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."

Monday, July 26, 2010

Review of Uren and Taylor's "Sh*tstorm"

Australia’s best record of the real-time political and policy consequences of the GFC, Shitstorm, by journalists David Uren and Lenore Taylor, is well worth a read. And it will be even more valuable as an historical account for future generations that were not directly exposed to these events.

Shitstorm is well written and thoroughly researched. The economic commentary is textured with considerable insight. As a reasonably close follower of these things, its principal value for me was in offering previously untold stories about the behind-the-scenes decision-making processes and interpersonal dynamics that shaped the Rudd Government’s prosecution of its policies during the crisis.

We hear how Lindsay Tanner was resistant to much of the early stimulus. The authors repeatedly belabour the mounting tensions within the ALP in response to the centralisation of authority within the PM’s ‘office’ without having the benefit of Rudd’s departure at the time they completed the book.

In anticipation of this, they relay the disintermediation of the traditional Cabinet processes by the four person ‘SPBC’, which started as a necessity due to the claimed sensitivity of measures such as the bank guarantees (surely Cabinet has resolved more confidential national security matters than bank guarantees?), and evolved into a relentless convention.

Here I have sympathy for Rudd’s approach. To some extent, I suspect he was just trying to impose standard leadership disciplines on the practice of government. One of the biggest mistakes people make is to confuse democracy with execution. We popularly elect people to make decisions on our behalf. But should they then be expected to do the same when carrying out their delegated responsibilities? In short, no. The most effective leaders do not manage by consensus or committee. Think about the way a CEO runs a big business or how a general wages war. They synthesise all of the available information supplied by their subordinates. They caucus in as open fashion as possible to collect competing views. But they don’t then put their ensuing decisions to a vote amongst staff or soldiers. And for very good reason. They have been selected to make the decisions, and will be held personally accountable for the results. If they keep on making poor decisions, they will eventually be removed—by shareholders, their Board, or their political masters.

My own experience suggests that managing by way of committee and/or consensus is a recipe for highly risk-averse and lowest-common-denominator solutions. When you decide a course of action you are going to inevitably choose a path that conflicts with the preferences of many people in the room. No decision will placate everyone, and trying to do so is a waste of time.

This is one of the conceptual mistakes politicians make when transitioning into managing government. They are so focused on the democratic process they forget about what is required to efficiently execute.

Shitstorm was also interesting for lifting the lid on some of the RBA’s internal processes. We learn how Dr Guy Debelle was the major advocate of slowing down the monetary policy tightening in 2007 and 2008 in recognition of the increasingly worrying external events. Uren and Taylor report how his colleagues thought he had become “captured by his constituency” (the banks). This is ironic, because I had thought that Guy’s superiors were captured by the same institutions in the context of financial services reform and competition considerations. The authors position Debelle as the most prescient of his contemporaries, which is consequential in the context of the succession debate.

My own views on 2007 and 2008 have evolved as I have come to understand the RBA. I was previously very critical of the February and March hikes, and the de facto rate increases thereafter. But when you start to appreciate that the RBA is first and foremost an ‘inflation targeter’, and you then account for the inflationary challenges that were accruing at the time, you can perhaps sympathise more with the RBA’s logic of least regret. That is, Sorry, but I am going to keep on hiking to address the inflation problem until I have overwhelming evidence to suggest that a demonstrable deterioration in growth will deal with it. I would prefer to err on the inflationary downside, rather than consistently breach the target. And so they only passed through the first cut in September 2008.

As discussed before, I appreciated the reference to Joshua Gans and my work on convincing the government to support the liquidity of the securitisation market, the accuracy of which, as I explained, could have been improved a bit.

Finally, I know from first-hand experience that there has been some rendering of history by Uren and Taylor’s sources. The government was very quick to cauterise the risks to the banking system. The authors quote Rudd himself as stating that stability, not fairness or competition, was the first order priority. What they miss is that the government was much slower to ensure that the institutions met their end of the bargain. We know that the major banks rationed credit to businesses, which caused problems. There was also the largely unreported case of one of the big banks seeking to ration credit to households, which ran the risk of introducing significant knock-on instability into the system. The CEO in question wanted to cut the maximum LVR to just 80%, which would have denied credit to around 30-40% of all residential borrowers. If this had happened, precipitous house price falls could have become a self-fulfilling prophesy. While there is a counterargument that other banks would have stepped into the breach, in a climate of extreme risk-aversion one of the majors seeking to protect itself--with the market then pricing in a positive premium for doing so--could have compelled others to follow suit, much as we saw in the UK. Thankfully this fate was avoided.

Instead we get the white-washed version that, “Rudd let the banks know there was a trade-off for the guarantees…‘We expected supply from the banking system to those that needed credit’…Rudd and Swan instructed the banks to supply APRA with highly detailed weekly lending data so that it could confirm that the banks were keeping their side of the bargain.”

I actually had a personal hand in the latter initiative, as I explained in a recent piece for the ABC (see here):

“So I asked Rudd's advisor what their assessment of the risks had been prior to launching this unprecedented and expensive initiative. In particular, I asked what they thought the banks' loan-to-value ratios (LVRs) were to the commercial property assets in question.

Westpac and ANZ had already had near-death experiences with commercial property in the early 1990s. Since that time all the majors had scaled back their exposures and adopted much more conservative lending practices.

My own intelligence suggested that the vast bulk of the loans were written with low LVRs of 50 per cent of less. This meant that the assets would have to suffer extraordinary hair-cuts in value before the banks were genuinely threatened.

The response I received was worrying. The short answer was that the PM's office did not know. Stunned, I enquired as to how they could possibly have made the decision to commit billions of dollars taxpayer funds without first having this information. After all, it existed - it was just a matter of getting it from the banks.

We cannot make head or tail of APRA's data, I was told. But mate, you are providing hundreds of billions of dollars worth of taxpayer guarantees to these institutions. Surely you have asked for this directly from them? Nope. We primarily just meet with the Chairmen and CEOs.

Shocked, I told them this was disturbing news. The PM's office should be getting fortnightly or monthly feeds directly from these institutions on all their key operating and risk metrics so long as the insurance is in place. [I actually remember suggesting “weekly” feeds, and think that Uren and Taylor are correct in this regard.]

Backtracking, I was asked whether I could prepare a 'data request form' that they could then send to the banks. I naturally obliged and was subsequently told by senior regulators that the PM's office had implemented the new regime.

The problem for Rudd and his advisors was they did not know what they did not know. The professional inexperience meant that they were being plagued by Rumsfeld's 'unknown unknowns'. But this is not the way it had to be. Rudd could have humbly taken the counsel of vastly more learned operators. That he chose not to is precisely why he is no longer Prime Minister today.”

One last area for future improvement would be to consider the long-term policy ramifications of the GFC--ie, the evolving role of banks and the new financial reforms that will be required to address the potential moral hazards now embedded in the system.

In summary, this is an excellent read, and a worthwhile purchase for anyone interested in this fascinating episode in Australia's political economy.