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, September 23, 2011

A challenge to Stephen Grenville

Dr Stephen Grenville, former Deputy Governor of the RBA, now visiting fellow at the Lowy Institute, has written this excellent article on the case for fundamental financial services reform. It is brilliant yet frustrating. Almost every single argument he makes I myself have outlined in detail over tens of thousands of words in countless publications. I will not even bother linking to them (simply Google my name combined with "taxpayer guarantees", "banks", "implicit guarantees", "offshore expansion", "utilities", "son of Wallis", "casino", "return on equity", "narrow banking", etc). In this courageous speech, the Shadow Treasurer, Joe Hockey, articulates a similar case.

Yet in contrast to Hockey and myself, Grenville directs none of his criticisms at Australia despite the fact that local institutions possess almost all the same characteristics. This is partly explained by the fact that he has (understandably) refrained from commenting on monetary policy and financial stability considerations given his previous position as 2iC at our central bank, which has responsibility for both. It may also be related to the fact that he is a director of the funds management subsidiary of a listed institution with a banking licence (although I doubt whether this counts for much).

The truth is Grenville left the RBA a decade ago. Bernie Fraser has no trouble speaking up nowadays. All of Grenville's criticisms of 'universal banks'--of mixing traditional retail banking with "derivatives, proprietary trading, underwriting, funds management and so on"--could be aggressively levied at Australia's four Goliaths. To be clear, Grenville claims:

"[T]here is unanimity that routine commercial banking should be separated from the rest of the financial sector's activities (derivatives, proprietary trading, underwriting, funds management and so on). Universal banks might make sense in a world of perfectly efficient markets, diligent managers and all-wise regulators. But now we have experienced just what trouble universal banks can get themselves into, and how taxpayers have to fund the consequences of even the most egregious behaviour, the idea of separating routine commercial banking from the difficult-to-manage remainder is compelling."

ANZ's explicit strategy is to expand beyond Australian retail banking and become a pan-Asian institution (the merits of which have only been belatedly questioned in public in the RBA's Financial Stability Review). CBA, which is already one of the nation's largest fund managers (as are Westpac and NAB), has announced it is on an M&A spree across a range of verticals. All the major banks have very substantial proprietary trading operations (the true extent of which is scantly appreciated).

The UK Volcker Commission's prescriptions, which Grenville enthuasiatically lauds, have already been rejected out-of-hand by Australian banks and their advocates.

Grenville is in the final years of his career. He has a huge, and at times uniquely incisive, intellect that has the capacity to make profound contributions to the domestic policy debate. But he largely does not partake when it comes to the question of banking reform. He leaves his withering criticisms for institutions beyond these shores.

(Again, I am perhaps heroically assuming here that he does not completely believe the popular narrative that Australia's success is explained by our policymakers' skill. I would remind him, as I have done others so many times before, that APRA was founded on the explicit premise that government would never guarantee any part of the private financial system given moral hazard concerns, something that was utterly anathema to the efficient markets-orientated recommendations of the 1997 Wallis Inquiry, as Ian Harper has repeatedly acknowledged.)

I hope it is clear I have enormous respect for the man. But I want to put this message bluntly: it is time you step up to the plate and tackle the policy issues that lie sleeping beneath Australia's financial system. You know that we have been extraordinarily lucky. You know that our 20 years of uninterrupted growth reflect the confluence of an array of coincidences of which policymaking prescience is only one independent variable with questionable explanatory power. I am talking here, of course, about things like our Antipodal position, exceptional natural resources base, trading partner mix, the depth of the post-1991 output gap, the benefits of Chinese disinflation, our tremendous immigration growth, the fact that the major banks did not, historically, have the need to look overseas for earnings (unlike their UK and European cousins), that they were about five years behind their UK and US equivalents--whom they nevertheless modelled themselves on--in the development of securitisation and non-conforming loans. It would be a foolish mistake to think that Canberra and Martin Place were responsible for divining our destiny.

Without fear or favour, we need to hear Grenville's voice more loudly alongside the handful of others willing to speak out on delicate matters of public controversy (eg, Warwick McKibbin). More specifically, I challenge you to hold Australian banks to the same policy standards that you expect of their UK, European and US competitors, and to question the ability of the domestic system to withstand a GFC-style crisis originating out of Asia in 10-20 years time. These are the issues that really matter to the next generation of Australians.