Saturday, March 29, 2008

Regulation riskier than recession?

That is the summary of a bunch of Australian corporate heads interviewed by the Sydney Morning Herald - Riding out the storm. Reading through the various comments I’m appalled that many of these people even attained the lofty positions they currently hold.

Sol Trujillo, Telstra of course is on a hiding to nothing in Australia. The sooner he heads back home the better off this country will be. But there are still the home grown CEOs and a handful of blow ins who simply fail to understand the philosophical and social underpinnings of this country.

Take this little lot:

Wal King, Leighton Holdings, one of our construction giants. “. I was in Davos [at the World Economic Forum] 12 months ago and "subprime" was never mentioned and the mood was pretty upbeat.”

My advice to Wal is to research wider than his little clique. The brewing subprime message has been evident for at least two years o my knowledge. It was discussed around regulars of this blog for at least that long.

John Stewart, National Australia Bank (NAB) - my bank as it happens.I am pleased to say Australia is in a much better position [than the US] because although we have the same problems in the debt markets we still have a strong economy. It is pretty well business as usual for us…”

Mortgage defaults and bankruptcies are ballooning, but the banks are still making profits. Meanwhile customers are churning between banks and other financial institutions trying to find some sort of edge against the increasing cost of surviving. The banks should be pleased they are building the strength of non-bank competitors.

Rob Murray, Lion Nathan – Brewer. “Despite being at the high end of the Reserve Bank's target range, inflation remains relatively low by historical standards. The industrialisation of China and India will undoubtedly continue to provide opportunities for Australian companies.”

One of the booze producers turning out caned alcohol/caffeine products for kids are obviously sampling their own wares. China and India are great customers for our abundant resources, but our financial institutions are still relying on foreign cash. The result is strong budget surpluses and inflation if the government attempts to spend it. That is globalization for you.

As Owen Hegarty, Oxiana a mining company, put it:

“We believe there's presently a disconnect between the financial markets and the fundamentals.”


lindsaylobe said...

Hi Cart
A group of CEO’s will not always be up to date or indeed knowledgeable on economic matters, except insofar as they impact directly on their business.

So I think we tend to be underwhelmed by their comments. No surprises amongst those quoted although you might have been a tad harsh on Stewart from the NAB.

Stewart has attempted to revitalize the NAB since taking the helm, and I think his statement was probably one made more as one from a reassuring point of view.
Glen Stevens from the Reserve Bank reminded us recently of the fact that in 1996 the difference between what Banks paid depositors and their lending rates was 4%, but currently the margin has shrunk to 2%. And non bank lending competition for the most part is reliant on unsustainable lending structures, such as borrowing short and lending long.

At the moment significant refinancing arising from financial stress is exacerbated by the pressure exerted by brokers, making up for more than half of such refinances and we now have about 80% of current mortgage portfolios which are not profitable. I think the Broker sector will come under a good deal of stress.

What’s of more concern however is the housing sector where median house prices used to represent 3 years average household income whilst today the ratio has leapt to 5 years, while real income and construction costs in that time frame have both only increased by 30%. Even so I think the risk of home loan loss rates further increasing badly remains very low, even if there is an increase in unemployment and housing prices were to fall.

Albeit at the moment we do have rising arrears and delinquencies, but that is from an exceptionally low base. Most people will still fight tooth and nail to keep their home. That attitude still prevails in Australia.

I have an open mind on Regulation, but I prefer descriptive to prescriptive regulation. I notice Obama has recently recommended the Federal Reserve be given, more supervisory power when acting as lender of last resort, as the equivalent of our Reserve Bank. He is also suggesting much stronger capital requirements for both financial companies and a consolidation of regulatory agencies.

Best wishes

abi said...

I'm like John McCain in one respect - the intricacies of economics confuses the hell out of me (but I'm not running for US president).

But somehow I think that, given globalization and the size of the US economy, the shockwaves will reach Australia and pretty much everywhere else if the US economy really tanks.

D.K. Raed said...

I'm with Abi. It looks like it's gonna be a bad few years here, and given our impact on the world, you can expect fallout to hit the jetstream.

Most of us can't say we didn't see it coming. We've been wondering what has propped up our stock market this long, in the face of one negative after another. We also remember the last 2 recessions and further back to the stagflation of the Carter era. yes with stagflation, our bank CD's earned 12-15%, but inflation was rampant; we dared not postpone purchasing something one day for fear it would substantially increase in price by the next.

As far as remedies, I don't grasp what the Fed Reserve is trying to do with more or less regulation. We've learned the hard way that things don't always mean what their title implies. Healthy Forest and Clear Skies regulation come to mind. I'm afraid the new regulation being proposed will have a few good things, but many more bad things riding in on its coattails that will actually lessen regulation.

Your mining exec put it best, “We believe there's presently a disconnect between the financial markets and the fundamentals.” AMEN!

Cart said...

D.K. – abi, Australia will, is, feeling the shockwaves. But as lindsaylobe would have it, we are in good shape to mitigate the worst effects.
Abi, I’m still trying to get a handle on economics, but I’m not about to be intimidated by the intricacies. In fact I’m finding it helpful to make a dumb statement them have the explanation put to me in a correction.
And – D.K. there are many approaches to regulation, currently a dynamic form, one where regulators can react quickly to changing conditions or negative outcomes is in vogue. The bottom line, to my thinking, is that the markets are necessarily self serving and need to be guided.
Lindsay, “A group of CEO’s will not always be up to date or indeed knowledgeable…” that is one of my points, they are market savvy, in which case they should not be quoted on matters economic.
But Stewart, dealing directly with the Reserve Bank, has a responsibility to be up to the mark. It seems to me that the banks were as much in favour of deregulation as Keating and the non-bank sector. Many of us were concerned about the direction then and now, but the chickens have come home to roost.
As for being a tad harsh, you could be right, I think NAB is the best of the bunch, but the bunch aren’t all that outstanding.

lindsaylobe said...

According to latest sets of Statistics from February it suggests we are in period of household consolidation of Finances.

Business Lending rose a modestly month on month basis ( half a percent) while housing credit also only increased by a .9%.

The bulk of the credit went to owner occupiers rather than investors.

These figures indicate a much softer outcomes to give a clear signall it is the end to the credit crunch induced surge in lending.

In fact I know that most of the big banks have already secured their borrowing requirements for the whole of the year ahead, well ahead of normal cycles.

In other words they are moving quickly to secure loans sufficient so that if there is any further tightening or deterioration in funding opportunities they are already covered,and have quality facilities in place for the current naf future requirements.

Personal credit was slightly negative driven mainly by reduced margin lending which is hardly surprising given the turmoil in equity markets.

I would expect the Reserve Bank, given this latest data, to leave rates unchanged at 7.25% at tomorrows meeting!

Best wishes

D.K. Raed said...

Linsay, does that mean your banks are paying over 7% in interest on savings? Our biggest banks are all down in the 2-3% range for bigger deposits, lower than 2% for little deposits. Guess it's all relative to what your COL & inflation is, but we are pretty disgusted with our artificially lowered interest rates here. Our Fed only knows one trick to "help" the economic downturn & that is to lower interest rates. Well, maybe two tricks -- they can also print more money. We in the middle feel like a squeeze-box.

lindsaylobe said...

Hi d.k. raed
These are interesting times and I guess it may be surprising to learn whist your Fed is running a very loose monetary policy, our equivalent which is the Reserve Bank has been tightening to dampen what is perceived to be excessive demand and likely higher inflation.

It is also prompted the Government to oversee what is likely to be a very large fiscal surplus, probably around $17 billion, coupled to the fact all of the states are also running sizable surpluses running into the billions.

Australia does not have any Federal Government Debt and the States also have only relatively small borrowings. The concern has been for the ballooning private demand and increased borrowings.

As far as interest rates go a AAA rated account on 24 hour call ( you can withdraw all of your money within 24 hours) will give you up to a top rate of 6.8% but on longer term deposits higher interest rates naturally apply. Say around 7.2% to 7.5% with the very big AAA rated banks to tie you money up for 6 months.

But I don’t think the Fed had too many options in the US, if your patient is at risk and likely to die, you would not worry too much about the side effects of inducing too much adrenalin

Notwithstanding there are those who think the easing and slack monetary policy is unwise and will only lead to further problems and possibly higher inflation later on.

I think I can appreciate your frustration.

Best wishes

D.K. Raed said...

Thanks for 'splanation, Lindsay. I see many differences. You have a fiscal surplus, both national & states. We are broke by any rational definition. Our middle class is being squeezed to the point of breaking. Our subprime fiasco will probably require some kind of govt-backed loan guarantees. We used to be able to say homeowners would do anything to hang onto their homes, but during the recent go-go housing market, everyone counted on equity build-up to cover a multitude of sins. Many of the subprime borrowers are one paycheck away from mortgage default, and with our sucky job market & looming inflation monster, maybe even less than the loss of one paycheck. Monthly mortgage payments are often near 50% of those subprime borrowers' income. That's crazy!

Also when you described AAA-rated banks, I suddenly realize another big difference. Because our banking system is propped up by FDIC insurance, depositors here have not had to think about bank ratings for yrs. I think we are about to find out that FDIC cannot handle very many big bank failures before it simply runs out of money. Then what? Well, I may yet live to see another revolution, or possibly mere anarchy -- the "interesting times" of which you speak.

Cart said...

Lindsay, I really do hope you ease yourself into the wider blog world with your explanations, even if I do tend to debate you on issues :)
You have a lot to offer in explanations of the mechanics and interactions.
Now that debate: "Australia does not have any Federal Government Debt and the States also have only relatively small borrowings."
I would argue that corporatism and privatization hides the debt of what would always have been considered public debt.
I always consider it as the great con. You can't hide from reality.

lindsaylobe said...

Hi Cart
Ref Australia does not have any Federal Government Debt and the States also have only relatively small borrowings

Although you can justify your argument that corporatism and privatization hides a public debt initially I would contend adding back all those cumulative privatizations as if they never happened would still leave us with no net Federal Govt debt to day.

Let me explain

Assume a public organization which was privatized has a yearly surplus of say 8% in real terms. After 12 years the Govt has forgone 8% yearly real return each year assuming its privatizations proceeds was based that price multiple.

So the net effect after several decades can be equilibrium.

eg ~The Governamnt has the benefit of reduced interest paid on the Commonwealth Securities retired from the initial privatization proceeds, but that interest saved wil be about half of the earnings it would have derived from those assets had they been retained.

Bear in mind the big items occurred predomonatly in the nineties and those organizations were all paying large surpluses either directly to the Government or by way of a dividends.

They were privatized on very attractive multiples to make them attractive propositions.

Bear in mind the Future Fund has already well over over 40 Billion in funds and we are probably going to add another 17 Billion this year. I would contend the surplus would have been higher without privatizations some time soon and that the net effect would not cancel out the existing net surplus in the Future fund for the reasons I have mentioned.

The same argument applies to the States privatization of many of their utilities which used to pay very hefty dividends.

In fact so much so that many complained they were unsustainable.

The philosophical argument as to whether some of those assets should have remained government assets or not or what is an ideal mixture is another matter entirely.

Suffice to say I think some strategic assets may well be better in as public institutions while others I think can benefit when in private hands and particularly in the form of individual equity.

But that’s another argument; an economic and strategic one that I think is also reasonably straightforward.

I am also not particularly in favor of public/private partnerships since in most cases the Government is left with the liability and in many cases all you have is a rather complicated financing arrangement that would be better served by the Government funding the project in the first place.

Best wishes

Cart said...

Now you are blinding me with science Lindsay :) Now the future fund is something few of us really understand. As a national savings account it is great, but is continually talked of as funding public superannuation, including the elected bunch. Though Rudd is talking about rolling back some of the benefits of the latter group.

On the privatisation issue will bow to your knowledge. I guess little State debt makes opposition claims a bit suspect, though they have not directly been denied by the government.
It is these political games that tend to give a misguided idea of our real economy.
I guess when corps like Telstra are not spending on infrastructure to the level we might have expected keeps borrowing down.

lindsaylobe said...

Telstra is a difficult one. Initially I was against the idea of privatization due to duplications of infrastructure by competitors and fracturing of efficiencies in relation to high speed internet connections. Telstra would have returned in excess of 20% pa in real returns as a government owned enterprise. But the question is would (under Government ownership) it have had the ticker to invest sufficiently. Telecommunications policy involved so many monumental stuff ups but notwithstanding the confusion once the current investment in new systems is completed I think Telstra t will be held up as model for the rest of the world. Whether that would have occurred under Government ownership will always remain unknown.

On to the Future Fund.
When the Federal government had extinguished all debt it was faced with the question “What will do with the surplus funds available now?
Federal Politicians and certain federal government departments had unfunded superannuation future liabilities, arising since employee contributions were insufficient to fund the extraordinary generous (more than double or in the case of politicians cases up to 4 times that provided for private super funds) pensions and any shortfall was paid out of consolidated revenue on a pay as you go type basis. What Costello proposed, presumably from advice from Treasury was to set up a future Fund which would eliminate the unfunded portion once and for all. Costello himself could not contain himself to the extent he went in the next budget to create another Future Funds, this time for Education.

But the reality was with the introduction of the GST, and in with Income tax continuing combined with the additional taxation flowing from the resources boom we were always going to have ongoing massive surpluses for some considerable time.
By the time the Future Fund was first mooted it was already apparent it was going to have far more in it than was necessary to accomplish those objective within the short time frame suggested by Costello. Costello presided over a period where he continued to present expected Budget surpluses which were shown to be very poor forecasts as at the close of each year the actual surplus was ballooning to double or even three times that figure originally forecast.

This was due to the high level of taxation income for the reasons I have mentioned.

Because the substantial GST tax receipts were returned to the states Costello claimed those should be ignored in determining the level of taxation, a complete nonsense in economic terms.

His justification was based upon the spurious claim in the national consolidated accounts receipts from the GST were offset by the entry, transferring those funds to the states.
Best wishes

Cart said...

Thanks again Lindsay. I like your 'take no prisoners' explanations. I'll just need some time to compute that lot. It seems to be confirming my prejudices :)