“Where might another shock come from? I’m not sure there will be one. I don’t think there will be,” said Reserve Bank Governor Glenn Stevens at a conference in Perth yesterday. Uh. You’d better mark those words.
The Guv also said he would not be too timid about raising interest rates. He believes the threat [of global financial calamity] has passed and that the bigger threat may well be inflation. That kind of tough talk sent the Aussie dollar right up to over 92 cents against the greenback. If it weren’t late fall, now might be the perfect time to take a trip to America and see how cheap things really are.
But it is a bit surprising that a Central banker would say he’s not sure there WILL be another shock to the world’s financial system. The last twenty years show a history of regular shocks. The economic models of economists suggest these shocks are 100-year or even 500-year events. But they just keep happening!
The Peso Crisis…the Asian Crisis…the Russian bond crisis which led to the fall of Long Term Capital Management…Bear Stearns…Iceland…Northern Rock…the entire GFC…nope! None of those could ever happen again. Especially in a world that’s reducing debt where asset markets are now undervalued and house prices have dramatically corrected and banks have recapitalised.
Well, that’s the story that Stevens probably believes. But you know our view. There’s a lot more bad debt out there posing as assets. There are more credit write downs. Banks have a boatload of commercial real estate and residential housing assets and a thin slice of equity capital supporting them. There is still a lot of leverage in the financial system. And that leverage exposes banks to losses.
For example, today’s AFR cites research from the International Monetary Fund and concludes that Aussie banks could lose as much as two percent of total loans outstanding if corporate and household defaults increase. And gee, that’s not likely at all when interest rates rise quickly, is it?
According to the AFR, the IMF report does conclude Aussie banks are “very sound”, but they could lose $33 billion from rising defaults. We’re not sure what default rate the report assumed, but we reckon it was probably too low. Nearly everyone in the financial establishment underestimated the depth of the crisis last time, too.
The other threat is that that Aussie banks source 30% of their loan funding from international credit markets, according to the IMF. Australia’s short-term external debt is about $400 billion this year, according to the AFR. Is that really a threat?
It doesn’t seem like one right now. Interest rates are rising and the Aussie dollar looks like it’s headed to parity against the USD. This makes Australia a popular destination for international capital flows. After all, you have heaps of foreign investors pouring in to buy Australian property. The place is a capital nirvana!
But yes, it is vulnerability. For one, it means growth in the Australian economy is not sourced from domestic savings but from borrowed foreign money, which must later be repaid. Second, it means that the income and rent from Australia’s capital stock (houses, property, shares, and bonds) may not be making Australians rich or even staying in Australia.
Granted, if the Boomers are selling their houses to Chinese investors in order to finance a comfortable retirement, it should work out well for the Boomers. But their children may be renting from Chinese landlords for a long time to come. And no, we’re not blaming the Chinese for this at all. It’s a great move for Chinese investors. But it may not be such a great development in the capital structure of Australia.
But at the moment, you wouldn’t get that sense that rising public debts and the transfer of ownership of Australia’s capital assets are any worry whatsoever. Sure haven’t seen much of it in the papers or on the TV shows. It’s like everyone’s forgotten that the more integrated the world’s financial markets have become, the more they’ve tended toward instability. Or everyone believes whatever was wrong before has been fixed now.
One person who had his wagon fixed yesterday was Bank of America CEO Ken Lewis. America’s new pay tsar (the U.S. Treasury Special Master for Compensation, Kenneth Feinberg) stripped Lewis of his 2009 salary. Don’t cry for Lewis just yet. His retirement package will leave him with between US$70 and US$120 million.
But why is there even a pay master to begin with? Isn’t that the job of boards of directors and shareholders? Could government charades to regulate the corporate sector get any more cosmetic? Coming soon, a pay master for your job.
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