In a series of interesting PRMIA blogs, Sai Sireesh has been looking at regulatory regimes in jurisdictions, such as Canada and Spain, that have appeared to have 'had a good war' during the Global Financial Crisis (GFC). Recently, he asked the question: what is the 'Australian secret sauce for managing risk?'
By being the first G20 central bank to raise its base rate, the Reserve Bank of Australia (RBA) has signaled that the Australian economy appears to have weathered the worst of the GFC storm. And there have been lots of fathers coming out of the woodwork to claim at least part of the success and to promote their particular recipe for the 'secret sauce'.
In truth, there is a lot of praise to go around, but the reasons that Australia has (so far) survived the crisis is a combination of good (or at least adequate) risk management, a number of economic factors unique to Australia and some very fortunate timing.
First: Regulation.
Admittedly, prudential regulation is strong in Australia but that is coming off a fairly low base. The disastrous events at HIH, the country's second largest insurer that went belly up, to the regulators' great surprise, in 2001 and the FX options losses at National Australia Bank (NAB) in 2004 both highlighted serious deficiencies in Australian prudential supervision and corporate regulation. Following these well-publicized disasters, APRA, the banking and insurance supervisor, and ASIC, the corporate regulator, have raised their game considerably, hiring many more, smarter and more proactive regulators. Congratulations to the regulators but hardly foresight, more necessity?
Next: Basel II.
Like their European counterparts, Australian banking regulators enthusiastically embraced Basel II but it should be noted that the final blizzard of regulation towards the end of 2007, to meet the 2008 deadline, coincided exactly with the start of the GFC (but in no way could have contributed to it nor for that matter could claim to have averted it). In the run up to the Basel II kick-off it must be admitted that Australian banks had, almost certainly as a result of regulatory pressure, begun to clean up their risk management act. As a result, by the end of 2007, Australian banks were never better placed to manage their risk assets, because they had just spend millions of dollars putting the necessary risk management infrastructure in place. It will be one of the great unanswerable questions of financial history to ask: 'What if the USA had gone through the pain of preparing for Basel II at the same time as everyone else, would the crisis have been averted or at least managed better?'
Banks, Markets and Assets.
Academics, rating agencies and central bankers have been pointing out for years that the Australian banking industry is structured differently to other financial markets, not least in the primacy of the Four Pillars (the 4 largest banks), which is written into law. This unusual and deeply uncompetitive structure means that the major financial institutions cannot acquire each other, nor be acquired by an overseas competitor. In turn, this had led to a sometimes-deep complacency and a natural risk aversion - in economic jargon the system has reached equilibrium so no need to rock the boat. Innovation is rare and new products and services are usually acquired from overseas, but slowly. In the markets that sunk the US banking system, i.e. mortgage lending, the Australian market is again distinctive. Mortgage securitisation does exist but the big banks tend to retain the best mortgages on their books, not least because defaults are low but also because income is predictable and very profitable (as interest rates tend to be higher than other advanced economies). Defaults are low not only because home ownership is embedded deep in the Australian psyche but also, unlike for example the USA, borrowers are legally responsible for their loans and cannot just walk away - no 'jingle' mortgages. Sub-prime mortgages (so-called 'low doc' loans) were given out quite liberally by mortgage brokers in the lead up to the GFC, but constituted only a small portion of the overall market. Generous tax incentives in the form of 'first time' buyers' grants and 'investment loans' also appear to have cushioned the blow of falling asset prices, for now. Australia does, however, have one of the highest high household debt to income ratio in the advanced economies, which may stifle the recovery of the mortgage market for some time.
Lets not forget: Superannuation.
By law, employers in Australia are required to contribute 9% of every employee's salary into an individual pension, or so-called superannuation, account. Over the 17 years of this system, Australians have built up an enormous pool of 'super funds' totaling today almost A$1.2 trillion dollars. This has grown not only by compulsory contributions, but also sound investment management, attractive tax incentives and, on average, a rising stock market. During the GFC, stock markets in Australia have fallen as far and as fast as elsewhere and there have been a number of spectacular corporate collapses, not least the Lehman-like Babcock & Brown, but this huge 'super pool' has acted as a very effective 'shock absorber' soaking up many of the losses that elsewhere would have crippled banks and other financial institutions. For Australian investors, the pain of the GFC will be felt gradually in diminished returns over their lifetime (30/40/50 years) rather than in mortgage distress and high unemployment as in other advanced economies. As an aside, courtesy of a generous government taxpayer-funded guarantee the big 4 banks have maintained, even improved, their risk ratings and hence have no problem raising capital from risk averse superannuation managers, coincidentally cementing their uncompetitive advantage over lesser institutions.
Finally: the Economy.
Sitting on top of a vast continent chock full of valuable, easily mined commodities, Australia has the luxury of having ready markets for every ton of coal, iron ore and uranium that can be dug out. This booming economy has had two major consequences for the management of the GFC, and incidentally many hundreds of fathers claiming credit for the healthy bouncing baby. First in the China-driven commodities boom that preceded the GFC, the Liberal government used the proceeds to pay down government debt placing the country on a much better footing to withstand the crisis than debt-laden countries, such as the USA. Equally, provided with a clean sheet and knowing that many trillions of dollars of commodities still remain under the soil, the new Labour government has been able to return to its Keynesian roots spending its way out of trouble with a huge 'stimulus package', knowing that future repayment will not a problem, and claiming much of the credit for managing the crisis. The game of Australian politics will be enlivened for decades to come by debates about which father was responsible for exactly which feature of the bouncing baby that is the Australian economy. Many politicians deserve a little bit of credit, but are unlikely to be unhappy unless full paternity is recognized.
There is a well-known Australian saying - 'fair shake of the sauce bottle, mate', which refers to the obligatory passing around of tomato sauce to dollop on one of the highlights of local cuisine - the late night meat-pie. It is a colourful variant of the old adage 'give credit where it is due'. Fair shakes would dictate that many people could claim some credit for steering the Australian banking system through the GFC cyclone, and many will. The Australian success in dodging the worst of the GFC (so far, fingers crossed) has not 100 but 100,000 fathers; politicians, investment managers, investors and the tax-payer who together have created what has proved to be a very resilient system. Many will claim personal credit of course. However, before the crisis, many of these supposed fathers were happily indulging in the very practices that caused such pain elsewhere. It is a bit rich now to claim foresight that just wasn't there.
The answer to Sai's question is really that there is no Australian 'secret sauce', but a very appetizing mixture of good luck and common sense, mixed with a pinch of natural caution, a generous slurp of tax incentives, simmered slowly in a large pot of savings. It is not a souffle created by a star TV chef to dazzle but ultimately deflate. The Australian formula is a long-standing family recipe modified to taste by different generations but always, like Mother's Chicken Soup, nourishing and sustaining.
For that last word on sauce recipes, Benjamin Tucker, the 19 th century American anarchist (a very rare breed indeed) may have had considerable foresight on the GFC, noting that 'Laissez Faire [economics] was very good sauce for the goose (labor) but was very poor sauce for the gander (capital)'.
