After holes, is it back to houses?

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Last week while I was in bed with flu, Commonwealth Bank CEO, Ian Narev, declared that the bank is in favour of a new Wallis Inquiry into the financial system. So long, that is, as it’s focussed on the following, from the AFR:

Commonwealth Bank of Australia chief executive Ian Narev has warned that the country’s big banks may not have enough money to lend if economic conditions improved, putting pressure on the government to hold an inquiry into the financial system.

Mr Narev commented yesterday after CBA defied the global economic gloom to post the biggest annual profit yet for an Australian bank of more than $7 billion, despite taking a hit in ­businesses exposed to volatile inter­national markets.

With the federal opposition pushing for a wide-ranging review of the financial system, Mr Narev said a “national debate” was needed to address concerns that banks would find themselves short of funds to lend to customers if the economy rebounded.

“There are legitimate questions to be asked about Australia’s future funding model, the role of banks and in fact the role of capital markets,” Mr Narev said. “If the view is taken that the best way to address those issues in an expedient way is through an inquiry, we’re OK with that.”

There a couple of points to make here. First, it is becoming clear that the agenda for a new Wallis Inquiry is now being pushed by seasoned housing interests: the non-bank sector and now the big banks too. That’s fair enough, but let’s not get this group mixed up with the needs of Australia.

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The reason this is coming about now is twofold. Obviously the Opposition looks like it’s going to win power and is committed to an inquiry. Less obvious, I suggest, is that with the mining boom peak within sight, some of those sectors that see themselves as having been marginalised to make room for resources investment are playing the long game for a resumption of their growth prospects.

By this I mean Ian Narev’s conflation of any economic “rebound” with greater credit issuance and the need to borrow more offshore. There is a gigantic question about whether that is desirable, let alone possible (though Narev should be praised for raising the question). Narev is effectively saying that any return of confidence to consumers must, by definition, resume Australia’s yesteryear economic model of expanding borrowing offshore and stuffing it into inflated houses.

This is a misrepresentation in-so-far-as Australian consumers are, for the most part, not lacking confidence. The last few year’s of savings behaviour, investing in cash not assets, has simply returned consumers to a pattern of behaviour that existed for decades before the post-millennium housing mania took hold. The red circled period was one of irrational exuberance not confidence:

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Moreover, the ratings agencies have already warned that a return to offshore borrowing will threaten ratings. As Moody’s said when downgrading the banks last year:

Moody’s expects the banks to continue reducing their wholesale funding requirements — in particular short-term wholesale funding — for the next 12-18 months.

However, the fundamental funding structure of the major Australian banks remains in place. Australia’s mandatory superannuation scheme will continue to capture retail savings, of which only a low proportion are available to fund the banks. This situation is due in turn to the low allocation– by international comparison — of superannuation savings to fixed-income investments and deposits.

Additionally, Moody’s notes that much of the recent increase in domestic deposits has come from the corporate sector. When the cycle turns and credit demand eventually picks up, the ratio of corporate deposits to loans may be expected to deteriorate. Retail deposit growth will then likely be insufficient to fund the banks’ needs, driving them to increase wholesale funding once more.

Moody’s also notes that Australia has heavy investment needs, and so is likely to continue to run a sustained balance of payments deficit, which is likely in turn to perpetuate the banking sector’s requirement for offshore funding.

Furthermore, with the domestic economy increasingly biased to the commodity sector, terms of trade that are exceptionally favorable by historical standards, and high asset prices, there is a potential for confidence shocks to impact the banks’ access to funding.

During the recent crisis, the banks demonstrated that natural economic stabilizers do permit them to adjust their funding mix. Nevertheless, the downgrade reflects Moody’s concern that — in a less liquid and more volatile post-crisis world– the banks’ sensitivity to market conditions is better reflected at the new rating level.

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More to the point, I’m buggered if a new Wallis Inquiry should be dedicated to figuring out how we can perpetuate our fundamental economic problem. After all its recent hard work to contain household indebtedness (which remains very high), I don’t think the RBA would be impressed either. Although judging by recent comments emanating from the Opposition, this is precisely what they have in mind for any inquiry: a return to public saving and private borrowing, the Howard/Costello model.

This is why I’ve spent so many wasted hours over the past four years railing against the destruction of Australia’s non-resource tradeable sectors as a way of “making room” for mining. It was always going to result in a black hole at the end of the boom in which you have limited options to grow your economy through exports. Instead, so long as you remain a current account deficit economy, you’re only engine for growth is a return to borrowing, either public or private. Or through productivity gains, which housing over-investment does nothing for either.

It was not all one-sided from Narev, though. He made good sense on deposits:

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“In terms of the tax treatment of deposits and other funding areas . . . I think it very important to have a national dialogue on that subject,” he said. “If the way to do that is through an inquiry, then do it through an inquiry. If not, through other channels. Because, once we are through the uncertainty in Europe we are back to the question of ‘is there a sufficient pool of saving in Australia to fund all the investment we want to do?’. It is a legitimate question and it is something I think would be worthwhile debating at a national level.”

Too right. But the more fundamental question any inquiry must ask is where should any greater flow of deposits go? Is it really just into more mortgages?

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.