Of Drop Bears, Drinking Games and Australian Banks

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This week, three seemingly unrelated stories hit the news.

  • ‘Australia’s banks facing a culture shift’, Malcolm Maiden told us at the Age.
  • A black bear from Colorado discovered his face strewn across the newspapers and computer screens of the world.
  • And staff at Dunedin Park Botanical Garden in New Zealand are reportedly troubled by a new drinking game.

Have you connected the dots? [Hint: The hidden link is gravity.]

First to the bear, which also featured in Monday’s Daily Reckoning. It was tranquilised and fell out of a tree after being judged too close to a student housing complex:

bear

Your editor’s short lived career as a trapeze artist was equally elegant, but never received much attention from the global media. In fact, the bear has its own Facebook page and we don’t.

Now on to the new drinking game being played in New Zealand. It’s called ‘Possum’ and involves getting very drunk while sitting in a tree. You only stop drinking when you hit the ground. We’re not sure how to win the game. Or why the tree is necessary in the activity. But consider it a metaphor for leverage – the use of debt to make things more exciting.

We submit to you that Australia’s banks are the next thing to fall out of their tree. At least, the next thing to fall out of a tree that is in your vicinity. The banks are both cornered, like the bear was, and drunk, like the students at Dunedin Park.

Watch out below.

Why do we say that? Well, just like the black bear in Colorado, Australian banks strayed into places they shouldn’t have been. And then got drunk on their exploits like the students up the trees. Maiden explains:

‘Foreign loans taken out by Australian banks to fund their own lending accounted for 82 per cent of Australia’s $521 billion net foreign debt load at the end of 2006.’

In other words, banks borrowed from far away places at low interest rates to lend locally at high rates. And on a large scale.

But one of the joys of banking is that debt has to be rolled over. Banks borrow for short periods of time and lend for long periods of time. That creates what’s called a maturity mismatch. And taking on the risk of a maturity mismatch is part of the reason banks make a profit. It’s a bet they will be able to find financing at agreeable rates.

But what’s important here is that banks have to be able to refinance themselves regularly after committing to long term loans. If they can’t source new cash at cheap rates, they become less profitable. If they can’t source enough cash, they do a Lehman Brothers. Which causes the global economy to do a global financial crisis. Which causes governments to bail out the banks. Which causes governments to default.

Greece is at the default point in that cycle. Spain just decided to bail out a bank, and has plenty more to go. The US and UK are in between the two, having bailed out banks but not yet entered a sovereign debt crisis. Australia is at the beginning of the cycle – where the banks are about to get into trouble.

That’s because the overseas sources of funds that allowed them to grow their lending in the early 2000s are in turmoil. Never mind why for now, we’re focusing on what might be lurking in the trees above your head, not on the other side of the world. So those sources of funding aren’t there anymore, creating a difficult situation for Australian banks. You’ve seen the symptoms plastered all over the media with newspaper editors demanding that the big four banks lower their interest rates in lockstep with the central bank.

That’s something the banks were happy to play along with while their important sources of funding (from overseas) were low anyway. They created an illusion that banks follow the RBA because they profited from that illusion. Now that the relationship with overseas lenders is no more, and banks are having to finance themselves in the face of tougher funding conditions, it’s time to make their customers pay up.

The issue isn’t that bank funding has become more expensive. It’s that it is normalising. Banks are now funding themselves locally more, and that means the interest rates that they borrow at and the rates they charge at are much closer together. There is less profit. But this change can’t be allowed to happen because of what it would do to an economy used to cheap credit imported from overseas by the banks. An economy used to rising house prices and lots of spending. An economy with a housing bubble and massive amounts of private debt.

We’ll put this simply because the world of banking is a little odd. Think of it like this. The banks used to import money from overseas, where it was cheap. Then prices there rose, causing banks to look locally for funding. But they are now fighting over a much smaller pool. That means less and more expensive funding, which gets passed on to you.

And that’s where we are now. In a world where deposits, hybrid debt issuance and superannuation are the new, more expensive, sources of funding for banks. If the mention of Super made you choke on an orange pip too, get this from Maiden:

‘… deposit funding would also require a restructuring of the $1.3 billion superannuation pool, to divert money from it to the banks.’

Do you smell a back door bank bailout in the making? Dan Denning made the case that there are big changes in store for Australia’s retirement system in his newsletter Australian Wealth Gameplan. We reckon the powers that be are pondering the idea that governments should require an allocation of your Super to cash at a bank.

To get a window into the mind of those calling the shots, why not take a 30-day trial of AWG?

One last story to round off the metaphors and analogies for today’s Daily Reckoning. Your editor lost his keys in the middle of the rather large Fawkner Park a few months ago. On the way home, the world seemed wonderful after a miraculous discovery of the keys in the dark. Then we got the fright of our life as a possum, not the drunk human kind, fell out of a tree right next to us. That’s how quickly things can change. One moment everything is wonderful, you’ve narrowly evaded a global financial crisis because of your supposedly strong balance sheet. You’re on top of the world, convinced of your own ability. And then – bam – out of nowhere a possum gives you a heart attack.

This is perhaps the most important lesson the armchair investor can learn. Things can happen very quickly – even if you expect them.

By the way, our three news stories have another similarity – they all end badly. Possum players in New Zealand were required to clean up after themselves by the University of Otago’s so called ‘Campus Watch’. And the same black bear who took the world by storm was taken out by two cars on a highway recently, two miles away from the university where it was tranquilised…after being relocated 50 miles away. So our question to you is, what are you doing again that you were doing in 2007? And does it involve the banks?

RIP Black Bear.

Until next week,

Nickolai Hubble.
The Daily Reckoning Weekend Edition

ALSO THIS WEEK in The Daily Reckoning Australia

When Financial Markets Decouple From Reality
By Dan Denning

The cosy relationship between central banks and governments is responsible for this. The financial has become political. And currently, the political is a complete mess in Europe. Central banks used to just be responsible for the stability of the currency, but now they’re responsible for the entire financial system. And because the financial crisis has torpedoed government finances and the economy, the entire system of free enterprise in the Western world has finally been supplanted by central planning.

How The US Military Is Sucking The Empire Dry
By Bill Bonner

A common view of what is going on – in order to be commonly shared – has to be stripped so bare of nuance and paradox that it ceases to be an idea at all. It is just a feeling. And sometimes, it becomes a grotesque, simpleminded fantasy that it is actually the opposite of the original thought or desire behind it. It becomes a zombie thought…actually harmful to the group that holds it.

Low Interest Rates Are A Dangerous Addiction!
By Satyajit Das

Low interest rates have become a panacea for economic problems. In part, this reflects the limited flexibility of governments to run budget deficits. This is driven by increasing scrutiny of public finances and the lack of willingness of investors to finance such deficits, as highlighted by the ongoing European debt crisis. But like all addictions, low interest rates are dangerous. They may be also ineffective in addressing the real economic issues.

Could The Revival of U.S. Manufacturing Mean China Has Lost its Edge?
By Chris Mayer

Even though labour costs have surged, one could argue they have not kept pace with the cost of living. “Food prices in China are ridiculous,” Scott says. “It’s a hell of a lot cheaper to live in the United States than it is in China if you equalize people’s incomes. As a percentage of someone’s income, the chunk for food is a huge line item there. Land prices have been skyrocketing everywhere. Apartment prices are through the roof. It is cheaper to live in the U.S.” Remarkable, isn’t it?

How Bailouts Encourage Bad Behavior
By Eric Fry

As we have observed time-after-time since the 2008 crisis, there is no economic downtick that is not simultaneously a call to action – a call to government action. Regrettably, most of these government actions address symptoms rather than the disease itself. They “cure” gangrenous limbs with Lidocaine rather than amputations. As a result, a smattering of politically connected banks and corporations feel better, but the overall economy remains deathly ill.

Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
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