CBA Sees More Bad Loans


Some days, there’s just nothing good to say about financial markets. Today is one of those days. But we’ll press on with the reckoning anyway. If the appetite for risk shrinks anymore, equity markets are going to starve, and national governments are going to be the spenders and lenders of last resort everywhere (those that survive, anyway).

Before we forget, drinks are confirmed for Tuesday, December 9th at the BLVD Bar, located at 6 Queensbridge Square on Southbank in Melbourne, from 6:30pm until (perhaps) midnight. Finger food will provided, and the first drink is on the DR. But after that, you’re on your own for food and beverages. Quite a few readers are eager to toast in the New Year, or say goodbye to the old one. Either way, see you then!

On to the markets. Australia’s biggest mortgage lender says its bad doubts could double this year. Commonwealth Bank said loans it made to now-defunct firms Lehman Brothers and Allco. Bad debts at CBA were nearly A$930 million in 2008, compared to $496 million the year before. Ouch.

The bad loans are still a small percentage of the total loan portfolio. You can see, though, that Aussie banks are trying to beef up their core capital to provide for future loan losses. NAB’s $3 billion institutional raise endeared it to investors. CBA may have to raise new capital as well, if only so its Tier 1 capital ratio matches that of its peers.


Tier 1 capital is a bank’s core capital-the amount of equity it has to withstand losses. It’s actually a ratio of core capital to risk-weighted assets. You might be surprised that, according to the Australian Prudential Regulatory Authority (APRA, or the agency that regulates Aussie banks), the minimum capital adequacy ratio for Aussie banks is just 4%.

They prefer it to be much higher, though, around 8%. And you can see why. Unusually large and unplanned losses in a bank’s asset portfolio could wipe it out if it didn’t have sufficient high quality capital on the balance sheet. This, by the way, is the reason the Paulson TARP plan in the U.S. morphed from a plan to buy bad mortgage assets on bank balance sheets into a direct inject of capital. It was meant to bolster the core capital positions of banks with troubled assets (cross fingers, hope asset quality improves.

Australian banks-at least the big four-do not appear to require any of the major capital injections taking place in Europe in the U.S. The banks appear to have parked a lot of their residential mortgage backed securities with the RBA, though (for safekeeping of course). It goes to show you, though, that banking is an inherently risky business.

Meanwhile, on Wall Street, the Dow fell by nearly five percent and the Nasdaq broke its 2003 low. It’s likely that stocks all over the world are going to test the 2003 lows again, and probably crash right through them. But we honestly thought that wouldn’t come until the first or second quarter of next year, and would be preceded by a significantly rally in shares.

That’s still possible. But the drumbeat of hideous economic news is pulverising investor sentiment. What’s so alarming about this market is that the popping of the credit bubble is not just forcing all asset classes much lower. It’s bringing the government into play as the key economic actor of the next five years (or much longer, perhaps). It’s like a giant global Red Dawn. Yikes.

Yesterday we promised to talk more about Aussie resource juniors. We’re running out of space today, so we’ll save it tomorrow. However, picture a world in which your great grandchildren have no idea what a petrol station is…because there aren’t any. It’s a world where petroleum is a construction material, not a fuel for internal combustion engines. And it’s a world where the most valuable resource isn’t paper capital…but energy.

Some reader mail?

Dear Dan,

As always, a well-written and thought-provoking article. But no Bill of Rights for me thanks . The problem with such a Bill is that unelected Judges can have an absolute birthday… at our expense. I do not want Activist Judges to dictate my life. While parliaments can be composed of a bunch of boofheads… at least we can vote the bastards out. Activist Judges are far more frightening than an absence of a Bill of Rights. Besides, we appear to have got along pretty well without a Bill of Rights.


Bob M.

Ahh yes. What to do with the boofheads? Vote them out!

From what we can gather, the worry about a Bill of Rights is that it becomes a specific list of things which you as a citizen may not do. Or worse, it becomes a laundry list of so-called rights the government extends to special interest groups. It becomes a list of particular laws rather than general principles.

That doesn’t sound like a Bill of Rights we’d want either. But then, as we understand it, a Bill of Rights is a very general list of negative rights. Negative rights specify what the government is NOT permitted to do. Positive rights, like the ones a lot of readers seem to hear, specify what YOU are permitted to do.

You’d want a Bill of Rights that negates the government’s power to make laws to tell you what you can and can’t do. The whole point is to remove critical freedoms like freedom of speech and freedom of the press from courtrooms and legislatures and put them, in a constitutional sense, above judicial or legislative deliberation. The government can’t touch them because they are off legal limits.

Of course other countries have had Bills of Rights that didn’t succeed at all in guaranteeing liberty. Weimar Germany is a great example. But if you’ll forgive us for being a barbaric American, we’d suggest that one reason these Bills of Rights didn’t help in the practical defence of liberty is that they did not include the right of the people to keep and bear arms.

The founders realised that having rights-freedom of speech, of the press, or religion-was no good if you didn’t also have the right to defend yourself from people who would deprive you of those right unjustly, including the government. What good is it having rights that can’t be taken away if you aren’t able to defend yourself from people who want to take them away?

Of course in a civilised and free society, a man wouldn’t generally have to worry about the State’s monopoly on violence infringing on his rights. None of us spend much time defending our rights to worship and speak freely because we enjoy them without challenge. For now.

Keep in mind the second amendment to the U.S. constitution-which clarifies that a man has the natural right to defend himself with arms-has its origin in British common law and not the violence of the American frontier, as is often suggested by people opposed to self-defence.

The 1689 English Declaration of Rights recognised the right of British people (although only Protestants) to bear arms in their own defence. A similar right to bear arms was introduced to the U.S. House of Representatives by James Madison with two big changes. One, it applied to everyone, not just Protestants. And two, it was not an Act of Parliament but an amendment to the Constitution.

That means it was not a right that could simply be taken away by a future Act of Parliament. To modify or eliminate a Constitutional right requires a specific and fairly difficult process. But remember, we’re not talking about “rights” like health care, education, or other socially desirable outcomes.

Parliaments of elected men and women are free to pursue those policies inasmuch as they represent what people want their government to do with their tax dollars. That’s consensual government, after all. But a clearly defined bill of negative rights simply tells the government what it cannot do with respect to individual liberty. That seems pretty handy.

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. “Of course in a civilised and free society, a man wouldn’t generally have to worry about the State’s monopoly on violence infringing on his rights.”

    Civilised and free societies end with the creation of a central government. The UK, US and Australia all went downhill once they were united under a central government.

    Central governments slowly increase their power over provincial governments. When they are created they remove choice (of jurisdiction) from the marketplace. When you cannot easily move out of one jurisdiction and into another of substantial difference, you are in trouble. That’s where we are today. In trouble.

    The central state doesn’t care what you think. It wants your money and it wants your blood.

    Adam Stanway
    November 13, 2008
  2. Firstly let me say that seems to be a more ‘balanced view’ than their american counterpart.

    Now to the bad news: for all the bashing of mainstream stocks and society, i dont excactly see
    1) resource stocks doing so well
    2) Indian stockmarket doing so well

    Sometimes a conservative ‘balanced’ investment approach, along the lines of 30% cash, 30% property and 30% stocks, an old time addage just makes simple sense.

  3. If you think that a bill of rights will protect us then think twice.

    If I am not mistaken, the Constitution of Zimbabwe has a Bill of Rights containing extensive protection of human rights.

    Notwithstanding that the people of Zimbabwe have seen widespread violations of human rights, political violence, intimidation and politicization of all branches of government.

    Constitutions and bills of rights can all be worthless things.

    Peter Carvapai
    November 14, 2008
  4. The simplistic investor:
    Well maybe in a bear market, stocks will continue to fall regardless of shortselling bans. But then maybe if shortselling had been permitted would stocks would be even more depressed than they otherwise are.
    Who knows?
    All i know is that on a simplistic viewpoint, and i am a simplistic investor (but one that was ‘smart enough’ to avoid investing in subprime rubbish, or stocks that pushed investing in toxic waste), at the end of the day banning short selling is not a bad idea.
    An investment in stocks should be seen as an equity investment in the underlying business.
    I fail to understand how an outsider has the right to sell an investment he doesnt have a stake in. Can you imagine the outcry if people started shortselling residentail property.
    Regardless of the liqidity aspect of it, if you dont have an equity position, so you dont have the inherent right to sell.
    mmmm for the academics out there, maybe you could even extend short selling to small business. After all if its good for the goose, its good for the gander right?

    There are some aspects of dailyreckoning that i really respect, especialy that the long term creation of wealth is achieved by spending less than you earn. Sure there maybe better optimal strategies that excelerate the earnings power of savings, but at the end of the day if you spend less than you earn you future has to be brigher.

    This is basical investing 101, and a lesson, many of the smarter players out there forget.

    As for me, i will take the simplistic approach.
    I will buy when others are scared,
    I will buy an asset class when it produces a decent cash (dividend) return on investment.
    I will not engage in finacial engineering,
    I will only use borrowings, when the cost of debt is significantly less than the cash return on investment (ie im not interested in capital gain adjustments, i will leave this to ‘smarter people’. In addition i wil fix those borrowings for as long as possible. Once again im not interested in flipping the asset, its the cash earnings that i am interested in.

    Until next time,
    Your simplistic investor

  5. “I fail to understand how an outsider has the right to sell an investment he doesnt have a stake in.”

    That’s probably because you fail to understand contract law. At law, you can contract to do anything that isn’t illegal. I can contract to sell you a tonne of wheat next Friday, even though I own no wheat. It’s up to me to find the wheat by next Friday or I’m in breach of contract and you can sue me for damages resulting from the breach.

    That’s what short-selling is. My example just has wheat instead of shares. Not hard to understand is it?

    If you wanted to ban short-selling of everything generally, the economy would screech to a halt, because everyone in business contracts to sell in future things they don’t possess right now. For example, a contruction company contracts to sell a building that it has yet to build. A printer contracts to sell books it has yet to print.

    People who oppose short-selling should take a course in contract law. Maybe then they’d understand why it is so important in a society that doesn’t inhabit mud huts.

    Adam Stanway
    November 15, 2008
  6. Oh, now I understand. I think. Kind of.

  7. Rici, always beware when attempting to make out an argument from personal incredulity. They never are very persuasive, and they typically indicate either ignorance or emotional affection for a particular point of view. Think twice before you begin “I can’t believe”, “I can’t see”, “How on earth could it be possible…”

    Nicely put Adam. To my mind, you’ve hit the nail on the head.

    A liberal society is one built upon a network of promises. And what more is a promise than an assertion that one will engage or forebear from some future conduct? Governments promise to represent their electors, borrowers promise to repay their creditors, employers promise to recompense employees for their labour.

    So to do short sellers make a promise. They promise to return borrowed shares, hopefully after acquiring them at a lower price than they sold them into the market. As Dan has touched on before, they are a vital component in a dynamical system. When the market is falling, they are the only ones to have to buy to exit their position. This buying pressure can be tipping-point that turns an otherwise bearish trend.

    Contract law is nothing more than a body of methodological rules that are buttressed by authority. What makes these rules Law is the fact that an entity more powerful than thou is willing and able to enforce them – even if it against my individual will.

    Why make certain promises legally enforceable? Because the moral foundations of our liberal ideology dictate mature and able-minded individuals – not Government – are best placed to look after their interests.

    If you beleive in this ideology, then you ought reasonably to believe that to uphold such a system, then we must do what we can to uphold the integrity of promises. I’d argue that it doesn’t mean that we should jump at every opportunity to oppressively constrain the types of promises individuals can make because it seems to serve prevailing interests or popular demands.

    There are of course countless examples, by one only needs to look back to WWII see the potential tyranny in majority. Deference the popular views of the mob is extremely dangerous in markets and societies alike.

    Look to Iran as an example of how bad things can get when trust and integrity is eroded. There, because social trust is so low, credit is almost non-existent and most employers only hire family members since they believe they can’t trust anybody else.

  8. Yes the object of a contract can be anything which is not illegal.

    That’s why slavery existed and flourished until well after we have stopped living in mud huts.

    From an economic perspective the problem is simple: is there any externalities which are not factored in the costs inherent to such practices? Apparently there are. For instance, the disruption that such practices can cause to the orderly functioning of the capital markets can end by causing huge costs to the whole society.

    Peter Carvapai
    November 18, 2008
  9. Pete, the disruption was caused by the leverage accessed by market makers under cover of derivatives. They should never have had access to that leverage because it was fraudulently risk rated and wouldn’t have otherwise stood up. I am a believer in regulators being able to unwind selected trades like the NYSE can do in certain circumstances. As for the socialist narrative …. nup. More bookkeeping and less sociology within economics thank you.

  10. Ross,

    Socialism has to do with the ownership of the collective means of production and, therefore, is about what to produce and for whom while an externality is an impact on any party not directly involved in an economic decision and do exist in any economic system. An example is pollution.

    Peter Carvapai
    November 19, 2008
  11. “People who oppose short-selling should take a course in contract law.”

    First, in every economic panic the experts point the finger at “speculators”, “short-sellers”, and “hoarders”. Hey! a crap shoot is a crap shoot and a hedge is a hedge…

    All I can remember about the old neighborhood is da’ boys busting an arm or a leg of those who ‘forgot’ to pay off their bad bets.

    Wonder who walked away with all that ‘naked short selling’ money? why they aren’t in jail? and, why does ‘joe sixpack the worker’ have to pay the freight ?


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