ECONOMIC AFFAIRS: by Colin TeeseNews Weekly
Politicians shirking their duty by bank-bashing
, December 11, 2010
Bank-bashing - does it make sense? Actually, no.
To be sure, the banks haven't handled themselves very well. In a global financial storm, they seldom do. Accordingly, they haven't been so much out of favour for a very long time - probably not since the 1930s Great Depression.
Their small borrowers - mostly home-buyers, wrestling with a larger than prudent mortgage urged upon them by the banks before the big crash - are understandably dismayed and disillusioned. And for the basest of political reasons, both sides of politics have joined the chorus of bank-bashers.
But instead of turning on the banks, both sides of politics should be looking at their own deregulationist policies. If they do so, they will find these are at the heart of the bank problems.
In an outburst of feigned rage, both Government and Opposition have threatened the banks with dire reprisals: a tax on super profits, a tax on excessive bank salaries and new measures to put the four major banks under real price competition pressures. The banks aren't quite laughing publicly in the face of these railings, but well they might.
Genuine price competition pressures represent the least credible of threats. Both sides of politics support the rhetoric of price competition - but they well know, even if Mr Graeme Samuel (our competition watchdog) doesn't, that healthy profits are essential if our banks are to remain solvent. And price competition doesn't deliver those.
Bank earnings seem, and are, large in cash terms; but in today's world our banks are being asked to stump up more capital if they want to be part of the international banking community. Without such a significantly enlarged capital base they won't be able to access the international borrowing market. Given the way we run our economy, tapping into this source of funds is essential for our lending institutions.
And keep the following in mind. Inside November's G20 meeting in Seoul, Prime Minister Gillard defended Australia's banks, saying that they are well capitalised and better run than most others. For these reasons our PM has asked, to no avail, that our banks should be excused the onerous conditions being imposed on the rest of the world's banks.
She's right, of course, but nobody's listening. International markets operate on the basis of one size fits all. Whatever the facts, our banks are being lumped together with all the others.
So they must have more capital and larger profits to service it.
Our media have taken firm positions, either for or against the banks according to political and/or ideological taste. One of the Australian Financial Review
's commentators takes the prize for silliness in his response to the banks' recent spate of interest rate rises following our Reserve Bank of Australia's decision to lift its "official rate" by a quarter of one per cent.
It might just be, the commentator claimed, that the four banks were doing the RBA a favour by relieving it of the opprobrium associated with the raising of interest rates - in future, the commercial banks could do it for them!
How much the hapless writer knew of what he was saying is unclear. Monetary policy - that is to say, regulating the supply of money entering our economy - should, in a democracy, be the function of government. But, as a part of financial deregulation, most of the Western democracies have handballed that responsibility to their central banks - supposedly as a means of divorcing monetary policy from political influences.
In the Hawke/Keating era, Australia duly followed suit. Thus, however much Opposition parties and the media might like to pretend otherwise, "official" interest rates are set by the Reserve Bank, not by our government. Market rates - that is, what ordinary borrowers have to pay - are set by the private banks.
Since then, successive Australian governments have deliberately dealt themselves out of the interest rate debate.
There are persuasive reasons why banks are unable to keep their market rates in lockstep with "official" rates. "Official rates" don't set the market rates at which banks borrow. True, they have made a poor fist of explaining this to their customers, and have given the Opposition a powerful stick with which to beat up the Government.
The merits and the justifications for managing our monetary policy in this way are certainly debatable; but it is the system we follow - and both sides of politics support it.
It is, of course, true that excess money feeding into an overheated economy generates inflation. But is the indirect method of making money more expensive by putting up interest rates the best way of dealing with the problem?
Why not, you might ask, simply keep excess money out of the system? Because in a truly deregulated financial system - with its associated floating currency and exchange rates - direct control over the supply of money entering our economy is impossible.
The RBA really does not possess the tools to make the system work. Notwithstanding that, it seems to maintain faith in the deregulationist/indirect approach - and this, despite the mounting evidence of its shortcomings, including the problem of bank mortgage rates.
The dilemma for the RBA is that the indirect approach to controlling the money supply is capable of containing inflationary pressures in an overheated domestic economy only if those pressures are internally generated. Unfortunately, inflationary pressures are frequently imported depending on what is happening in the economies of countries with which we trade. These the RBA cannot contain.
Free-market ideology stands behind the reason why successive Australian governments have chosen to continue supporting unregulated capital flows into and out of the economy. Thus, we allow market pressures, including currency speculation, to play a large part in setting both currency levels and real world interest rates.
For all that, it ill behoves the Australian Financial Review
to suggest, even flippantly, that the RBA's major function on behalf of the community be left to the commercial banks. But it might just have drawn attention to the shortcomings in our approach of managing inflation by manipulating domestic interest rates.
Certainly, that could be a useful starting point if we want to understand what might be wrong with our banks. In the real world, financial deregulation and its necessary companion, market-determined interest and exchange rates, make sense only if all participating countries in a trading and payments system solemnly commit themselves not to interfere with the free movement of exchange rates or the price of money.
Of course, no such perfect world exists. Before 1971, the Bretton Woods agreement organised the West in a system whereby participants agreed to maintain exchange rates within a narrow band and to manage capital flows and domestic inflation. Between 1971 and the early 1980s, financial flows and exchange rates were regulated in varying ways by governments.
Since that time, financial deregulation has been in place in most of the West and some of the emerging Asian economies. However, the emerging Asian economies were so badly burnt in the 1997-98 Asian financial crisis that they now regulate financial flows and manage their currencies. China, of course, never deregulated at all.
The imperfections and uncertainties of this system have, over time, led to imbalances in trade and currency flows that ultimately pushed the entire world economy into a disastrous crisis.
Before that system began unravelling in the early part of this century, interest rates had been kept at low levels for many years and thus some of the inherent faults in the system were concealed.
Now the correction measures being introduced internationally are beginning to have an impact on Australia's banks, and all of them are compelled to raise market interest rates out of line with the RBA's "official rates".
Low-wage earners with home mortgages are especially hard hit. Other borrowers, persuaded by banks to borrow more than can be comfortably serviced at emerging interest rates, are perhaps the most vocal and exercise the most political influence.
Both of these groups want governments to act against the banks. Politicians have been flirting with the idea of regulating interest rates. The Greens are even suggesting that bank rates should move in line with the cost of borrowing. None of these ideas can ever be implemented - nor should they be.
If there is one area above all others that should be subject to market forces, it is ordinary bank-lending.
But if we want to preserve future opportunity for those on low incomes to aspire to home ownership, then we cannot subject these buyers to market rates of interest. The existing banks cannot afford to provide long-term loans at concessional rates of interest, and low-income families can't afford to pay market rates.
What we must do for low-income families is to take home loans out of the system - as we once did. Back then, various government-owned or government-controlled banks or building societies were able to offer low-income borrowers low, fixed-interest rates for the term of the loan.
Borrowers with incomes able to support more ambitious housing could be left to finance their needs through the commercial institutions.
It would be theoretically possible to reconstruct such a system, but is unlikely to happen given the large number of vested interests likely to oppose it. Also, the previous system rested on the idea that low-income families could count on secure long-term and well-paid employment. Without that, it's hard to make any kind of concessional loan system work.
Meanwhile, governments will continue huffing and puffing while low-income workers see their opportunities for home ownership receding further into the distance.Colin Teese is a former deputy secretary of the Department of Trade.