A glance behind the curtain of Invispower!

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Regular readers will recall that a part of the MB lexicon is the term Invisopower!. The word describes the fog deployed by regulators to conceal the past (and ongoing) reliance of Australia’s large banks upon public support.

From the SMH via Wikileaks today we can peer through a small opening in that fog and discover that, voila, Australian banks were indeed a part of the global financial crisis:

Commonwealth Bank chief executive Ralph Norris was worried Australia might be stripped of its top-notch credit rating during the global financial crisis, and that a downgrade would ”ripple through the real economy”, WikiLeaks cables show.

According to previously secret US government cables, Mr Norris ”expressed concern” over a potential cut in Australia’s AAA credit rating during a meeting in April 2009.

Although he reportedly said a downgrade was ”not particularly likely”, he had not ruled out the prospect, which would have had far-reaching consequences due to Australia’s reliance on overseas funding.

Rod Eddington, head of Infrastructure Australia and then a board member of Rio Tinto, reportedly said in a separate meeting that he and Prime Minister Kevin Rudd had ”lost sleep” over a downgrade in Australia’s credit rating.

Australia retained its AAA sovereign rating throughout the crisis, though in late 2008 Standard & Poor’s said there was growing pressure on the rating due to plunging economic growth.

Analysts at S&P also noted the outside possibility that the government would have to invoke its guarantee of bank funding in late 2008.

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The “ripple” effect that Mr Norris refers to is the danger that once the government rating was downgraded so too is the debt that it guarantees. Suddenly bank funding becomes more expensive, which is passed on to mortgage and business customers at a most inopportune time. This potentially triggers a feedback loop as out-of-cycle interest rate rises turn more loans sour, threatening the bank’s balance sheets and exposing them to further increases in offshore funding costs as investors perceive increased risks. In the worst case, a deflationary loop of deteriorating assets and downgrades can take hold.

If that sounds familiar, that’s because it is. It’s precisely the process that undid Wall St. Norris and Sir Ed and the PM were right to lose sleep, which makes the other statement by Norris in the cable ludicrous:

The cables also report Mr Norris as saying he was ”not concerned” about an Australian housing bubble.

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I don’t know what that says about Mr Norris. That he can worry about the stability of a government guarantee underpinning the assets of his bank yet not conclude that the assets themselves are perhaps a bit overvalued speaks volumes about the values that brought us to the impasse. The story goes on:

A separate cable reports that a June 2009 meeting with US officials and officials from banking regulator Australian Prudential Regulation Authority said Australia needed to make only minor changes to rules covering the financial sector, but all changes would be in line with global changes.

It quotes APRA official Wayne Byres as saying the financial crisis in Australia would not be ”officially over” until the big Australian banks stopped making use of the Australian government bank guarantee.

The government’s wholesale funding guarantee expired early last year while the deposit guarantee is scheduled to finish next month.

It is reassuring to know that behind the veil of Invisopower! that our regulators do not see us as exceptional to the crisis at all. Indeed, there’s no doubt they’ve done a good job of lengthening the profile of Australian bank wholesale funding. And the RBA has also done a great job with monetary policy in engineering much higher proportions of deposit funding.

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However, I fear the half a trillion dollar vulnerability has been mitigated, not cured. Clearly, so do global markets, which are pricing Australian CDS rates at similar levels to the GFC. Any extended freeze in global wholesale markets may well result in the same outcome, a revived wholesale guarantee. We can do it again, if you don’t mind, as a tax payer, carrying the risk of the banks’ profits, but it comes with a price tag. The last round of stimulus took the Budget from a surplus of around $20 billion to a debt of roughly 22% of GDP. You can’t repeat the magnitude of that act and AAA guarantee the banks again.

Anyway, Mr Norris is out now. Good luck to him.

About the author
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal. He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.