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.

About Steve Keen

I am Professor of Economics and Head of Economics, History and Politics at Kingston University London, and a long time critic of conventional economic thought. As well as attacking mainstream thought in Debunking Economics, I am also developing an alternative dynamic approach to economic modelling. The key issue I am tackling here is the prospect for a debt-deflation on the back of the enormous private debts accumulated globally, and our very low rate of inflation.
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  • debtjunkies

    mfo,

    The only time a busi­ness should bor­row to invest is to help them­selves, not the econ­omy.

    That said, imag­ine if you did bor­row to invest in new pro­duc­tiv­ity mea­sures. This should then enable you to reduce costs and there­fore become more com­pet­i­tive inso­far as you can reduce your prices thereby the­o­ret­i­cally increas­ing mar­ket share.

    If you can main­tain this strat­egy and your busi­ness has good cash flow then the end game is to be one of the last stand­ing.

    Per­son­ally I think now is a great time to invest in capac­ity and for future poten­tial gains. All around you hear about strug­gling busi­nesses. If you are not one of those and you have cash or the banks will lend you money (yes they are lend­ing) then counter cycli­cal invest­ing can mean that you are in a much stronger posi­tion to max­imise poten­tial gains when activ­ity picks up as it always does…eventually.

  • mfo

    Debtjunkies

    I’m just a small fish(very small with a lot of cash and no debt) in a big pond with very big fish with big debts and over­heads.
    Trou­ble is many of these big fish are being sup­ported with stim­u­las money. They have also pur­chased the best in equip­ment thanks to Gov­ern­ment incen­tives.
    My plan is, if Steve is cor­rect and prop­erty falls as it is every­where else, these firms will go belly up. When that hap­pens, I’ll buy their equip­ment from the receivers at fire­sale prices with cash.
    The risk is, in a war of attri­tion when there is more sup­ply than demand and you enter a price war, those on Gov­ern­ment life sup­port will win over those with­out, no mat­ter how poorly they are man­aged.
    I’m still bet­ting we will have a major cor­rec­tion in house prices send­ing my com­peti­tors to the wall because all they see ahead is blue sky and calm seas.
    For many fam­i­lies, they work inse­cure jobs on wages less than $50k. They go to bed each night won­der­ing where their next dol­lar is com­ing from or if they will still have a job next week. The only cer­tainty is that they have to find huge sums of money each month for the next 10–20 years to pay down debt. Ill­ness , divorce, loss of hours or work, preg­nancy- any­thing like that hap­pens (not to men­tion exter­nal factors)you’re gone. It’s only a mat­ter of time. 

    (I believe banks are lend­ing to busi­ness only if they have prop­erty equity as secu­rity.)

  • mfo
    I have just attended a con­fer­ence odf small busi­ness bro­kers Aus­tralia wide in Ter­ri­gal NSW for 4 days 

    My back­ground is own­ing small busi­ness for 20 years and advi­sory fro 10. Bro­ker for 8 

    Yes, it’s tough out there and not going the same as the rest of the econ­omy is being reported, not sure if MSM has a clue am sure Govt’s don’t.

    Receivers are not being appointed by the Banks. THis fact I know for I used to do their work None at the moment. More likely they will con­tinue to let SME’s hang out to dry if they have NEGATIVE EQUITY, they believe some­body else will call it in and the Banks have the secu­rity.
    I too am “cashed” up and I think it is a pro­longed process and not nec­es­sar­ily a guar­an­teed one that will give you what you expect.

    If you wish to you can give me a call I would love to dis­cuss the sit­u­a­tion with you. No not for busi­ness just mutual con­cerns for I don’t know many sme’s that post this site.
    Click on gaday for con­tact

  • mfo

    Gaday

    Thanks for that. Will call. Cheers.

  • BH

    Jonathon (17),

    I’m hav­ing trou­ble rec­on­cil­ing this need for Aus­tralian banks to bor­row from over­seas with the con­cept of banks being able to cre­ate credit.”

    Just been ask­ing that ques­tion in “Delever­ag­ing, Decel­er­a­tion and the Dou­ble Dip”. After think­ing on the response and dis­cussing with my wife I think the answer is sim­ply bank mar­gins. The banks get a bet­ter mar­gin going off­shore than home.

  • mar­venger1

    BH

    I haven’t read the answer in the other post but I imag­ine its because the banks have to aquire the for­eign cur­rency that we pur­chase from them in order to import. Due to the imports being greater than exports, in aggre­gate that is debt aus­tralians are tak­ing on but it can’t be financed out of money cre­ated from thin air beca­sue it is for­eign cur­rency, it has to bought in for­eign mar­kets.

  • Paul Andrews

    Jonathon @ 17:

    West­pac loans Fred $1000: it is now owed $1000 by Fred (the loan), and it now owes $1000 to Fred (the deposit).

    If Fred buys some­thing from Bar­ney for $1000 and Bar­ney also has a West­pac account, West­pac now owes Bar­ney $1000.

    If Bar­ney now buys some­thing from Wilma, who has a CBA account, West­pac now owes CBA $1000, and CBA owes Wilma $1000.

    If Wilma now imports some­thing worth $1000 from Betty who banks at the Bank of China, CBA now owes the Bank of China $1000, and the Bank of China owes Betty $1000.

    CBA now owes Bank of China $1000, i.e. they are bor­row­ing over­seas.

    If there were no con­tracts and agree­ments in place between all the bank­ing par­ties, this could not hap­pen. Off-shore loan arrange­ments are part of these, and need to be nego­ti­ated, main­tained and rene­go­ti­ated to allow the process to con­tinue.

    Even though the bank can essen­tially cre­ate credit out of noth­ing, they only “own” (i.e. “earn”) the lit­tle bit of inter­est dif­fer­en­tial that exists between what Fred pays them and what they pay CBA (the inter-bank rate). The credit they cre­ate is largely off­set by the debt they cre­ate, and often that debt ends up off-shore.

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  • DrBob127

    For any­one inter­ested the lat­est free Residex spruik is out:

    http://www.residex.com.au/newsletter/source2010_10aMC.html?content=wrap&from=news1010a

    You know things are tight­en­ing when they start say­ing thinks like:

    What this data tells us is that while un-afford­abil­ity is not at its worst posi­tion although it is get­ting there and will not take too many inter­est rate increases to reach the point where the Reserve Bank would need to exer­cise extreme cau­tion.

    Given the above, as investors we need to be sig­nif­i­cantly savvier than we have been in the past.”

    Savvy enough to wait and see? Park your cap­i­tal in the bank, at least that is cov­ered by the govt guar­an­tee until late next year

  • mahaish

    yes bh,

    the greater the lever­age the bank has the greater the profit,

    there are two sources of fund­ing for banks, equity, and lia­bil­i­ties in the form of deposits and whole­sale fund­ing

    banks can only gear up their deposit base so much to meet the fund­ing requirments of the pri­vate sec­tor.

    thats why they com­pete for deposits which is a tough gig for them given com­pe­ti­tion from our super annu­a­tion sys­tem, and also why they obtain fund­ing off­shore.

    they obtain off­shore fund­ing by issu­ing secu­ri­ties of vary­ing matu­ri­ties, in for­eign cur­ren­cies, which they try and hedge by under tak­ing var­i­ous foreign/local cur­rency swap arrange­ments.

    the vast bulk of secu­ri­ties issued have matu­ri­ties between 2 and 5 years, the longer the bet­ter one pre­sumes

    whether its a good idea to let them do it, well thats another mat­ter,

    far as im con­cerned its a dan­ger­ous game, and they should be pre­vented from doing so. hedg­ing is all well and good, but one day you are going to get caught out either on the orig­i­nal trans­ac­tion or the swap.

    and obvi­ously theres rollover risk, which reard its ugly head at the hight of the gfc, which required a gov­ern­ment gau­ran­tee to over­come

    and besides, if the banks need addi­tional fund­ing, i cant see why the gov­ern­ment cant set up a fund­ing vehi­cle and pur­chase the secu­ti­ties them­selves, in our cur­rency.

    thats my under­stand­ing of it from 30,000 feet, oth­ers may wish to cor­rect me if ive led peo­ple astray

  • mahaish

    Gov­ern­ment bor­row­ing crowd­ing out pri­vate invest­ment is true in a nor­mal envi­ron­ment”

    hi marv,

    a gov­ern­ment deficit pro­vides the fund­ing for the pur­chase of the gov­ern­ment bonds(government debt)

    the gov­ern­ment issues the cur­rency into the econ­omy, and then takes some of it back to meet its mon­e­tary objec­tives.

    theres no crowd­ing out,

    infact there is pretty strong rela­tion­ship between gov­ern­ment deficits and ris­ing pri­vate sec­tor sav­ings

  • mahaish

    If we have a sav­ings rate close to zero, then we must import most of that cap­i­tal”

    good point btb, couldnt agree more,

    and gov­ern­ment sur­pluses dont help the sav­ings rate, no mat­ter how much national income account­ing is dis­torted and mis­repere­sented under igbc(inter tem­po­ral gov­ern­ment bud­getary con­straint).

    gov­ern­ment sav­ing isnt good for national sav­ing

  • mfo said: “As a small busi­ness oper­a­tor I con­stantly read that I should bor­row to invest in new plant and equip­ment to help the econ­omy.… But I can’t sell what I pro­duce already… so bor­row­ing to invest at this point of time is crazy.”

    When you invest, the eco­nomic stim­u­lus has a neg­li­gi­ble effect on demand for what you pro­duce. But if every­one invests, then does not the new invest­ment in pro­duc­tion cre­ate it’s own demand? And if that is so, what kind of gov­ern­ment mea­sure, tax cuts, or what­ever, would induce a broadly based invest­ment boom?

    Mar­venger1 said: “the type of gov spend­ing is cru­cial, if its pro­duc­tive it will cost a lot less, per­haps even more than pay for itself. Yeah I know I don’t like the chances of that hap­pen­ing…”

    Well is there any chance at all of “that hap­pen­ing,” and if so, how? Does any­one have some sug­ges­tions. In the UK, one might sug­gest bull­doz­ing the whole place, pretty well — at least every­thing build since 1945, and build­ing rea­son­ably intel­li­gently designed com­mu­ni­ties with rea­son­able energy effi­cient hous­ing and trans­porta­tion, etc. Would that not yield a return on invest­ment (i.e., from energy con­ser­va­tion, travel time con­ser­va­tion, pol­lu­tion reduc­tion, etc.)? 

    But in the back of my mind I see Steve’s chart of expon­tential debt growth since 1945. Can this curve be pushed ever upwards until debt expands faster than the speed of light?

  • TruthIs­ThereIs­NoTruth

    BH @35

    Credit cre­ation is an effec­tive the­ory. An effec­tive the­ory is one which can repro­duce some observed behav­iour but it is not an exact model of what pro­duces the actual obser­va­tions in the first place. 

    I think you have to be care­ful with this the­ory first kind of think­ing. That is, imply­ing cer­tain behav­iour from an effec­tive the­ory.

    Credit cre­ation is a clas­sic exam­ple and your post rep­re­sen­ti­tive of this kind of think­ing.

    In real­ity banks don’t con­sciously cre­ate credit indis­crim­i­nantly. Under very strict assump­tions of fric­tion­less cap­i­tal mar­kets and zero risk this might be the case. In real­ity what hap­pens is that banks source fund­ing from a diver­sity of cap­i­tal mar­kets attempt­ing to steer to those which is cheap­est. Cap­i­tal mar­kets are very much demand dri­ven, there is a cer­tain allo­ca­tion of funds for bank paper from investors. If a bank wanted to issue beyond this demand they have to offer more attrac­tive rates, so by going over­seas they increase the over­all pool of demand for bank paper. If they were restricted to fund­ing in Aus­tralia, there is sim­ply not enough demand here which means not enough liq­uid­ity and when mar­ket liq­uid­ity dries up you start to get large price volatil­ity, this would lead to a dra­matic increase in the cost of funds.

    On the lend­ing side, bank lend­ing is lim­ited by per­ceived risk. The more you lend the higher the mar­ginal risk, its a no brainer, and I would give some credit to Aus­tralian banks risk assess­ment abil­ity based on their GFC per­for­mance.

    So in the real world the real con­straints are ris­ing mar­ginal cost of funds and ris­ing mar­ginal risk in lend­ing.

  • ned

    I think this is also due to the pur­chase of imported goods, for exam­ple just say you sell your house and use some of the profit to buy a new BMW. That money leaves Oz for Ger­many, leav­ing the banks short of deposits that they now need to find some­where over­seas.

  • TruthIs­ThereIs­NoTruth

    ned, there is enough money in the coun­try to cover bank­ing needs, but it is not all invested into banks. If local funds increased the allo­ca­tion to bank paper by enough there would be enough cap­i­tal to cover, but it would have to dis­ap­pear from else­where such as the stock mar­ket or pri­vate equity or a whole range of other ways funds use their money.

    Why do banks go over­seas? Because they can.

  • Jason Mur­phy

    Folks — 3 words:

    Cur­rent Account Deficit

  • Gam­ma_home

    The banks go over­seas because they have to. There is not enough appetite amongst Aus­tralian investors. All the funds are full to gills with Aussie bank paper.

    Jonathon @ 17:
    “I’m hav­ing trou­ble rec­on­cil­ing this need for Aus­tralian banks to bor­row from over­seas with the con­cept of banks being able to cre­ate credit. If Aus­tralian banks can just cre­ate credit (pre­sum­ably by writ­ing loans to busi­nesses and home-own­ers) why do they need to go off­shore for fund­ing? Doesn’t this credit then feed back into the bank­ing sys­tem as deposits? What am I miss­ing?”

    When the banks make loans they cre­ate “cur­rent” deposits…money which is avail­able to be with­drawn from that account at very short notice. They can only tol­er­ate a cer­tain por­tion of their lia­bil­i­ties in cur­rent accounts. They need the vast pro­por­tion of it to be in term deposits or bonds. So when banks “source” fund­ing what they are actu­ally doing is turn­ing cur­rent deposits into term deposits or bonds. They often have to go off­shore to find enough will­ing hold­ers of this term debt.

  • TruthIs­ThereIs­NoTruth

    good point gam­ma_home

    the key in the con­text of this con­ver­sa­tion is that whilst there is not enough appetite for bank paper, that does not mean there is not enough cap­i­tal.

    I think what we may have stum­bled on, which maybe be obvi­ous to some already, is that there is a damp­en­ing effect in the credit cre­ation cycle. Quite clearly only some per­cent­age of the money ‘cre­ated’ by loans ends up back in the banks. So maybe some of the engi­neers can answer what is the sys­tem impact if we include this damp­en­ing or leak­age.

    So the cre­ated money has to churn through the sys­tem and end up as longer term fund­ing. Slightly dif­fer­ent pic­ture to the instant cre­ation of deposits by loans, which hap­pens at incep­tion, but then peo­ple go and do stuff with that money, the banks have no claim on that deposit and where it goes. So really given that from a bank’s per­spec­tive, they are lim­ited by what the depositers are will­ing to ‘give back’ which is con­sis­tent with observed behav­iour at the coal face. I can accept credit cre­ation as a two way street, but I reject any con­cept of it being dri­ven entirely by the banks.

  • ak

    Joe is not back­ing off, he prob­a­bly knows that all he need to do is to wait:
    http://www.smh.com.au/business/hockey-steps-up-fight-with-big-banks-20101029-177m0.html

    A lit­tle (20%) drop in house prices and the so-called “pro­gres­sive” neolib­er­als (also called the ALP) are toasted. 

    In the cur­rent polit­i­cal con­fig­u­ra­tion they may be pre­vented from reflat­ing the prices unless some­thing dra­matic hap­pens over­seas.

  • hopetobedr­joe

    There was a car­toon in the Her­ald of all papers today which was call­ing Hockey a com­mu­nist! A com­mu­nist, no less! For propos­ing that we actu­ally reg­u­late inter­est rates! In the wake of the worst cri­sis since the great depres­sion!

    In times gone past I must say that my thoughts on Joe Hockey, the Lib­eral Party’s chief axe­man on gov­ern­ment spend­ing and before that Min­is­ter for Employ­ment and Work­place Rela­tions in the dying days of Work­Choices, echoed the immor­tal words of Bill Hicks: “every­thing you say is like a turd drop­ping into my drink”.

    Now he finally says some­thing emi­nently sen­si­ble and he is vil­li­fied on both sides of pol­i­tics AND in a sup­pos­edly mod­er­ate news pub­li­ca­tion (you would just expect that sort of thing from the Aus­tralian). What is this mad­ness?

    I must say that the world is com­pletely puz­zling to me right now. Julia Gillard, head of a pro­gres­sive gov­ern­ment, refused to even engage in a dis­cus­sion on whether we might have been a bit over­en­thu­si­as­tic in embrac­ing free trade even though it might have helped her sure up a deal with Bob Kat­tar. The Amer­i­cans had (have) some of the worst health­care in the devel­oped world with some of the biggest spend­ing, yet Obama had to fight tooth and nail to get some sort of reform. Now his administration’s under threat from a bunch of red­necks who think they can just cut the life­line of gov­ern­ment spend­ing and want to dereg­u­late fur­ther. And lis­ten­ing to the BBC world news all I seem to hear about is the over­whelm­ing con­sen­sus about the need to impose ‘aus­ter­ity’ mea­sures in an already eco­nom­i­cally aus­tere cli­mate. The per­sis­tence of bad ideas in the face of over­whelm­ing evi­dence is rather dis­heart­en­ing. Steve, keep up the good work, hope­fully they will come around even­tu­ally…

    Ok sorry rant over.