Seconding Llewellyn-Smith on Joe Hockey

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I don’t have time to write a full post on Joe Hock­ey’s call for Aus­trali­a’s banks to be brought to heel, so I’m sim­ply going to link here to David Llewellyn-Smith’s blog “Go Joe”, with which I large­ly agree. Hock­ey copped a rol­lick­ing lev­el of abuse from the stan­dard com­men­ta­tors for his call, which is one of the best indi­ca­tors that he was on to some­thing sen­si­ble.

Below are some excerpts from David’s arti­cle on Hock­ey; for the full sto­ry, please click on the link.

Yes­ter­day, Shad­ow Trea­sur­er, Joe Hock­ey, was torn to shreds for mak­ing the most sen­si­ble sug­ges­tion regard­ing Aus­tralian banks that this nation has heard since the glob­al finan­cial cri­sis…

Banks are priv­i­leged busi­ness­es like no oth­er. Their role as medi­a­tors of sav­ings and cred­it give them a vir­tu­al license to print mon­ey. Yet, this posi­tion is also cen­tral to the smooth run­ning of every dimen­sion of an econ­o­my. There is always there­fore a bal­ance to be struck between the banks’ prof­it and its duty of care…

Since the 1997 Wal­lis Inquiry the mon­i­tor­ing of that duty of care has been split in two. Deposit-tak­ing banks were gov­erned by the Aus­tralian Pru­den­tial Reg­u­la­to­ry Author­i­ty (APRA) and its rules that banks keep cer­tain lev­els of cap­i­tal in reserve in case of loss­es, and that they do not over-lever­age…

Then, when the GFC arrived, both sides of the reg­u­la­to­ry struc­ture failed…

Non-banks were found to rely heav­i­ly on cheap short-term fund­ing from investors for the long-term loans they pro­vid­ed cus­tomers. As the GFC gath­ered pace, this short-term fund­ing sud­den­ly became very expen­sive and the inter­est rate spread that under­pinned the non-banks busi­ness mod­el col­lapsed. Most were absorbed for a pit­tance by the banks.

When the cri­sis reached fever pitch after Lehman Broth­ers hur­tled off a cliff, the banks were found to have a sim­i­lar prob­lem. They had bor­rowed a huge amount of mon­ey off­shore and much of it was also of the cheap, short-term vari­ety. As glob­al mar­kets froze, nei­ther APRA nor the RBA had the fire­pow­er to con­tain the bank’s bleed­ing.

A gov­ern­ment guar­an­tee of $157 bil­lion in off­shore bor­row­ings was need­ed to stave off prob­a­ble insol­ven­cy for all major banks and a calami­ty for Aus­tralia.

So nei­ther APRA’s reg­u­la­tions nor the mar­ket’s dis­ci­pline suf­ficed to hold banks and non-banks with­in the social com­pact out­lined by Wal­lis…

But Aus­tralia is in a bind. Hock­ey’s sug­ges­tion for increased com­pe­ti­tion is to extend the nation’s AAA guar­an­tee to RMBS issues. This is a ludi­crous solu­tion for a num­ber of rea­sons, not the least being it relies on the same Wal­lis struc­ture that has just proved unac­cept­ably vul­ner­a­ble…

Besides which, a sur­feit of cred­it has already inflat­ed the great Aus­tralian hous­ing bub­ble, the most stark real eco­nom­ic con­se­quence of the fail­ure of the Wal­lis struc­ture. We don’t need more mort­gages, we need more busi­ness lend­ing.

Indeed! Part of Hock­ey’s dilem­ma in com­ing up with reform sug­ges­tions was that the bank­ing sec­tor is too big because it has lent too much to house­holds, yet at the same time bank cred­it is essen­tial for busi­ness, and a con­trac­tion of the bank­ing sec­tor would cause a cred­it crunch for busi­ness.