Banks Win Again


–The year began with everyone worrying about bank failures. It’s ending with everyone worried about whole nations failing, or at least national governments. And it’s not just Greece we’re talking about. It’s the Big Kahuna of the global economy, the United States. And to their credit, it looks like Australia’s politicians know this.

–You could view last week’s rise ten-year bond yields as a kind of global fire alarm for dollar-denominated assets. You saw a politically weak U.S. President and a weak-willed U.S. Congress both agree to do nothing about spending less money. The rise in U.S. bond yield s is a vote of no confidence in America’s bonds.

–It might not look like that today. In fact the U.S. dollar rallied on higher retail sales figures in America. If you thought the spike in bond yields would lead to a rapid dollar crisis, that’s not going to happen. So what is?

–This is an important point for understanding what Treasurer Wayne Swan is up to with his bank reforms. The U.S. government is set to borrow so much money in the next few years that it will crowd out other borrowers (corporates and governments) and drive interest rates up. If you want to borrow money and you’re, say, an Australian bank trying to grow your balance sheet, you’re going to have to find some other source of funding.

–It’s kind of like if you knew that it wasn’t going to rain next year at all. Or, if all the rainfall went to irrigate one farmer’s crops, and that farmer was not you. If you knew the drought was coming, you’d do everything you could to stockpile water now or find other people willing to sell you water.

–All the big reforms announced by the Treasurer this weekend are aimed at keeping Australia’s housing bubble alive and booming. First was another $4 billion in government money to buy residential mortgage backed securities (RMBS). This is how smaller lenders finance mortgage lending. It’s a clever way to channel tax-payer money directly into housing prices (and bank profits).

–But the big reform was the introduction of covered bonds. It’s a story we wrote about late last month. On the surface, finding more local sources of lending looks good. If you know you’re going to have trouble borrowing from abroad, why not borrow closer to home?

–The trouble with covered bonds, in our view, is that it puts bond holders in line for depositor’s money ahead of depositors. Of course this would only happen in the case of a bank failure. And that could only happen in Australia if, say, the housing market collapsed. And that could never happen. So maybe we’re all worried over nothing.

–And after all the government says it’s going to look after depositors. They will now be covered by the Financial Claims Scheme. That little ripper was an outgrowth of the GFC and provides government-backed deposit insurance in the case of a bank failure. Depositors don’t get wiped out, even if secured creditors and equity investors do.

–But once you waft away the smoke you can see what’s happened. The liability for paying back depositors has shifted from the banks to the government. You are the government. So now if a bank fails, you’re going to have to pay out depositors.

–The banks and the government will tell you that the guarantee is there to provide confidence in the banks. As such, it will never be needed because just having it will reassure people they can always get their money from the bank, even if the bank fails. But this just conceals an obvious trend: more and more of Australia’s wealth is being tied up and invested in residential housing.

–This is precisely what doomed economies in Spain, Ireland, and the United States. Yet the banks and the government are essentially doubling down on housing as a national investment priority/get rich quick scheme. Even if you were to argue that this is just prudent provisioning for a world where the cost of credit is going up, it’s still a national gamble on rising housing prices.

–All of the measures taken over the weekend aim to funnel more money into the housing market—from covered bonds to the RMBS program to steps which allow the flow of retirement funds into the mortgage market. The rigmarole about exit fees was just bread and circuses for the media and the masses. The real aim was to keep the money flowing to housing and keep the bubble going.

–This is a clear winner for the banks. For banks to keep growing they have to keep lending. And since they already have so much of their loan book tied up in housing, even more housing loans grow the loan book AND support the assets already on the book.

–And it’s always a win if a bank engineers a deal where all the profits are private but all the losses are fobbed off on investors and the public. But just why Australia would increase the financialisation of its economy when that same policy is failing everywhere else on the planet…that’s a real had scratcher.

Dan Denning
For The Daily Reckoning Australia

Dan Denning
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.


  1. Thanks Dan, an interesting and appreciated observation… I am still scratching my head? as there appear to be many scenarios undefined…

  2. HI Dan, great article !! I am an aussie living in Dublin and its exactly what the irish government tried to do back in 2008 and now the irish tax payer is footing the bill with austerity measures. I was home in August this year for my fathers 60 birthday and tried to convince all his mates that Australia was in a property bubble and that the banks would fall as there loan books were over 50% reliant on property.All except one bloke agreed with me which makes me realise how the media over there manipulate the public. Guys like steve keen got slatted in the media (we had a guy here named David Mcwilliams who was also slatted) however he will turn out to be correct in his predictions and everyone will ask themselves ‘why didnt we listen’ when the unemployment rates hits 10% and people who bought in the last 10 years are in negetive equity !

    scott jeffers
    December 13, 2010
  3. Who in their right mind would allow this (rhetorical question). The deck of cards just keeps getting built higher and higher. The public debt to GDP may be low now but in the event of one of the big four failing that would change pretty fast. Time for radical change!

  4. In all this furore over the banks, no one has brought up something that might help. That is to decrease or elminate tax on interest earned. This would serve to bring down funding costs to the bank, reduce pressure on interest rates as well as take some (only a little mind you) heat out of the housing market. Or am I missing something here?

  5. “In all this furore over the banks, no one has brought up something that might help. That is to decrease or elminate tax on interest earned. This would serve to bring down funding costs to the bank, reduce pressure on interest rates as well as take some (only a little mind you) heat out of the housing market. Or am I missing something here?”

    It was one of the recommendations of the KHR Don. I suspect what you are missing is that we have a socialist government that thinks it would lose them more votes than it would win them. (Favouring the ‘rich’ over the ‘poor’ and such like?) But they did pay it a bit of lip of service by saying Yep, we’ll do that: But only on bank interest of up to $1,000 pa! :D

  6. Well, if you do it right, there is no tax at all on bank interest, Don.
    Of course you need either a SMSF, or to be retired over 60.

    The right asset combination can lift the amount of non-taxable bank interest appreciably.

    The government’s problem is this: If you do drop all tax on bank interest, no new private investment in residential construction would ever occur again… until massive accommodation shortages occurred… and rents went through the roof. Fair amount of chaos in there during the shift! :D

    Yes, I’m aware that chaos presents all kinds of opportunities to individuals, but sitting governments tend to _try_ to avoid it… ;)

  7. I thought Kris Skayce had some, erm, interesting ideas in today’s MM:

  8. My scalp has started bleeding from all the head scratching.
    I am now substituting a frowning/puzzled expression, but suspect that I will rapidly develop a lot of wrinkles on my forehead.

  9. “The banks and the government will tell you that the guarantee is there to provide confidence in the banks.”

    Of course. They can now offload their risk department, throw caution to the wind and let people buy houses, no money down, bad credit accepted. Perhaps we should spread the risk a bit though and package the mortgage in to units, then we can sell the derivatives! We’re financial geniuses down here in Martin Place! What could go wrong!

    Our options as I see it:
    -We find a way to softly deflate the bubble. Risky, oh so risky. But probably the best move. Just layer on disincentives each few years. Like slowly changing tax rules on negative gearing over a decade, trying to avoid a rush for the exit. Scrap mortgage insurance, bring back 80% LVR for home ownership entry. Drop -all- first home buyer grants. Raise bank reserve rates, tighten lending criteria, etc. One step at a time over years.
    -We decide to ‘do nothing’ and leave the problem for the next head of the rba \ government to explore options on, or wait for external pressures to pop it for us (hence no blame!). I still get a 80% discount though. Thanks!
    -We try to stagnate the market by inching up the rates until we reach a balance and allow wage inflation to reduce the PE. This looks like the plan we’re following. Balance on a ball for 10-20 years… It has success written all over it. All you need is an external funding spike or rise in defaults and the market drops on affordability.

    We need to KILL DEAD the idea of making money flipping houses. Then we have a decent chance to survive the massive set of bank defaults around the world on the horizon when contigation commences.

    But don’t trust me I’m biased! :) I’m the one waiting for it to all happen so I can pick at the bones. LOL…

    Whenever you are scratching your heads on new legislation ask two questions:
    – Who just got rich?
    – Who has an exception \ or is naturally excluded from it’s effects…

  10. So now we taxpayers fund the banks’ reserves (via the RBA) AS WELL as their liquidity. Why not just have done with it an nationaise them?


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