Here’s some of the interview taken from Wednesday’s AFR:
…the assumption that Australia could maintain a high level of foreign borrowings because the economy was underpinned by the mining boom and demand from Asia was worrying. “That’s a very risky position”. Australia’s foreign debt position relative to the size of the economy is higher than that of the United States or France.
Mr Murray admonished politicians for glossing over the risk posed to Australia’s economy from foreign indebtedness. Instead, he said, they had chosen to focus voters’ attention on abolishing government debt. “The debate is all being run at a level that completely ignores this vulnerability”.
If Australia’s economy were to slow, the ability to service those foreign borrowings could be affected. There is also the risk that the cost of foreign capital could rise further, which would be felt by many through higher domestic mortgage rates. Banks’ foreign borrowings have funded Australia’s housing boom…
It’s refreshing to hear these views being expressed publicly by Mr Murray, even if he was one of the people responsible for Australia’s housing/debt addiction. Let’s not forget that Mr Murray was at the helm of the CBA in the late 1990s when it ignited a price war amongst the banks by slashing its variable mortgage rate (remember “equity mate”?). Let’s also not forget that the CBA is the second largest issuer of offshore wholesale debt as well as Australia’s second largest mortgage lender behind Westpac.
As I have said on multiple occasions, Australia’s housing bubble has been fuelled by:
- an increased emphasis on mortgage lending relative to other forms of lending (e.g. lending to businesses); which has been funded through
- heavy offshore borrowing by Australia’s lenders, led by Australia’s big four banks (see below chart).
This approach to banking worked fine whilst global credit conditions were benign and household debt levels and asset prices were rising. Rising home values in the early 2000s made Australians feel richer, spurring consumer confidence, spending and employment growth. An economic boom followed and a positive feedback loop was created whereby households took on more debt and housing values rose further, causing the process of confidence, spending and employment growth to repeat.
But the process of debt feeding asset prices feeding confidence, consumer spending and employment growth cuts just as deeply on the way down. And the onset of the Global Financial Crisis (GFC) looked as if it was going to be the catalyst that turned the party into one giant hangover.
The GFC showed Australia just how vulnerable it is to external shocks. With the securitisation markets seizing-up and Australia’s banks unable to roll-over their maturing wholesale funding, the Australian Treasury and Reserve Bank were called upon to: (1) guarantee the banks’ wholesale funding; (2) provide unprecedented liquidity support via the repo market; and (3) buy-up securitisation issues; all in the name of keeping credit flowing into the Australian economy (particularly housing). The Government also provided heavy support to the asset-side of the banks’ balance sheets – i.e. the home values providing collateral against mortgages – via their temporary increases to the first-home buyer’s grant; the relaxation of the rules on foreign ownership of residential property; and a significant increase in the immigration intake.
These measures worked well to reflate the housing/credit bubble and delay the inevitable deleveraging that will follow. But by further increasing housing values and debt, the authorities have likely made the problem much worse, and ensured that the pain on the way down will be more severe than if they had let the bubble deflate on its own accord.
To Mr Murray’s credit, he also advocates a new comprehensive banking inquiry to “allow a cool, calm examination of the system” – something this blogger, Houses and Holes and Delusional Economics are pushing for (see the Son of Wallis Challenge).
Unfortunately, our calls for a warts-and-all inquiry on Australia’s financial system are likely to fall on deaf ears, particularly given the Treasurer, Wayne Swan, is expected to make an announcement on banking competition on Sunday, which is likely to result in some form of hare-brained government guarantee of the RMBS market. An announcement by Swan on Sunday would provide yet another example of poor, reactive policy making by this Government, since it would also pre-empt the outcome of the Senate Inquiry on Banking Competition, which is due to report on 31 March 2011.
And if the minimum eligibility criteria set by the Australian Office of Financial Management (AOFM) for its purchases of RMBS is any guide, then Australia’s taxpayers are in trouble (see below).
95% LVR; $750,000 loan size; 10-year interest only. WTF? Hat tip to Tasmanian Real Estate Trouble for pointing this out.
Even worse, there is a rumour that the AOFM will “become an investor, and price leader, in subordinated tranches of mortgage-backed securities rather than restricting itself to AAA-rated senior debt, as it does now.” That is, Australian taxpayers will buy the high risk shitty loans that will default first. Yeah, that worked out real well for Fannie Mae and Freddie Mac. Sub-prime anyone?
Hold on to your wallets ladies and gentlemen. Here comes the Wayne Swan shake-down.