The problem for the Rudd Government is that its solutions are causing other problems in the financial sector.
The Rudd Government’s evolving rescue package for the Australian economy is based first and foremost on shoring up the big four banks.
But the October 12 sovereign guarantee has produced its own set of unintended consequences, sparking a run on mortgage funds and, to a lesser extent, on cash management and market-linked funds as small investors have rushed to secure their savings in the government-backed banks.
Around $25 billion in funds under management have been frozen.
And, as the crisis rolls on, it is becoming apparent that Prime Minister Kevin Rudd and Treasurer Wayne Swan are in danger of putting short-term political fixes ahead of considered policy-making.
Ugly political stoushes
Senior bureaucrats, including Treasury Secretary Dr Ken Henry and Reserve Bank of Australia Governor Glenn Stevens have been dragged into ugly political stoushes, while allegedly the Government has deliberately chosen to keep a distance from possible alternative advice from the Reserve Bank.
Unfortunately, on the matter of the banks, the Government had little choice in the current climate.
Despite all the rhetoric about superb regulators and the “strength” of Australia’s financial system compared with other beleaguered nations, Australia’s massive foreign debt – held mostly by the banks – leaves little room for mistakes.
The Global Financial Crisis – or “GFC”, as Kevin Rudd now likes to call it – is like a fast-moving locomotive without a driver. Nothing can stop it, and no one can really assess the full extent of the damage until it runs its course.
Financial regulators themselves have no corporate memory of any similar crisis, except for individuals like US Federal Reserve chairman Dr Ben Bernanke who wrote a book, Essays on the Great Depression (Princeton University Press, 2004).
The real problem for all hapless national governments, particularly the Rudd Government managing a middle-sized resource-dependent country, is to decide what can and should be done in the meantime.
Mr Rudd’s twin aims are to minimise the fallout in Australia and take a role in international forums leading the world out of the crisis.
Because of the unprecedented nature of the crisis, authorities are turning to solutions which would never have been contemplated previously. What Mr Rudd calls “extreme capitalism” is on the back foot; regulation is back in vogue, and outlandish executive salaries are being questioned.
The incredibly complex derivative and hedge markets were unheard of in the last comparable event, the 1920s. While stockbrokers back then had the novelty of “ticker tape” buy-and-sell updates, the speed of today’s electronic trading can result in tens of billions of dollars evaporating in seconds.
In such a climate, in which investors have been stricken with such a high level of fear and aversion to risk, any hint that Australia’s banks might be in trouble or unable to repay debt and interest would have catastrophic consequences.
The problem for the Rudd Government is that its solutions are causing other problems in the financial sector. It also risks saddling Australia with problems which are not dissimilar to the United States further down the track.
Australia’s housing market is starting to soften. If this accelerates in conjunction with higher unemployment next year, default and problem loans are going to have an impact.
The big banks are also the principal vehicle for bringing in the foreign capital each month that Australia requires to fund the country’s $600 billion net foreign debt.
The collapse in the Australian dollar from close to parity with the US dollar to around US60 cents will see that foreign debt rise over coming months.
When the late mining boom increased our export revenue, the nation’s current account deficit fell from $60 billion a year (requiring just over $1.1 billion of capital a week from overseas) to “just” $30 billion a year (requiring the banks to access $570 million a week).
The bad news is that now that the commodity boom has popped, that gap could widen again.
The PM and Treasurer Swan decided early on that everything else had to be thrown overboard to keep all-important confidence in the economy relatively buoyant in the face of a barrage of daily news about market turmoil, falling commodity prices and declining superannuation balances.
Mr Swan has shown he is prepared to sideline competition in the banking sector by ticking off the sale of St George to Westpac. BankWest is also likely to succumb to the Commonwealth, with Queensland financial giant Suncorp also being eyed off.
Now the Government is swinging the other way – inviting the institutions whose funds have been frozen to become pseudo-banks by coming under the umbrella of the Australian Prudential Regulation Authority. Most funds are unlikely to take up the offer, but some of the more conservative older institutions may see the benefit of this added security.
Mr Rudd has been applauded for being decisive early, and the polls suggest that the public is pleased he is stepping up to the role of national leader in a crisis.
But hard heads in the Cabinet need to keep the PM in check – rash decisions in the current climate, just to secure tonight’s evening news bulletins and tomorrow’s headlines, can also backfire.