The author has been described by News Ltd as an "iconoclast", "Svengali", a pollie's "economist muse", and "pungently accurate". Fairfax says he is a "Renaissance man" and "one of Australia’s most respected analysts." Stephen Koukoulas concludes that he is "85% right", and "would make a great Opposition leader." Terry McCrann claims the author thinks "‘nuance’ is a trendy village in the south of France", but can be "scintillating" when he thinks "clearly". The ACTU reckons he’s "an enigma wrapped in a Bloomberg terminal, wrapped in some apparently well-honed abs."

Friday, January 15, 2010

Updated II: Obama listens...

So a senior member of the Obama Administration recently wrote to inform me that they’re taking a serious look at my solution to the US housing crisis, which I presented at the Transforming America’s Housing Policy summit in February last year (I spoke alongside Professor Robert Shiller of ‘irrational exuberance’ fame). For the curious reader, a summary of my proposal was published by Martin Wolf in the Financial Times’ Economists Forum. A more detailed version can be found at Professor Nouriel Roubini’s RGE Economics site (see here).

At the time, I did receive some positive feedback from several US academics, and the chief advisor to one of the most influential Democratic congressman. Yet then nothing—complete radio silence. While I am obviously a non-objective judge of my own work, I had thought that this idea was pretty bullet-proof, and an unequivocal $77 billion improvement over the Administration’s cash-splash, which temporarily cauterised the GFC wounds yet did little to prevent the same problem reemerging in the future (in fact, one can argue that Obama's efforts heighten the risk of such events happening again). All of that changed when the Administration official’s kind note popped over the transom a few weeks ago.

Moments like this afford some succour when you start wondering whether your intellectual exertions are really worthwhile. I recall being similarly fortified by the words of a former prime minister, who in response to a close colleague questioning a policy proposal I'd come up with was said to have retorted, You don’t criticise creativity. It is all too easy to say 'No'. In contrast, enduring innovations are actually hard to come by.

It also reminds me of some wise words about the durability of ideas that I stumbled across when reading Robert Skidelsky’s new text on Kenyes. In contemplating the man’s influence over the ages, Skidelsky asks himself whether ideas “are part of the base or the superstructure of social life – society’s building blocks or weapons in the struggle for power.” To which he responds, “I know of no way of answering…except in terms that Keynes himself would have given: whatever the short-run fate of ideas, the ideas that survive are those that [provide] answers to what is universal in human nature or experience and not just to the interests of particular groups.”

One of my private, never-before-voiced frustrations with our public dialogue is that there is not enough nuance or granularity. Academics, columnists, politicians and other would-be players find far too much comfort in blunt, fissiparous reductionism, when many of the questions and challenges we confront cannot be shunted into simple black-and-white bins.

You know the siren calls. You either believe markets are efficient or inefficient. Humans are highly rational or irrational. You are a conservative, neo-liberal or a social democrat. Government regulation is good or bad. State ownership of assets is to be resisted at all costs or encouraged. There is no halfway house--you are either with us or against us. While each of these themes attracts a wealth of argument for and against, the truth is that our world is, in fact, all of these things: we are capable of extreme rationality and irrationality; regulation can be good or bad; most politicians belong to neither the far left or right (judged by their own actions, they tend not to conform to any cohort); markets are neither highly efficient or inefficient—indeed, there are times when they are both, but most often the informational and allocative integrity of markets rests somewhere in between.

Let’s consider two examples from politics and finance. In doing so, I will try and tender some alternative ideas. If you find politics hum-drum, skip to the finance (a few paragraphs down).

Outside of a national security crisis, when was the last time you saw the two major political parties unite around their shared support for a compelling policy proposition? It very rarely, if ever, happens. Our politicians seem to be enamoured by a false dichotomy: they think that their interests are best advanced by opposing the other side on all matters irrespective of their merit. You heard this rhetoric replayed endlessly around the time of the last Liberal Party fracas. Tony Abbott was regularly quoted as saying, “The job of the Opposition is to be an alternative, not an echo.” Although these are fine words, is also the job of an Opposition not to pervert good policy; that is, not to hamper human progress, which all too often is the order of the day in our conflicted political process. The sad fact is that given the choice between helping facilitate important policy innovations and landing a few juicy low blows against the other side, politicians regularly opt for the latter.

This motivates a critique of the conventional wisdom that oppositions should focus on resisting incumbent governments rather than actually building constructive ideas. I suspect the antecedents of this belief can be traced back to the ashes of the 1993 election. According to noted political commentator, Paul Kelly, one of the chief learnings from the 1993 experience is that oppositions must always adopt a low radar cross-section; offer minimal policy definition while concentrating on maximising the attention drawn to the government’s shortcomings:

“[Dr John] Hewson’s defeat demanded a tactical and strategic reappraisal. The tactical reappraisal for opposition parties has been translated into firm rules: don’t release comprehensive policies too early; don’t pretend to be governments; don’t give too much detail; and avoid decisions that allow incumbents to make you the issue. It is now part of our political practice, courtesy of Hewson and Keating.”

Kelly’s advice has been embraced by Kevin Rudd, Malcolm Turnbull, and Tony Abbott with varying success. In my judgment, the mistake Kelly and others make is taking one unusual episode—the 1993 election—and trying to extract universal constants from its innards. As always, life is more nuanced than such reductionism allows.

In Kevin Rudd’s case, he faced a government that had been in power for an extraordinary eleven and a half years. Howard was clearly on the nose, offered no succession plan, and the community wanted change. This is the well-known risk of long-lived incumbency.

Adopting the stealth approach was entirely appropriate for the conditions of the day. Just as equally, however, was the inappropriateness of this strategy for a newly appointed opposition leader, Malcolm Turnbull, attempting to defeat a wildly popular first-term government for only the second time in history.

As I have noted before, Turnbull desperately needed ‘definition’. In a post-Howard period, the electorate wanted to understand what he stood for. Contrary to the advice he was presumably getting at the time, Turnbull should have formulated a high-level policy manifesto that resolved what his administration represented. Furnishing the public with a compelling choice was the only hope he had of wresting away support from the political phenomenon that is Kevin Rudd. In the absence of creating this striking alternative, he was left with the low probability hope that somehow Rudd would implode.

In Paul Kelly’s reading, the current opposition’s policy-free stance (save for Turnbull's admittedly valiant death-rolls around climate change) is justified by the lessons yielded by Hewson’s two main blunders back in 1993. The first was announcing a comprehensive policy program, Fightback!, well in advance of the pending election. The second was seeking to impose on the public a sweeping ‘neo-liberal’ ideological agenda, the key component of which was a GST that had been previously endorsed by both parties, and which was firmly backed by the Commonwealth Treasury.

Yet the integrity of Kelly’s conclusions are undermined by his own evidence. In Kelly’s telling, Fightback! was privately applauded by both sides of politics, and, during the early days, the electorate. In this respect, Kelly himself acknowledges that, “It is easily overlooked that Fightback! was an instant success. The first Newspoll after its launch showed a 53-35 per cent Coalition primary vote lead: its existential daring had outweighed its political traps…The media was [also] enthusiastic about Fightback! Hawke seemed immobilised and Labor was stunned.”

Self-described ‘bleeding heart’, Dr Don Watson, who was Prime Minister Paul Keating’s left-leaning speechwriter and advisor, is quoted by Kelly as confiding, “I found myself admiring [Fightback!]—so did others who had never voted anything but Labor.”

Arguably more penetrating insights are sourced from senior members of the opposition at the time, who felt that although the Fightback! strategy was broadly-speaking the right one, it was scuppered by the poor execution of an inexperienced leader. Former Prime Minister, John Howard, recalls, “When Hewson brought it out people lapped it up…it was a plan and all the research was telling us that people wanted a plan….a more skilful leader would have won… We only lost the campaign.”

Perennial rival, Peter Costello, concurs: “There was a lot about Fightback! that I admired and supported…[but] Hewson’s ineptitude was the key…I thought we lost because of Hewson’s miscalculation. He did not have the experience to know which policy issues the public would stomach, and which ones he should leave alone.”

As Kelly highlights, Hewson’s defeat at the 1993 election was also an artifact of Paul Keating’s peerless fighting skills. Keating went to the election with a superficially attractive, if rather questionable, alternative proposal, One Nation, that promised major tax cuts (instead of a hefty GST) based on contentious forecasts that were strongly opposed by the Treasury, and his Treasurer, John Dawkins. As it turned out, Keating’s forecasts were, in Kelly words, a ‘shambles’ within six months of their release, and the proposed tax cuts were never delivered, which ultimately led to the resignation of Dawkins prior to the release of his first post-election budget.

Notwithstanding Keating's win-at-all-costs approach, it should be acknowledged that his reformist legacy alongside Bob Hawke has no precedent in Australian history. In line with the Campbell Committee’s recommendations, Hawke and Keating floated the exchange rate, deregulated the financial system, opened the doors to foreign banking competition, and eliminated interest rate caps. Yet they went much further than this
by abolishing centralised wage fixation and introducing enterprise bargaining with the support of the union movement, advocating free trade and cutting tariffs, privatising utilities, and legislating Australia’s world-class superannuation system. It was, ironically, a mostly neo-liberal agenda.

One fascinating historical aside that Kelly unearths relates to the authorship of the superannuation idea. While it is well known that super was first introduced as part of the 1980s Accord negotiations between the ACTU and the Hawke Government, it is less well understood that the inspiration behind it was the trade union chief, Charlie Fitzgibbon. According to his successor, Bill Kelty, Fitzgibbon exclaimed, “Whatever happens, Bill, if Labor only governs for two months, we’ve got to get super”. Kelty continues, “In my judgment, Fitzgibbon was the greatest union leader, in intellectual terms, this country has had—and I agreed with him. We had to get super.” With Kelty and Keating’s imprimatur, Hawke was to formally enshrine the new system into law in 1992 while his understudy sat brooding on the backbench. It is, of course, an open historical question as to how many of these reforms could have been achieved had the other side been in power.

My principal point in all of this is that purportedly sophisticated orthodoxy is often based on flimsy foundations, and it consequently pays to inspect them (put more specifically, the people are sick-and-tired of destructive politics, which is, quite frankly, an affront to their faculties). And the same argument applies to the stereotyping we see in financial markets.

Although many private sector participants, and even some bureaucrats, are paranoid about the spectre ‘over-regulation’ in response to the recent crisis, the truth is that smart public oversight can be a source of comparative advantage. That is, financial markets should actually pay a premium for assets originated and managed in jurisdictions where the risk of dysfunction is minimised by an intelligent set of rules. There does not, therefore, need to be the combative interactions that you often see played out in the press between the public and private sectors. Indeed, the real point of the conception we refer to as ‘efficient markets’ is that it is policymaking aspiration; one of the main goals of regulation should be to optimise the efficiency of the market mechanism.

Take the case of securitisation. Australian taxpayers thoughtfully injected $8 billion into the residential mortgage-backed securities market to vouchsafe its integrity during the GFC. This was a critical lifeblood of liquidity for smaller banks, building societies, and non-bank lenders that relied much more heavily on securitisation than the ‘majors’.

Although this was commendable ad-hoc policy action that I had advocated from the outset, my one consistent criticism was that there was no overarching strategy accompanying it. The government made no statement about their long-term approach to dealing with this particular sector. Even when they invested a further $8 billion we were given no substantive policy architecture or decision-making framework. The real opportunity for policymakers would have been to extract some positive regulatory gains in exchange for their support. For example, Wayne Swan could easily have said, We are investing $16 billion into this space, and in return we are going to require all securitisers to be properly licenced and regulated under a new set of standards governed by APRA or ASIC.

Remember that securitisation is a completely unregulated over-the-counter activity that was the principal delivery device for cataclysmic contagion during the GFC. One of the biggest problems with securitisation in the US was the lack of transparent information between those lenders that were selling home loans, and the investors that directly and indirectly acquired exposures to them. This issue, known technically, as ‘asymmetric information’, was one of the major causes of the collapse of institutional funding and liquidity around the world and the resultant failure of many large banks, such as Northern Rock in the UK.

I have heard more recently that one Australian industry body is thinking about promoting a set of ‘self-regulated’ market standards. But in a post-GFC world this will be of little value. A much better idea would be for all lenders to pro-actively engage with government and agree a new licencing regime that explicitly deals with securitisation. So in order to sell a portfolio of home loans in the future, and get the benefit of occasional public support during crises, lenders would have to be formally licenced by APRA or ASIC. This process would be tantamount to the Australian Government warranting that these institutions have:

* Very rigorous credit assessment standards;
* First-rate compliance, governance and risk-management systems;
* Robust mortgage servicing capabilities;
* Best-in-breed reporting and disclosure processes;
* Minimum levels of financial solvency; and
* A commitment to securitising loans in a manner that aligns the interests of lenders and investors (eg, through maintaining equity contributions in their portfolios).

In this way, Australian securitisations could become a global best-practice benchmark. And investors would be comforted that the dysfunctions that plagued these structures in the past had been comprehensively and permanently dealt with.

A related idea would be the establishment of the National Electronic Credit Register that I have previously proposed. This would involve setting up a central government 'clearinghouse' that captured data on every residential loan advanced in Australia. It would give the RBA and APRA unprecendented resolution on the quantity of leverage flowing through the system, the credit standards applied by lenders, and the changing riskiness of the underlying borrowers. Such a utility could also serve as a valuable resource for private investors during times of extreme uncertainty by eliminating the informational asymmetries that were drivers of the GFC.

Okay, I know--I've covered a lot rather varied territory. But this was my round-about way of crunching through the thoughts in my head.