds than on the stock market if you put your money on the stock market and left it there for the next 30 years, compared to buynig bonds and sticknig to that for 30 years.

I’m not about Oz, paul but I believe the US stock market more or less flatlined from about 1932 to the early 60’s until the Kennedy tax cuts. I may have read that it was the same here., but not sure.

SJ
SJ
13 years ago

Joe, let me remind you of your original statement.

The US basically runs a semi socialist house financing market with Freddie Mac and Sallie Mae (I think its them) which we dont. Our banking system is in better shape in terms of the quality of assets on board.

What you said was complete and utter crap, and you didn’t understand anything at all about it.

Now that you’ve looked at Google, you should understand that what you said was complete and utter crap, and apologise.

It’s pointless now for you to argue about the minutiae, because until about an hour ago, you knew nothing about the subject whatsoever.

Fred Argy
Fred Argy
13 years ago

The discussion has been very interesting, thanks. I should make it clear that I am not concerned about the recent increase in volatility per se (or indeed the practice of short selling). What I am concerned about is the erosion of trust a problem which extends well beyond share markets and assumes more dangerous dimensions in credit markets.

A decline in trust arises from inadequate transparency, infrequent, poor quality or corrupt information and investors fear of the unknown (with contagion panic). I feel that, once the present crisis is over, a quiet inquiry into the financial system could explore ways to mitigate all three problems, through better disclosures, better accounting, an insurance fund for nervous risk-averse lenders etc. Thats not being alarmist.

Bring Back CL's blog
Bring Back CL's blog
13 years ago

if the financial markets are working then why is there still no trading in the covered bond market in Europe?

Patrick
Patrick
13 years ago

an insurance fund for nervous risk-averse lenders

Can’t risk-averse lenders just a) lend to lower-risk borrowers, b) price their debt higher to justify the extra perception of risk to them and/or c) insure their debt anyway in the CDS and lenders’ insurance markets??

Is that not what most of them are doing? How else could we have had record corporate borrowing?

I don’t see any ‘breakdown of trust’, rather, if anything, I see a welcome return of mistrust and cynicism – N Gruen’s favorite historian of economics (IIRC) JKG would have applauded. For once, let’s applaud with him.

Jc
Jc
13 years ago

SJ , you do drone on, dont you? Are you always this angry? LOL

Angry Anderson, you lifted a part of wiki that said there is no explicit US government guarantee. There isn’t explicitly, but there most certainly is an implicit one. You conveniently omitted this. Why should we think there is an implicit one?

1. Investors buy and sell the securities on the basis there is (in terms of the spread to govies)
2. The leverage in the balance sheet certainly indicates that people think there is.

Moreover there is a great deal more distortion going on as a result of HUD’s activities as I showed.

My first comments didn’t exactly cross the T’s and dot the I’s in terms of putting it all together however my previous comment did.

I nice retraction and an apology would go down well with my latte, thanks.

Hi Fred.

Yes lets get back to the thread

I think youre obviously leading to this weeks drama in the stock market. There could be a little more than meets the eye here

Lets be hypothetical and expansive for a moment and not always think what we read in the papers actually went on.
.

We have a small firm that runs a large margin lending business supported by a large Australian bank through a margin master lending agreement. Small firm is aggressive but totally above board in its dealing. Owner is as straight, honest up guy.

The small firm sets up a margin loan for the directors of a boom time company which we will call ALCAM. The directors borrow money against the stock they own in ALCAM through a margin lending agreement with the explicit provision that the small broking firm cannot lend out the stock for shorting purposes. The agreement is reached and the small firm transfers over the stock to the large bank as security pass through for the loan. The large bank then transfers the stock over to a subsidiary that lends out the stock thereby ignoring the restriction in the agreement. The large banks subsidiary lends out the stock to a hedge fund type which then shorts ALCAMs. Hedge fund doest know anything about the provision.

ALCAM stock begins to fall and the small firm doing the right thing sells the stock to cover its margin commitments. The large banks sub is unable to get the securities back from the hedge fund as they have used it to short ALCAMs stock.

The small firm is caught short of the stock to meet settlement because the large bank is unable to get possession of the stock from its subsidiary and then refuses to meet normal settlement with the ASX. Fine mess we got themselves into. Small firm gets accused of all sorts of nefarious dealings despite having met all margin requirements.

No problem with transparency here if the large bank had honoured the provisions of the original agreement and hadnt on lent the stock which was used to short ALCOM stock that helped to destroy peoples lives in the process. But nothing wrong with shorting stocks if it is done above board too.

What have we learnt here?

1. Dont trust big domestic banks

2. Small firm AlCAM and other shareholders of ALCAM should hire a hotshot legal team and rip large banks face off.
3. May be short large banks stock because theres going to be an unholy legal claim.

There is something really nasty in this hypothetical example where the large bank lends money to cover the margin. It then lends the stock it isn’t allowed to that helps sink the price of the shares thereby ruining some people in the process.

Conclusion : this isn’t a transparency issue. This is an issue for a judge to decide in terms of just how much compensation ought to be awarded and offer a lesson to firms that they should abide by agreements.

Homer:

You think catching the flu is market failure. So there’s no point in discussiong it with you. We have been through this stuff at Catallaxy over and over and over. Stop it as it really is getting boring.

Fred Argy
Fred Argy
13 years ago

Patrick, perhaps not “a breakdown in trust” but what we have is a ridiculously high risk aversion for Australian debt securities at present. Here are some figures cited by Alan Wood in The Australian today:

* The “normal” spread between the interest rate on cash and a bank bill would be 8 to 10 basis points. Now it’s 25 to 30.

* The “normal” spread between bank bills and Australian prime residential mortgage-backed securities is 25 to 30 basis points and has recently been as low as 15 basis points. Now it’s 50 basis points.

And all this is despite our strongly capitalised low-exposed banking system and a buoyant housing market.

Bring Back CL's blog
Bring Back CL's blog
13 years ago

you are right Fred there is no rational reason for any liquidity premium in Australia given the strength of their balance sheets.

You can understand counterparty risk in the Us and the UK but not here.

just before Christmas we had 30 day libor rates in london higher than 90 day rates. In other words Banks did not believe they might get their money back after Christmas.

We still have no trading in the covered bond market in Europe which is the safest market after the Government bond sector.

Central Banks simply have not done their job.

Jc
Jc
13 years ago

Homer:
As much as I despise modern day central banks, they have actually done a decent job keeping the market open for business. They can’t compel banks to lend money to each other.

The turn of the northern hemisphere was tight; libor was way up in spread terms. However we got though it and spreads are normalizing with interbank lending return to some normality.

you are right Fred there is no rational reason for any liquidity premium in Australia given the strength of their balance sheets.
You can understand counterparty risk in the Us and the UK but not here.

Well maybe some of our regionally based banks ought not rely so much on professional market for funding. They really should not be involved in some lending areas and seem to be asking for trouble. One semi large regional bank is heavily involved in margin lending while borrowing on the professional market.

What’s wrong with this covered bond market you keep annoying everyone about Homer? And stop annoying Fred, please. Sorry Fred, Homer does this sometimes. We dont know what the hell is the matter with him.
——————

Fred:
I think you will find spreads are actually not that far off their historical levels in terms of risk spread to Govies. Its actually healthy to have risk spread widening seeing that previously the market was pricing in perfection and zero default forever (only small exaggeration).

Bring Back CL's blog
Bring Back CL's blog
13 years ago

JC you have completely missed the point.
There shouldn’t be any liquidity premium in Australia. We had no exposure to CDOs , the Banks balance sheets were solid. There was never a chance of counterparty risk yet there it was.

Indeed if you look at swap spreads it is ridiculous.

Jc
Jc
13 years ago

JC you have completely missed the point.

Why Homes? Put you best paw foward on this one.

There shouldnt be any liquidity premium in Australia.

I’m not sure I agree, even for a bank that has Central bank support. If they fund a good portion of their book on the interbank market it does create a potential problem. In times of global uncertainty would you rather give your money to Westpac, CBA that has a pretty solid funding base or Bendigo bank that funds proffessionally. Your suggestion is extraodinary. You are suggesting there should not be any credit risk diferentiiation between the banks.

We had no exposure to CDOs , the Banks balance sheets were solid.

Doesn’t matter, it’s a global market these days.

Indeed if you look at swap spreads it is ridiculous.

Not at all.

SJ
SJ
13 years ago

From the Cambria fact-free-zone again:

…I believe the US stock market more or less flatlined from about 1932 to the early 60s until the Kennedy tax cuts. I may have read that it was the same here., but not sure.

In June 1932 the Dow hit a low of 43, down from the January high of 81.

By 1933, it was back up to 102. By 1938 it was up to 152. By 1950, 235.

1957, 509.
1958, 584.
1959, 680.
1960, 641.
1961, 731.
1963, 763.
1964, 875.

Some “flatline”. And by “Kennedy tax cuts” I assume you mean the Revenue Act of 1964. Remind be again what happened on November 22, 1963?

You’re a barrow-boy, Cambria. You’ve been in the industry, but you’re just a spiv. You know the language, but you don’t understand what any of it means.

Jc
Jc
13 years ago

SJ,

What are you taking for all those angry voices that speak to inside your head, bro. LOL.

Yea, I was wrong on that, I read that recently and I was mislead. thanks for correcting the error.

Any reason for the abuse though, or is the part of the front you show to disguise your issues with envy ridden non-virtues we recetly discussed on another thread?

I was wrong on the Dow and happy to admit it. I’m still waiting for the apology on that WiKi piece you lifted pretending it was your own and forgetting to read the last bits. :-) Go on admit it, you had no idea what it meant, did you?

I’ll have that apology and retraction please and do try to ignore that vioce in your head that tells you to say angry things. Tell the voice that when you’re right the facts will speak for themsevles.

SJ
SJ
13 years ago

I’ll use Wikipedia for a change.

In psychology, psychological projection (or projection bias) is a defense mechanism in which one attributes to others ones own unacceptable or unwanted thoughts or/and emotions. Projection reduces anxiety by allowing the expression of the unwanted subconscious impulses/desires without letting the ego recognize them.

In psychopathology, projection is an especially commonly used defense mechanism in people with certain personality disorders

* Paranoid personality disorder
* Narcissistic personality disorder
* Antisocial personality disorder
* Psychopathy

Jc
Jc
13 years ago

Actually, I take it back. I retract my admission after doing some digging and restate that the Dow did basically flat line over that 30-year period. It grew at a compound rate of 3.13% while bonds returned 4.55%

The Dow opened at 244.2 on January 1st 1930 and closed at 615.89 on Dec 30 1960. Thats an astoundingly low 3.13% compound return for that 30-year period. So the point I made supporting Paul Fs contention was basically accurate in that the stock market performed dismally over that period (yes, you could broadly describe it as flatlined) and that the return would have higher investing in bonds. So as far as Im concerned 3% equity return over that whole period is dismal ( flatlined) in relative terms.

How bad? Well lets compare that the 27 years from 1980 to 2007.

The Dow closed on January 1st 1980 at 824.57 and closed on December 30 2007 at 13264.82. The return during this continuous bull market has been 10.83%: 350% higher than the same the 30 years after 1930.

Dont agree if the voice in your head tells you 1930/60 offered better returns, as it isnt true. Just ignore the voice, SJ.

Here, try to avoid the angry voices in your head and figure out the calculator by yourself.

http://www.measuringworth.com/DJA/

Now lets check to see what bond rates were doing 1930/60, shall we? Bond data from 1930 to 1960 shows that the return was 4.55%. In other words bonds returned a better rate than the stock market over that period.

http://www.measuringworth.com/datasets/interestrates/result.php

Just how low was this 30 year return? The life of the Dow from 1896 to end of 2007 show a return of 5.41% compared to 3.13% 1930 to 1960. Dismal again.

Note to self. Always check Angry Andersons facts as those voices get to him.

And thats two apologies now please along with the retraction.

Jc
Jc
13 years ago

In June 1932 the Dow hit a low of 43, down from the January high of 81.

So let’s pick the lowest rate for that dismal year and compare it to the highest rates we can extract for the later years that make those voices in your head think you’re right SL. LOL.

You know I thought you had something there and then I realized that i ought to check what you say after that abysmal attempt at lifting wiki and not even reading the last bits

I know I should go with the hunch as that angry voice always seems get the better of you especially when envy is involved. LOL.

SJ
SJ
13 years ago

I’m not going to bother checking anything in your last comment. I stand by my earlier comments, which I’ll summarise here: Barrow-boy, spiv, nutcase.

Jc
Jc
13 years ago

Im not going to bother checking anything in your last comment. I stand by my earlier comments, which Ill summarise here: Barrow-boy, spiv, nutcase.

Is this what the voice in your head is telling you to say J
You were wrong both times , so you ought to talk to that angry voice and tell it you want to show a little virtue like your opponent (moi) and admit mistakes. You have now made two incorrect assertions and refuse to retract or offer an apology.

Thanks SJ.

And remember to not speak to that voice in your head. lol.

Bring Back CL's Blog
Bring Back CL's Blog
13 years ago

JC,

I will give you the benefit of the doubt and actually believe you understand what the liquidity premium is about.

Please state any reason you like why it exists in Asutralia.

Given Australian Bank’s profitability and very strong balance sheets and the fact no one is worried about any bad debt appearing anywhere there in no rational reason for the swap spread at present.

There are legitimate reasons for counter party risk in both the USA & UK but none here.

Jc
Jc
13 years ago

Homer

For Christ sake, you’re a market economist so you ought to understand these things better than I do.
.
Under floating and the RBA’s domestic money market management, you can’t have a “liquidity” problem. You can only have “liquidity” issues under a fixed exchange rate regime. Liquidity problems can only happen (under fixed rate) when people are demanding foreign currencies with their domestic currency from the RBA causing RBA to sell bonds to obtain the funds to meet it obligations.

What we had/ have is a credit issue. People/ firms are concerned about counterpart risk and therefore will reduce lending to each other. This incidentally is normal in a changing environment that we have now compared to previously when there were oceans of global liquidity.

We have just seen the price of money rise to attract sellers (lenders). It’s a credit risk issue, Homer. The system (as I said earlier) cannot be long or short of cash, because Fred was good enough to advise we introduce a floating exchange rate.

Given Australian Banks profitability and very strong balance sheets and the fact no one is worried about any bad debt appearing anywhere there in no rational reason for the swap spread at present.

There sure is from both a historical and present day perspective. I would argue that the easy credit conditions of the recent past were the unusual period. We had junk debt could sold in the market at wafer thin margins to benchmarks! Two things are happening:

1. Counterpart risk is being reassessed.
2. Swap spreads to benchmarks are in fact normalizing

Jc
Jc
13 years ago

T

here are legitimate reasons for counter party risk in both the USA & UK but none here.

Yea? MFS, that home lender (forgot the name), ALCO, smal regional banks funding far too much on the professional market. We’ve has our share of problems here too Homermeister. On top of that, we run a fairly large C/a which means things do stiffen up against us when global risk appetite jaws begin to tighten.

Bring Back CL's blog
Bring Back CL's blog
13 years ago

JC,

just for your inflrmation any risk in the BBSW market is between banks.

Swaps spreads are in essence the risk of Aussie banks.

so we have the liquidity premuim in the short end and also in the swaps market. As I write the spreads for 10 yr swaps over Gubbies is 92 bps.
That isn’t normalising at all.

Jc
Jc
13 years ago

Homes:

I’ve seen the US 10 year at 10 basis points and 120 over. What is 92 so magical? It’s just higher than it was before.

just for your inflrmation any risk in the BBSW market is between banks.

So what, the banks have other options in terms of lending to each other. If things tighten up the credit risk of say st. George will widen to that of Westpac.

Bring Back CL's blog
Bring Back CL's blog
13 years ago

JC,

The US bonds have nothing to do with this.

It is the Aussie market we are talking about here.

hit adswap 10 index and gacgb10dex hs and look at the spread and then consider whether it has normalised.

The major point is what happened in the US shouldn’t have happened here as there was no reason for it to happen.

Fyodor
13 years ago

Homerkles,

It’s a global liquidity pool; our market is not isolated from US and European markets, and our banks rely to a material extent upon funding from offshore banks and debt investors. So long as the global system is hoarding cash, our banks will have to pay more – simple demand & supply.

Bring Back CL's blog
Bring Back CL's blog
13 years ago

Fyodor,

unfortunately that doesn’t answer the problem.

It certainly answers the problem in the USA and UK swap rates.

One might expect given the worries about Balance sheets in both countries if anything the demand for Aussie swaps would rise and the spreads would fall.

Financial markets have for a long time differentiated risk between comapnies and markets. It isn’t at present.

In terms of the line of banks lining up for funds the Aussie banks should be near the top of the queue.

To state the obvious in the US prime borrowers get loans at a lower rate than subprime borrowers.

Prime borrowers don’t pay the same rate.

Fyodor
13 years ago

Spreads have gone up pretty much everywhere, Homer.

You’re arguing that Australian bank spreads should have risen relatively less because our banks are so much safer than foreign banks. Maybe – and I think you’re probably right – however the market clearly doesn’t agree with you at this point in time. I don’t think that’s terribly unusual. From what I’ve seen there are all kinds of credit mispricings apparent right now because market participants are panicking amidst a dearth of liquidity.

Bring Back CL's blog
Bring Back CL's blog
13 years ago

Good we agree on that

Jc
Jc
13 years ago

Homer

Fyodor’s answer in 46 is about right.

You say:

It is the Aussie market we are talking about here.

Yea I know, but I had a little more familiarity with the US spreads to say Ive seen that stuff at those extremes.

What’s you point though, homer, you think it ought to be wider?

Just kidding.

You wanna see pressure?

Babcock and Brown infrastructure (you love infrastructure, Homester) is trading at a yield of around 12% and Beppa the vehicle they used to buy Alinta at around 14.5%.

(note to SJ these are only approximate and in no way should you take my advice to buy these securities if I screwed up a little with the yields, so don’t yell at me if I’m out by 14 basis points yell at Citigroup as they deserve it).

Homer You work at a place that should get decent research.

Get Goldmans global liquidity indicator that measures global risk appetite. It’s a marvel to behold in terms of watching that thing open and close it’s jaws and the effect it has on the Aussie market

Bring Back CL's blog
Bring Back CL's blog
13 years ago

JC,

the credit crunch is all about repricing risk.

Nothing has changed in Australia from pre-crunch to postcrunch re swaps market.

There is no rational reasson for swaps spreads apart from market panic