Com­pe­ti­tion is not a panacea in bank­ing

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Inquiry into com­pe­ti­tion within the Aus­tralian bank­ing sec­tor

Sub­mis­sion by Asso­ciate Pro­fes­sor Steve Keen, School of Eco­nom­ics & Finance, Uni­ver­sity of West­ern Syd­ney;

The Aus­tralian Senate’s Stand­ing Com­mit­tee on Eco­nom­ics has estab­lished an inquiry into com­pe­ti­tion in the bank­ing sec­tor, and I was invited by the Com­mit­tee to make a sub­mis­sion. Click here for the PDF of my sub­mis­sion. The RBA’s sub­mis­sion is linked here. All sub­mis­sions to the inquiry are avail­able here.

Request to submit

I thank the com­mit­tee for invit­ing me to make a sub­mis­sion. As noted below, the focus of my sub­mis­sion is point (m) in the terms of ref­er­ence, “any other related mat­ter”, since as I argue below, past attempts to improve bank­ing via increased com­pe­ti­tion have actu­ally exac­er­bated the main prob­lem in bank­ing: the ten­dency for banks to fund spec­u­la­tive bub­bles.

Executive Summary

The major prob­lems of the finan­cial sec­tor are macro­eco­nomic and related to the level of debt, rather than micro­eco­nomic and related to the price of debt. These are that:

  1. Banks have an innate desire to issue more debt than is good for the econ­omy as a whole, and increased com­pe­ti­tion tends to exac­er­bate this ten­dency rather than con­trol it;
  2. As a con­se­quence of (a), debt has grown inex­orably rel­a­tive to incomes until the finan­cial cri­sis began. This expan­sion of debt caused the appar­ent boom prior to the cri­sis, while the slow­down in the rate of growth of debt is the pre­dom­i­nant cause of the cri­sis itself;
  3. Banks are lend­ing too much to house­holds and too lit­tle to busi­ness; and
  4. Lend­ing has been ori­ented towards financ­ing spec­u­la­tion rather than invest­ment and the work­ing cap­i­tal needs of busi­ness.

Increas­ing com­pe­ti­tion once again, with­out ensur­ing that lend­ing is restrained rel­a­tive to incomes, and that it is directed away from house­holds and spec­u­la­tion and towards busi­ness and invest­ment, would only exac­er­bate prob­lems caused by ear­lier intro­duc­tions of unbri­dled com­pe­ti­tion in the 1980s and 1990s.

The focus of pol­icy on bank­ing there­fore needs to shift from the micro­eco­nomic issues of the degree of com­pet­i­tive­ness and so on to the macro­eco­nomic issues of the impact of debt on the econ­omy. In par­tic­u­lar, we need an effec­tive means to con­trol the bank­ing sector’s ten­dency to cre­ate too much debt—a ten­dency that increased com­pe­ti­tion tends to make amplify rather than atten­u­ate.

The one com­pet­i­tive reform I would sug­gest is to licence local banks to exclu­sively lend to small busi­ness to pro­vide work­ing cap­i­tal, where lend­ing can­not be secured against mort­gaged prop­erty.


Econ­o­mists and politi­cians have a ten­dency to per­ceive prob­lems in bank­ing as being ones of micro­eco­nom­ics and effi­ciency, because stan­dard eco­nomic analy­sis regards bank­ing and the level of pri­vate debt as hav­ing lit­tle or no macro­eco­nomic impli­ca­tions.

This belief is reflected in the terms of ref­er­ence for this inquiry, which has arisen because the gen­eral pub­lic and the non-bank busi­ness sec­tor have been com­plain­ing about the impact of the bank­ing sec­tor on their lives and liveli­hoods. All of the terms of ref­er­ence, save the catch-all final one of “(m) any other related mat­ter”, con­sider micro­eco­nomic top­ics of such as “(a) … com­pe­ti­tion, (b) .. prod­ucts … fees and charges…” and so on. The focus is on com­pe­ti­tion and the prices of the prod­ucts that banks pro­vide, rather than on the macro­eco­nomic impact of banks and their fun­da­men­tal prod­uct, which is debt-based money.

I believe that this con­ven­tional view is mis­in­formed. Though the micro­eco­nomic issues are of some impor­tance, they are triv­ial com­pared to the issues of the vol­ume of debt that the banks cre­ate, and its effect upon macro­eco­nomic per­for­mance and asset prices.

To estab­lish this, I will first review the his­tory of two pre­vi­ous attempts to reform the bank­ing sec­tor by increas­ing the level of com­pe­ti­tion. Both of these had only tran­sient impacts upon the price of debt, but caused a last­ing increase in the level of debt, and made the Aus­tralian macro­econ­omy even more sub­ject to the dele­te­ri­ous dynam­ics of debt than it had been pre­vi­ously.

The past failures of increased competition in the finance sector

Recent crit­i­cism of banks has focused on the increase in vari­able mort­gage rates by more than the RBA’s increase in the cash rate since the “Global Finan­cial Cri­sis” (GFC) hit in 2008. How­ever, while the mar­gin between mort­gage rates and the cash rate has risen com­pared to post-Wal­lis Com­mit­tee lev­els, it is still below the level that applied prior to the Wal­lis reforms, which encour­aged a sub­stan­tial expan­sion in mort­gage lend­ing com­pe­ti­tion by secu­ri­tised lenders. As Fig­ure 1 indi­cates, after the econ­omy had recov­ered from “the reces­sion we had to have”, but before the Wal­lis reforms were intro­duced, the mar­gin var­ied between a low of 3 per­cent and a high of 5. It is now back to 3 per­cent.

Thus though the mar­gin has increased sub­stan­tially since the GFC hit (from 1.8 to 3 per­cent, a 67% increase in 2.7 years), this has only restored mar­gins to what they were prior to the last time the finance sec­tor was reformed to intro­duce more com­pe­ti­tion (in line with the rec­om­men­da­tions of the Wal­lis Com­mit­tee).

Fig­ure 1: Rela­tion­ship between mort­gage rates and RBA cash rate since 1990

Then, as now, increased com­pe­ti­tion was expected to ben­e­fit cus­tomers via lower costs. The Wal­lis Com­mit­tee described the com­pet­i­tive intent of its reforms in the fol­low­ing way:

The Inquiry has not pur­sued change for its own sake, but has sought an appro­pri­ate bal­ance between achiev­ing com­pet­i­tive out­comes and ensur­ing finan­cial safety and mar­ket integrity. In par­tic­u­lar, its rec­om­men­da­tions seek to…:

  • ensure that reg­u­la­tion of sim­i­lar finan­cial prod­ucts is more con­sis­tent and pro­motes com­pe­ti­tion by improv­ing com­pa­ra­bil­ity;
  • intro­duce greater com­pet­i­tive neu­tral­ity across the finan­cial sys­tem;
  • estab­lish more con­testable, effi­cient, and fair finan­cial mar­kets result­ing in reduced costs to con­sumers;
  • pro­vide more effec­tive reg­u­la­tion for finan­cial con­glom­er­ates which will also facil­i­tate com­pe­ti­tion and effi­ciency; and
  • facil­i­tate the inter­na­tional com­pet­i­tive­ness of the Aus­tralian finan­cial sys­tem.

Pre­cise pre­dic­tion of the direc­tion and per­for­mance of the finan­cial sys­tem can­not be made. How­ever, the Inquiry is con­fi­dent that imple­men­ta­tion of its rec­om­men­da­tions will place Australia’s finan­cial insti­tu­tions and mar­kets in a strong posi­tion to adapt to change and to respond to the ever increas­ing com­pet­i­tive pres­sures which lie ahead. (Stan Wal­lis et al., 1997, p. 2)

The main com­pet­i­tive impact of the Wal­lis Com­mit­tee rec­om­men­da­tions was to accel­er­ate the growth of secu­ri­tised lend­ing. As Fig­ure 1 indi­cates, this did indeed reduce costs for con­sumers, in terms of the mar­gin between offi­cial and mar­ket inter­est rates. But the tran­sient nature of this com­pet­i­tive ben­e­fit, the fact that its unwind­ing coin­cided with the most severe inter­na­tional finan­cial cri­sis since the Great Depres­sion, and the pub­lic anger at banks today, indi­cates that com­pe­ti­tion did not func­tion entirely in the man­ner expected by the Wal­lis Com­mit­tee.

The markup on the cost of funds itself was low­ered not so much by an increase in effi­ciency, as by a diminu­tion of qual­ity, as essen­tial costs were cut in a com­pet­i­tive race for mar­ket share—a com­pe­ti­tion which also increased the aggre­gate hous­ing loans to GDP ratio.

As the National Direc­tor of the Aus­tralian Prop­erty Insti­tute noted to the House of Rep­re­sen­ta­tives hear­ing into Home loan lend­ing prac­tices and processes, detailed prop­erty val­u­a­tions have been replaced by “drive by” checks that do no more than con­firm via a “cur­sory glance” that a prop­erty had a dwelling on it:

what we have seen, par­tic­u­larly from a val­u­a­tion point of view, is that the asset test that many of the ADIs state they under­take, they quite lit­er­ally do not under­take. We do not have val­uers going out doing asset tests on all loans that are under­taken by finan­cial insti­tu­tions. Some banks get their own either ex-man­agers to drive by to see if the actual house exists or we have a lower form of val­u­a­tion being under­taken.

These days it is get­ting to the point where you actu­ally have the val­uer who would not actu­ally even see if the house or asset existed in the first place. You have a drive-by which is at best a cur­sory glance to see if there is a prop­erty on the lot that has been pur­chased. (Mr Warner, Stand­ing Com­mit­tee On Eco­nom­ics Finance And Pub­lic Admin­is­tra­tion, 2007, p. 34)

Sim­i­larly, detailed eval­u­a­tions of the borrower’s capac­ity to ser­vice a loan, and a com­mit­ment to keep loan repay­ments below 30% of gross bor­rower income, were replaced by auto­mated checks that the bor­rower had suf­fi­cient income left after loan repay­ments to be just above the Hen­der­son poverty line. As APRA’s Gen­eral Man­ager for Indus­try and Tech­ni­cal Ser­vices, Heidi Richards, told the Com­mit­tee:

Our research has also con­firmed that ADIs have mate­ri­ally increased the max­i­mum amount they are will­ing to lend to a given bor­rower. The increase has come about in a shift away from tra­di­tional debt-ser­vic­ing ratios based on sim­ple gross bor­rower income cal­cu­la­tions. In the newer income sur­plus mod­els bor­row­ers are assumed to con­tinue repay­ing their mort­gage until they reach a min­i­mum level of house­hold expen­di­ture, with these min­i­mum lev­els often based on poverty level mea­sures.

The tra­di­tional rule of thumb was that debt-ser­vic­ing expenses should amount to no more than 30 per cent of gross bor­rower income but, based on a review of lend­ing poli­cies that APRA con­ducted last year, we found that loans with debt-ser­vic­ing ratios above 30 per cent are now often well within ADIs’ pol­icy para­me­ters. (Ms Richards, Stand­ing Com­mit­tee On Eco­nom­ics Finance And Pub­lic Admin­is­tra­tion, 2007, p. 5)

The lower mar­gins between mort­gage rates and the cash rate that con­sumers tem­porar­ily enjoyed between 1997 and 2008 were thus achieved largely through a drop in the qual­ity of the mort­gage prod­uct. This, and the dra­matic increase in the level of debt, allowed loan to val­u­a­tion ratios to blow out from the con­ser­v­a­tive 70% of the 1960s and early 1970s to the 97% lev­els on offer today. This dra­matic increase in the size of mort­gages rel­a­tive to incomes (and con­se­quent drop in the ini­tial equity that bor­row­ers have in their prop­er­ties) has meant an enor­mous increase in cost of ser­vic­ing mort­gages, despite lower mar­gins. This is the main rea­son that banks are the sub­ject of such intense pub­lic oppro­brium today.

At the aggre­gate level, the drop in mort­gage qual­ity caused an explo­sion in unpro­duc­tive lend­ing to the house­hold sec­tor, the same phe­nom­e­non that in the USA fuelled an appar­ent boom known as “The Great Mod­er­a­tion”, which ended in the finan­cial col­lapse that Amer­i­can econ­o­mists now call “The Great Reces­sion”. Though the mar­gin between mort­gage rates and the cash rate fell by 50 per­cent rel­a­tive to 1992 lev­els, the vol­ume of mort­gages rose four­fold (see Fig­ure 2). This increase in the vol­ume of debt rel­a­tive to GDP is the pri­mary rea­son that bank prof­its have increased: had the impact of addi­tional com­pe­ti­tion only been to affect the mar­gin between the banks’ cost of funds and the RBA rate, then bank profits—and there­fore the cost of debt to consumers—would be lower today than prior to the Wal­lis reforms.

Fig­ure 2: A halv­ing of mort­gage mar­gins, a four­fold increase in vol­umes

In the after­math of the finan­cial cri­sis, all the secu­ri­tised lenders have either col­lapsed, or have been taken over by the four major banks: com­pe­ti­tion has given way to oligopoly—as it did in the 1980s. Mar­gins on all classes of loans (except those to large busi­nesses) have risen, but only in the case of per­sonal loans are these mar­gins gen­er­ally higher than applied in the pre-Wal­lis period. As Fig­ure 3 indi­cates, though the recent focus has been on the 1.1% increase in the mort­gage mar­gin, the mar­gin has risen most aggres­sively on per­sonal loans—where it is up 3.7%–while the small busi­ness loan mar­gin has risen 1.8%.

Fig­ure 3: Mar­gin of aver­age loan rates above RBA rate

Falling margins and rising volumes—too much debt

Com­pe­ti­tion thus ini­tially reduced mar­gins, only to have them rise once more—so that the ben­e­fits of com­pe­ti­tion proved tran­sient.

The drop in the qual­ity of loan assess­ment led to an explo­sion in the vol­ume of debt, most of which financed spec­u­la­tion rather than invest­ment. The last­ing impact of the reforms was to sus­tain the ten­dency that the bank­ing sec­tor had already demon­strated even prior to the attempts by gov­ern­ments to reform it via increased com­pe­ti­tion, to increase the level of pri­vate debt com­pared to income. While inter­est rates have var­ied wildly and widely over time, the level of debt com­pared to GDP has risen almost inex­orably prior to the Global Finan­cial Crisis—after 20 years of sta­bil­ity between 1945 and 1965 (see Fig­ure 4).

Fig­ure 4: The real rea­son that bank­ing is a prob­lem today is the blowout in the ratio of debt to GDP

Though the drop in mar­gins was tran­sient, the increase in the vol­ume of debt car­ried by the hous­ing sec­tor was sub­stan­tial and, if not per­ma­nent, much more endur­ing: as Fig­ure 5 indi­cates, whereas it would have taken a mere 2 months of GDP to repay all out­stand­ing mort­gage debt in 1990, it would take more than 10 months of GDP to do the same today.

Fig­ure 5: Vary­ing sec­toral debt lev­els over time

This increase in debt could have been pro­duc­tive had it increased the stock of hous­ing, or improved its qual­ity sub­stan­tially. How­ever though Aus­tralian houses have grown dra­mat­i­cally in size—resulting in so-called “McMansions”—the pro­por­tion of mort­gage debt that has financed con­struc­tion of new homes has fallen from 60 per­cent for investors in the late 1980s to barely 5 per­cent today, while the pro­por­tion of owner-occu­pier loans that financed con­struc­tion has fallen from 20 per­cent to about ten per­cent (see Fig­ure 6; the recent increase was clearly due to the tripling of the First Home Own­ers Grant for new dwelling con­struc­tion, and that is now rapidly revers­ing since the Boost has ter­mi­nated).

By impli­ca­tion, the vast major­ity of mort­gage finance has financed spec­u­la­tion on the prices of exist­ing prop­er­ties, dri­ving up house prices with­out adding to the hous­ing stock of the coun­try.

Fig­ure 6: Per­cent of hous­ing loans financ­ing con­struc­tion

Though the increase in prices has made house­holds feel wealth­ier, the increase in the real debt per house has far exceeded the increase in the CPI-deflated house price index. As Fig­ure 7 shows, though house prices have risen by a fac­tor of 2.5 in real terms since 1977, the CPI-deflated debt level has risen more than 4 times as much. The diver­gence between the debt level per house and house prices began in 1990—before the Wal­lis reforms were introduced—but the rate of diver­gence increased after Wal­lis encour­aged the growth of secu­ri­tized lend­ing.

Fig­ure 7: Increase in debt per house and house price

Thus even though house prices have risen sub­stan­tially, house­hold equity in houses has fallen over the last 2 decades—from above 90 per­cent in the late 1980s to under 70 per­cent (see Fig­ure 8; the sig­nif­i­cant rise in the last two years has been caused by the increase in house prices sparked by the First Home Own­ers Boost). This equity is now extremely depen­dent on house prices remain­ing high, since though debt has dri­ven house prices up, debt will not fall if house prices fall.

Fig­ure 8: Value of house­hold assets minus mort­gage debt

As equity has fallen, the cost of enter­ing the mar­ket has risen. Those who have recently entered the mar­ket have had to devote a pro­hib­i­tive por­tion of their incomes to ser­vic­ing their mort­gage, while those con­sid­er­ing enter­ing must con­tem­plate a daunt­ing level of debt com­pared to their incomes.

As a result, hous­ing afford­abil­ity has dete­ri­o­rated sharply: the claim that many prop­erty lob­by­ists and banks make that it has not is sim­ply absurd. Fig­ure 9 shows the ratio of the aver­age loan taken out by a first home buyer to the aver­age wage, which has risen from just over 2.5 in 1992 to as much as 6 in 2009.

Some com­men­ta­tors have claimed that this rise in the size of mort­gages com­pared to incomes was just a con­se­quence of falling mort­gage rates: as rates fell, the level of debt taken on rose, leav­ing the cost of ser­vic­ing the debt con­stant. RBA Gov­er­nor Glenn Stevens made pre­cisely this claim to the House of Rep­re­sen­ta­tives Stand­ing Com­mit­tee on Eco­nom­ics, Finance and Pub­lic Admin­is­tra­tion in 2007:

The rough sta­tis­tic that I have quoted many times was that the aver­age rate of inter­est was about half; that meant you could ser­vice twice as big a debt. Guess what? That is exactly what occurred, and that had a very pro­found effect on asset val­ues. (Glenn Stevens, remarks to the House of Rep­re­sen­ta­tives Stand­ing Com­mit­tee on Eco­nom­ics Finance and Pub­lic Admin­is­tra­tion, 2007, p. 26)

Though there were peri­ods where this was the case, Fig­ure 9 shows that in gen­eral this was not true. Debt lev­els did rise as rates gen­er­ally fell from 1990–1998, but since then debt lev­els have almost dou­bled com­pared to incomes, while mort­gage rates are higher now than then.

Fig­ure 9: Ratio of the aver­age first home loan to the aver­age yearly wage

A focus on the inter­est costs of debt also under­states the prob­lem, since as debt lev­els rise rel­a­tive to income the cost of pay­ing down the prin­ci­pal over time rises more than the inter­est rate cost alone. On this basis it is unde­ni­able that the increase in the vol­ume of mort­gages, which was the main last­ing impact of increased com­pe­ti­tion, has made Aus­tralians worse off. Fig­ure 10 shows that in 1996, prior to the Wal­lis reforms, the aver­age first home loan could be ser­viced with 30 per­cent of the after tax salary of the aver­age wage earner; today, the fig­ure is 80 per­cent. It is no longer fea­si­ble for a sin­gle per­son on the aver­age wage to buy a dwelling today, and even a cou­ple has to devote more of their take home pay to ser­vic­ing a mort­gage than an indi­vid­ual did just 15 years ago.

Fig­ure 10: 80 per­cent of the aver­age wage needed to ser­vice a first home loan

The dele­te­ri­ous impacts of increased com­pe­ti­tion in lend­ing to the house­hold sec­tor have clearly out­weighed the ben­e­fits. The one ben­e­fit was that the mar­gin between mort­gage rates and the cash rate halved for a decade, but it has now reverted to three-quar­ters of the pre-Wal­lis value. Real house prices have dou­bled, mak­ing some house­holds (espe­cially those who own their houses out­right) wealth­ier, but debt has increased four­fold, and in the aggre­gate house­hold equity in prop­erty has fallen.

Competition’s history of excess in banking

A sim­i­lar process applied the pre­vi­ous time that a mas­sive boost to com­pe­ti­tion was intro­duced into the finan­cial sector—in Feb­ru­ary 1985, when Paul Keat­ing per­suaded the Hawke Labor Gov­ern­ment to intro­duce not merely 4 for­eign banks into the Aus­tralian mar­ket, but six­teen. Then, lend­ing to the busi­ness sec­tor exploded, ris­ing from 33% of GDP to 55% in just 4 years. Much of that lend­ing was unpro­duc­tive, financ­ing the spec­u­la­tive activ­i­ties of now acknowl­edged Ponzi mer­chants like Alan Bond, Christo­pher Skase and Lau­rie Con­nell.

In the after­math of the Stock Mar­ket Crash of 1987 and the real estate bub­ble and bust that pre­ceded the 1990s reces­sion, all the for­eign banks either with­drew from the mar­ket or had their oper­a­tions taken over by the Big Four—one of which, West­pac, almost col­lapsed itself in 1992 when it recorded a $1.6 bil­lion loss.

Increased com­pe­ti­tion in the finan­cial sec­tor has thus failed on two pre­vi­ous occa­sions to achieve the results its advo­cates expected. Instead on both occa­sions, the qual­ity of loan eval­u­a­tion dropped and the vol­ume of lend­ing increased dra­mat­i­cally, with most of that lend­ing fund­ing spec­u­la­tion rather than invest­ment.

The sec­tor to which the lend­ing was directed var­ied, as Fig­ure 5 indi­cates: busi­ness debt more than dou­bled between 1977 and 1987, and then oscil­lated for the next twenty years, only to explode once more from 2005–2008 (when it funded some pro­duc­tive invest­ment in min­er­als, but also the “lever­aged buy­out” frenzy that ended when the stock mar­ket crash began). Mort­gage debt was con­stant through­out the late 70s and 80s, but then increased more than five­fold between 1990 and 2010.

The absence of any long term pat­tern in the sec­toral data masks a very clear pat­tern in the aggre­gate data. For the first 20 years after WWII, pri­vate debt was con­stant at roughly 25 per­cent of GDP. From then on, the level of pri­vate debt com­pared to income has risen relent­lessly, until a crit­i­cal turn­ing point was reached in early 2008. From mid-1964 until early 2008, the pri­vate debt to GDP ratio grew expo­nen­tially, reach­ing a peak of 157 per­cent of GDP in mid-2008. As Fig­ure 11 indi­cates, call­ing this growth “expo­nen­tial” is not mere hyper­bole: the cor­re­la­tion of the actual ratio to a sim­ple expo­nen­tial growth rate of 4.2% p.a. is 0.993.

Fig­ure 11: An inex­orable increase in debt from 1965 until 2008

The only rea­son that this cor­re­la­tion is not even closer to a per­fect 1 is the exis­tence of two “super-bub­bles” in 1972–77 and 1985–1994, and the recent top­ping-out of the ratio in March 2008. This growth rate was sus­tained despite sig­nif­i­cant shifts in reg­u­la­tory regimes, dra­matic volatil­ity in inter­est rates, and as noted ear­lier, sig­nif­i­cant shifts in the sec­toral breakup of pri­vate debt.

This his­tory should give pause to the cur­rent renewed enthu­si­asm for intro­duc­ing more com­pe­ti­tion into the finan­cial sec­tor. If debt—the fun­da­men­tal out­put of the bank­ing sector—has grown inex­orably despite dra­matic changes in the struc­ture of the finan­cial sec­tor and the econ­omy over time, then is there some­thing inher­ent to bank­ing that leads to unre­strained growth in debt? And if increased com­pe­ti­tion had unin­tended dele­te­ri­ous con­se­quences on pre­vi­ous occa­sions, what might be the con­se­quences of enhanc­ing com­pe­ti­tion again now, in the after­math of a finan­cial cri­sis? Is com­pe­ti­tion the panacea, as con­ven­tional eco­nomic analy­sis argues, or is it to some extent the prob­lem in the finan­cial sec­tor?

Funding bubbles rather than productive enterprise

Bank­ing is clearly a vital func­tion in a mar­ket econ­omy, and much of what banks do is essen­tial for com­merce: pro­vid­ing work­ing cap­i­tal to firms, fund­ing invest­ment, enabling con­sumers to own their homes as an alter­na­tive to rent­ing, and so on.

How­ever bank­ing also has poten­tially dam­ag­ing con­se­quences if it funds spec­u­la­tive activ­i­ties rather than gen­uine invest­ment on a large scale—as I argue that, based on the empir­i­cal data, it has. This neg­a­tive side of bank­ing is unlikely to be con­strained by competition—in fact it is likely to be made worse by more com­pe­ti­tion.

This is because bank­ing dif­fers from com­mod­ity production—to which stan­dard “sup­ply and demand” analy­sis is nor­mally applied—in ways that mean that it has an innate ten­dency to try to pro­duce as much of its prod­uct (effec­tively, debt that simul­ta­ne­ously cre­ates credit money) as it can entice its cus­tomers to take on. The only fac­tor that can pre­vent this ten­dency lead­ing to exces­sive debt lev­els is a limit to the will­ing­ness of its cus­tomers to bor­row money.

If bor­row­ers base their desired level of lend­ing on either enhanc­ing imme­di­ate con­sump­tion, or fund­ing activ­i­ties that may lead to income gen­er­a­tion in the future, then debt will gen­er­ally be con­strained to sus­tain­able levels—as occurred dur­ing the 1950s and early 1960s. If, how­ever, bor­row­ers go into debt to finance spec­u­la­tion about asset prices, then there is a poten­tial for the level of bor­row­ing to grow out of pro­por­tion to incomes and lead to a finan­cial cri­sis.

An essen­tial side-effect of this process is the cre­ation of an asset price bub­ble from the pos­i­tive feed­back between ris­ing lev­els of lever­age and asset prices. Asset prices are dri­ven up by debt-financed pur­chases of assets, and this rise in price entices more bor­row­ers into debt. An increase in debt to income ratios there­fore goes hand in hand with an asset price bub­ble. These bub­bles ulti­mately burst for three main rea­sons:

  1. Bor­row­ing to buy exist­ing assets adds to the debt bur­den of soci­ety with­out adding to its income gen­er­at­ing capac­ity. The indi­vid­u­als who profit from ris­ing asset prices are essen­tially Ponzi spec­u­la­tors whose “enter­prise” is fun­da­men­tally loss-mak­ing. Ulti­mately they must fail, and this real­ity is masked only by ris­ing asset prices. As soon as they fal­ter, they are likely to go bank­rupt;
  2. Price to income ratios get dri­ven to lev­els that appear irra­tional even to insid­ers, lead­ing to greater volatil­ity, and even­tu­ally an asset price crash that ends the bub­ble; and
  3. The lev­els of debt that exist­ing spec­u­la­tors and new entrants need to under­take to con­tinue dri­ving the bub­ble becomes pro­hib­i­tive com­pared to their income lev­els. The bor­row­ing slows down, thus end­ing the pos­i­tive feed­back process that dri­ves the bub­ble.

The dan­ger in allow­ing increased com­pe­ti­tion in finance, with­out pro­vi­sions to ensure that the lend­ing is directed to pro­duc­tive uses, is that the sector’s innate ten­dency to fund Ponzi schemes will be ampli­fied by the pres­sure of com­pe­ti­tion.

Competition in the 1980s—the stock market bubble and bust

In ret­ro­spect, this is clearly what occurred dur­ing the 1980s. The ini­tial bub­bles then were in shares and com­mer­cial property—though any­one who claimed there was a bub­ble before Octo­ber 1987 was widely derided. The stock mar­ket bub­ble then burst spec­tac­u­larly, as Fig­ure 12 indi­cates, but in the after­math, spec­u­la­tion shifted to res­i­den­tial prop­erty (thanks in no small mea­sure to the gov­ern­ment re-intro­duc­ing the First Home Own­ers Grant to ward off a feared reces­sion). Prices rose 36% in real terms between Octo­ber 1987 and March 1989, and then stag­nated in real terms for the next decade.

Fig­ure 12: Stock mar­ket bub­bles of the 1980s and 2000s

Competition in the 1990s-2000s—housing and share market bubbles

The addi­tional com­pe­ti­tion from secu­ri­tized lenders that the Wal­lis Com­mit­tee cham­pi­oned has had a sim­i­lar effect, this time pri­mar­ily on house­hold debt and spec­u­la­tion on house prices. Increased com­pe­ti­tion in finance has once again had the dele­te­ri­ous effect of fund­ing spec­u­la­tion rather than pro­duc­tive invest­ment, dri­ving up debt lev­els and caus­ing asset bub­bles in both the share and the prop­erty mar­kets.

Pre­dictably, banks have denied that their activ­i­ties have funded spec­u­la­tive bub­bles. With regard to hous­ing, they assert that house prices reflect fun­da­men­tal forces, on the basis of four propo­si­tions:

  1. That the house price to income ratio in Aus­tralia is not as high as those who assert that there is a house price bub­ble claim it to be;
  2. That there is an excess of demand for hous­ing over sup­ply in Aus­tralia, reflect­ing prob­lems with reg­u­la­tion that have pre­vented the con­struc­tion of new houses in line with under­ly­ing demand;
  3. Strong pop­u­la­tion growth is dri­ving up prices; and
  4. That Aus­tralians have a pref­er­ence to live near the coast and are will­ing to pay a pre­mium to do so.

In order to estab­lish my posi­tion that the bank­ing sec­tor has once again funded a spec­u­la­tive bub­ble, I need to con­sider these argu­ments in detail. As I show below, none of them stand up to close scrutiny.

No house price bubble (and “Coastal living”)

The Com­mon­wealth Bank made the fol­low­ing asser­tions that com­bine argu­ments 1 and 4 above:

  • Aus­tralia the 4th least densely set­tled coun­try in the world—83% live within 50 kms of the coast.
  • Coastal loca­tions demand a premium—Australia’s pop­u­la­tion con­cen­tra­tion in capital/coastal cities dis­torts com­par­isons to other, more densely set­tled coun­tries.
  • Australia’s cap­i­tal city house price to income ratio of 5.6 is con­sis­tent with coastal city met­rics glob­ally (Com­mon­wealth Bank, 2010, p. 4)

These asser­tions were sup­ported by the table shown in Fig­ure 13:

Fig­ure 13: Com­mon­wealth Bank coastal cities com­par­i­son table

This table is a piece of bla­tant sophistry. Note that there are 2 sources given: Demographia (Wen­dell Cox and Hugh Pavletich, 2010) and UBS. All of the over­seas city data points are taken from the Demographia sur­vey, while all of the Aus­tralian cities are derived from UBS research. The dif­fer­ences between the Demographia data for all the cities in this table and the UBS-CBA data are shown in Table 1

Table 1: CBA (Com­mon­wealth Bank, 2010) and Demographia (Wen­dell Cox and Hugh Pavletich, 2010pp. 36–37) house price ratio com­par­i­son

House Price to Income Ratios

Unaf­ford­abil­ity Rank­ings

Coun­try City







Aus-tralia Syd­ney







Aus-tralia Mel­bourne







Aus-tralia Bris­bane







US San Fran­cisco







US Los Ange­les







US New York







Canada Van­cou­ver







UK Bris­tol-Bath







NZ Auck­land







NZ Welling­ton







The UBS-CBA doc­u­ment thus under­states the house price to income ratio for Aus­tralian cities by 30 to 38 per­cent com­pared to the orig­i­nal Demographia doc­u­ment. It por­trays Aus­tralian cities as falling in the mid­dle of the range when, accord­ing to Demographia, Aus­tralian cities are amongst the most unaf­ford­able in the world—in fact in Demographia’s com­par­i­son of 272 cities around the world, Syd­ney was the 2nd most expen­sive, behind only Van­cou­ver.

There are, I believe, two main rea­sons why the CBA-UBS fig­ures for Aus­tralia are so much lower than Demographia’s. Firstly, the Demographia sur­vey com­pares median house prices to median incomes, whereas the CBA-UWS study com­pares median house prices to aver­age incomes. Since income dis­tri­b­u­tion is skewed, the aver­age income sub­stan­tially exceeds the median. Sec­ondly, the Aus­tralian Bureau of Sta­tis­tics includes income from prop­erty (includ­ing the imputed rental income from owner-occu­pied dwellings) when cal­cu­lat­ing the aver­age income, whereas the median income relies on wage income only.

Had the CBA-UBS study applied the same trans­for­ma­tions to the over­seas data, then their fig­ures for those cities would also have been sub­stan­tially lower than the Demographia fig­ures, and the rel­a­tive expen­sive­ness of Aus­tralian cities com­pared to coastal cities around the world—let alone land-locked ones—would have been obvi­ous.

Includ­ing income from prop­erty in the income to which one com­pares prop­erty prices is also an inher­ently flawed approach: it will under­state the price to income ratio when prices are ris­ing (and, con­versely, exag­ger­ate the ratio when prices are falling). Prop­erty income derives pri­mar­ily from the change in price, and this will be pos­i­tive when prices are rising—making income larger than it would oth­er­wise be. Using this data to con­clude that there is not a house price bub­ble is turn­ing a Nel­son­ian eye to the prob­lem.

When one is not try­ing to not see a bub­ble, sta­tis­ti­cal evi­dence of it abounds. I will present three mea­sures: the ratio of house prices to dis­pos­able income per head; the ratio of house prices to GDP per head; and the gross rental yield on Aus­tralian rental prop­er­ties.

The house price to dis­pos­able income data shows a slow upward drift in this ratio from 1960 till 1997 (see Fig­ure 14), and then a take­off of the ratio since then to ten stan­dard devi­a­tions above its mean.

Fig­ure 14: House prices to dis­pos­able income–upward trend then bub­ble since 1997

It could be argued that this series always shows a ris­ing trend, and the accel­er­a­tion in that trend is not con­clu­sive evi­dence of a bub­ble. The house price to GDP per capita cal­cu­la­tion, on the other hand, shows no trend between 1953 and 2000, but an explo­sion in the ratio since 1997 that has taken the ratio from under the mean to more than 7 stan­dard devi­a­tions above the mean (see Fig­ure 15). This and sev­eral other met­rics indi­cate that (a) the house price bub­ble began in 1997 and (b) it has dri­ven Aus­tralian house prices to a level at least 50% higher than his­toric lev­els.

Fig­ure 15: House prices to GDP per capita

The low return on rent­ing in Aus­tralia makes it obvi­ous that “investors” in this indus­try are seek­ing cap­i­tal gain rather than income—and are there­fore pri­mar­ily spec­u­la­tors rather than gen­uine investors (see Fig­ure 16). The rental yield hov­ered around 3.5 percent—low, but not trivial—between 1998 when records became avail­able, and 1997, when the pre­vi­ous two mea­sures also indi­cate that the most recent bub­ble began. Since then the aver­age yields fell to a low of under 2 per­cent as house prices rose far more than did rents—and the recov­ery in the ratio to a not quite so abysmal 2.5% was entirely due to the fall in house prices that pre­ceded the Rudd Government’s intro­duc­tion of the First Home Own­ers Boost.

Fig­ure 16: Rental yields are well below deposit rates, let alone loan rates

There­fore, to put it politely, bank argu­ments that there is no house price bub­ble in Aus­tralia (and the CBA-UBS table in par­tic­u­lar) are duplic­i­tous and misleading—even when one makes an “apples to apples” com­par­i­son of Aus­tralian house prices to coastal cities over­seas, we still have amongst the most expen­sive hous­ing in the world. But the argu­ment that we should only con­sider coastal cities is also non­sense.

The propo­si­tion that coastal cities com­mand a pre­mium begs the ques­tion: com­pared to what? In coun­tries like the USA, the answer is easy: com­pared to land-locked cities where the vast major­ity of the pop­u­la­tion lives. But in Aus­tralia, there is no inland mar­ket over which a pre­mium can be charged (apart from Can­berra, which, at a price to income ratio of 5.8, is the 228th least afford­able city in the world out of the 272 in the on the Demographia sur­vey). In Aus­tralia, if you live in a city, then you either live on the coast or in Can­berra: there is no non-coastal city mar­ket over which coastal cities can com­mand a pre­mium.

Underlying demand”

The argu­ment that there is an under­ly­ing short­age of hous­ing, and that this is why house prices are high, is also eas­ily dis­missed. The sup­ply short­age is derived from esti­mates devel­oped by the National Hous­ing Sup­ply Coun­cil.

the Coun­cil esti­mated a gap of around 85,000 dwellings between under­ly­ing demand for and sup­ply of hous­ing at 30 June 2008. The Coun­cil devel­oped a method­ol­ogy for mea­sur­ing the gap based on selected mea­sures of home­less­ness, includ­ing the num­ber of mar­ginal res­i­dents of car­a­van parks and the under­sup­ply of pri­vate rental dwellings indi­cated by the rental vacancy rate. The mea­sures used in the 2008 report were: 2008 gap size =

  • addi­tional pri­vate rental dwellings required in 2008 to increase the num­ber of vacant pri­vate rental dwellings to 3 per cent of the total pri­vate rental stock

These measures—especially the last two—express a social need for addi­tional hous­ing. But they are in no way express a mar­ket demand for hous­ing, Frankly, if you believe that house prices are being dri­ven up by either home­less peo­ple or “mar­ginal res­i­dents of car­a­van parks”, then I have a Bridge or two I’d like to sell you.

Population pressure

The pop­u­la­tion pres­sure argu­ment does appear super­fi­cially convincing—like any story that gives rise to a Ponzi Scheme—but it is sim­ply not sup­ported by the data. While the asser­tions that Aus­tralia didn’t have an over­build­ing spree like those in the USA or China, that our pop­u­la­tion growth rate exceeds the OECD aver­age, and that it spiked recently when house prices were ris­ing sharply are all true, pop­u­la­tion growth per se bears no cor­re­la­tion to changes in house prices.

Fig­ure 17: Absolute growth lev­els of pop­u­la­tion, immi­gra­tion and dwellings

If the argu­ment that a short­age of new houses rel­a­tive to pop­u­la­tion growth is the cause of ris­ing house prices were true, then Aus­tralia should have expe­ri­enced falling house prices between 1955 and 2006—because for this entire period the rate of growth of new dwellings exceeded the rate of growth of pop­u­la­tion (see Fig­ure 18).

Fig­ure 18: Falling ratio of pop­u­la­tion to dwellings for all years except 2006–2010

Over the long term, the cor­re­la­tion between pop­u­la­tion growth and change in house prices is effec­tively zero. Lag­ging house price change behind pop­u­la­tion change—to test the argu­ment that pop­u­la­tion growth causes price change, but with a lag—does not improve the cor­re­la­tion (see Fig­ure 19). The cor­re­la­tion between change in pop­u­la­tion and change in house prices remains neg­a­tive.

Fig­ure 19: There is no cor­re­la­tion between pop­u­la­tion growth and house prices, even when time lags are con­sid­ered

Even dur­ing the one period when the rate of growth of pop­u­la­tion exceeded the rate of growth of pop­u­la­tion, the change in house prices is uncor­re­lated with the change in pop­u­la­tion and pop­u­la­tion den­sity (see Fig­ure 20).

Fig­ure 20: A neg­a­tive cor­re­la­tion between pop­u­la­tion and house prices

The sim­ple rea­son that pop­u­la­tion change doesn’t deter­mine house price move­ments is that the real mar­ket demand for hous­ing is given fun­da­men­tally by the num­ber of peo­ple who have recently taken out a mort­gage, This can vary rad­i­cally as a pro­por­tion of the pop­u­la­tion, swamp­ing vari­a­tions in the rate of pop­u­la­tion growth itself (see Fig­ure 21).

Fig­ure 21: Volatil­ity of new owner occu­pier loans as per­cent of pop­u­la­tion

The two fac­tors that do have a strong causal cor­re­la­tion with changes in house prices are the vol­ume of new lend­ing, and gov­ern­ment manip­u­la­tion of the mar­ket via the First Home Own­ers Grant. The lat­ter will—I hope—be the sub­ject of a sep­a­rate inquiry one day. The for­mer demon­strates that the key fac­tor in deter­min­ing house prices is the growth rate of mort­gage debt: the cor­re­la­tion is strong (0.56), and new lend­ing leads price change by about 3–6 months (see Fig­ure 22).

Fig­ure 22: The growth in mort­gage debt is the key deter­mi­nant of house price changes

Unregulated banking has financed Ponzi Schemes rather than investment

The data thus clearly shows that, on the two pre­vi­ous occa­sions where com­pe­ti­tion in bank­ing was inten­si­fied, the result was an increase in lend­ing for spec­u­la­tive rather than pro­duc­tive pur­poses.

While the boost in lend­ing was tak­ing place, aggre­gate demand increased—as explained later—which made the econ­omy appear buoy­ant. But when the buoy­ant lend­ing came to an end, an eco­nomic cri­sis ensued, since the lend­ing pre­dom­i­nantly drove asset prices higher (rather than adding to the level or pro­duc­tiv­ity of assets).

The end result was an increased level of debt com­pared to income, with lit­tle to show for the increased gear­ing save more expen­sive assets. That is the main rea­son why banks are “on the nose” today. To amplify com­pe­ti­tion a third time, with­out heed­ing these lessons of the past, would be a seri­ous mis­take.

What we should do instead is:

  1. Prop­erly iden­tify the prob­lems in the sec­tor, rather than assum­ing that, what­ever the prob­lems might be, more com­pe­ti­tion will fix them; and
  2. Tai­lor the reforms to the prob­lems, so that there is at least some chance the pro­posed solu­tions will make things bet­ter rather than worse.

The macro-dynamics of debt

As out­lined above, the key prob­lem with the bank­ing sec­tor is that it has cre­ated too much debt, and that the major­ity of this debt has funded spec­u­la­tion rather than pro­duc­tive invest­ment.

This prob­lem has been exac­er­bated by reforms that have been based on a naïve faith in dereg­u­lated mar­kets, but the prob­lem itself is an endemic one, as the his­tor­i­cal record attests. As Fig­ure 23 empha­sises, the pri­vate debt to GDP level today dwarfs any­thing pre­vi­ously expe­ri­enced in Aus­tralia, but there have also been two pre­vi­ous lesser debt bub­bles that both ended in seri­ous Depres­sions (Chay Fisher and Christo­pher Kent, 1999).

Fig­ure 23: Australia’s pri­vate debt to GDP ratio over the very long term

Most econ­o­mists pay lit­tle if any atten­tion to this ratio—and most were there­fore caught com­pletely unawares when the Global Finan­cial Cri­sis hit. By way of con­trast, this ratio and its deriv­a­tives are cru­cial to my analy­sis (Steve Keen, 1995), and to that of the hand­ful of other econ­o­mists around the world who antic­i­pated the GFC (Dirk J Beze­mer, 2009, Dirk J. Beze­mer, 2010, Edward Full­brook, 2010).

An instance of the san­guine way that most econ­o­mists think about pri­vate debt is given by RBA Deputy Gov­er­nor Ric Battellino’s obser­va­tions on the extra­or­di­nary level of house­hold debt as at Sep­tem­ber 2007 (when it was 94% of GDP):

The fac­tors that have facil­i­tated the rise in debt over the past cou­ple of decades – the sta­bil­ity in eco­nomic con­di­tions and the con­tin­ued flow of inno­va­tions com­ing from a com­pet­i­tive and dynamic finan­cial sys­tem – remain in place. While ever this is the case, house­holds are likely to con­tinue to take advan­tage of unused capac­ity to increase debt. This is not to say that there won’ t be cycles when credit grows slowly for a time, or even falls, but these cycles are likely to take place around a ris­ing trend. Even­tu­ally, house­hold debt will reach a point where it is in some form of equi­lib­rium rel­a­tive to GDP or income, but the evi­dence sug­gests that this point is higher than cur­rent lev­els.” (Ric Bat­tellino, 2007, p. 20)

I am not so san­guine, firstly because the his­tor­i­cal record shows that when pri­vate debt reaches a peak, it does not remain at an equi­lib­rium level but goes into reverse (see Fig­ure 23), and sec­ondly because even if debt did reach “some sort of equi­lib­rium rel­a­tive to GDP or income”, this would cause a large fall in aggre­gate demand.

This point is not con­sid­ered by the vast major­ity of econ­o­mists because they believe that the level of debt has no impact on macro­eco­nomic out­comes. Ben Bernanke pro­vides a good illus­tra­tion of this in his dis­missal of Fisher’s argu­ment (Irv­ing Fisher, 1933) that the Great Depres­sion was caused by “debt-defla­tion”:

Fisher’ s idea was less influ­en­tial in aca­d­e­mic cir­cles, though, because of the coun­ter­ar­gu­ment that debt-defla­tion rep­re­sented no more than a redis­tri­b­u­tion from one group (debtors) to another (cred­i­tors). Absent implau­si­bly large dif­fer­ences in mar­ginal spend­ing propen­si­ties among the groups, it was sug­gested, pure redis­tri­b­u­tions should have no sig­nif­i­cant macro­eco­nomic effects. ” (Ben S. Bernanke, 2000, p. 24)

Bernanke’s con­ven­tional argu­ment is false because it ignores the role that changes in debt play in deter­min­ing aggre­gate demand. In the equi­lib­rium per­spec­tive that vir­tu­ally defines con­ven­tional eco­nomic the­ory (known as “neo­clas­si­cal eco­nom­ics”), debt is merely a redis­tri­b­u­tion of spend­ing power from one per­son (the lender) to another (the bor­rower). But in the real world (and in the non-ortho­dox “Finan­cial Insta­bil­ity Hypoth­e­sis”: Hyman P. Min­sky, 1982), the aggre­gate level of debt can expand or con­tract, and this change in the aggre­gate level of debt does have macro­eco­nomic effects because it alters aggre­gate spend­ing power.

In a nut­shell, aggre­gate demand is the sum of GDP plus the change in debt (Steve Keen, 2009a, c, d), and for this rea­son a sim­ple sta­bi­liza­tion of the debt to GDP ratio can cause a reces­sion.

This can be illus­trated using a sim­ple exam­ple. Con­sider an econ­omy with a nom­i­nal GDP of $1 tril­lion, which is grow­ing at 10% per annum, where half (5%) is real growth and half is infla­tion. The econ­omy also has a pri­vate debt level of $1.25 tril­lion that is grow­ing at 20% p.a. Total spend­ing in the econ­omy that year will there­fore be $1.25 tril­lion, con­sist­ing of $1 tril­lion from GDP and $250 bil­lion from the increase in debt.

Then assume that GDP con­tin­ues to grow at the same rate, so that it is $1.1 tril­lion the year after, and that the rate of growth slows down to 10% per annum—the same speed as the rate of growth of nom­i­nal GDP, so that the debt ratio remains con­stant at 150%, the level it reached in Year 1.

Total aggre­gate demand will there­fore be $1.25 trillion—the sum of the $1.1 tril­lion GDP and the 10% increase in debt from its level of $1.5 tril­lion. This is the same level of nom­i­nal demand as the year before—but since there has been 5% infla­tion, the level of real demand has fallen by $60 bil­lion. This is enough to cause a reces­sion (if the impact is felt entirely by the sale of goods and ser­vices), or a sharp fall in asset prices, or some com­bi­na­tion of the two.

This hypo­thet­i­cal example—summarised in Table 2—is a milder ver­sion of what actu­ally occurred in 2008 and caused the Global Finan­cial Cri­sis. The actual expe­ri­ences of the USA and Aus­tralia are sum­ma­rized in Table 3 and Table 4 respec­tively.

Table 2: Hypo­thet­i­cal exam­ple of impact of debt to GDP ratio reach­ing equi­lib­rium

Variable/year Year 1 Year 2
Nom­i­nal GDP



Growth rate of nom­i­nal GDP (%)



Real growth rate (%)



Infla­tion rate (%)



Pri­vate debt



Growth rate of pri­vate debt (%)



Change in pri­vate debt



Nom­i­nal aggre­gate demand (GDP + change in debt)



Real aggre­gate demand (in Year 1 terms)



In the USA, the rate of growth of debt did not merely slow but actu­ally turned neg­a­tive: there­fore the change in debt actu­ally sub­tracted from aggre­gate demand, rather than adding to it. But as illus­trated by the hypo­thet­i­cal sit­u­a­tion in Table 2, the mere slow­down in the rate of growth of debt prior to the year end­ing in Jan­u­ary 2010 was enough to start “The Great Reces­sion” in 2008-09.

In the year end­ing in 2008, America’s GDP was $14.34 tril­lion, and the growth in pri­vate debt was $4.04 tril­lion, so that pri­vate sec­tor aggre­gate demand was $18.38 tril­lion. In the year end­ing in 2009, nom­i­nal GDP was slightly higher at $14.35 tril­lion, but the growth in debt was only $1.45 tril­lion (the rate of growth of debt had slowed from 11.1% p.a. to 3.6% p.a.). Pri­vate sec­tor aggre­gate demand was thus $15.8 trillion—a four­teen per­cent fall from the year before.

The increase in gov­ern­ment debt atten­u­ated the fall in total aggre­gate demand to some extent, but this still fell 9% over the year, and America’s asset mar­kets, com­mod­ity mar­kets, and unem­ploy­ment took a huge hit.

The fol­low­ing year saw the slow­down in the rate of growth of debt turn into absolute delever­ag­ing, with pri­vate debt falling by $1.86 tril­lion (falling mort­gage debt con­tributed $220 bil­lion of this). Pri­vate sec­tor aggre­gate demand was thus $12.55 tril­lion, com­pared to $18.38 tril­lion just two years ear­lier.

Table 3: Delever­ag­ing in the USA

Variable\Year 2006 2007 2008 2009 2010






Change in Nom­i­nal GDP






Change in Real GDP






Infla­tion Rate






Pri­vate Debt






Debt Growth Rate






Change in Debt






GDP + Change in Pri­vate Debt






Change in Pri­vate Aggre­gate Demand






Gov­ern­ment Debt






Change in Gov­ern­ment Debt






GDP + Change in Total Debt






Change in Total Aggre­gate Demand






Mort­gage Debt






Change in Mort­gage Debt






Aus­tralia suf­fered a reduc­tion in aggre­gate demand as well from the slow­down in the rate of growth of pri­vate debt in the year end­ing in 2008. GDP was $1.13 tril­lion, while the increase in pri­vate debt that year was $260 billion—so that pri­vate sec­tor aggre­gate demand was $1.39 tril­lion. GDP grew to $1.24 tril­lion the next year, while the growth of debt slowed sub­stan­tially to $134 bil­lion. The sum was $1.37 tril­lion, slightly less in nom­i­nal terms than the year before.

Table 4: Avoid­ing delever­ag­ing in Aus­tralia

Variable\Year 2006 2007 2008 2009 2010






Change in Nom­i­nal GDP






Change in Real GDP






Infla­tion Rate






Pri­vate Debt






Debt Growth Rate






Change in Debt






GDP + Change in Pri­vate Debt






Change in Pri­vate Aggre­gate Demand






Gov­ern­ment Debt






Change in Gov­ern­ment Debt






GDP + Change in Total Debt






Change in Total Aggre­gate Demand






Mort­gage Debt






Change in Mort­gage Debt






The implications for economic performance of excessive private debt

From this debt-dri­ven per­spec­tive, these macro-eco­nomic impli­ca­tions of debt are far more impor­tant than the micro­eco­nomic issue of the cost of debt. But since Aus­tralia has appar­ently done so well dur­ing the GFC, these macro­eco­nomic issues have been far less dom­i­nant here than in the rest of the world. It is there­fore impor­tant to con­sider why Aus­tralia dif­fered from the rest of the world: was there some­thing unique about Aus­tralia which meant the GFC didn’t hap­pen here, or are the macro­eco­nomic impli­ca­tions of the GFC still rel­e­vant to us? We can get some guid­ance from com­par­ing the Aus­tralian expe­ri­ence to the US one.

There are three major dif­fer­ences between Aus­tralia and the USA, which in turn are by far the major rea­sons why Australia’s eco­nomic per­for­mance was so much bet­ter than America’s:

  1. While Australia’s debt to GDP level is unprece­dented in its own his­tory, the USA’s is higher still;
  2. Delever­ag­ing as such did not occur in Australia—though this almost guar­an­tees that it will occur in the future; and
  3. Growth in mort­gage debt con­tin­ued, largely under the influ­ence of gov­ern­ment pol­icy.

Were the cur­rent pri­vate debt to GDP ratio unre­mark­able, these fac­tors would be gen­er­ally positive—a handy boost to credit-dri­ven demand would have helped us side­step a reces­sion, with only minor long term con­se­quences. But since pri­vate debt is at unprece­dented lev­els, these short term gains in 2009–2010 imply that a rever­sal of our eco­nomic for­tunes in 2011 is pos­si­ble, if pri­vate sec­tor delever­ag­ing com­mences here. To explain why, I need to pro­vide more detail on each of those three dis­tin­guish­ing fac­tors between the USA and Aus­tralia.

Level of Debt

Fig­ure 24 shows both how much greater America’s pri­vate debt level is that Australia’s, and also shows that Amer­ica is rapidly delever­ag­ing now. Thus even though Australia’s debt-dri­ven boost to aggre­gate demand was larger in 2008 than America’s—since pri­vate debt grew 17.2% that year in Aus­tralia, ver­sus 11.1% in the USA—the sheer scale of the USA’s debt com­pared to its GDP means that its depen­dence on ris­ing debt was even more extreme than ours. It also meant that when the debt went into reverse, the depress­ing impact of this was greater for the USA than Aus­tralia.

Fig­ure 24: The USA’s pri­vate debt to GDP ratio is sig­nif­i­cantly larger than Australia’s

The rate of change of debt—no deleveraging here

The fun­da­men­tal cause of the GFC was the burst­ing of a global debt bub­ble. With the growth of debt going from pos­i­tive to negative—so that we went from ris­ing debt adding to aggre­gate demand, to falling debt sub­tract­ing from aggre­gate demand (see Fig­ure 25)—what had appeared to be a period of stel­lar eco­nomic per­for­mance gave way to the biggest eco­nomic cri­sis since the Great Depres­sion.

Fig­ure 25: The GFC was the first time the change in debt reduced aggre­gate demand since the Great Depres­sion

Aus­tralia, on the other hand, avoided a seri­ous down­turn because delever­ag­ing was stalled, and in fact turned around—so that ris­ing debt once again added to aggre­gate demand. While Amer­ica and the rest of the world had a delever­ag­ing-dri­ven cri­sis, Aus­tralia avoided the cri­sis by relever­ag­ing on the back of a renewed prop­erty bub­ble (see Fig­ure 26).

Fig­ure 26: Aus­tralia abruptly stopped delever­ag­ing in 2010

Since eco­nomic activ­ity and employ­ment in a mar­ket econ­omy is demand-dri­ven, delever­ag­ing in the USA (and else­where in the OECD) caused a seri­ous reces­sion, while Australia’s relever­ag­ing boosted aggre­gate demand and resulted in it expe­ri­enc­ing only a very mild down­turn.

The piv­otal role of the change in pri­vate debt in deter­min­ing eco­nomic activ­ity is eas­ily seen in Fig­ure 27, which cor­re­lates the debt-dri­ven frac­tion of aggre­gate demand with the unem­ploy­ment rate. This fig­ure shows why it is not hyper­bole to com­pare the cur­rent cri­sis to the Great Depres­sion, since this is the only time since then that the debt-con­tri­bu­tion to aggre­gate demand has turned neg­a­tive (the appar­ent neg­a­tives in 1945 were due respec­tively to the end­ing of WWII, and a break in the sta­tis­ti­cal series). The cor­re­la­tion with unem­ploy­ment points out the “Ponzi” nature of the US’s eco­nomic per­for­mance in both the Great Depres­sion and recently: when debt grew, unem­ploy­ment fell, and vice versa—with dis­as­trous consequences—when delever­ag­ing struck. In the Great Depres­sion the cor­re­la­tion was –0.76; across the whole of 1955 till now, the cor­re­la­tion was –0.36; and in the last 20 years, when the pri­vate debt has sur­passed the Great Depres­sion level, the cor­re­la­tion was –0.9.

Fig­ure 27: Debt dri­ven-demand and unem­ploy­ment, USA

I’ve used the same ver­ti­cal scales for the Aus­tralian data (Fig­ure 28) as the Amer­i­can to empha­sise both dif­fer­ences and sim­i­lar­i­ties between the two coun­tries.

Firstly, both GDP and the change in debt deter­mine aggre­gate demand, and with its lower level of debt dur­ing the 1950s and 1960s, the debt-dri­ven frac­tion of aggre­gate demand was far less impor­tant in Aus­tralia than in Amer­ica. The cor­re­la­tion over 1955–2010 was 0.25, which is both small and the wrong sign, show­ing that the debt con­tri­bu­tion to demand was swamped by that of GDP—which is the sign of a well-func­tion­ing econ­omy.

Sec­ondly how­ever, this dif­fer­ence dis­ap­peared as Australia’s debt to GDP ratio grew expo­nen­tially from 1965. Between 1990 an today, the cor­re­la­tion is sig­nif­i­cant, the cor­rect sign for the causal argu­ment I am mak­ing here, and large at –0.82. So by the time the GFC hit, the debt-dri­ven com­po­nent of aggre­gate demand was almost as dom­i­nant in Aus­tralia as it was in the USA.

Thirdly, we avoided a seri­ous down­turn, not by hav­ing an econ­omy that was fun­da­men­tally dif­fer­ent to the USA’s, but by pre­vent­ing delever­ag­ing. Whereas dur­ing the 1990s reces­sion, absolute delever­ag­ing did occur (and unem­ploy­ment exceeded 10 per­cent) dur­ing the GFC, delever­ag­ing was pre­vented solely because a gov­ern­ment policy—the First Home Own­ers Boost—encouraged Aus­tralian house­holds to go on a debt-binge.

Fig­ure 28: Debt-dri­ven demand and unem­ploy­ment, Aus­tralia

The busi­ness sec­tor, whose debt had been grow­ing strongly in the leadup to the GFC, delev­ered at a faster pace than it did dur­ing “the reces­sion we had to have”, when the debt frac­tion of aggre­gate demand briefly turned neg­a­tive. On the other hand, mort­gage debt rose strongly. Australia’s avoid­ance of delever­ag­ing was there­fore entirely due to the growth in mort­gage debt (see Fig­ure 29).

Fig­ure 29: Debt-dri­ven demand by sec­tor

This growth in mort­gage debt would not have come about with­out the First Home Own­ers Boost (see Fig­ure 30). Prior to that pol­icy being intro­duced, mort­gage debt was on track to fall by about 2% of GDP between mid-2008 and March 2010. Instead, it rose by over 6% of GDP. This effec­tively added $100 bil­lion in debt-financed expen­di­ture to the Aus­tralian economy—a larger boost to aggre­gate demand than either the Rudd Government’s stim­u­lus pro­gram, or the impact on house­hold dis­pos­able income of the RBA’s rate cuts.

Fig­ure 30: The impact of the FHOB on the trend in mort­gage debt

The great dan­ger for the future is that this pol­icy suc­cess in 2008-09 has set Aus­tralia up for a greater pol­icy dilemma in future when the house­hold sec­tor joins the busi­ness sec­tor in delever­ag­ing. That this may already be hap­pen­ing can be seen by con­sid­er­ing the third aspect of pri­vate debt, the “credit impulse”: the impact of the accel­er­a­tion or decel­er­a­tion of debt on the change in aggre­gate demand.

The credit impulse

The fact that aggre­gate demand is the sum of GDP plus the change in debt means that the change in aggre­gate demand is the sum of the change in GDP plus the accel­er­a­tion of debt. Just as the debt con­tri­bu­tion to demand is highly cor­re­lated with the level of employ­ment, the accel­er­a­tion of debt—or the credit impulse, which is defined as the change in the change in debt divided by GDP (Michael Biggs et al., 2010)—is highly cor­re­lated with the change in employ­ment.

In stark con­trast to the assump­tion made by Bernanke and most neo­clas­si­cal economists—that debt only has macro­eco­nomic impli­ca­tions if the dis­tri­b­u­tion of debt affects con­sump­tion (to cite a recent paper by Krug­man, “It fol­lows that the level of debt mat­ters only if the dis­tri­b­u­tion of that debt mat­ters, if highly indebted play­ers face dif­fer­ent con­straints from play­ers with low debt”, Gauti B. Eggerts­son and Paul Krug­man, 2010, p. 3)—the sheer scale of debt, its rate of change, and whether it is accel­er­at­ing or decel­er­at­ing, have very sig­nif­i­cant impacts on the macro­econ­omy. If Bernanke, Krug­man and other neo­clas­si­cals were cor­rect, the cor­re­la­tions between the accel­er­a­tion in debt and the change in unem­ploy­ment should be insignif­i­cant.

Instead, the cor­re­la­tion is highly sig­nif­i­cant, large, per­sis­tent, and causal, since it leads changes in employ­ment and GDP by about 3 months. The cor­re­la­tion dur­ing the Great Depres­sion was –0.72; over the whole post-WWII period from 1955 the cor­re­la­tion was –0.59, and since 1990 it was –0.82 (see Fig­ure 31).

Fig­ure 31: Decel­er­a­tion of US debt in the GFC more extreme than in Great Depres­sion

The com­par­i­son of Aus­tralia with the USA dur­ing the GFC con­firms that Aus­tralia had a milder GFC by hav­ing a milder neg­a­tive credit impulse, and by revers­ing it before the USA did (Fig­ure 32).

Fig­ure 32: Australia’s credit impulse was milder and reversed ear­lier than did the USA’s

The size of the neg­a­tive credit impulse in 2008–2010 in Amer­ica was the major cause of the sharp increase in unem­ploy­ment, and the recent improve­ments have been due to the credit impulse turn­ing less neg­a­tive (see Fig­ure 33).

Fig­ure 33: The USA’s large neg­a­tive credit impulse caused a large increase in unem­ploy­ment, since mildly reversed

Australia’s milder reces­sion and current—though appar­ently faltering—recovery has been due to its neg­a­tive credit impulse being smaller than in the USA, and being reversed ear­lier (see Fig­ure 34).

Fig­ure 34: Australia’s smaller neg­a­tive credit impulse meant a smaller down­turn

At a super­fi­cial level, this implies an easy solu­tion to an eco­nomic down­turn: if the econ­omy slows down, encour­age the growth of credit, and the econ­omy will recover. Effec­tively, this is how Aus­tralia and most of the OECD has over­come past reces­sions: by expand­ing the level of pri­vate debt even more and caus­ing a new debt-dri­ven boom to replace the old one.

The prob­lem with this solu­tion is that it nec­es­sar­ily involves a ris­ing level of debt com­pared to income over time. At some point, this will result in a level of debt which is so large com­pared to income that many eco­nomic agents refuse to take on any more debt. The credit impulse there­fore turns neg­a­tive and a major cri­sis ensues—a Depres­sion.

In late 2005, I formed the belief that we had reached such a point in the credit cycle, which is why I went pub­lic with my views that a seri­ous eco­nomic cri­sis was immi­nent (along with a hand­ful of other non-ortho­dox econ­o­mists; for details see Dirk J Beze­mer, 2009, Dirk J. Beze­mer, 2010, Edward Full­brook, 2010). The occur­rence of the Global Finan­cial Cri­sis, against the expec­ta­tions of the vast major­ity of econ­o­mists, vin­di­cated my analy­sis.

Australia’s appar­ent avoid­ance of the cri­sis has led to my analy­sis car­ry­ing less weight in Aus­tralia than over­seas. How­ever as out­lined above, Australia’s avoid­ance of a seri­ous down­turn to date has largely occurred because it delayed the process of delever­ag­ing. In effect, we avoided the GFC by recre­at­ing the con­di­tions that caused it: an asset price bub­ble caused by ram­pant lend­ing to the house­hold sec­tor.

Implications for competition policy

Attempt­ing to increase com­pe­ti­tion in the bank­ing sec­tor once more could risk con­tin­u­ing this process of an ever-increas­ing level of debt caus­ing appar­ent pros­per­ity, at the expense of guar­an­tee­ing a future severe delever­ag­ing-dri­ven con­trac­tion.

How­ever an equally prob­a­ble out­come, given the exces­sive and unprece­dented level of house­hold debt (higher than that pre­vail­ing in the USA—see Fig­ure 35—and with a much higher debt ser­vic­ing cost—see Fig­ure 36), is that new com­peti­tors will fail to gain a foothold in the mar­ket, because the mar­ket will now shrink rather than expand as the house price bub­ble deflates.

The like­li­hood that the level of house­hold debt will fall is rea­son enough to be less than enthu­si­as­tic about the ben­e­fits of increased com­pe­ti­tion in the bank­ing sector—since in the past this has led to ris­ing lev­els of debt. It is also hard to con­tem­plate how increased com­pe­ti­tion could be con­sis­tent with falling debt volumes—such a phe­nom­e­non is more likely to mean con­sol­i­da­tion in the sec­tor rather than an increased num­ber of play­ers fight­ing over a smaller pie.

Fig­ure 35: Aus­tralian house­hold debt com­pared to GDP is now 5% higher than America’s

Fig­ure 36: Inter­est on mort­gages cost 6.5% of GDP here ver­sus under 4% in the USA

A lack of competition, or a lack of control?

The pre­ced­ing analy­sis shows that the prob­lem with bank­ing is not so much a lack of com­pe­ti­tion, as a lack of con­trol over the level of lend­ing. The ques­tion then is whether increased com­pe­ti­tion would pro­vide the con­trol needed over the level of lend­ing.

The his­tor­i­cal record is decid­edly that it will not: as shown above, both pre­vi­ous pol­icy-inspired increases in com­pe­ti­tion caused a blowout in debt lev­els. Com­pe­ti­tion is not the solu­tion to the social and eco­nomic prob­lems caused by the bank­ing sec­tor.

Why then are politi­cians and econ­o­mists rec­om­mend­ing more com­pe­ti­tion for bank­ing? To some degree this is because of they tend to apply the stan­dard “sup­ply and demand” model to banking—and there­fore to argue that if the indus­try is the sub­ject of com­plaints, it must be because it is too monop­o­lis­tic. Unfor­tu­nately how­ever, the “sup­ply and demand” model is a false guide to the oper­a­tions of the bank­ing sec­tor. So too is the “money mul­ti­plier” the­ory of how credit money is cre­ated that is still taught in eco­nom­ics text­books, despite being found to be empir­i­cally false over the last 3 decades.

One of the main rea­sons that the world is now mired in a seem­ingly never-end­ing series of finan­cial crises is because of the appli­ca­tion of appeal­ing but false mod­els of how bank­ing behaves. It is there­fore impor­tant for policy-makers—like the mem­bers of this Committee—to have an accu­rate under­stand­ing of how the sec­tor they are attempt­ing to reform actu­ally oper­ates.

The con­ven­tional “money mul­ti­plier” model argues that the cre­ation of credit money begins with an injec­tion of gov­ern­ment-cre­ated “Base Money”, which is then deposited by an indi­vid­ual in a bank account. The bank then retains a por­tion of this—the so-called Reserve Ratio—and lends the rest. A process of re-deposit­ing and re-lend­ing then occurs, at the end of which the total amount of money cre­ated is equal to the Base Money injec­tion divided by the Reserve Ratio.

Were this model accu­rate, then we would find that there was a time lag between the cre­ation of Base Money (M0) and the cre­ation of Credit Money (M2–M0). But in fact the lag has been found to be the other way around: credit money is cre­ated first, fol­lowed by changes in base money. As Nobel Prize win­ners Kyd­land and Prescott put it:

There is no evi­dence that either the mon­e­tary base or M1 leads the cycle, although some econ­o­mists still believe this mon­e­tary myth. Both the mon­e­tary base and M1 series are gen­er­ally pro­cycli­cal and, if any­thing, the mon­e­tary base lags the cycle slightly… The dif­fer­ence of M2 — M1 leads the cycle by even more than M2, with the lead being about three quar­ters. (Finn E. Kyd­land and Edward C. Prescott, 1990, p. 12)

A more real­is­tic per­spec­tive on bank­ing is the “endoge­nous money” the­ory, and its impli­ca­tions are that dereg­u­lated, com­pet­i­tive bank­ing has an innate ten­dency to cause finan­cial crises of the kind the global econ­omy is now expe­ri­enc­ing. As Basil Moore put it, the essence of this model is the obser­va­tion that

In the real world banks extend credit, cre­at­ing deposits in the process, and look for the reserves later” ((Basil J. Moore, 1979, p. 539) cit­ing (Alan R. Holmes, 1969, p. 73); see also more recently (Piti Disy­atat, 2010, “loans drive deposits rather than the other way around”, p. 7)).

This empir­i­cal real­ity makes it easy to under­stand a fun­da­men­tal point: that banks have an innate ten­dency to want to cre­ate as much debt as pos­si­ble, and the only effec­tive stop to this is not com­pe­ti­tion between banks, but insti­tu­tional reforms that limit the will­ing­ness of bor­row­ers to take on debt for spec­u­la­tive pur­poses.

I have con­structed mod­els of a pure credit econ­omy to illus­trate this point (Steve Keen, 2009a, b, c, d, 2008, 2010); rather than repro­duc­ing these here I have put a model which enables these points to be illus­trated in a dynamic sim­u­la­tion (see Fig­ure 37 for a sam­ple out­put) on my blog at the page The model and mod­el­ing soft­ware can be down­loaded directly from the fol­low­ing link:

Fig­ure 37: Sam­ple out­put from dynamic mod­el­ling pro­gram with vari­a­tions in lend­ing vari­ables

Fig­ure 38 illus­trates the basic insight of this endoge­nous money per­spec­tive: bank income increases if more debt is cre­ated. This ten­dency will not be reduced by increas­ing com­pe­ti­tion: instead, as the his­tor­i­cal record of Aus­tralian bank­ing has illus­trated, an increase in com­pe­ti­tion will often amplify this ten­dency as the com­pe­ti­tion for mar­ket share leads all banks to search out avenues to mar­ket debt.

Fig­ure 38: Bank income increases with faster lend­ing, more rapid money cre­ation, and slower loans repay­ment

The eas­i­est way to do so is to fund spec­u­la­tion on asset prices, since that weak­ens the one effec­tive con­trol on the amount of debt that banks can cre­ate, the will­ing­ness of firms and house­holds to go into debt.

If firms and house­holds limit their bor­row­ing to what they can rea­son­ably antic­i­pate ser­vic­ing from income, then broadly speak­ing debt would not become a prob­lem. Though there will always be firms who bor­row with unre­al­is­tic expec­ta­tions of profit, and prodi­gal house­holds who live beyond their means, by and large these will be periph­eral issues if bor­row­ing is income-based.

But when bor­row­ing becomes based instead on expec­ta­tions of prof­it­ing from ris­ing asset prices (“asset-based lend­ing”), then a pos­i­tive feed­back loop is set up that, almost inevitably, leads to a blowout in debt lev­els and an even­tual finan­cial cri­sis. Ris­ing debt lev­els them­selves drive up asset prices, indi­vid­u­als accept a higher debt to income ratio than they oth­er­wise would in the belief that debt can be repaid from the pro­ceeds of asset sales, and an actual boom is gen­er­ated in the econ­omy as the increase in debt spurs aggre­gate demand. Once such an appar­ent “vir­tu­ous cir­cle” is in train, it is almost impos­si­ble to stop, since vir­tu­ally every­one in soci­ety has an inter­est in its con­tin­u­ance: the banks, stock­bro­kers and real estate agents because their prof­its are higher, the gen­eral pub­lic because they feel wealth­ier as asset prices rise (and some of them do profit from buy­ing and sell­ing on a ris­ing mar­ket), and even the gov­ern­ment because the Ponzi boom gen­er­ated by ris­ing pri­vate debt makes it seem to be a “good eco­nomic man­ager”.

But the boom must ulti­mately end in a cri­sis, because it dri­ves up debt lev­els with­out adding to the economy’s income-gen­er­at­ing capac­ity. Ulti­mately, a level of debt will be incurred that can­not be ser­viced, and the econ­omy will col­lapse into a Depres­sion. I have mod­eled this process in another more tech­ni­cal paper (Steve Keen, 2009d). Two sam­ple out­puts from this model are shown in Fig­ure 39 and Fig­ure 40. With­out asset-based lend­ing, though the debt level rises, it does not get out of hand and cause a cri­sis.

Fig­ure 39: a debt-financed pure credit econ­omy with­out asset-based lend­ing

With asset-based lend­ing how­ever, spec­u­la­tive lend­ing even­tu­ally pre­dom­i­nates over pro­duc­tive invest­ment and even­tu­ally, after a series of finan­cial cycles, the level of debt over­whelms the econ­omy.

Fig­ure 40: a debt-financed pure credit econ­omy with asset-based lend­ing

Conclusion: the problem is not microeconomic, and competition is not the solution

Since the main prob­lems with the bank­ing sec­tor relate to the amount of debt it gen­er­ates and the macro­eco­nomic prob­lems these cause, the solu­tion lies not with micro­eco­nomic reforms—and espe­cially not with increased com­pe­ti­tion, which exac­er­bates the under­ly­ing prob­lem of exces­sive debt—but with insti­tu­tional reforms and macro­eco­nomic pol­icy.

From the expe­ri­ence of the Great Depres­sion itself, it is clear that reg­u­la­tory reform is not enough to pre­vent bank lend­ing get­ting out of hand. Reforms such as the Glass Stea­gall Act may tem­porar­ily usher in a period of sta­bil­ity. But if the reforms leave open the pos­si­bil­ity of fund­ing asset-price spec­u­la­tion, then banks will do this and in the process, under­mine the reforms. The pub­lic will gain a tem­po­rary ben­e­fit from the lend­ing as it expands eco­nomic activ­ity, bank power will rise with ris­ing debt, and ultimately—as we saw in 1999—the very reforms them­selves will be abol­ished.

Some­thing more per­ma­nent is required, and it has to, in my opin­ion, tackle the will­ing­ness of bor­row­ers to take on debt, rather than attempt­ing to limit bank will­ing­ness to lend—since I see this as rather like try­ing to stop the tides com­ing in.

I have devel­oped two basic reform ideas, both of which I know I have Buckley’s Chance of hav­ing imple­mented at present—especially in Aus­tralia, since the dom­i­nant per­cep­tion here is that we have in fact avoided the prob­lems that have beset the rest of the world. How­ever unless I put these ideas into cir­cu­la­tion now, there will never be any chance of hav­ing them imple­mented, even when atti­tudes to the finan­cial cri­sis are much more melan­choly than today.

Reform Proposals

My pro­pos­als are, in one sense, “micro­eco­nomic reforms”, since they are rede­f­i­n­i­tions of fun­da­men­tal com­po­nents of every­day con­tracts rather than grand reg­u­la­tory schemes to con­trol bank­ing, or fis­cal or mon­e­tary pol­icy rec­om­men­da­tions to counter the excesses of the bank­ing sec­tor. How­ever, I am sure they are not the kind of micro­eco­nomic reforms the Com­mit­tee had in mind—and nor are they likely to be adopted.

These pro­pos­als are:

  1. To rede­fine shares so that, when pur­chased from a com­pany, they last indef­i­nitely as they do today, but once they are sold to a sec­ondary pur­chaser, they have a defined life­time of 50 years, after which they expire (I call this a Jubilee Share pro­posal); and
  2. To base lend­ing for prop­erty on the rental income (actual or imputed) of the prop­erty being pur­chased, and to limit the debt that can be secured against a prop­erty to ten times its annual rental income.

The object of both reforms is to make lever­aged spec­u­la­tion on asset prices much less likely than it is today.

The vast major­ity of trades on share mar­kets are of spec­u­la­tors sell­ing to other spec­u­la­tors, with val­u­a­tions osten­si­bly based on the net present value of expected future div­i­dend flows, but in real­ity based on the “Greater Fool” prin­ci­ple, where ris­ing debt funds the Greater Fool. If instead shares on the sec­ondary mar­ket pro­vided div­i­dends for up to 50 years, but after that date had a value of zero, it is far less likely that share pur­chases would be under­taken with bor­rowed money. Val­u­a­tions would then be actu­ally based on con­ser­v­a­tive esti­mates of future div­i­dend flows up until expiry, lead­ing to much less volatile share prices and much less spec­u­la­tion.

Such a change would also encour­age cap­i­tal for­ma­tion via the share mar­ket, since the only means to secure a per­pet­ual div­i­dend flow would be to pro­vide money directly to a com­pany via an ini­tial pub­lic offer­ing.

The prop­erty reform would break the pos­i­tive feed­back loop that cur­rently exists between lever­age and prop­erty prices: prices rise because some bor­row­ers are will­ing to take on more lever­age to trump other bor­row­ers, and the increased lever­age dri­ves prices up, feed­ing back into the lever­age-price bub­ble process.

With this reform, all would-be pur­chasers would be on equal foot­ing with respect to their level of debt-financed spend­ing, and the only way to trump another buyer would be to put more non-debt-financed money into pur­chas­ing a prop­erty.

Though I know there is no prospect of these reforms being adopted, I nonethe­less rec­om­mend that Sen­a­tors at least pon­der them. The Global Finan­cial Cri­sis is not going away any time soon, because its fun­da­men­tal cause is still with us—an exces­sive level of pri­vate sec­tor debt, gen­er­ated by a finan­cial sec­tor that was hap­pier fund­ing Ponzi Schemes than it was doing the more dif­fi­cult work of financ­ing pro­duc­tive invest­ment. Only when the intractabil­ity of the cri­sis with­out fun­da­men­tal reforms becomes appar­ent, will pro­pos­als like these that actu­ally go to the heart of the prob­lem be con­sid­ered.

In the mean­time, I expect that mis­taken ideas—such as that the prob­lem is exces­sive mar­gins rather than exces­sive debt, and that addi­tional com­pe­ti­tion will solve this problem—are more likely to be pro­posed by Inquiries such as this one. I remain opposed to unstruc­tured attempts to increase com­pe­ti­tion in the bank­ing sec­tor, but there is one com­pet­i­tive reform that I would sup­port: intro­duc­ing lenders whose sole pur­pose is to pro­vide small busi­ness with work­ing cap­i­tal. At present, small busi­ness is being squeezed by higher loan mar­gins more than all other sec­tors, and much small busi­ness lend­ing is actu­ally secured against and based on the prop­erty owned by small busi­ness own­ers, rather than on their busi­nesses and cash flows,as it should be.

A com­pet­i­tive reform that encour­aged lend­ing to this sector—to finance actual busi­ness activity—would be worth­while. Any other approach that relied sim­ply on increased com­pe­ti­tion to fix the sector’s ills would either fail to work—given the cur­rent exces­sive level of debt—or make our prob­lems worse.


Bat­tellino, Ric. 2007. “Some Obser­va­tions on Finan­cial Trends.” Reserve Bank of Aus­tralia Bul­letin, Octo­ber 2007, 14–21.

Bernanke, Ben S. 2000. Essays on the Great Depres­sion. Prince­ton: Prince­ton Uni­ver­sity Press.

Beze­mer, Dirk J. 2009. ““No One Saw This Com­ing”: Under­stand­ing Finan­cial Cri­sis through Account­ing Mod­els,” Gronin­gen, The Nether­lands: Fac­ulty of Eco­nom­ics Uni­ver­sity of Gronin­gen,

Beze­mer, Dirk J. 2010. “Under­stand­ing Finan­cial Cri­sis through Account­ing Mod­els.” Account­ing, Orga­ni­za­tions and Soci­ety, 35(7), 676–88.

Biggs, Michael; Thomas Mayer and Andreas Pick. 2010. “Credit and Eco­nomic Recov­ery: Demys­ti­fy­ing Phoenix Mir­a­cles.” SSRN eLi­brary.

Com­mon­wealth Bank. 2010. “Aus­tralian Res­i­den­tial Houses and Mort­gages: Cba Mort­gage Book Secure,” Syd­ney: Com­mon­wealth Bank of Aus­tralia,

Cox, Wen­dell and Hugh Pavletich. 2010. “6th Annual Demographia Inter­na­tional Hous­ing Afford­abil­ity Sur­vey,” Demographia,

Disy­atat, Piti. 2010. “The Bank Lend­ing Chan­nel Revis­ited,” BIS Work­ing Papers. Basel: Bank of Inter­na­tional Set­tle­ments, 35.

Eggerts­son, Gauti B. and Paul Krug­man. 2010. “Debt, Delever­ag­ing, and the Liq­uid­ity Trap: A Fisher-Min­sky-Koo Approach,”

Fisher, Chay and Christo­pher Kent. 1999. “Two Depres­sions, One Bank­ing Col­lapse,” Reserve Bank of Aus­tralia Research Dis­cus­sion Papers. Syd­ney, NSW, Aus­tralia: Reserve Bank of Aus­tralia, 54.

Fisher, Irv­ing. 1933. “The Debt-Defla­tion The­ory of Great Depres­sions.” Econo­met­rica, 1(4), 337–57.

Full­brook, Edward. 2010. “Keen, Roubini and Baker Win Revere Award for Eco­nom­ics,” E. Full­brook, Real World Eco­nom­ics Review Blog. New York: Real World Eco­nom­ics Review,

Holmes, Alan R. 1969. “Oper­a­tional Con­traints on the Sta­bi­liza­tion of Money Sup­ply Growth,” F. E. Mor­ris, Con­trol­ling Mon­e­tary Aggre­gates. Nan­tucket Island: The Fed­eral Reserve Bank of Boston, 65–77.

House of Rep­re­sen­ta­tives Stand­ing Com­mit­tee on Eco­nom­ics Finance and Pub­lic Admin­is­tra­tion. 2007. “Ref­er­ence: Reserve Bank of Aus­tralia Annual Report 2006,” Perth: Hansard,

Keen, Steve. 2009a. “Bail­ing out the Titanic with a Thim­ble.” Eco­nomic Analy­sis & Pol­icy, 39(1), 3–24.

Keen, Steve. 2009b. “The Dynam­ics of the Mon­e­tary Cir­cuit,” S. Rossi and J.-F. Pon­sot, The Polit­i­cal Econ­omy of Mon­e­tary Cir­cuits: Tra­di­tion and Change. Lon­don: Pal­grave Macmil­lan, 161–87.

Keen, Steve. 1995. “Finance and Eco­nomic Break­down: Mod­el­ing Minsky’s ‘Finan­cial Insta­bil­ity Hypoth­e­sis.’.” Jour­nal of Post Key­ne­sian Eco­nom­ics, 17(4), 607–35.

Keen, Steve. 2009c. “The Global Finan­cial Cri­sis, Credit Crunches and Delever­ag­ing.” Jour­nal Of Aus­tralian Polit­i­cal Econ­omy, 64, 18–32.

Keen, Steve. 2009d. “House­hold Debt-the Final Stage in an Arti­fi­cially Extended Ponzi Bub­ble.” Aus­tralian Eco­nomic Review, 42, 347–57.

Keen, Steve. 2008. “Keynes’s ‘Revolv­ing Fund of Finance’ and Trans­ac­tions in the Cir­cuit,” R. Wray and M. Forstater, Keynes and Macro­eco­nom­ics after 70 Years. Chel­tenham: Edward Elgar, 259–78.

Keen, Steve. 2010. “Solv­ing the Para­dox of Mon­e­tary Prof­its.” Eco­nom­ics: The Open-Access, Open Assess­ment E-Jour­nal, 4(2010–31).

Kyd­land, Finn E. and Edward C. Prescott. 1990. “Busi­ness Cycles: Real Facts and a Mon­e­tary Myth.” Fed­eral Reserve Bank of Min­neapo­lis Quar­terly Review, 14(2), 3–18.

Min­sky, Hyman P. 1982. Can “It” Hap­pen Again? : Essays on Insta­bil­ity and Finance. Armonk, N.Y.: M.E. Sharpe.

Moore, Basil J. 1979. “The Endoge­nous Money Stock.” Jour­nal of Post Key­ne­sian Eco­nom­ics, 2(1), 49–70.

National Hous­ing Sup­ply Coun­cil. 2010. “National Hous­ing Sup­ply Coun­cil 2nd State of Sup­ply Report,” H. Depart­ment of Fam­i­lies, Com­mu­nity Ser­vices and Indige­nous Affairs, Can­berra: Aus­tralian Gov­ern­ment,

Stand­ing Com­mit­tee On Eco­nom­ics Finance And Pub­lic Admin­is­tra­tion. 2007. “Round­table on Home Loan Lend­ing Prac­tices and Processes,” Can­berra: Proof Com­mit­tee Hansard,

Wal­lis, Stan; Bill Beer­worth; Jeff Carmichael; Ian Harper and Linda Nicholls. 1997. “Final Report of the Finan­cial Sys­tem Inquiry,” Trea­sury, Can­berra: Aus­tralian Gov­ern­ment Pub­lish­ing Ser­vice,

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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  • goidcc

    Thanks for the detailed arti­cle. About your pro­posal for reforms: How about we just limit the mar­gin accounts that are used to spec­u­late on stock mar­kets or raise the mar­gin requirments and down pay­ments for mort­gage loans. These two sim­ple con­di­tions will itself limit the spec­u­la­tion. I think set­ting up expi­ra­tion date on stocks is basi­cally mak­ing stocks behave like bonds with higher default risk. 


  • I’m think­ing in a 50 year time frame goidcc: reforms like that will work, and then be eas­ily abol­ished because they did work. Look at what hap­pened to Glass-Stea­gall. We need some­thing that out­lives the mem­ory of those who expe­ri­enced the cri­sis itself. That’s why I think any lesser reforms are wor­thy but … won’t last.

  • alain­ton


    I think that this posts gives too lit­tle atten­tion to the issues con­cern­ing the elas­tic­ity of sup­ply of hous­ing. You are right in stat­ing that the key dri­ver is mort­gage lend­ing; but for a mort­gage to exist houses must exist. What mat­ters is the ratio of expan­sion in mort­gage lend­ing (in real terms) to the expan­sion in the dwelling stock. If both rise in tan­dem with­out spec­u­la­tive excess there can be no hous­ing asset price bub­ble.

    There are three unusual aspects of the hous­ing mar­ket that need to be incor­po­rated into your model. Firstly new hous­ing, like money, is endoge­nous, to expand sup­ply a third party, a landowner, must develop it, and obtain devel­op­ment finance prior to a house­holder pur­chaser obtain­ing finance. Sec­ondly hous­ing mar­kets are not clear­ing in a down­turn, if some­one lives in a house and does not have to move for employ­ment or other pur­poses then they wont put the house on the mar­ket, they will hold out on expec­ta­tions of long run house price increases. Sim­i­larly devel­op­ers of prop­er­ties not reliant on loan financ­ing wont nec­es­sar­ily sell or rent at rock bot­tom prices — they will sit things out in many cases leav­ing newly com­pleted houses empty, the same with bank repos­sessed houses (there is plenty of empir­i­cal evi­dence of this in china and dubai, and ire­land — ghost estates and ghost cities). In these cases first time buy­ers from newly formed house­holds have a dis­pro­por­tion­ate impact on house prices. What mat­ters is not pop­u­la­tion increase per se but house­hold increase. House­holds have been increas­ing in many coun­tries despite falling pop­u­la­tion lev­els because of divorce, aging etc. etc. 

    Finally for the work­ing age pop­u­la­tion the expan­sion of hous­ing in an area will be lim­ited by the amount and wages of employ­ment in the houses catch­ment area. If employ­ment is high paid in an area and hous­ing sup­ply lim­ited then house prices will rise and hous­ing devel­op­ers in that area will make super prof­its. It is the per­ceived abil­ity of hous­ing devel­op­ers to make these super prof­its that feeds hous­ing con­struc­tion and mort­gage lend­ing, of course exces­sive sup­ply and exces­sive lever­age can result in the herd instinct.

  • Agreed that there wouldn’t be a bub­ble with­out spec­u­la­tive excess Andrew, but my point was that there has been spec­u­la­tive excess.

    The elas­tic­ity of sup­ply turns up in how, gen­er­ally speak­ing, the rate of growth of dwellings has matched pop­u­la­tion growth plus demo­graphic change. I would think that the prop­erty spruik­ers are the ones who under­es­ti­mate this elas­tic­ity rather than me–they’re for­ever explain­ing the increase in prices on rigidi­ties in sup­ply, after all.

    The capac­ity of sell­ers not to sell does make prop­erty dif­fer­ent to shares for instance, where a mar­gin loan will com­pel sell­ing given a suf­fi­cient price drop. This does give it dif­fer­ent, slower dynamics–which is why my expec­ta­tion of a 40% price fall was always over a 10–15 year time period.

  • cja

    Where do you think the Credit Impulse is head­ing for Aus­tralia?
    I found this arti­cle (also here) from about a month ago where Deutsche Bank are quoted as say­ing:

    A more use­ful mea­sure is the accel­er­a­tion or decel­er­a­tion in credit growth as it tracks the eco­nomic cycle much more closely. We call this the credit impulse and it cur­rently points to above trend con­sumer demand growth.

    Are they talk­ing non­sense, or is it likely to have stalled since then?

  • Hi cja,

    Those Deutsche Bank econ­o­mists were the ones who actu­ally iden­ti­fied and mea­sured the Credit Impulse before I did–my own cau­tion on whether there could be a close cor­re­la­tion between a first and sec­ond deriv­a­tive in eco­nomic data undid me here.

    But what those ana­lysts don’t con­sider is the aggre­gate debt to GDP and its impact as a limit on the credit impulse. For the credit impulse to remain pos­i­tive, ulti­mately the debt to GDP ratio has to rise. That, I believe, ain’t going to hap­pen. The more recent data than they were using shows this too–the last 3 months worth of the credit impulse have been neg­a­tive. I’ll cover this early next year.

  • cja

    Awe­some. I was try­ing to do this in Excel, but it made my head hurst and I prob­a­bly had the wrong data any­way. I’ll wait will the new year!

  • jon­now

    Hi Steve, I enjoyed the thor­ough paper.

    I want to ask, how did you deter­mine that Aus­tralia escaped depres­sion because of the first home owner boost? While it is true that Aus­tralia avoided delever­age by going back to bub­ble con­di­tions, I would like to hear more of your argu­ment on why it worked. After­all, you were con­vinced dur­ing the GFC that recov­ery would be stalled if the gov­ern­ment inter­vened the way they did.

    The stan­dard global response to the GFC was to avoid delever­ag­ing by cut­ting bank fund­ing costs and rein­flate spec­u­la­tive mar­kets. Aus­tralia was no dif­fer­ent.

    Being a “risky coun­try” we could not cut our inter­est rates. We couldn’t print money due to our weak cur­rency and for­eign denom­i­nated debt. We did not bail out trou­bled busi­nesses as the US did with banks and motor com­pa­nies. We could not turn to invest­ment banks to prop up the mar­ket. We didn’t give out tax cuts and con­ces­sions other than first home buy­ers.

    Sure we guar­enteed deposits / bank debt and handed out some free money. But that was far from the efforts of other coun­tries.

    So the ques­tion should be why did Aus­tralia suceeded while oth­ers failed?


  • Hi Jon­now,

    I hope I’ve answered this query with the lat­est blog post, which com­pares the dynam­ics of credit in Aus­tralia and the USA. It really does come down to the First Home Ven­dors Boost, with­out which we would have hit delever­ag­ing ter­ri­tory, as they have in the USA.

  • Dur­ing my expo­sure to the Euro­pean bank­ing sector’s insides some 15 years ago, I was repeat­edly faced with the com­mon fact to the numer­ous banker insid­ers with whom I had rela­tion­ships with, that the whole of the Euro­peans larger banks were all tech­ni­cally bank­rupt and deep in col­lu­sion with their national lead­ers and the game and the order of the day (every­day), not to save the banks but to cover up this state of affairs and to save the bankers col­lec­tive necks. Lead­er­ship, of course, all — were more than co-oper­a­tive due to another fact, that the con­di­tion of bank­ruptcy had come about by their nefar­i­ous “pol­icy” mak­ing and dip­ping into the slop pot… of cap­ture bank­ing.

    My posi­tion has been for many years, since this time, that bank­ing is a seri­ally dan­ger­ous and deadly polit­i­cal tool that does not respond to com­pe­ti­tion — at all, but on the con­trary, cap­tures and cor­rupts social val­ues and which always dri­ves soci­ety into sig­nif­i­cant bloody dis­as­ters — which are always paid for by the cur­rent and future pro­duc­tive work­force. IOW, it is by far worse than a Ponzi scheme as it has been now described by so many; it is indeed a preda­tory sin­gle minded deadly syco­phan­tic par­a­site that con­sumes human val­ues and pro­duc­tiv­ity whilst being dressed in expen­sive suits and couched in warm and polit­i­cal cor­rect lan­guage; it is per­va­sive and ubiq­ui­tous and indeed wel­come — with eager antic­i­pa­tion, into all cor­ners of brood­ing con­tem­pla­tions of power.

    In other words, it is mans’ worst enemy and that which resides within… pre­tend­ing and feed­ing and has a life of its own; the vam­piric alien.

    Swan has shown this past week that he is indeed hav­ing his strings pulled by those that he says are to be con­tained — my words. Now RBA has yes­ter­day announced a new mech­a­nism to top up those all pow­er­ful 4 pil­lars of Aussie her­culean strength with a slop fund for … the Min­ski Moment and / or ‘just in case’. So much for the ill-termed and mis-named “fifth pil­lar”, which never was.

    From Wik­ileaks we get the fol­low­ing:

    Mon­day, 17 March 2008, 18:27
    C O N F I D E N T I A L LONDON 000797
    EO 12958 DECL: 03/17/2018
    Clas­si­fied By: AMB RTUTTLE, rea­sons 1.4 (b) and (d)

    1. Since last sum­mer, the nature of the cri­sis in finan­cial mar­kets has changed. The prob­lem is now not liq­uid­ity in the sys­tem but rather a ques­tion of sys­temic sol­vency, Bank of Eng­land (BOE) Gov­er­nor Mervyn King said at a lunch meet­ing with Trea­sury Deputy Sec­re­tary Robert Kim­mitt and Ambas­sador Tut­tle. King said there are two imper­a­tives. First to find ways for banks to avoid the stigma of sell­ing unwanted paper at dis­tressed prices or going to a cen­tral bank for assis­tance. Sec­ond to ensure there’s a coor­di­nated effort to pos­si­bly recap­i­tal­ize the global bank­ing sys­tem. For the first imper­a­tive, King sug­gested devel­op­ing a pool­ing and auc­tion process to unblock the large vol­ume of finan­cial invest­ments for which there is cur­rently no mar­ket. For the sec­ond imper­a­tive, King sug­gested that the U.S., UK, Switzer­land, and per­haps Japan might form a tem­po­rary new group to jointly develop an effort to bring together sources of cap­i­tal to recap­i­tal­ize all major banks.

    Sys­temic Insol­vency Is Now The Prob­lem


    Just to repeat: sol­vency or “Insol­vency” is the prob­lem which is of no sur­prise to me at all.

    Eric Hoffer’s mag­nif­i­cent and reveal­ing work ‘The True Believer” grants us (who­ever reads any­more) real insights as to why we just fol­low flawed par­a­digms (Kuhn) to bliss­ful con­sen­sual social sui­cide; Long Live the King — which in a qual­i­ta­tive sim­plic­ity sug­gests that 1), we just don’t care, 2). we don’t dare inquire, and 3). we do not have the nec­es­sary intel­li­gence to be that which we think we are, ie, homo sapien sapien. Or, we just want des­per­ately to belong to some­thing con­sen­sual, no mat­ter what, but not, of sen­tience or thought.!

    Please note that the 1st. global rev­o­lu­tion has begun and appro­pri­ately this rev­o­lu­tion is ulti­mately about being informed, being aware and being sen­tient; sup­posed and the­o­ret­i­cal human con­di­tions, and attrib­utes. All facts must fit the the­ory espe­cially anom­alous facts for a the­ory to be some­where in the vicin­ity of being ready for adop­tion as a Maxim.

    As such, the real­ity is that this global sys­temic cri­sis (GSC) is a bank­rupted “lead­er­ship” cri­sis, where “lead­er­ship” has decid­edly and absolutely failed to lead the loyal, gullible and trust­ing to higher ideals, val­ues and sci­en­tific pur­suits and Prin­ci­ples but have instead, cho­sen to lead the World unknow­ingly and con­sen­su­ally back into bar­baric devo­lu­tion — aided and abet­ted by that ancient cor­rup­tive tool of ‘Cap­ture Bank­ing’ and prim­i­tive “force” instilled through fear.

  • And, from Kris Sayce of Mon­day Morn­ing today: (Facts tend to upset… some)

    NAB Execs Admit Bank Was In Trou­ble
    Fri­day 17th Decem­ber, 2010 — Mel­bourne, Aus­tralia
    By Kris Sayce
    NAB Execs Admit Bank Was In Trou­ble
    Mar­ket News This Week

    You’ve got your eye on a stock — but you’re not sure if it’s the right time to buy it…

    You’re hold­ing another stock that just went up — or down — sig­nif­i­cantly… but you don’t know whether it’s time to sell…

    The solu­tion to both of these dilem­mas will become a lot clearer once you’ve watched this video (turn on your speak­ers)


    If you haven’t found the time to read the tran­scripts from the Sen­ate eco­nom­ics select com­mit­tee I sug­gest you find the time.
    Sim­ply because com­ments from two National Aus­tralia Bank [ASX: NAB] exec­u­tives con­firm — that’s right, con­firm — every­thing we’ve writ­ten about NAB’s secret bailouts in 2008 and 2009.

    You can down­load the tran­script by click­ing here.

    We told you the banks need the loans because they faced a mas­sive liq­uid­ity and sol­vency prob­lem.

    Our crit­ics said we were talk­ing rub­bish. That we had finally lost our mar­bles.

    They tried to say NAB was just being cheeky. That is was snaf­fling Fed­eral Reserve loans on the cheap. They said NAB did what any back should do, take the oppor­tu­nity to bor­row low and lend high.

    We coun­tered the argu­ment by explain­ing how bank bor­row­ing works. How banks have to roll over debt on a reg­u­lar basis. If there’s a prob­lem with rolling the debt over, then, well, it can leave a bank in the lurch.

    We showed you how NAB and West­pac [ASX: WBC] had stood hunched shoul­der to hunched shoul­der with other trou­bled banks. Banks such as Royal Bank of Scot­land, Lloyd­sTSB, Citibank and ABN Amro.

    Believe me, the admis­sion I’ll show you in a moment is dyna­mite. It’s an admis­sion straight from the horses’ mouths. That the Aus­tralian bank­ing sys­tem was in dire trou­ble in late 2008.

    Yet where is the Aus­tralian main­stream press on this story?

    Good ques­tion. Nowhere. The main­stream press con­spired with the banks and reg­u­la­tors to sweep the secret loans scan­dal under the car­pet. And now they’ve done the same with the Sen­ate com­mit­tee state­ments.

    To be hon­est, the incom­pe­tence of the main­stream press doesn’t sur­prise us. We’d waited a cou­ple of days for the tran­scripts to be posted to the Hansard web­site (Hansard is the offi­cial record of par­lia­men­tary debate).

    Until then, like you, we had to rely on what the main­stream press had reported. And what did they focus on? Of course, they focused on the easy stuff… banks’ inter­est mar­gins, bank fees, exec­u­tive pay lev­els… the sort of stuff that’s easy for the jour­nal­ism cadets to get their teeth into.

    I mean, the bomb­shell I’ll reveal to you today isn’t the sort of thing the sea­soned finance hack would touch with a barge­pole. Why? Because the sea­soned finance hack doesn’t want to ruin his chances of an invite to the next bank­ing din­ner party.

    Or the chance to inter­view a top bank­ing exec­u­tive. That’s more impor­tant to them than uncov­er­ing a story that proves the fragility of the bank­ing sys­tem.

    Although to be fair, even if they did want to report on it, chances are their edi­tor would exer­cise a veto and cut out all the juicy stuff.

    So, when we read the tran­script, guess the first thing your edi­tor did. Go on, guess.

    What’s that, you can’t? Think harder. Think how annoy­ing we can be… that’s right, we fired off another email to our pals at the ASX. I won’t reprint it here, instead I’ll expand on what I wrote to them.

    Remem­ber some of the pre­vi­ous ban­ter we had with the ASX folks. They told us the ASX didn’t have the power to request infor­ma­tion from a com­pany. Not unless there was an unex­plained price move­ment.

    We told them their ver­sion of ASX Rule 3.1 was wrong. The ASX did have the power to request addi­tional infor­ma­tion from the banks. Not only did they have the power, but that they should do so imme­di­ately.

    Fun­nily enough, two weeks since the US Fed­eral Reserve released the extra­or­di­nary details of NAB and Westpac’s secret loans and the ASX is still sit­ting on it.

    The ASX con­tin­ues to con­spire with NAB and West­pac to keep the mar­ket unin­formed about secret loans that pre­vented two of Australia’s banks from going bust. I don’t know about you but I’d think that was some­thing the ASX would want an expla­na­tion on.

    Yes, I’ve been crit­i­cised for my com­ments on the seri­ous­ness of these loans. I’ve been told on more than four occa­sions (five I think… maybe six) that Australia’s banks were nowhere near going bust.

    Well, it turns out your edi­tor was right. But don’t just take my word for it. In a moment I’ll show you what two top execs at NAB — one of them the top dog — told the Sen­ate com­mit­tee about the finan­cial con­di­tion of the banks in 2008 and 2009.

    But first, Money Morn­ing reader Paul sent us this timely reminder of the spin put out by the bank­ing indus­tries pup­pet mouth­piece, the Aus­tralian Bankers’ Asso­ci­a­tion (ABA) in Octo­ber 2008:

    The Aus­tralian Bankers’ Asso­ci­a­tion (ABA) is con­cerned that recent announce­ments by the Fed­eral Gov­ern­ment to guar­an­tee deposits and whole­sale fund­ing are being char­ac­terised as the Aus­tralian banks hav­ing been ‘bailed out’.

    This is false

    No bank deposits have been at risk. Bank deposits are safe — with or with­out the government’s guar­an­tee.

    Aus­tralian banks and the reg­u­la­tory frame­work have been suc­cess­ful. Unlike in the UK, Europe and the USA, no taxpayer’s money has been allo­cated to sup­port an Aus­tralian bank. Aus­tralian banks are very strongly cap­i­talised and con­tinue to hold assets that are of good credit qual­ity.”

    It’s inter­est­ing the ABA would say that, because one year prior to that state­ment West­pac had grov­elled to the US Fed­eral Reserve for USD$1 bil­lion. And one month later NAB would need to raise bil­lions of dol­lars on the Aus­tralian Secu­ri­ties Exchange.

    As NAB direc­tor of finance Mark Joiner told the Sen­ate com­mit­tee:

    There were two peri­ods dur­ing the cri­sis when our credit rat­ing was on neg­a­tive watch. If we dropped out of the AA sta­tus, then the cost of funds and our access to funds inter­na­tion­ally would have been severely altered.”

    Despite that, the ABA claimed Australia’s banks were “strongly cap­i­talised”. So “strongly cap­i­talised” that the NAB had to raise $6 bil­lion on the mar­ket plus another USD$4.5 bil­lion in secret from the US Fed.

    That doesn’t sound very strong to me.

    But right there, in Mr. Joiner’s state­ment is the pre­cise rea­son why the NAB grabbed the secret loan money from the US Fed­eral Reserve. Not because it was try­ing to make a few extra bucks, but because the bank was on a neg­a­tive credit watch.

    The bank execs knew that if the mar­ket knew just how tight the bank’s bal­ance sheet was, the bank would have lost its AA credit rat­ing. Here are Mr. Joiner’s com­ments to the Sen­ate com­mit­tee:

    There were two peri­ods dur­ing the cri­sis when our credit rat­ing was on neg­a­tive watch. If we dropped out of the AA sta­tus, then the cost of funds and our access to funds inter­na­tion­ally would have been severely altered. Then our abil­ity to sup­port the econ­omy in the ways we described before—staying open for busi­ness and pre­dictable for customers—would also have gone. We would have had to freeze our bal­ance sheet growth and the like. While you prob­a­bly do not want obscene amounts of prof­itabil­ity out of your bank­ing sys­tem, it is good for every­body to have a strong bank­ing sys­tem that sup­ports a degree of eco­nomic self-deter­mi­na­tion and flex­i­bil­ity.”

    See, with­out these bailouts Mr. Joiner admits it would have been hard for the bank to stay open for busi­ness.

    Yet just like the secret loans, you didn’t hear about this state­ment in the main­stream press. They didn’t seem to think it was impor­tant enough.

    But that wasn’t all, NAB CEO Cameron Clyne backed up his finance direc­tor. Here’s what Mr. Clyne told the com­mit­tee:

    As we went to the cri­sis, we were in a sit­u­a­tion where obvi­ously, quite appro­pri­ately, investors and pru­den­tial reg­u­la­tors were seek­ing us to hold greater cap­i­tal. We had to go to the mar­kets. We went to the mar­kets in Novem­ber 2008 and in July 2009 and raised about $6 bil­lion in equity. We effec­tively had to absorb that and suf­fer the drop in return on equity. Had we tried to main­tain the same return on equity on the addi­tional $6 bil­lion in cap­i­tal, prices would have been sub­stan­tially higher. I do con­test the fact that we main­tained return on equity. We most cer­tainly did not.”

    There you have it. Australia’s banks were on the edge. It needed the cap­i­tal raised on the mar­ket, plus US Fed­eral Reserve secret loans in order to make it.

    Think about it. Think about the other bailouts the banks received — the first home­buy­ers grants, the whole­sale guar­an­tee, the deposit guar­an­tee… but still it wasn’t enough to prop up NAB and West­pac.

    They needed more. These two “strongly cap­i­talised” banks needed the secret Fed loans. Plus top-up loans from the Reserve Bank of Aus­tralian (RBA), which itself received USD$53.5 bil­lion from the US Fed.

    Yet all the while the ABA yapped that “Aus­tralian banks are very strongly cap­i­talised and con­tinue to hold assets that are of good credit qual­ity.”

    We now know that to be false. A strongly cap­i­talised bank­ing sys­tem doesn’t need a raft of gov­ern­ment and cen­tral bank bailouts. It cer­tainly doesn’t need secret loans from a for­eign cen­tral bank.

    But even now, the reg­u­la­tors are spin­ning the same yarn. We printed this com­ment on Wednes­day by RBA assis­tant gov­er­nor Guy Debelle:

    The RBA par­tic­i­pated in the swap line [with the US Fed­eral Reserve] to help dis­trib­ute US dol­lars into this time zone… It did not reflect any issue with the Aus­tralian bank­ing system’s own need for US dol­lars. The funds pro­vided under the swap line were cheaper than the extremely wide mar­ket price at the time. As a result, Aus­tralian based banks availed them­selves of this and in a num­ber of cases on-lent the funds to banks in other juris­dic­tions.”

    We thought about his state­ment some more after we sent it to you. The way Debelle car­ries on he’s mak­ing out that Amer­ica and Aus­tralia were play­ing doc­tor and nurse to the sick global bank­ing sys­tem…

    That Aus­tralia was fine. Our banks were sim­ply being good doc­tors by help­ing out oth­ers.

    He’s mak­ing the RBA and the banks out to be the Dr. John For­rest and Matron Grace Scott of the bank­ing world. In real­ity they’re no more than the Den­nis Jamieson and Ada Sim­mons of bank­ing.

    But con­sid­er­ing the mag­ni­tude of the admis­sion, how did the good Sen­a­tors’ respond?

    Fol­low­ing Mr. Clyne’s reply, Sen­a­tor Hur­ley con­tin­ued:

    All right. Let us talk about the most recent rate rise above the RBA cash rate.”

    What?! Handed on a plate an admis­sion that Australia’s banks were in dire trou­ble in 2008 and 2009, and the hap­less Sen­a­tor blabs on about the lat­est inter­est rate deci­sion.

    end extract.

  • por­toalet

    Hi Steve,

    How much debt can Aus­tralia take? Have you done any mod­el­ing?
    So far you “only” com­pare Aus­tralia to USA in terms of ‘pri­vate debt to GDP’ ratio and maybe use USA ‘pri­vate debt to GDP’ ratio as a guide to tell whether Aus­tralia has reached max­i­mum pri­vate debt to GDP ratio.

    I sus­pect the max­i­mum ‘pri­vate debt to GDP’ ratio is sim­i­lar to that for the USA, but how do you model this?

    Also I do think that your pro­pos­als will not be lis­tened to (who likes them?), but the more impor­tant reform is to make the gov­ern­ment stop bail­ing out finan­cial insti­tu­tions (read: nation­alise loss, pri­va­tise profit) when the tide turns (it’s a when not an if any­more based on your exten­sive research).

  • I was asked this last week por­toalet, and this was the answer I gave:

    Hi yre­brac,

    And sev­eral oth­ers who’ve posed a sim­i­lar ques­tion. Firstly there is no hard and fast num­ber, but the ulti­mate limit is not “debt ser­vice equals income” but “debt ser­vice equals dis­pos­able income”. If ser­vic­ing your debt leaves you below sub­sis­tence, then you will fail finan­cially.

    Clearly no eco­nomic sys­tem as a whole gets to that level–though many indi­vid­u­als do. The feed­back from some fail­ing to the over­all dynam­ics of a Ponzi Scheme start­ing to col­lapse is some­thing that involves not only aver­ages but also sto­chas­tic issues–in fact this is one area where some econo­physics analy­sis could be very use­ful.

    Hav­ing said that, in my own sim­u­la­tions (which include real­is­tic ratios of wage to non-wage income and model only cap­i­tal­ists bor­row­ing and there­fore hav­ing to ser­vice debt), the level at which break­down occurs is roughly com­pa­ra­ble to the non-finan­cial sec­tor debt lev­els for the US and Aus­tralia right now: roughly 175% of GDP.

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