Today I am going to dissect in more detail the RBA’s testimony to Parliament, and throw out some ideas as to how the central bank might play a more useful role in our society. I can also reveal for the first time that the RBA has formally modified the way it communicates with journalists after the ‘Board leaks’ saga.
I would summarise the RBA’s parliamentary performance as a bit of a mixed-bag. I thought the Governor was, in many respects, outstanding. He offered much intelligent, counter-intuitive and, on occasion, withering insight (even if I did not always agree with him). He was also conspicuously humble and respectful of the forum’s importance, and did not dismiss the politicians’ surprisingly thoughtful questioning. The Assistant Governor, Phil Lowe, was also noticeably sharp, and could well make a good Governor one day. He is clearly being groomed as one candidate for the job, which I will return to later.
On asset prices, the Governor once again reiterated that the RBA has no intention of ‘targeting’ them (read trying to engineer specific ‘levels’). He also, interestingly, reiterated a rarely observed point I went to great lengths to highlight only a week or so ago: when the RBA thinks about ‘asset prices’, this encompasses many different things, including listed equities and corporate debt markets, commercial real estate equities and credit, and, presumably, private equity and the leveraged finance it heavily relies on, in addition to housing. The living room expert will inevitably respond, But housing debt is a much bigger part of the economy. True. Yet it also exhibits significantly lower empirical risks to our financial system’s stability (see again here), as the Governor repeatedly confirmed.
Despite the fact that the listed US, UK and Australian equities markets suffered from much bigger measured ‘bubbles’ during the GFC than their local housing markets (judging by the extent of their ensuing contraction), and have been responsible for many more financial and corporate crises in modern history, the media seems utterly fixated with housing. I think the RBA is also a tad culpable here. To redress the imbalance, the RBA should at some point explicitly acknowledge that when it thinks about asset prices, it is just as concerned about the highly interdependent corporate equities and debt markets, which pose demonstrably far greater hazards to our banking system’s health (think 1991 or the provisions made by the major banks during the recent calamity).
The RBA could achieve this by simply saying something like, If we were to observe positive feedback loops between the listed equities and debt markets, as we saw during the 1980s, early 2000s, and prior to the GFC, this could be a cause for policy concern. That would be more than enough to remedy the current intellectual asymmetry, and to put the stock jocks on notice. Or perhaps words to the effect, It would indeed be disturbing to once again experience leveraged-induced asset price appreciation in listed equities given the high volatility of that market.
Anyways, this is what Stevens and Lowe had to say on the subject:
“Mr Stevens—There is a big difference between ‘leaning into’ and targeting asset prices. I do not actually favour—at this point in time, anyway—having an asset price. Which asset price would you be talking about, for a start? There are many assets. But I do not favour having a target.
Dr Lowe—I think it is important that people do not think of this as the central bank targeting asset prices or pricking asset price bubbles, because I do not think anyone thinks that is sensible. The issue is really: if you are seeing imbalances develop in the financial system, what should monetary policy and regulatory policy do… I think the weight of opinion is shifting towards the view that both regulatory and monetary policy need to do something. These financial imbalances arise if credit is growing very quickly, if asset prices are growing very quickly....But it is not about targeting asset prices; it is not about pricking bubbles. It is about responding to financial developments in a sensible way.”
Now one objective rejoinder here. It is not actually up to Phil Lowe or Glenn Stevens to decide whether the ‘weight of opinion’ suggests Australian monetary policy should shift to take account of asset prices. The indisputable fact is that leaning on asset prices was not conceived as a part of the Reserve Bank Act of 1959, nor was it countenanced within the 1996 Statement on the Conduct of Monetary Policy. As Stevens himself has claimed many times before, this has, in truth, been a highly contentious and unresolved debate. (And it would be a stretch to argue that the RBA believes the debate is now 'closed' in any event.)
The question is not, therefore, one for the RBA executive to address. It is actually a question for their political masters and then, and only then, the RBA Board. Accepting this logic, it is also not adequate for the RBA to tell Parliament that they are not exercising themselves about these matters, as they clearly did. Because they should be.
These are emphatically not concerns for the next Governor, the next Government, or the next Statement on the Conduct of Monetary Policy, as the RBA stated. They are questions that have to be directly answered today if the RBA wishes to expand its current delegated remit, which is undoubtedly its intention. While the RBA may think that it has a mandate to manage asset prices on the basis of the direction of the debate, others disagree. And those ‘others’ include, amongst many respected experts, two of their most distinguished members: Dr David Gruen, an alumnus who is now 2iC at Treasury, and Dr Guy Debelle, an Assistant Governor of the Bank today.
I would simply ask this of Glenn and Phil. What does the Prime Minister of Australia think about the RBA deciding to change the conduct of monetary policy in this way? And what is the position of the Secretary of the Treasury, Ken Henry? I personally don’t know. But if there is a shadow of doubt as to their views, the RBA is standing on very shaky territory.
I think the bubble Glenn Stevens is proving most adept at bursting is media myths. And, as is normally the case with the RBA, he was especially adroit when it came to housing. Specifically, he pointed out that notwithstanding the robust house price growth recorded in 2009, lending standards have actually tightened while credit is not growing at an unseemly rate:
“The rate of growth of housing credit behind that is about eight per cent…I would not regard that as grossly excessive—it used to be 18. One of the real worry points you are looking for is rapidly rising asset values, very strong growth in credit and declining lending standards. What we have is pretty strong growth in house prices over the past year…but credit growth is not too bad; it is moderate. Lending standards for households are actually increasing, not falling. Banks are tending to reduce loan-to-value ratios—you have got to have a bigger deposit and so on, and I do not think you can get a no deposit loan now et cetera. I welcome that; I think that is a very good thing. We may well see more of that if house prices continue to escalate because the banks own risk management will tell them, ‘Be careful here, and maybe be a bit tougher on the standards.’ That is what they should do. So we do not see incredibly fast growth in credit at the moment—we might, but at the present time we do not—and we do not see lending standards falling, we see them rising.”
I have previously presented detailed data on the banks’ historical loss rates across their different lending silos, which illustrate that even during the deep 1991 recession the shortfalls realised on residential mortgages were a tiny fraction of the losses on corporate loans. And the same proved true during the GFC. This is precisely why regulators apply such a favourable risk-weighting to home loans vis-à-vis business lending. Following some forgettable statements by a business banker last week that regulators unfairly disadvantage corporate lending, which was duly picked up by one of the pollies, the Governor obliged with some hard facts:
“I think it is an economic fact that lending for mortgages has historically been far safer than for other things. That is why the Basel process downweights the weighting on mortgages when you are calculating the capital charges. Certain mortgages in America, of course, proved to be much more risky than had been assumed. But, leaving that aside, in this country certainly it has been and remains a very safe form of lending. It is true that for a dollar of capital if you are just earning the same returns you can do more on housing. This is why you charge more for business loans. This is why the business loan has a risk margin built in which is considerably higher than a risk margin on a housing loan, so the banks compensate for that in the pricing…It is true that the capital charge system does discriminate, but that is what it is supposed to do because mortgage lending is less risky and that is why a business loan costs more to get.”
There was, to be sure, much other good content that time does not permit me to cover. Before I turn to consider the Member for Mayo’s grilling, let me first tender a few ideas.
The five ‘lay’ business members of the RBA’s Board are arguably only useful for two things. First, helping the Governor and his team resolve difficult decisions under uncertainty, which is, of course, one of the principal problems they face. And, second, assisting him build and manage a successful organisation, as all Boards are meant to do. So Glenn, if you have not already considered this, why not take the entire Board on an offsite to contemplate how you can improve the way the RBA is managed? I am not, to be clear, suggesting there are any problems here! But the RBA does confront some awkward challenges. Here are a few that spring to mind:
1) By virtue of its responsibilities, the RBA has an insular gene pool. There are few if any ‘lateral hires’ as occurs in almost all other organisations. Due to the very specialised nature of the role, most recruits join as graduates or after a few years elsewhere (eg, Treasury). Even more unusually, there are almost never senior-level appointments. This means that the top echelon at the RBA have spent most of their careers within that institution’s orbit (ie, including perhaps sojourns at universities, the IMF and the OECD). The truth is that every once in a while a very senior external hire, like Bernie Fraser in 1989, is exactly what the central bank needs. It is very difficult to credibly argue otherwise. In many ways, Bernie was one of the best things that ever happened to the Bank. And we should not be closed-minded about infusing the RBA with external DNA at some point in the future, which could then pose succession problems;
2) The RBA has a more atypically tenure-based tournament system than most private companies. Simply stated, you have to put in decades worth of service before you can run the show. That is not necessarily a bad thing—experience counts for more than innate expertise. However, it can deter impatient talent. So the challenge is, Can the RBA do more to attract and retain top talent? And is there a case for re-thinking their executive promotion system to make it more meritocratic. I suspect so;
3) Related to (1) above, there is a question whether the community is extracting the maximum value out of the RBA’s peerless economic resources. Now I am thinking out loud, but maybe we can bequeath the RBA with more of a ‘roving policy-development responsibility’ in addition to its core monetary policy and system stability focus. The RBA already satisfies one key criterion to meet this objective: it is independent, much like the Productivity Commission. I have another aim in mind as well. I am to trying to think of a conduit via which we can leverage the ideas of the internal executive team on a broad range of policy matters in order to: (a) afford them more stimulating professional opportunities; and (b) help the RBA better contribute to society without undermining the institution’s price stability objectives.
There are two ways in which we might implement this latter thought. First, the RBA could establish an independent policy unit akin to a government think-tank. When talented execs get burned out with, say, the day-to-day grind of forecasting inflation and setting interest rates, they could be seconded for a year or two into this innovative policy unit.
Second, the RBA could establish a new discussion paper series that concentrates purely on independent policy ideas. Some will impulsively say this is crazy. But this is also precisely the sort of disruptive innovation that the public sector should be engaging in. Thought-leaders like Dr Nicholas Gruen have been agitating to wrest government policymakers out of their patent torpor for years (pun intended!).
Okay, that’s my contribution to today’s suggestion box. For those who don’t know, I criticise the RBA at my commercial peril. The business I run, Rismark, supplies the central bank with valuable research information in combination with our data partner. Over the years some have queried why I would risk speaking out like this. But I guess my view is first that life is just too short. And, second, it has never affected my relationship with the RBA, or at least the folks I deal with. I would like to think they respect independent trains of thought, even if they don’t agree with them. The RBA needs intelligent criticism, like any good business. We should all seek to constantly reinvent ourselves and resist the powerful tendency to ‘institutionalise’ the moment of our success. As the long-serving CEO of Intel, Andy Grove, once said, Only the paranoid survive.
