The Leader of the Opposition, Malcolm Turnbull, has delivered a speech on leadership and action in response to the international economic crisis. He addressed the first annual conference of the newly-formed Liberal National Party in Queensland.
This is the transcript of Malcolm Turnbull’s speech:
Tonight I will speak about leadership and action in this time of economic crisis but before doing so may I say how delighted I am to be speaking here at the first annual conference of the LNP. Because the formation of the LNP – now the Queensland Division of the Liberal Party of Australia – is a triumph of leadership over indecision. It represents a decision that the conservative forces of Queensland were tired of squabbling over the spoils of Opposition, had recognised that they had failed the people of this State by not providing a viable alternative to an inept State Labor Government and had resolved that now was the time to unite as one force to give Queensland the good Government this great State deserves.
Turning to Wall Street, I am constantly reminded of Mark Twain’s observation that only fiction has to be credible.
And it is true that today the dramas in Washington and Wall Street put the script writers to shame. The world of “West Wing” looks positively mundane compared to the drama of Obama v. McCain, not to speak of Palin v. Biden!
And any novel which forecast the financial turmoil we have seen this year would have run the risk of consignment to the science fiction section.
Yet these events are about much more than bankers and bail outs.
The fact that banks’ funding costs are high, that smaller banks are under pressure is important because it means thousands of businesses not to speak of millions of homebuyers will be feeling the pinch today.
The developer whose line of credit is cut back cannot engage the subcontractor who cannot employ the bricklayer who cannot pay the interest on his mortgage without cutting back on something else – a new car, a holiday, the kids’ school fees. And so it goes – Wall Street may be where it began, but the rubber hits the road and hits it hard on Main Street.
The origins of this crisis were not in Australia and if the United States had been regulated and governed as wisely as our nation was for eleven and half years the crisis would not have begun at all.
So how did it all happen?
In the United States, a long period of low interest rates combined with imprudent lending practices resulted in a large percentage of home loans being made to people with poor credit histories and little prospect of repaying the loan – so called “sub-prime loans”. The loans were made in the expectation that house prices would continue to rise and repayment would come about from a resale or refinancing.
A classic asset bubble developed and inevitably it burst. House prices have declined on average by more than 20% in real terms across the United States. In some areas the fall has been closer to 50%. Most economists expect the eventual decline to be more than 30%.
These loans were securitised. This involved pooling or packaging mortgages and selling claims on the package to investors. Many of these securities were sliced and diced and packaged into different forms of securities and derivatives. Credit ratings were given to many of them which were clearly too optimistic. The complexity of the more esoteric products has made them hard to analyse and price.
And the volume was enormous. Right now there is about $11.3 trillion in residential mortgage debt in the United States of which about $1 trillion is delinquent or in foreclosure (Goldman Sachs US Economics Analyst October 3 2008 p. 5). Overall, sub-prime loans make up about 15% of the total US mortgage book, and a sizeable proportion of them – more than 20 per cent of adjustable rate subprime mortages, and more than 15 per cent of fixed rate subprime mortgages – are currently more than 30 days in arrears. According to the Bank for International Settlements, between 2004 and 2006, over 15 per cent of residential mortgage-backed securities that were issued in the United States were classed as sub-prime. In other words, much of these non-performing loans were securitised.
The closest equivalent to sub-prime loans in Australia are the so-called non-conforming housing loans, which account for less than 1 per cent of all outstanding mortgages. And compared with the US, a relatively low proportion of these – just over 8 per cent of non-conforming securitised home loans – are more than 90 days in arrears.
As the US housing market fell the value of these securities also fell, their complexity made them hard to value and the fact that they were widely held across the banking world made banks distrust each other, confidence collapsed and banks were reluctant to lend to each other. US and European banks asked themselves was the institution they were dealing with today going to be the next Bear Stern or Lehman or Washington Mutual?
Central Banks around the world have been playing a heroic role in keeping the money flowing, directly lending to commercial banks who are reluctant to deal with each other. The US Government’s Troubled Asset Relief Program (TARP) is designed to boost liquidity by buying these assets from banks – clearing up their balance sheets so they can get their houses in order.
The crisis has now moved well beyond the problems of sub-prime loans. A virus of fear and anxiety has overwhelmed financial markets and it is self reinforcing. Even if a banker knows his fear is irrational, how can he assume that if he overcomes his fear and advances funds to a bank that those irrational fears of others will not bring it down.
Governments have been searching for an adrenalin shot of confidence. In the United States we have had the $700 billion of TARP. In the United Kingdom we have £250 billion being injected into banks as capital and liquid cash funds. It amounts to a partial nationalisation of the British banking industry. Here in Australia, blessed with a far more secure and stable financial sector, our own central bank has delivered an unusually big rate cut and that has been followed large cuts from other central banks around the world.
We do well to recall the words with which Franklin Roosevelt galvanised a nation – as relevant today as they were in 1933.
“The only thing we have to fear is fear itself – nameless, unreasoning, unjustified terror which paralyses needed efforts to convert retreat into advance.”
Now even if the TARP Bill can get the money flow going again and give banks the breathing space to rebuild their balance sheets, even if the UK bail out steadies British nerves, there can be no doubt that we are moving into a different economic environment.
The IMF’s latest World Economic Outlook describes the world economy as decelerating quickly and forecasts the developed economies as being “in or close to recession in the second half of 2008 and early 2009”. There are many economists taking even gloomier views than that.
As far as Australia is concerned the IMF is more positive, it forecasts our economic growth will slow from 2.5% p.a in 2008 to 2.2% in 2009.
Australia certainly is in the midst of a wild and unpredictable economic storm. We will get wet, but we will not sink.
And why will we not sink? What enables us to be positive about our future?
It is eleven and a half years of sound economic management. $96 billion of Labor debt paid off. Future obligations to public service and defence force pensions provided for.
And why is our banking system so much more stable than that of other countries? Why wasn’t there an outbreak of imprudent lending and other dubious and risky financial practices.
It was prudent financial regulation by the Coalition. Our prudential regulators in Australia were reconstituted under the Coalition – the combination of an independent Reserve Bank, an independent prudential regulator APRA and the corporate regulator ASIC all bear the Coalition stamp of good economic management.
By contrast, the Rudd Government’s economic management has been awkward, confused and often mistaken from the moment it took office.
You will remember that earlier this year our Treasurer Mr Swan took it on himself, unique among Treasury ministers around the world, to talk down his own country’s economy and talk up inflation. Inflation was not just high – it was out of control. The “inflation genie was out of the bottle” he said again and again. Not to be outdone in hyperbole his leader, Mr Rudd, described an “inflation monster” as wreaking havoc across the land. I could only imagine our anxious Prime Minister with sleep disturbed by visions of an economically malignant Shrek!
The Coalition, on the other hand, took a different approach. We pointed to the growing credit crisis in the United States and urged the Reserve Bank to stay its hand, not to put up rates but rather monitor the developments overseas which we feared would slow global, and Australian, economic activity. In other words if tighter money was deemed desirable, we were likely to get more than enough tightening anyway.
Mr Swan denounced us as populist and reckless. With the benefit of hindsight we appear to have been prudent and responsible.
But if you run around the countryside saying inflation is out of control, and if you are the Treasurer of the Commonwealth you will send inflationary expectations through the roof and consequently pressure the Reserve Bank to raise rates. Which they did, twice.
Now we have the bizarre spectacle of a Prime Minister and Treasurer who become apologists for the big banks, making their case in advance of an anticipated RBA rate cut for them not having to pass onto their borrowers the full extent of that cut.
Never mind the millions of homebuyers battling to meet their mortgage payments. Never mind the thousands of businesses struggling to pay higher business interest rates as sales start to decline.
No, our Prime Minister, took it on himself to speak up for only one part of the Australian business world and that was the largest and most profitable part.
Only the Coalition put a stake in the ground for the rest of the community for small business, for homebuyers and for borrowers across Australia. And what we were accused of by Labor – the big banks’ best mates – once again “cheap populism”. Well the only thing going cheap this week past has been the credibility of a Labor Government that is as out of touch with homebuyers as it is with small business, as out of touch with pensioners as it is with motorists.
So out of touch, people are starting to wonder if “Hollowmen” is just another reality tv show.
Australia needs leadership and it needs action. The Rudd Government hit the ground reviewing and hasn’t stopped. Meetings, committees, summits, inquiries and reviews are no substitute for
decisions. Less than two weeks ago, Mr Rudd responded to a question by saying that he thought it was time to “review carefully the review” that he had “commissioned some time ago” (September 30, Press Conference Parliament House, Canberra).
So let me propose three decisions that should be taken immediately.
The Government must recognise that its plans to introduce an Emissions Trading Scheme by 2010 are recklessly and irresponsibly rushed.
When we were in Government in 2007 our best advice was that an ETS could not be introduced prior to 2011. There was some considerable significance in that date. We all know, as Professor Garnaut notes, that whatever Australia does to reduce emissions will have no impact on global emissions and therefore on global warming unless the rest of the world also takes action.
Worse still if we impose a carbon cost on our industries and other countries do not then we will simply export both the emissions and the jobs. The world will keep getting warmer and we will start getting poorer.
So the most important aspect of any Australian ETS, indeed any Australian action to mitigate climate change, must be the extent to which what we do is matched or meshes in with global action. So what will the rest of the world do?
Well, we won’t begin to know at least until the end of next year when the world’s nations meet in Copenhagen to, hopefully, agree on a successor to the Kyoto Protocol one which will include all the major emitters including the USA, China and India.
Another key issue is what will the new US President do. Both Senators McCain and Obama favour the United States establishing an ETS. They each have very different approaches to climate change to President George W Bush.
But what will they come up with? How much of a carbon cost will the new Congress agree to impose on Americans during what will be a very tough period of economic hardship. What, for that matter, will China’s attitude be as it confronts slower economic growth?
These are all unknown and common sense demands that the design of any Australian ETS should not be finalised until after we see what the new US President is going to do and what the world’s nations will agree to at Copenhagen.
We knew this was important last year when the global economic outlook was much sunnier than it is today. But now, with all of today’s uncertainty and turmoil, it is completely irresponsible to rush in an ETS without knowing what the major global players are going to do.
And it is not as though the draft of the ETS is particularly encouraging. We still do not have the Treasury’s economic modelling but major Australian industries including the LNG exporters are predicting considerable damage to their operations for absolutely no environmental gain.
The Coalition is committed to an effective response to climate change. We recognise that Australia as a wealthy developed nation should take a leading role, but finalising the design of an ETS in the dark is reckless.
And this is not just our view. We know that one industry leader after another has given the same advice to the Prime Minister and his Climate Change Minister, Senator Wong.
It will be said by some responding to climate change is urgent. Well so it is, but given any ETS would start with a low trajectory and low carbon price, given we are set to meet our Kyoto Target in 2012 anyway, delaying the introduction of a scheme by one or two years will make no difference, on any objective appraisal, to the effectiveness of our ultimate response.
The time has come for the Prime Minister to admit that his promise of a 2010 start date was no more than an election year flourish and return to a timetable that enables Australia to make decisions when we are fully informed.
I will now turn to the impact of the global economic crisis on banks and the implications for financial regulation in the future.
At the outset, we should be pleased that our regulatory system has stood up well. Nonetheless there are a number of lessons already learned (and many more lessons to come no doubt).
Securitisation – transforming otherwise illiquid assets into marketable securities can provide investors with a diversified portfolio with a reasonable return, and a well developed secondary market can reduce transaction costs between investors and borrowers. Access to a liquid market for residential mortgage-backed securities can and has enhanced competition in Australia’s mortgage market.
On the other hand, securitisation can often be accompanied by increased complexity, which is the enemy of transparency. And without transparency one cannot have effective accountability.
While the root cause of the problem has been imprudent lending into a housing bubble, the complexity of the many securities derived from those loans has made it very hard for people to value them. In other words, in anxious times nobody will invest in things they do not understand.
This is an important point because the lack of liquidity caused by banks being unwilling to lend to each other is not simply the result of distressed assets. There are and always have been highly liquid markets for distressed assets – loans worth 10 cents in the dollar for example. The problem here has been that the complexity makes it hard to do a credit analysis to work out what these assets are actually worth.
So banks, regulators and above all ratings agencies must become much more sceptical of financial products the complexity of which makes their analysis difficult. Additionally, they must cooperate to ensure that the paper trail from complex derivatives to simple assets like mortgages is short and simple. Put another way, we know that we shouldn’t jump into water unless you can readily determine how deep it is first.
Turning now to competition in the Australian banking market. The reason why Australians have had access to mortgage finance on keen rates in recent years is that the market was opened up to competition. Aussie Home Loans, Wizard, RAMS, Bank of Queensland and many other smaller banks and non-bank lenders provided competition to the big banks and supported by an army of mortgage brokers drove down the mortgage margins of the big four.
The smaller lenders were especially dependent on the residential mortgage backed securities market the process where mortgages were sold off to investors not as individual mortgages but as part of a larger pool. This market enabled smaller lenders to, in effect, outsource their balance sheet to the market and gave them the ability to compete with the big banks who also accessed this market which ultimately provided about one quarter of the finance for Australian residential mortgages.
Since late last year this market has been all but completely shut. It doesn’t deserve to be. Unlike the United States where 15% of mortgages are sub prime, Australian residential mortgages are of high quality overall with relatively low levels of default. That is why a few weeks ago I advocated that the Government, through its Australian Office of Financial Management, invest in the RMBS market to provide additional confidence and liquidity and support the maintenance of competition. Now this was not a bail out proposal – Australian RMBS are of investment grade and entirely within the legal investment framework of the AOFM.
Mr Swan ridiculed this idea as “a monumental gaffe” – but then five days later adopted it. The adoption of our suggestion was as gratifying as the backflip was baffling.
He committed initially $4 billion in two equal tranches.
Given the continuing demand for liquidity in the mortgage finance area, and having consulted widely with the industry and other experts our second recommendation for immediate action is that this level of investment should be raised to at least $10 billion. That compares to an RMBS issuance of around $18 billion a quarter prior to the sub-prime crisis, but it will nonetheless make a more meaningful contribution to supporting competition and do so without compromising in any way the prudent investment standards of the AOFM under its Act.
However in times like this competition will always take second place to financial stability and as we are seeing now the big banks will take advantage of the crisis to increase their market share. This is a familiar pattern. In times like these smaller institutions tend to be acquired by larger ones and if large banks get into serious trouble Governments step in, as they have in other countries very recently, on the basis that they are too big to fail.
BankWest’s UK parent, HBOS, has been in dire straits and was a forced seller of its Australian subsidiary. Commonwealth Bank has got itself a bargain buying BankWest for a discount to its book value (0.8 x book). Only three months ago Westpac agreed to acquire St George for 2.7 x book. I would note that it speaks volumes for the confidence in our major banks that Commonwealth was able to raise $2 billion the night before last.
Suncorp Metway is also in discussions with buyers , it is reported. Every financial institution below the level of the big four is less competitive today than it was a year ago. Not only is money dearer and harder to get for the smaller banks, but depositors in times like this will often prefer the larger institutions.
Recently the Government announced with our support a scheme to provide a guarantee of deposits in authorised deposit taking institutions up to $20,000. While deposit insurance is common place in other countries (and becoming more so), Australia has not seen any need for it given the priority the Banking Act gives depositors over other creditors and the sound prudential management of our banking system.
However, the absence of an explicit guarantee can be interpreted as meaning there is an implicit guarantee of all deposits. So the argument in favour of a guarantee is that it is better to have an explicit limited guarantee than an implicit unlimited guarantee.
This deposit guarantee scheme has been a long time in the making and indeed we proposed to introduce one ourselves last year but felt if we had done so in the wake of the sub-prime crisis it may worsen rather than bolster confidence in institutions.
However, in the light of the current global economic crisis, the Coalition considers that the proposed $20 000 cap per person is less than adequate and, moreover, out of line with similar schemes in the rest of the world. Accordingly, the third immediate action the Coalition recommends is that the cap in the proposed scheme be increased to at least $100 000 to allow Australians, including small businesses, additional assurance in these difficult times.
However, we are aware of the potential additional moral hazard from the introduction of the scheme, and propose that its effectiveness and efficiency be reviewed by the Productivity Commission not later than three years after the scheme’s commencement.
In addition, I note that the prudential regulator – APRA – has a vital role to closely monitor ADIs to minimise moral hazard.
Every economic cloud has a silver lining for someone and in this case it is the big banks. These of course are the same institutions the Prime Minister has reserved for special consideration. They will emerge from the crisis in a much stronger competitive position.
And while I recognise as previously noted that in times like this competition will take a back seat to stability in the mind of governments and regulators, nonetheless there is a strong public interest in supporting competition if it can be done without sacrificing stability.
We should not forget the great benefits Australians have enjoyed from competition in the lending market. The expanded participation in the residential mortgage backed securities market that I have recommended here will support competition.
So will a larger deposit guarantee. There is a real risk at present that depositors will shift their savings from smaller institutions such as regional banks and credit unions to the big four banks. This has the potential to considerably strengthen the big institutions’ competitive position at the expense of their smaller rivals. I note, for example, that Commonwealth Bank’s domestic deposits are up by $21 billion, or 9 per cent, in just the last two months.
In conclusion, let me say that these suggestions are offered in a constructive manner. For all of our partisan disagreement, both sides of politics should be committed to ensure the stability and security of our great nation.
There is no doubt that a long period of economic growth has led to many people and institutions, especially in the United States, becoming complacent about risk. Too many of us have forgotten old fashioned values of thrift and saving. Many of us have borrowed against assets assuming they can only go up in value and never down.
I am sure that we will emerge stronger from this crisis – we will relearn old lessons we should never have forgotten and we will recognise once more, the important difference between confidence (always important) and complacency (always dangerous).
And as we pull through these difficult times, I know that in the engine room of our national economy there will be no relenting in the energy and the enterprise from the great state of Queensland.