RBA breaks the panic button

From Guy Debelle, deputy governor of the RBA:

It is now just over 10 years since the date that people most associate with the Global Financial Crisis (GFC), namely 15 September, the day that Lehman Brothers filed for bankruptcy.[1]There have been quite a number of articles written in recent months looking back at that time and the period leading up to it.[2] It is interesting to read the differing perspectives on the same set of events, especially those that recount events that I had a ringside seat at, or was even in the ring itself. As I have said recently, it’s a bit like the standard line about the sixties, those who can remember the GFC probably weren’t there. The sleep-deprived haze that was pervasive at the time affects the memory. Critical decisions were made under extreme duress and fatigue, particularly in the US, which by and large stack up well with the passage of time.

Today I am not going to give another detailed account of what happened. I will talk about some of the events, but the main thing I intend to do is to talk about some of the lessons learned and relearned from the crisis. This list of lessons is by no means comprehensive. I will also discuss some questions that arise from the crisis that remain unresolved, at least in my mind. They are questions which I think should be a focus of the economics profession. Answering them will help guide policymakers should they be faced with similar situations to the one we confronted in 2008.

I am going to talk about both macro and finance today. Some events can be seen through mostly a macro lens with finance playing a lesser role (the seventies in Australia is an example), some events can be seen with the spotlight on finance with macro as a sideshow (e.g., the dotcom bubble). I don’t think it is possible to look at the GFC and talk about one without the other.

It is clearly important to integrate finance into macroeconomic analysis. Indeed, the failure to do that is a criticism that is often levelled at central banks and the macroeconomic profession in the aftermath of the crisis. I think this criticism is overstated. One obvious counter example is the work of Ben Bernanke himself on the Great Depression, Japan and the financial accelerator. His large body of work very much informed the Fed’s actions during the GFC.

How should this integration occur? Should finance be built directly into the models that inform (though do not dictate) policymaking decisions? There is a body of work directed at that goal currently underway.[3] Building finance into macro models is one approach but by no means the only one. At the very least though, macroeconomics should have an understanding of finance and vice versa. Macroeconomics is like the model of the engine, finance is the oil that lubricates the engine. One can understand how the engine works without really needing to worry about the oil, as long as the oil is flowing. But at least a basic understanding of the plumbing is useful when the oil dries up.

The key lesson that comes from the crisis that I will highlight today is leverage really matters. Leverage significantly magnifies the effect of any shock that hits the economy. Leverage might not start the fire, but it will pour petrol on a burning platform. At the same time, you need to keep the credit flowing to prevent the economy from seizing up.

Ballad of a Thin Man

Something’s happening here but you don’t know what it is, do you Mr Jones?

That is the Dylan version of the question Queen Elizabeth posed: why didn’t anybody see this coming? There were those who saw the storm clouds on the horizon. Michael Lewis wrote a book about some of them. Though often the storm didn’t quite take the form these people were expecting. Very few appreciated the extent of the financial interconnectedness and what that implied. For example, one common prediction was there would be a US dollar crisis with consequent calamity, but, in the event, the US dollar appreciated through the crisis.

Looking back on how financial markets reacted through 2007, the onset of the crisis is often dated from BNP Paribas shutting three funds with subprime mortgage exposure on 9 August. That caused a short-lived wobble in equity markets, but after that it was onwards and upwards for much of the rest of the year, with the equity market peaking in November. The equity market was the lens through which the public saw events unfold. So by that metric, 2007 was fairly benign.

Macroeconomists generally looked at what was unfolding in the US housing market and expected that its spillover to the rest of the economy would be contained. The slowdown would be mild and, to an extent, welcome in containing the inflationary pressures that had been building.

But the fixed income market took fright and got more and more scared through 2007. Uncertainty increased about the quality and value of asset-backed securities and the assets that underpinned them. There was further uncertainty about whose books these assets resided on, generating a marked rise in counterparty risk aversion amongst financial institutions. That is, institutions became less willing to lend to each other, both because of concerns about the financial strength of the counterparty as well as a desire to hoard any available liquidity, should they themselves need it. The indicator of the tension in fixed income markets is the LIBOR/OIS spread (BBSW/OIS here in Australia), which summarises the unfolding of the crisis well (Graph 1).

Graph 1
Graph 1: Short-term Interbank Lending Rates

These tensions continued to increase with a rolling series of flare-ups, including notably the rescue of Bear Stearns by JP Morgan in March 2008. By this stage, these concerns were increasingly reflected in the equity market too. GDP growth in a number of economies started to slow, but it was not until the fourth quarter 2008 when the economic forces took hold with a vengeance.

Lehmans filed on the Monday morning Australian time. It is interesting to look back at the time. That day was a relatively quiet one in financial markets. Lehmans wasn’t the turning point. The actual zenith of the crisis was still to come in the following weeks. AIG, the poster child of financial connectedness, was rescued. TARP was rejected by Congress and then passed after financial tumult broke out. The prime mutual fund Reserve broke the buck. Washington Mutual failed.

Markets were driven by fear, with huge swings in prices. Many of these swings occurred late in the New York trading day, which was early in the Australian day. The correlation between the Australian dollar and the US equity markets through those periods was indicative of the extremely high degree of co-movement across all markets. Markets regularly recorded ‘25 standard deviation events’ in the words of then Goldmans CFO David Viniar. These sorts of events are only supposed to be happening once in the lifetime of the universe, which says something about the risk models that were being used at the time.

My recollection of the worst of it was in the early hours of Saturday morning 11 October after we had been intervening in the foreign exchange market through the Friday evening to provide liquidity into an almost completely illiquid market. Talking on the phone to the RBA desk in New York, they reported that US Treasuries, the most liquid market in the world, had effectively seized up.

It is worth recounting this, just to recall how dislocative and disruptive these developments were. It was really not clear how this was going to end, except badly.

The fourth quarter of 2008 was bad. Global GDP declined by 1.5 per cent. GDP in the US fell by 2.2 per cent. In Australia, GDP contracted by 0.5 per cent (Graph 2). The impact was particularly severe in global trade, which collapsed as trade finance dried up because of extreme counterparty risk aversion (Graph 3). Companies and banks were unwilling to accept the guarantee of another bank that underpinned the trade lines of credit. They had little confidence they were going to be paid.

Graph 2
Graph 2: Real GDP
Graph 3
Graph 3: Global Merchandise Trade

The breadth and depth of the impact was remarkable. Output fell by more in the Great Depression, but the Great Depression was not synchronised nor as widespread as this was.

These macroeconomic and financial developments very much underpin the nature of the global policy response, both monetary and fiscal.

There was a fiscal response in many (though not all) countries, buttressed by the G20 leaders meeting in April 2009.[4]

Central banks responded by reducing policy rates rapidly to very low levels. Some of these actions were coordinated in a hitherto unprecedented manner. Central bank balance sheets expanded rapidly (Graph 4). The re-intermediation by central banks mitigated the withdrawal of intermediation by the banking sector. A part of that increase in the balance sheet addressed the large counterparty risk aversion. Central banks were willing to stand between institutions that were unwilling to deal with each other, as well as accommodate the rapid increase in demand for liquidity. That large increase in central bank balance sheets mitigated the large contraction in the financial sector, which goes a long way to explaining why it has still yet to lead to a marked rise in inflation, despite this being foreshadowed by a number of commentators over the past decade.

Graph 4
Graph 4: Central Bank Balance Sheets

The central bank actions were designed to alleviate the credit crunch. An alphabet soup of programs was implemented in the US to address the dysfunction in a number of markets,[5]with similar programs in other countries. The aim was to keep the credit flowing and limit the need for fire sales wherever possible.

An important motivation for this first phase of quantitative easing (QE) in the US and elsewhere was addressing the market dysfunction. Indeed, for a time, the Fed characterised it as credit easing. This first phase of QE was particularly effective. My view is that subsequent phases of QE had diminishing returns, though I acknowledge that much of the empirical evidence tends not to find that.

A question worth considering about QE is: if QE was effective on the way in, then surely there must be a large degree of symmetry? Hence we should expect to see similar but opposite effects on the way out. If there were diminishing returns to QE, then it might take a little while before we see the full impact of the reduction in the Fed’s balance sheet that is currently underway, but the effect should grow over time.

Turning to Australia, why did Australia come through the crisis better than many other countries? There were a number of contributing factors.[6] Good luck certainly played a role. But the policy actions made an important contribution too. Monetary policy was eased rapidly. The Australian banking system was much less affected by the problems bedevilling banking systems in other countries (partly through good luck). This meant that the transmission of the significant easing in monetary policy to the economy worked pretty much as normal. The exchange rate depreciation combined with the fact that the Australian economy could adapt flexibly to the depreciation were beneficial.

Fiscal stimulus in Australia in my view was absolutely necessary and was a critical factor behind Australia’s good economic outcomes.[7] While one can argue about the exact nature of the implementation, the fact that it was designed to take effect quickly was vital in the circumstances: ‘go hard, go early, go to households’ as Ken Henry put it.

China was certainly a major contributor to Australia’s resiliency. But it is important to remember that China’s strong growth at the time was a direct consequence of their large fiscal stimulus. Hence it seems inconsistent to me to argue that China ‘saved’ Australia, as a result of its fiscal stimulus, while simultaneously dismissing the direct impact of fiscal stimulus here in Australia.

What lessons did we learn (and relearn) from this experience?

Policy capacity matters, both monetary and fiscal. Fiscal space is really important. We still have that in Australia. It is less clear there is fiscal capacity in some other countries.

Monetary capacity matters too. The Reserve Bank has repeatedly said that our expectation is that the next move in monetary policy is more likely up than down, though it is some way off. But should that turn out not to be the case, there is still scope for further reductions in the policy rate. It is the level of interest rates that matters and they can still move lower. We have also been able to examine the experience of others with other tools of monetary policy and have learned from that. Hopefully, we won’t ever have to put that learning into practice. QE is a policy option in Australia, should it be required. There are less government bonds here, which may make QE more effective. But most of the traction in terms of borrowing rates in Australia is at the short end of the curve rather than the longer end of the curve, which might reduce the effectiveness of QE. The RBA’s balance sheet can also expand to help reduce upward pressure on funding, if necessary, as occurred in 2008.[8]

Finally, the floating exchange rate matters and remains an important shock absorber for the Australian economy.

Everything Flows

I will now step into the plumbing and talk briefly about the lessons learned on liquidity provision and other measures undertaken to keep financial markets functioning as best as possible.

The RBA’s balance sheet expanded in Australia for a number of reasons.[9] Exchange settlement balances at the RBA increased as banks’ preference for liquidity increased. We were able to accommodate this in our daily market operations. Part of the increased demand for liquidity arose from the large rise in counterparty risk aversion that I referred to earlier. We also offered more repos at longer terms to our counterparties, which saw our domestic repo book approximately double in size and the average maturity increase from 20 days to four months. This helped to provide some additional certainty to funding and mitigate some of the upward pressure on bank funding costs.

The balance sheet of the central bank, and that of the public sector more generally, has the capacity to intertemporally smooth more than any other balance sheet in the economy, be it financial institutions, corporates or households. The capacity to do this is particularly important when you are dealing with a systemic risk event, as was the case in the GFC. The central bank can intermediate extreme counterparty risk, functioning as much as intermediary of last resort as lender of last resort.

Another example of this was the provision of the FX swap lines.[10] These facilities were introduced to address the global shortage of US dollars (outside the US), which was causing a substantial dislocation in swap markets. In our case, we were able to intermediate the provision of US dollars into the Asian time zone, where this shortage was particularly acute. By the end of the trading day in the US, these shortages had often abated. Note that the swap lines were not about providing US dollars to the Australian banks to meet US dollar obligations. The Australian banks were predominantly funding Australian dollar assets (the hedges on their US dollar borrowing provided them with the US dollars as these matured). They needed Australian dollars rather than US dollars.

On 12 October, the Australian Government introduced a guarantee on wholesale debt and deposits. This followed on from the introduction of the guarantee in Ireland on 30 September. With the guarantee in place in many other countries, Australian banks would have been at a significant disadvantage in terms of funding costs without the guarantee. In addition, the guarantee allowed the banks to access another group of investors who had an appetite for sovereign credit but not bank credit.

It is interesting to consider the question of how much the guarantee addressed the issue of quantity or price. There was a period of time where debt markets were closed at any price in the last quarter of 2008. But at some point it became more an issue of price rather than quantity. As an indication of the price that might have had to be paid, Goldmans issued a bond around this time at a spread of 500 basis points. It is also worth noting that short-term funding continued to be issued by the Australian banks without the need for a guarantee.

Both the RBA operations and the government’s funding guarantee were priced such that usage would decline as market conditions improved, and, indeed, that is what happened. The many Fed facilities introduced to address market dysfunction were priced the same way. That is an important lesson which has been around since the time of Bagehot. These facilities were introduced to facilitate the flow of credit to the real economy at a reasonable price and, in some cases, alleviate the need for asset fire sales, which have the capacity to tip markets and the economy into a worse equilibrium.[11]

It is also worth noting that the depreciation of the exchange rate also helped out on the funding side. With a lower exchange rate, a given amount of $US funding translates into more Australian dollars to fund Australian dollar assets. Unlike in some other countries, the maturity-matched hedging of the banks’ offshore funding meant there was no issue of currency mismatch. Indeed the CSAs (Credit Support Annexes) associated with those hedges actually provided a short-term source of additional funding.[12]

Finally, the similarity of the business models of the Australian banks was probably beneficial in the GFC. There was not much to differentiate between them, which meant that the counterparty uncertainty present in other banking systems was nowhere near as prevalent here.

The Australian banks’ similarity is not so obviously beneficial in the current circumstance. Their similar behaviour and similar reaction functions to events such as falling house prices run the risk of amplifying the downturn in the housing market.

The crisis very much demonstrated the critical importance of keeping the lending flowing. The lesson is that countries that did that fared better than countries that didn’t. That lesson is relevant to the situation today in Australia, where there is a risk that a reduced appetite to lend will overly curtail borrowing with consequent effects for the Australian economy.

Karma Police

After the crisis has come the regulatory response, coordinated by the Financial Stability Board (FSB).[13] In the banking space, the regulation has included:

  1. The Basel capital standards have required the banks to hold more capital thereby reducing leverage.
  2. The Liquidity Coverage Ratio (LCR) had addressed liquidity/runnable funding.
  3. The Net Stable Funding Ratio (NFSR) has addressed funding mismatch/maturity transformation.
  4. The Volcker rule (in the US), and increased balance sheet costs more generally, have reduced banks’ capacity to provide services such as market-making and repo in other jurisdictions.

The first of these has clearly reduced the leverage in the core banking system. Some argue that the leverage should be reduced further (see below), but unambiguously banks hold more capital than they did pre-crisis.

The enhanced liquidity regulation in Australia has been in place since the beginning of 2015, and its effects have been present even before then as the banks adjusted their funding and assets to meet the new requirements. In other parts of the world, I think the effect of the liquidity regulation has been diluted by the large liquidity provided by the greatly expanded central bank balance sheets.

As the Fed balance sheet is shrinking, it is likely that the liquidity regulation will start to bite more in the US. Indeed it is possible we are starting to see some effects now, not necessarily in aggregate, but in particular parts of the money markets.

As important as the liquidity regulation is, in my view, asset quality matters more than funding in the end.[14] If asset quality remains sound, as a creditor of the bank, I should be confident of being repaid. An example of this is to compare the German domestic banks and the Australian banks. The German banks were predominantly deposit funded. However, with relatively low returns on offer in Germany, they sought out higher-yielding assets offshore including RMBS (residential mortgage-backed securities) and CDOs (collateralised debt obligation) in the US. In contrast, the Australian banks utilised more wholesale funding but were able to earn high returns on their domestic Australian assets. During the crisis, the German banks were faced with much greater asset quality issues than the Australian banks. They had $US asset positions that were difficult to fund in the market, notwithstanding the fact that their funding (in euros) is regarded as more stable.

One (intended) impact of the Volcker rule and similar regulations is that banks have retreated from their former role as market makers and risk warehousers. This was by design, to ensure that the core part of the intermediation process would not be affected by concerns about the quality of assets on their books accumulated through these activities, particularly given the difficulty in distinguishing between risk warehousing and speculation (which can be observationally equivalent).

What does this imply for market dynamics? It is distributing the risk from the banking sector to real money such as asset managers. That is fine in principle, as asset managers have more capacity to absorb and manage the risk with less disruption to the real economy. But it still remains an open question as to how quickly people with deployable capital respond to dislocations in market prices, given that the banks play a considerably smaller role.

That said, one should be careful not to look at the past with rose-coloured glasses. Banks didn’t rush in to catch a falling knife when asset prices were falling. Liquidity pockets occurred at least as much in the past, with one good example being the frequency of large big figure movements in foreign exchange rates. Bid-ask spreads used to widen a lot in the past too. The ultimate widening in bid-ask spread back then was not to answer the phone.

In addition, the market liquidity provision mechanism is now more machines and less people. The shape of liquidity has changed and with it market dynamics in a stress environment. The potential volatility of markets has increased (even though actual volatility has generally been low).

In such circumstances, some have talked about central banks acting as market-maker of last resort, stepping in to provide liquidity in a dislocated market (like foreign exchange intervention). This is an interesting question to consider. I think it is a mischaracterisation to call this market-making. It is more likely the central bank will be the buyer of last resort. It may well be some time before the central bank can sell on the asset at a reasonable price. This might well be justified to prevent fire-sale dynamics taking hold, but it should be recognised for what it is, which is not market-making. The potential implications for central bank balance sheets also need to be thought through.

One lesson from any number of crises past is that it is almost inevitable the next crises will originate somewhere different. The inevitability of this in part arises because of the reforms introduced to address the sources of the previous crisis. So where might one possible location of the next crisis lie?

To me, one possibility is that it will involve central counterparties (CCPs). They have a high degree of interconnectedness, considerably greater than before, and very much sit at the heart of the financial system today. Their resilience is of first order importance, as they potentially constitute single points of failure. Much has been done to increase their resilience, recovery planning and resolvability already, including by my colleagues at the RBA. The FSB has a work program to address CCP issues, but it remains a work in progress.

How Much Is Enough?

Finally, I will pose a critical, but unresolved, question: what is the right amount of leverage in the system? When is there too much?

Leverage was at the heart of the GFC. Leverage in the banking system and highly leveraged non-bank institutions like Bear Stearns and Lehmans played a fundamental role in significantly amplifying the crisis. Excess leverage in housing sectors, such as those in the US, Ireland and Spain, was incredibly damaging. This has led to the long-lived effects we still see today, both economic and political.

But we still don’t really have a great handle on what level of leverage is dangerously excessive for governments, households, banks and corporates. This surely is a major challenge for the economics profession to address.

As I said earlier, banks have increased capital and reduced leverage. But those such as Anat Admati still make the argument that further reduction in leverage is necessary.[15]

In terms of government, public debt is sustainable until it is not. It is not at all clear whether there is a threshold of sustainability. We have seen crises erupt at very different levels of public debt. Public debt in Japan is currently at 240 per cent of GDP, but there has not been a crisis. We have seen other countries have debt crises at considerably lower levels of debt to GDP. The market can turn on these countries very quickly.

We do know that unhedged borrowing in foreign currency significantly increases the vulnerability. And, relatedly, the European situation highlights the issues that arise when the government doing the borrowing and the central bank are part of the same currency union but not the same country.

On the private sector side, what are the appropriate metrics?

Corporate debt sustainability is assessed in terms of debt to equity ratios or serviceability. It is probably the form of debt about which we have the best understanding of sustainability.

But what about household debt? Debt to income is commonly used, but that is dividing a stock by a flow, a metric not commonly used for corporates. We can look at household leverage, but that is very much dependent on the value of the denominator, house prices in this case, and we know they can decline quite rapidly. Serviceability can be a useful metric, but we don’t have a good sense of sustainability at the aggregate level.[16] The quality and distribution of household debt matters as well as the level. The policy measures implemented in Australia over recent years have been aimed at improving the quality, and hence sustainability, of household debt.[17]

While acknowledging that household debt is higher in Australia than many other countries, there is little to form a strong conclusion about how much is too much.[18]

How much debt is enough and how to best manage the risks are two of the large questions remaining unanswered, ten years after the GFC.

History Never Repeats?

To conclude, the GFC provided many lessons, some old, some new. One of the main lessons was an old one: leverage matters.

Leverage can turn a manageable macroeconomic event into a very hard to manage crisis. The regulatory response has been aimed at addressing this by reducing the leverage in the core of the financial system, while being mindful that the risk and leverage is not excessively relocated elsewhere.

The second lesson is that timely policy responses are effective. In a crisis, go fast and go hard. Don’t die wondering.

The third lesson is that the plumbing can sometimes really matter. Keep the credit pipes flowing.

Fourth, targeted policy responses/interventions are effective. Use Bagehot pricing, where these interventions are priced to work in bad times but not in the good times.

But the questions of how much debt is enough and how much is too much remain unresolved.

The lessons learned from the GFC will be useful, provided they are not forgotten. But there will be new challenges ahead and the source of the next crisis will probably be different.

History does not repeat itself but it often rhymes.

So, the next move in rates is up except that it is is down followed by QE. Nice!

When the next external shock comes, Australia’s problem might be long term funding costs if we see capital flight, in which case QE could help by buying government bonds. But the problem this year, which did not occur during the GFC at all, is short term funding costs via BBSW:

That’s counter-party risk that will get worse if bank balance sheets deteriorate. The RBA is yet to address this issue with any kind of persuasive explanation let alone what it will do about it if gets worse in a crisis, which it will surely will now that Australian bank’s credit quality has huge questions hanging over it post royal commission.

During the Q&A we also saw Debelle address house prices:

…absolutely something we are paying attention to…From what I can tell what we haven’t seen anywhere in the world is a decent fall in house prices in two capital cities at the same time unemployment is going down and the economy is growing at a reasonable pace. This is uncharted territory.

Credit is still flowing but at a much slower rate and it’s something we are watching – but that is as much a function of banks willingness to lend and not so much the price.

If it so unknown then why has the RBA hung everything on it in their forecasts? Yesterday I asked if the RBA believed its own rubbish or was just taking a wild gambit. Now we have the answer.

It’s doubled down, bet everything on black, and it is losing.

Comments

  1. “It’s doubled down and bet everything on black.”

    I was never in any doubt of that outcome. They only know one thing, and that’s what they will pursue.

    • …absolutely something we are paying attention to…From what I can tell what we haven’t seen anywhere in the world is a decent fall in house prices in two capital cities at the same time unemployment is going down and the economy is growing at a reasonable pace. This is uncharted territory.

      We also haven’t seen house prices this high ever! This much Chinese capital flooding in to pump it up, such loose lending standards by our “best regulated” banks in the world. This much mania and speculation etc.. Basically the reason it’s falling is that nobody could really afford these prices without being interest only for the past 5 years. And there was only incentive to do that if other muppets did the same because they thought prices could only go higher.

      I can’t wait to see them smash savers again with QE. Economic geniuses who get paid stupid amounts of money to screw the rest of us over.

      • You’ve hit the nail on the head, Gav. They set the high water mark, now for the pain of deleveraging and socializing the losses.

      • We NEEDED the Chinese capital. We HAD to have the Chinese capital to maintain our standard of living i.e.keep on consuming. The houses being bought by foreigners are just a conduit for getting money into the general economy and without it the A$, GDP etc collapse. The high house prices are just a symptom of the disease really.

      • Jumping jack flash

        The debt machine did its job well, no?

        Debt creating debt capacity, and simultaneously insuring debt using a broken asset valuation model based on prices pumped up through debt. All risks, except LVR, ignored, allowing the cheapest debt you could buy, ever.

        Yes, too much debt was always going to be the result of that recipe.
        They seem to be using a lot of words to simply say “the problem is too much debt, and now it needs to be repaid plus interest which is a painful and lengthy process”.

        As I said, it wasn’t a conspiracy, it was just the natural evolution of the system when run by people motivated by greed and looking for instant gratification, with the absence of any meaningful regulation – if indeed meaningful regulation was actually possible.

        There is no faster nor easier way to get rich than to get someone to hand you a lump of debt they’re liable for. No faster way.
        It is absolutely no wonder that this mechanism has been tweaked and refined and exploited as much as it could be.

      • jjf – of course the debt machine did its job well but it also like most commodities probably drove construction up as well causing a building bubble. Listening to some property planning economist on the radio yesterday whilst driving they mentioned that the increase in prices due to lending and Chinese investment locally kickstarting a local positive feedback loop. Which drove a huge increase in housing construction which has mostly been paused/freezing now. With high immigration I wonder if the debt bubble didn’t go off whether we would have the same supply shock that we have now. High prices caused by debt seems to be the cure for high prices in the long term.

        The only real way to repay the debt in a credit/debt based money system is to print money and/or default/jubilee it away. As a country we can’t really pay it back; if everyone is paying off debt that destroys money and the ability to repay gets exponentially higher for each individual. I see QE of something (probably mortgage bonds) as the most likely scenario in all of this to be honest as it isn’t politically risky, reduces costs for mortgage borrowers and when confidence returns has a good exit strategy.

      • @AK Good point about the Impossible task of ever repaying debt because it never could be repaid. All that is/was ever possible is for the debt that exists to be serviced by the operational cash flow of our Assets (Capital and Human). We’re at the junction where that is no longer possible.

      • @fisho – That’s why I think Government intervention is inevitable at the end of the day or else we will see defaults rise with its own winners and losers. Where I disagree is that until recently as you say “serviced by the operational cash flow of our Assets (Capital and Human)” was actually happening relatively smoothly with debt arrears pretty low. The current problem isn’t serviceability; its the fact that we’ve broken the “debt rollover” mechanism forcing defaults (i.e. forcing debt to go down which is a big no-no in a credit economy) to borrowers otherwise keeping up payments. Banks are now free to jack up rates on these borrowers since we’ve removed/impaired the ability to refinance mortgages recently.

        After all if people are servicing the mortgage/debt now (arrears are still very low) why change anything? Why lock them as mortgage prisoners if they could pay that indefinitely just because the lending rules change? I don’t agree with increasing the debt from here; but forcing otherwise paying debt holders to default isn’t smart by the RBA either as trapped borrowers get squeezed by ever increasing rates as prisoners to their current bank. Any crash from here is artificial and government induced IMO.

  2. So the little battler could wind up with a 3 in front. Great for rates all those foreign investors having been chopped to pieces will magically front up for another serve? Deluded economic dreams

    • LOL. They might have their backsides handed to them on the way out at the airport by the next batch of gun Asian investors. In fact we ought to just set up a land transfers kiosk at each airport, complete with its own priority queue.

  3. Speaking of capital flight, if you look at the RBA’s latest chart pack in the net capital import chart, does that bright red bar in the negative in the latest reading denote capital starting to leave ?……..doesn’t seem to be any such bars there before.

  4. About the only useful comment in the entire speech.

    The rest is just more head in the sand apologia for the broken and dysfunctional status quo.

    “..The balance sheet of the central bank, and that of the public sector more generally, has the capacity to intertemporally smooth more than any other balance sheet in the economy, be it financial institutions, corporates or households..”

    The balance sheet of the Central Bank would be even more effective and useful if every citizen and non-bank were permitted to open and operate a deposit account.

    If you want some real reform of the private banks this is where you start. Make the banks sweat and work harder to attract unsecured short term loans.

    https://theglass-pyramid.com/2018/11/03/fixing-oz-banks-pt-7-what-should-be-the-role-of-the-rba/

      • Yep that is what Guy means.

        According to the RBA (and APRA) vision of a central bank the role is limited to providing unlimited public support to a privatisation of the power over public money.

        No Central Bank balance sheet for YOU.

        4. Can I open a bank account with the Reserve Bank?

        The Reserve Bank is not a commercial bank and so does not provide banking facilities to the general public. It does, however, provide banking services to some government, commercial bank and other clients.

        https://www.rba.gov.au/qa/

        The banks are even paid interest by the RBA on their 100% safe and risk free Central Bank deposits.

        https://www.rba.gov.au/rits/info/pdf/ESA_Interest_Rates.pdf

        A complete joke.

        Yet supposedly I am a “money crank”

      • The RBA doesn’t have to provide banking Services!
        Just an ‘At Call Deposit Account’ for any citizen that wants one at the cash rate% minus ( pick a figure). Traditional banking services from a Cheque Account to Term Deposits to Internet banking and Home Loans can all still be handled by the commercial banks. But as Pfh writes, they’d have to compete for (1) your money, unsecured, in their alternative deposit accounts and (2) liquidity from the RBA, which they would have some of from the very same deposit account with them that they could/should offer to we deplorables!
        And that allows them to scrap the Deposit Guarantee, actual or implied.

      • Exactly Janet,

        No need to provide day to day payment services.

        Just a deposit account that is 100% risk free for those that want it.

        No need to provide a public guarantee on the short term loans to banks that are currently called ‘deposits’.

        And if anyone doubts the RBA could do it here they are bragging about just how good they are at providing banking services when they feel like it.

        https://www.rba.gov.au/speeches/2018/sp-so-2018-10-03.html

        And this

        https://www.rba.gov.au/speeches/2018/sp-ag-2018-08-23.html

        They could provide a MyRBA deposit account without raising a sweat but they will not because they are protecting the private bank privatisation model of money creation.

  5. Not only is BBSW increasing, the spread to BBSW has jumped this year especially in the past month.

    At the beginning of the year the majors were issuing 5 year paper at BBSW+0.77%. In the middle of last month Westpac issued at BBSW+0.95%, then at the end of the month ANZ was forced to pay BBSW+1.03%. Apparently these last 2 issues are trading even higher than that in the market

    • The easiest is something traded on the ASX.

      There are ASX traded Aus govt bonds, and exchange traded funds that track gold and USD. Those seem to be the most popular for people looking for a “safe haven” (although USD and especially gold do move around in price and carry greater risks. And you pay a fee).

      MB might in an alternative universe do an article on “how to move your money offshore” but in this universe it is called “MB fund” (not all money will move offshore, but you can still avoid the banks).

      • Arrow2 – but via the ASX you have counterparty risk that might be as high as for the banks…or worse ?

      • There is in theory some counterparty risk but it should be very low. I think I recall the USD etf buys actual usd to back its fund and Perth Mint Gold (exchange traded) likewise has actual gold. Yes obviously it’s not the same as burying the stuff in your back yard, and the Perth Mint could just decide to keep it, but honestly that is end of days prepper stuff. I think the risk is absolutely tiny. And an ETF it is vastly simpler to execute (buy, sell etc) and administer than the underground bunker option.

        (All that said, I also think the risk of bail-in and the deposit guarantee not being activated is also pretty low).

        I tried to outline the simplest options. Yes, for a fair bit more effort, you can get safer options still.

        All the disclaimers apply, do your own research, this isn’t advice, don’t take the advice of some shut ins on a blog!

      • The issue I have with moving funds out of banks and into ‘other assets’ on an electronic register somewhere is that they can still be gotten at by the authorities. In order to completely escape the clutches of a voracious Govt (and a central bank that actively taxes your savings via debasement of the currency) you need to buy real (physical) assets and store them yourself somewhere appropriate.

      • @R2M -” Buy precious metals and store in a safety deposit box in a company that is not exposed to any financial risks that could cause them to foreclose on you.”

        Totally Bad Advice! Gold excellent –
        BUT there is NO protection & NO insurance on ANY Safe Deposit Box.
        If it disappears there is no recourse because no one knows what you have deposited in the Box.

        Perth Mint – Unallocated even (until things get a lot worse) .5% diff between Buy/Sell if invested Min $50K
        Proceeds part or all — settlement in Cash within 2 days on a phone call. You need ACCESS !
        OR – – Physical & keep at home – mouth firmly closed. Easy.

      • Que? He just asked for a list of places to store money that aren’t banks. That isn’t illegal.

  6. Once again the speech was BS because central banks are re-lying on BS inflation numbers.
    The Chapwood Index in the US is comprised of 500 goods and services typically bought by the average middle-class American in 50 major cities.These inputs are never changed.
    The increase of these inputs over the last 5 years has averaged 9.8% per year, while the US government’s version of price inflation has averaged 1.53%.
    I’m sure that the result of using the Chapwood Index in this country would show the same result.
    Central banks are like children wandering through fantasy land too frightened to face the truth and forever telling themselves that if they don’t speak the truth, everything will get better in the end.

    • Recently returned from the US and was very surprised at the cost of staples. Friends who are more regular visitors there are shocked at the rapid price growth. Not sure how those low income families survive over there.

      • The killer in the US is medical insurance. The costs are outrageous. You dare not retire unless you can afford thousands per month in med. ins.

    • Is there an Australian equivalent ?

      Also, do they do a breakdown to see if any items in the basket are particularly driving an increase (/decrease) ?

      • The Chapwood Index(or the same idea as it) could be used anywhere.\’\

        With 500 goods and services used instead of the small number used by governments now?
        I guess that breaks the whole thing down anyway, each would end up being a very small percentage… eg instead of just measuring a few food groups, you might measure 40 commonly used foods.
        Importantly the 500 goods and services are not changed so that you can’t cheat like they do now.

        You can google :http://www.chapwoodindex.com/

      • Yeah, I found the website, I understand the idea, my question is do you know of anyone doing it for Australia ?

        The goods and services would have to have some sort of changeability in them. For example, to account for an original iPhone vs one of the current models.

    • The ABS should also maintain CPI in constant volume/weight/measure terms.
      For example a block of Cadbury chocolate was 250g years ago, then it went to 220g then to 190g. This should be factored into CPI.

  7. Wow: So many words, so little understanding.
    Our Financial institutions are our problem, it’s that simple.
    No economy (and no model of an economy) can employ 15% of the population in function of capital allocation without imploding from the weight of this impost!
    Just go back to modelling basics and try to construct an economic / social model that even functions with this level of unproductive costs, I don’t believe it is possible.
    Herein lies the root cause of Australia’s problems. This whole Royal commission is really just a way of admitting to ourselves what we already know namely that our financial institutions are robbing us blind. My point is that this cannot be other than as it is with 15% of the workforce devoted to what should simply be a capital allocation function. Our Financial institutions have to be robbing the broader economy (in one way or another) because their decisions (the macroeconomic effect of their work-product) cannot now (and can never) sustain this percentage of the population deriving their primary income from this sector.
    The rest as they say is policy / execution, such as legalizing theft of an individuals savings because it is necessary…this is all happening because this is necessary.

    Lets for a second consider a restructuring of the Aussie economy.
    Where would it start?
    Who would be first in line to get paid a huge bonus for setting us on the right path?
    Which sector would grow the quickest (profit the most from this imposed / directed change) ?

    I suspect we are beyond the point of return where every penny spent to fix our problem is absorbed by the expansion of the problem, we’re like a drug addict who says I want to get clean, but their actions always speak louder than their words, because they continue down dysfunctional pathways and are only ever clean for a short while. The addicts that I’ve seen get clean make the decision to change their life completely before they even attempt to get off drugs…this key decision is what’s missing from Guy’s story of-course he’ll never see my point because for him it’s always a financial problem so the solution obviously lies in the financial sector.

    • We need the Dodd Frank act, the separation of Bread and Butter Banking from Investment Banking. We also need better financial regulation of banking and a new publicly owned bank that dolls out mortgages at a fixed rate for 25 years. Without all the voodoo terms and conditions other financial institutions love to employ to keep the mug punters confused.

      Don’t even get me started on being punished for paying down your mortgage sooner (with fixed rates). etc.. Or all these BS establishment fees etc.. what utter insanity. We need banks that look after their customers, not shaft them.

      • Yeah might work, but I don’t think that’s a solution because mortgages are not created (or supported) by savings.
        Maximum sustainable mortgage levels within an economy have little if anything to do with savings arising from delayed consumption. The two things aren’t really related.
        However that said two things that are related are:
        Our maximum rate of mortgage issuance AND our Current Account imbalance
        In today’s model the one is directly funded by the other, suggesting any mortgage model that lacks this CA balancing function seems to me to be doomed to failure.
        Again, see what I mean by, this is happening because it must happen.

      • @fisho Spot on!
        However I’d opine that sustainable mortgage levels have everything to do with savings. The link is through the current account. To fix the Current Account we have to save and thereby the sustainable mortgage level is linked to savings.
        So to fix the CA we’d have to save….Consumption gets trashed – DEREP DEEP recession.
        To fix CA we’d have to have a much lower A$- which would redistribute wealth from Sydney and Melbourne to regions and rural areas. The spoilt brats of Wentworth et al re not going to tolerate that. So it is NEVER going to happen – willingly. When the unwilling force comes the society will crack wide open.

        The morons like Keating, Howard, Costello, Rudd et al set the ation on a path to total economic and social collapse.
        The answers lie back in time.

      • @flawse
        Yeah, morally I think we all like the concept of real world net savings however the reality of this sort of world is a little less appealing
        I’d settle for a world where an individuals savings are supported by a unit expansion in the Asset base or an Asset quality expansion for a constant base case.
        I think we can all agree that in Australia we have neither of these thing happening, rather what we have is Asset price inflation covering up a diminished asset quality (quality in the sense of the asset generating easily sustainable net free cash flow).
        WRT company accounting there’s a very good reason why Asset repricing and Operational earnings are treated very differently in the accounts. The two are fundamentally different and impact the operation of the company in different ways. Sustainable operations (with positive net free cash flow) has to be the base case for any long term business plan, if you happen to be sitting on (or creating) Assets that the market upwardly revalues, than that’s all gravy. The opposite operations case is nowhere near as attractive. Somewhere in the middle you have the case of Encumbered Assets generating just enough cash to keep the bond holders happy while allowing for expansion of the Asset base (I suspect that this is the optimal operations point for a modern economy).

    • The model you conclude with has a limited lifespan. Yet, to try to make sensible financial decisions it is the none we have to adopt. e.g. we know these clowns at the RBA are just going to print. It’s all they can do. So we have to devise our financial path to fit.

  8. The Traveling Wilbur

    And so it begins… this country’s economy is about to replicate 2011 world economy conditions. But it’s OK. Don’t panic!

    Australia is safe from what happened in almost every other developed country in the world as the quality of the debt issued in Australia, e.g. mortgages, is so much higher than all those other countries.

    She’ll be right mates.

  9. Does Guy even hear his own voice?

    BBSW-OIS is blowing out and bank funding spreads for term lending are even higher.

    The banking system is gasping for oxygen and the RBA is standing on its throat.

    They need to do large scale repo and term repo lending to banks to get BBSW down. Surely banks have adequate collateral they can post to the RBA?

  10. So
    What do you expect from Australia’s economy?
    We used to make cars. Now they’re made in Thailand;
    We used to make clothing: – Gone to China (Though they do hoard our milk powder);
    We export Iron Ore: – So other people can make things they sell to us. Our labor is too expensive;
    We export coal: – Hint of double standards there? – but then, a prostitute literally can’t afford to take a moral stand.
    All that’s left is endless housing construction with the demand created by a flood of immigration and offshore money laundering. All leveraged to [email protected] and of course, no-one looks at the supporting infrastructure bogeyman (sewers, roads, water, hospitals, schools blah blah blah) that will sink it.
    No-one knows this better than our politicians. They are NOT stupid. They are opportunists and they’re brighter than a lot of us. We have no mechanism to punish them.
    Yes, the reckoning has been nicely put off with the RBA pushing the interest rate lever up and down (they can do f/all else) like a demented monkey. Of course, some of you just might have noticed that the rate has been trending inexorably down. Now, I believe we can nicely define the start of the final impact as the moment when the rate hits zero. The rate of descent will accelerate with the last couple of percentage points going very quickly.
    If you’re young, get out now.

    • This has been pretty inevitable once Keating opted not to do anything about the CAD and, instead, headed us off down the debt road. As you say, there really is no going back.
      It’s not only politicians that are silent on this. It’s Banks (understandably), Treasury (well nearly all of it), RBA, media and Universities.
      Nobody wants to think about it at all.

      • MediocritasMEMBER

        Yep, when they floated the AUD, they eliminated the need to protect foreign currency reserves hence eliminated the need to avoid prolonged deficits with trading partners. The RBA kicked back with a cold one, watched the private sector run debt through the roof to enable sustained deficits and convinced itself that the “efficient” free market knew exactly what it was doing.

        Keating was one of the biggest neoliberals of them all and the working piggies trotted calmly into his abattoir while still thinking highly of the man. He didn’t start the ball rolling though, he was just the acting man at that time, implementing policy that had already been pressed into action around the world by the Lords of Finance.

    • the final impact as the moment when the rate hits zero

      And then goes negative, to flush out the savings ill-gotten hoardings belonging to the savers antisocial money hoarders

      • The only money hoarders are those of us that hoard gold.
        That’s you and I and almost every government on earth.
        All other currencies have been credit, 97% of which has been created by retail banks since August 1971.

  11. …absolutely something we are paying attention to…From what I can tell what we haven’t seen anywhere in the world is a decent fall in house prices in two capital cities at the same time unemployment is going down and the economy is growing at a reasonable pace. This is uncharted territory.

    Part of the problem is the widening gap between “official unemployment rates” and the experience of the average person.

    We have more part time employment, more casual work, and more zero hours contracts (i.e. we will employ you but hours of work will vary according to our requirement and there are no minimum guaranteed hours). …. Real jobs like manufacturing are disappearing. Retail is struggling – look at all the empty shops in centres, and notice how few shops have signs advertising for workers. Now building is facing a downturn – not just the builders, but all the suppliers and other businesses that feed into building. any work or pay).

    Hence the average worker is not feeling that confident – regardless of what the ABS says the unemployment rate is.

    We have changed the definition of unemployment over time to suit various agendas. “You want a low unemployment rate?” “Sure, we can do that, lets transfer some of the long-term unemployed across to the disabled list.”

    It was the same with Sydney trains a few years back – the fastest way to get them to run on time was to stretch the definition of “late” and overnight (literally) more trains ran on time. Same with Police and crime figures – falling official crime rates are easy to achieve. Same with falling standards and static pass rates an Universities

    Goodhart’s law. When a measure becomes a target, it ceases to be a good measure.
    https://en.wikipedia.org/wiki/Goodhart%27s_law
    All metrics of scientific evaluation are bound to be abused. Goodhart’s law (named after the British economist who may have been the first to announce it) states that when a feature of the economy is picked as an indicator of the economy, then it inexorably ceases to function as that indicator because people start to game it.

    And that is why the unemployment rate is now a less reliable predictor of what will happen next. It has become so corrupted as to be almost meaningless.

  12. Guy quoted from Ballad of Thin Man (Bob Dylan), probably could have gone to read/listen to “Desolation Row”.
    Concur with Rob B above…”If you’re young get out now”. Can someone explain QE?
    PS just happen to be listening to My Chemical Romance…!

  13. QE can GF. It’s time for a UBI that is harvested back through the only two efficient taxes: land tax, because land can’t be hidden, and consumption tax, because consumption can’t be avoided.

    The QE of the world has just materialised into the hoardings of billionaires and despots.

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