Terry McCrann has booked a shocker today:
OH dear. One of the Fin’s portfolio of — let’s be generous — idiosyncratic columnists, Christopher Joye, is at it again, pushing his loony line that all our banks, and indeed every bank in the world, is functionally insolvent.
Now to most normal people, the very notion is at least bizarre, if not, well, insane. To them, ‘the problem’ is surely that the banks make too much money, year in and year out — not a condition, normally associated with insolvency.
So let me state immediately upfront, while I couldn’t and wouldn’t want to speak to all the banks in the world, OUR banks are certainly not insolvent. Importantly, they were not insolvent, or even close to being so, even at the time of the Global Financial Crisis.
What our banks faced then, at the peak of what was the most chaotic and nerve-jangling global financial implosion since the Great Depression, was a liquidity challenge. That’s a challenge, not even a crunch, far less a liquidity crisis and certainly nothing remotely like insolvency.
And on it goes in the very high-handed tone that he accuses Chris Joye of abusing. But let’s not get too bogged down in cheap shots. The important claim of McCrann’s article is that Australia’s banks were not insolvent during the GFC. He ties himself in all sorts of knots defending the claim when the historical facts are quite clear. From my co-written book with Ross Garnaut, The Great Crash of 2008:
In the early days of October 2008, money poured into the big four Australian banks from other financial institutions. But life was becoming increasingly anxious for them as well. One by one they advised the government that they were having difficulty rolling over their foreign debts. Several sought and received meetings with Prime Minister Rudd. The banks told him that, if the government did not guarantee their foreign debts, they would not be able to roll over the debt as it became due. Some was due immediately, so they would have to begin withdrawing credit from Australian borrowers. They would be insolvent sooner rather than later.
To be sure, a sudden and extreme freeze on credit, perhaps enforced by the insolvency of the banks, would end the Australian current account deficit. Spending would fall sharply, and with it the value of imports. The awful reliability of the market process in removing an external deficit once financing dried up was demonstrated in Australia when domestic booms funded by foreign debt ended abruptly with depression in the early 1890s and 1930s. It was demonstrated just as clearly in the Asian Financial Crisis. But the process of adjustment would be enormously disruptive and costly.
The government quickly formed the view that the avoidance of a sudden adjustment through the automatic market process was a worthy object of policy. On 12 October it announced that, for a small fee, it would guarantee the banks’ new wholesale liabilities. This would include the huge rollovers of old foreign debt as it matured. The government also announced a guarantee on all deposits up to A$1 million. All four banks expressed their thanks and relief in a joint meeting with the Prime Minister on 23 October.
There was relatively little public comment on the guarantee of wholesale funding, with The Australian’s experienced economic columnist Henry Thornton being a rare exception. Much more attention was given to the less significant partial guarantee of bank deposits. Australia was engulfed by a different kind of crisis than that consuming other Anglosphere countries. In the United States, falling asset prices had triggered the collapse of shadow banking. In the United Kingdom, the fallout from that collapse had undermined the larger banks whose assets had been devalued, or which had depended on the continued reliability of the shadow banking mechanisms. The subsequent withdrawal of credit undermined the United Kingdom’s own housing market. In Australia, however, the difficulties were on the liability side of bank balance sheets. Banks had become heavily reliant on foreign borrowing and suddenly they were unable to borrow abroad. The non-banks had had no buyers for their securities for almost a year.
There are no degrees of insolvency. A firm is just as insolvent if it is not able to meet its financial obligations as they fall due because it cannot roll over debt, as it is if the value of the assets in its balance sheet is deeply impaired.
The difference is that the problem on the liability side is much more easily (and in most cases cheaply) repaired by a guarantee than the problem on the asset side. The sudden risk of insolvency in Australian banking was simply a more tractable problem than those experienced by other Anglosphere nations.
The banks might counter that they only needed the guarantee because other governments around the world were guaranteeing the debts of their national banks. This does not sit easily against the survival of banks without wholesale funding guarantees in many countries where banks had stayed within the old operational templates— for example Australia’s neighbours Indonesia and Papua New Guinea. In any case, this avoids the point. The Australian banks’ dependence on government-guaranteed debt was exceptional: in July 2009, Australian banks accounted for 10 per cent of the world’s government guaranteed debt. Through foreign borrowing to support domestic lending, the big four Australian banks were active, enthusiastic participants in the global shadow banking system that was now unravelling.
The act of demanding a government guarantee to avoid imminent insolvency should be enough to convince any rational observer that our banks were in deep crisis. Whether they were presently or imminently insolvent is quite beside the point. Without the guarantee, they, and we, were bust.
Indeed, five years on, after APRA has forced the banks to radically overhaul their liability profiles by pushing deposit funding much higher, they still rely on the implied guarantee for a two notch credit rating uplift.
We should be talking about how the moral hazard attached to the bailout can be addressed, not gesticulating wildly in a denial of the obvious.
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.
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