Your Money Isn’t Yours

Finally, the boring, bullish month of August is over. Let the drama of September begin! September is traditionally the most dangerous month of the year for stock market crashes. If it holds true to form, the next crash will catch investors blissfully unaware. The bear likes his meat fresh and full of delicious, juicy hope.

American markets will take Monday off to celebrate Labor Day. It’s a well-earned rest. The S&P 500 was up 3.8% in August, its best month since February. Aussie stocks didn’t fare as well. If you play with the numbers a little, you get a 4.38% rise from the August 8th intra-day lows to the August 21st intra-day highs. For the calendar year, the S&P ASX/200 is up 5.17%.

But let’s not talk about price action. Let’s talk about things that really matter, like business earnings and profits. The reporting season is over. The numbers were alright, at least superficially. 54% of Australia firms exceeded analyst expectations in terms of revenue. What’s more, 65% increased their dividends.

In the spirit of raining on a parade, though, I have to point out a troubling fact: You can’t grow a business by cutting costs. Earnings per share (6.3%) grew faster than revenues (5.2%), according to data from CIMB reported in the Australian Financial Review. That’s only possible in a universe where cost cutting is the key driver of earnings growth. And that is not a universe that’s friendly to higher share prices.

That last line is more of a claim than fact. But here’s my point: You can make investors happy by cutting costs and increasing dividends (up 7%). But if a business doesn’t reinvest cash in future growth, there will be less cash to pay out later. Businesses are not automated teller machines that exist to deliver annuity payments to shareholders. Growth requires investment. Investment requires cash. The national obsession with dividends — perfectly rational from a tax perspective — is detrimental to the formation of the nation’s future capital stock.

Besides, there is no investment boom in the pipeline for Australia. It already happened. It was called the Mining Boom. When Wednesday’s GDP figures come out, don’t be surprised to see a negative number for the June quarter. The consensus expectation is for 0.3% growth according to Bloomberg. The Reserve Bank of Australia expects 0.4%.

Speaking of the RBA, it meets tomorrow to discuss interest rates. That should be exciting! The Bank has nowhere to go with rates right now. The cash rate’s been steady at 2.5% for over a year now.

Low interest rates have spectacularly failed to ignite an investment boom in the non-mining sectors of the economy. There is a myth that the Australian economy is in the middle of a ‘re-balancing’. But the economy is fundamentally unbalanced, with houses and banks and mines on one side, and everything else on the other side.

Low rates have been great for the housing market. But can you see the RBA’s dilemma? With flat or negative growth, it can’t raise rates. It would probably like to raise rates to take some steam out of rising house prices. In the middle of the night, Glenn Stevens must wake up and fret about how little monetary policy can actually achieve.

It’s not all the Reserve Bank of Australia’s fault, either. Chinese nationals are driving up home prices for all Australians by paying 20-30% premiums on homes at the top end of the property market, according to buyers’ agent David Morrell. Is this financial xenophobia or financial fact?

Morrell told the Financial Review that Chinese buyers are pushing up home prices all along the property ladder by swamping the market for trophy homes above $10 million and houses between $1.5 and $3.5 million. He’s called for the Foreign Investment Review Board to investigate whether property agents and lawyers are helping foreign buyers illegally enter the market. Why would it be illegal?

Morrell says the agents doing the deals are happy to bank the big commissions without having proof that the foreign buyers are residents or have permission from the Foreign Investment Review Board to buy real estate in Australia. It’s a form of queue jumping that involves tens of thousands of dollars in profit per transaction to the real estate industry. That seems like a claim that’s relatively easy to investigate, for anyone interested in seriously investigating it. On the other hand, if you’re on the housing gravy train, why bother asking pesky questions that might derail the whole thing?

While I’m on the subject of pesky questions, here’s another one: Are bank depositors unsecured creditors or not? I’ve been asking the question for months. I’m not trying to foment a loss of confidence in the banks. But it makes sense to think through the next financial crisis before it happens. You’d want to know if, as a depositor, you were at risk from a ‘bail in’ regime in the event of a failed bank. The answer, at least to me, is still not clear.

The RBA didn’t clarify the matter in its submission to David Murray’s Financial System Inquiry in March of this year. It described the evolution of depositor protection via the Financial Claims Scheme (FCS). In the early days of the depression, we’re now in (2008), the FCS provided up to $1 million of deposit insurance per depositor, per institution. In February of 2012, it was reduced to $250,000 per depositor, per institution.

The Bank said the reduced total was still enough to ensure confidence in the financial system. It covers most people. You prevent a bank run by reassuring depositors that no matter what happens to the bank, they’ll get their money from somebody. That somebody might be another bank or the government. But there’s no need to stuff the mattress.

The whole scheme is anchored by the idea of ‘depositor preference’. The RBA describes it thusly:

Historically, the primary mechanism for depositor protection in Australia has been depositor preference, which is enshrined in the Banking Act. Under this arrangement, depositors have preferred legal status over other unsecured creditors in the hierarchy of claims against a failed ADI, meaning that they must be paid out before other claims are honoured.’

That seems pretty clear cut. But is it? It says depositors have ‘preferred legal status over other unsecured creditors’. But by the use of the word ‘other’, aren’t depositors considered unsecured creditors. And if so, doesn’t that mean that depositors are subordinate to secured creditors?

And here’s the real issue. Doesn’t that mean a ‘bail in’ to recapitalise a bank would treat depositors as unsecured creditors first and depositors second? Your savings would still be subject to a ‘bail in’ even though your deposits are insured. It’s still not clear to me. If you can provide any clarity on the matter, feel free to enlighten me at

Incidentally, the RBA shed a little more light on the matter in its Supplementary Submission to the Financial System Inquiry. That submission garnered headlines last week because, in it, the Bank quashed the idea of relaxing capital reserve ratios at regional Aussie banks. The proposal was put forward by those banks in the name of competition. They argued that lower capital reserve ratios would be better for borrowers and result in more housing loans to the economy (just what we need!).

There was ‘little evidence’ of a shortage in housing finance in Australia, the Bank said. That’s an understated way of saying there’s plenty of money for everyone. But in the note about the Financial Claims Scheme, it also reiterated its support for ‘a safe financial product promising full payment’. Can you guess what it was referring to? That’s right! Your savings account!

If you’re like me, you probably don’t think of a savings account as a ‘financial product promising full payment’. You probably think of it as ‘your money’. But by the letter of the law, it’s not. Once you make the deposit, it’s the banks money and you’re an unsecured creditor. More on the implications of that tomorrow.


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Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.

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