I read Ken Henry’s speech on competition in the banking and finance sectors this morning and was, quite frankly, disappointed. On the positive side of the ledger, Henry acknowledges that there has been a ‘diminution’ in competition as a consequence of the GFC while making the legitimate point that Australia’s lending markets remain ‘contestable’. Some experienced journalists have nevertheless interpreted Henry’s statements as a defence of the major banks. I didn’t really get that impression. Indeed, there were some subtle shots across the ACCC’s bow to remind them that consolidation should not be allowed to undermine competition.
What I did find galling was Henry’s repeated references to the government’s investments in the securitisation markets as the centerpiece of their policy efforts to support competition during the GFC. My problem here is that Treasury aggressively opposed precisely this initiative, and, truth be told, had to be dragged kicking and screaming by Rudd and Swan to implement it. It was one of those rare instances where progressive politicians triumphed over the narrow-minded intransigence of the bureaucracy. (This is something that Dr Nicholas Gruen, head of the government’s Web 2.0 task force, has spent much of his career fighting.)
Treasury’s staunch opposition to the proposal that I first developed with an academic colleague in early 2008 (which called for it to use the Australian Office of Financial Management (AOFM) to invest directly in AAA-rated residential mortgage-backed securities) was formally put on the record in August 2008 in senior officers’ testimony to a parliamentary inquiry. Prior to that point, I had been informed by key advisors to the government and leading politicians that there was immense resistance to the idea emanating from both Treasury and the RBA.
I have even sat inside the Treasury’s offices in Canberra and had some of their most senior executives tell me that just because two academics thought that the AOFM initiative was good policy, it does not mean that it actually is. (Wayne Swan announced in late 2008 that the government would commit $4 billion to the idea, which he has subsequently expanded to $16 billion.) In fact, I was told that Treasury officers had formally advised the government against pursuing the opportunity, and that if things went awry they would ‘not be losing their jobs over it’. And then, of course, there were the not unexpected howls from the far-right as best represented by The Australian’s impassioned columnists.
Yet you would never know this reading Dr Henry’s speech. According to the Treasury Secretary, “smaller institutions can be expected to be in a position to increase their competitive influence over time as securitisation markets recover, supported by the Government’s direct investment in residential mortgage backed securities.”
A few paragraphs later, Henry further highlights the ‘important role’ this unprecedented measure played, exclaiming, “the Government’s investment in residential mortgage-backed securities is supporting competition from smaller lenders at a time when securitisation markets remain affected from the fallout of the global financial crisis. This initiative continues to play an important role in promoting the market’s recovery and investor confidence.”
As I have argued in many other contexts (such as the need to have a post-GFC, system-wide financial inquiry), it would be refreshing if, just occasionally, Australia’s bureaucrats levelled with us and infused a little objectivity and frankness into their pronouncements. Ken Henry could have said something like, “We learnt an enormous amount during the GFC, and put in place some unproven and controversial policies. While at the time there was debate as to the merits of these schemes, they appear to be paying dividends and will offer government new options to help combat future calamites.” In fairness to Treasury, I have made similar criticisms of the RBA in respect of their defence of flawed governance practices in recent testimony to parliament.
Let me now turn the cross-hairs on the industry that benefited from these interventions. I was recently invited to speak at a roundtable comprising major lenders that rely on securitisation. This included both senior executives from banks and non-banks. Every single one of them stated that were it not for the AOFM investments both they and Australia’s securitisation market would have been cactus during the GFC. But what was most disturbing is that they all look to be myopically heading back to ‘business as usual’. There was no introspection as to how incredibly lucky they were to have the Prime Minister commit $16 billion of taxpayers’ money to support smaller lenders. More importantly, nobody was asking themselves the question, What will happen in a future crisis? Is there a risk that with a change of government the administration of the day will decide that these investments are just one step too far, or should be significantly scaled back? When I put this to the roundtable, I basically got blank looks.
As I’ve argued before, one of the chief failings of the government’s policy approach to assisting the securitisation market was that they did not accompany it with a strategic policy framework: for example, an explanation of the economic rationale for the investments; how this initiative complemented measures being deployed to underpin the deposit-taking sector; why they thought it was worthwhile making a commitment to vouchsafing a minimum level of liquidity in securitisation markets over the long-run; and, most crucially, the new regulation they would impose on participants that were the beneficiaries of this money.
In short, there has to be some ‘cost’ associated with these taxpayer bailouts. To date, there has been none, which only raises the spectre of moral hazard—ie, the attitude, Don’t worry, Swannie will save our bacon the next time liquidity evaporates. What Rudd and Swan should have done is say, Okay guys we are going to provide you with billions of dollars of emergency funding (just like we did with the banks), but the quid pro quo is that if you ever want to get access to this money you cannot remain part of the ‘shadow banking’ (ie, unregulated) system.
One simple yet powerful policy solution here would be to establish a new licencing regime regulated by APRA for all ‘securitisers’ (if you are already a bank, this would not be a problem). I put this to the industry participants at the round-table and argued that they should view regulatory change as a potential positive, something that can be harnessed as an international comparative advantage when trying to convince global investors of the integrity of Australian assets.
I argued that there could be no assurances that they would get bail-outs in future crises. They should, therefore, be seeking to institutionalise this implicit contract between industry and government. And the best way to do so is by pro-actively embracing regulatory action. In this way, government could work collaboratively with the securitisation industry to define minimum levels of solvency (for non-banks), information disclosure, and, critically, best-practice securitisation structures (including the documentation governing these investments) that avoid the obtuse and moral hazard-laden approaches employed in the US that ultimately created the stigma that destroyed global liquidity for all things related to mortgages.
In the future, Australian securitisers should be able to market themselves as APRA-regulated institutions that are subject to strict oversight and a set of agreed approaches to origination, credit assessment, and the best possible methods to align the interests between issuers (ie, lenders) and the investors in their structures.
