SENATE ECONOMICS
REFERENCES COMMITTEE
Tuesday, 28 July 2009
Members: Senator Eggleston (Chair), Senator Hurley (Deputy Chair), Senators Bushby, Joyce, Pratt and
Xenophon
Participating members: Senators Abetz, Adams, Back, Barnett, Bernardi, Bilyk, Birmingham, Mark Bishop,
Boswell, Boyce, Brandis, Bob Brown, Carol Brown, Cameron, Cash, Colbeck, Jacinta Collins, Coonan, Cormann,
Crossin, Farrell, Feeney, Ferguson, Fielding, Fierravanti-Wells, Fifield, Fisher, Forshaw, Furner, Hanson-
Young, Heffernan, Humphries, Hutchins, Johnston, Kroger, Ludlam, Lundy, Ian Macdonald, McEwen,
McGauran, McLucas, Marshall, Mason, Milne, Minchin, Moore, Nash, O’Brien, Parry, Payne, Polley,
Ronaldson, Ryan, Scullion, Siewert, Sterle, Troeth, Trood, Williams and Wortley
Senators in attendance: Senators Bushby, Eggleston, Joyce and Pratt
Terms of reference for the inquiry:
To inquire into and report on:
(a) the circumstances and basis of the decision to introduce an unlimited bank deposit guarantee and of subsequent
decisions to change or define the guarantee;
(b) the circumstances and basis of the decision to introduce an unlimited wholesale bank funding guarantee and of
subsequent decisions to change or define the guarantee;
(c) the effect that the initial announcement of, and subsequent changes to, an unlimited bank deposit guarantee had
on operations of the Australian financial sector, including for entities not regulated by the Australian Prudential
Regulation Authority (APRA);
(d) the effect that the initial announcement of, and subsequent changes to, an unlimited wholesale bank funding
guarantee had on the operations of the Australian financial sector, including for entities not regulated by APRA;
(e) the estimated effect of the bank deposit and wholesale funding guarantees on interest rates in Australia;
(f) how Australia’s deposit guarantee and wholesale funding guarantee schemes compare with guarantees offered in
other countries and the way in which these schemes were introduced and changed in major overseas countries;
(g) the interaction between the deposit guarantee scheme and other recent measures implemented by the
Government since September 2008, including the wholesale funding guarantee and the purchases of residential
mortgage backed securities;
(h) the nature of the financial and economic distortions that the unlimited deposit guarantee scheme has created visa-
vis savings products that are not covered by the guarantee scheme;
(i) the optimal cap, if any, for the deposit guarantee in the light of international experience;
(j) recommendations for ameliorating the moral hazard associated with the deposit guarantee and wholesale
funding guarantees;
(k) recommendations for timelines and for policies to credibly remove the wholesale funding guarantee and to
reduce the deposit guarantee to any recommended optimal cap;
(l) the effects of the bank deposit guarantee and wholesale funding guarantee on competition within the financial
sector;
(m) the effects of the announcement of the unlimited bank deposit guarantee and unlimited wholesale funding
guarantee on consumer and business confidence;
(n) the broader economic and social consequences of these distortions;
(o) the size and nature of the contingent liability that the unlimited deposit guarantee has created for Australian
taxpayers; and
(p) other matters relevant to the bank deposit guarantee and wholesale funding guarantee that the committee
considers appropriate.
WITNESSES
ANDERSON, Ms Anne, Head of Fixed Income, Asia-Pacific, UBS Global Asset Management,
Investment and Financial Services Association
CHAPMAN, Mr Keith, Executive General Manager, Supervisory Support Division, Australian
Prudential Regulation Authority
EDEY, Dr Malcolm Lawrence, Assistant Governor, Financial System, Reserve Bank of Australia
GILBERT, Mr Richard, Chief Executive Officer, Investment and Financial Services Association
JOHNSON, Mr Graham Neal, General Manager, Industry Technical Services, Supervisory
Support Division, Australian Prudential Regulation Authority
JOYE, Mr Christopher, Private capacity
PORGES, Mr Stephen, Chief Executive Officer, Aussie Home Loans
SCHWARTZ, MR Carl Justin, Deputy Chief, Financial Stability Department, Reserve Bank of
Australia
SORBY, Mr Joseph, Senior Policy Manager, Investment and Financial Services Association
………………………………………………………………………………………………………………………………………………………………….
CHAIR—We will now go to Senator Joyce via teleconference.
Senator JOYCE—I have been interested in listening to what you have had to say. What
would happen right now if we removed the guarantee? Would it really have any major effect?
Mr Joye—I presume you are talking about both guarantees?
Senator JOYCE—Yes.
Mr Joye—The RBA submission was excellent in terms of its content, but in terms of what
was missing from it I thought it was somewhat disappointing. I think we are not yet in a position
whereby the cost of funding available outside of guarantees—that is, outside of the government
guaranteed debt markets—is lower than the cost of funding available in those markets,
particularly on a longer term basis. As a result of that there is a case that, given we have this
Tuesday, 28 July 2009 Senate E 15
ECONOMICS
situation where governments around the world are all guaranteeing their institutional liabilities,
our institutions would be placed at a comparative material disadvantage and there would be quite
adverse ramifications. That is to say, it is entirely possible that these institutions would face
challenges funding themselves. I am not necessarily an expert on this subject but that would be
my observation.
Senator JOYCE—If that is the case, either the whole world goes on funding them forever—
which I am sure no one in the world wants to do—or there has to be a coordinated removal,
otherwise there are going to be market discrepancies and money is going to flush around the
world to wherever these guarantees still remain. Has there been any international process of
removing these guarantees in a coordinated form?
Mr Joye—I think that is a very, very good question. I think that the Prime Minister has
referenced a number of different forums—the G20 and the Financial Stability Board—and I
know that our regulators, particularly the RBA and Treasury, are intimately engaged with their
overseas counterparts. This is something that does need to happen; we need to have a globally
coordinated approach to evaluating the application and then ultimate removal of guarantees. But
we also need to have some level of global consensus on the future architecture and the manner in
which governments will intervene in these capital markets going forward.
In relation to the six economists’ call for a first principles review of the financial system at
large—like a son of Wallis or a daughter of Campbell—part of that review has to consider the
policy measures implemented around the world and how they impact on Australia. We need to
have some institutionalised bodies that serve as global coordinating agents. But I do not think
there is any simple answer to your question as to when they will be removed. I do not think that
day is today, and I am not personally aware of any cogent transparent agreement between all of
the major developed economies as to how they will remove them.
Senator JOYCE—You also talked about the discrepancy between federally coordinated
monetary policy and the actual actions of the Bank and how this is getting more and more
divergent. We have said before that the Reserve Bank can do what it likes and the banks will say,
‘We know what we are paying for the money and this is what we are going to charge.’ That, in
itself, starts to show that your capacity to deliver a monetary policy outcome is being lost and
one of the reasons it is being lost is the centralisation of the marketplace in the delivery of
finance. Is there a role for the government to become involved in dealing with money at a retail
level, not just at a Reserve Bank level? Obviously, the essence initially of the Commonwealth
Bank was government involvement in the delivery of money at a retail level. The Queensland
Industry Development Corporation and a couple of others, like the Bank of SA, were complete
disasters. If it becomes apparent that they cannot deliver a monetary outcome purely from a
position taken by the Reserve Bank, is there a role for the government to look at possibly reentering,
for a period of time, their role at a retail level?
Mr Joye—It is an interesting question and I do not think it should be dismissed out of hand,
as some on the right have done. I would make the point that there seems to be a stereotypical
aversion to the notion of any government activity in retail banking markets. The fact of the
matter is we do have a publicly subsidised bank, the Reserve Bank, which is the central bank to
the banks, and that appears to have been managed extremely well, and is certainly populated by
world class individuals—Ted Evans was the former secretary of the Treasury and is chairman of
E 16 Senate Tuesday, 28 July 2009
ECONOMICS
Westpac; David Morgan was a senior Treasury official and he ran Westpac; and Ian Macfarlane
sits on the board of the ANZ. Ironically, and I think this is a nuance that has not really been
touched on, I presume the government will be seeking retail funds—that is, they will be seeking
mums and dads to invest in government bonds. The government will, in a sense, be taking retail
deposits.
We know that that money is being used to fund or buy residential mortgage backed securities
through the AOFM. The fact of the matter is, de facto, there will be government retail deposit
taking channels in one form or another and, de facto, the government will be lending to mums
and dads—and has already lent about $8 billion to mums and dads through the AOFM. I would
encourage you, Barnaby, to read again John Quiggin’s submission because he raises this point
very explicitly. He highlights this bifurcation between the notion of narrow banking and broad
banking. John’s point, which I have a lot of sympathy with, is that banking is essentially a very
commoditised activity, where you take in savings and you distribute those savings in the form of,
ostensibly, low-risk loans. Perhaps there is a role for government to leverage off its infrastructure
in the manner of a Kiwibank in New Zealand to provide commoditised services where it
potentially has a comparative advantage by virtue of its unique infrastructure.
I would also say many folk, including government officials, have cast aspersions on this idea
in light of the failed experiences Australians have had with the various state banks in the past.
Private sector financial institutions fail all the time. We have seen a litany of private failures at
the institutional level—the entire UK banking system has been nationalised; and Lehmans has
gone, Merrells has gone and Bear Stearns has gone. So I do not think necessarily the private
sector is a shining beacon of excellence and, moreover, the only reason, as we have noted
already, that our major banks survive is due to the multiplicity of implicit and explicit subsidies
that taxpayers supply them with. I am not necessarily endorsing the so-called people’s bank—not
terminology we have ever used but rather something that was apparently created—but I actually
think it is a very healthy avenue of inquiry and it is something that should be undertaken,
because, as I said before, the fact of the matter is our banking system is akin to a public/private
utility. We need to understand the ‘pro quo’ is for the quid that taxpayers are providing.
Senator JOYCE—I worked for the Queensland Industry Development Corporation before it
became Suncorp. QIDC were small, had low overheads and was very effective. You can read
about Suncorp in the paper. It was not a great move forward. About 50 per cent or so of the total
securitisation of the banks is now underwritten by residential loans, or is it more?
Mr Joye—What is your question?
Senator JOYCE—How much of the four major banks’ security is now supported by
residential housing loans?
Mr Joye—I do not have the exact numbers off the top of my head, but I would assume it is
about 50 to 60 per cent.
Senator JOYCE—What happens for all of us? I know that we have not suffered the same sort
of collapse in the price of residential real estate, but if unemployment kicks on there then is
really no reason we should not. If houses have been underwritten by 1½ or two salary or wage
earners in a McMansion and we go down to one then what is going to happen to the large
Tuesday, 28 July 2009 Senate E 17
ECONOMICS
swathes of recently built mortgage belt properties? Are we now ourselves exposed, through the
use of the derivative—right back to every taxpayer in Australia—to the ramifications of our own
real estate collapse? If that has been ruled completely out, why?
Mr Joye—I can tell you why. There are a lot of myths and misconceptions that surround
residential housing in this country but, as I have mentioned many times in public and as others,
such as the Reserve Bank, have noted, the Australian housing market is incredibly robust. We
have what are believed to be the largest housing shortages in history. Building approvals in New
South Wales have been near all-time lows. On the demand side, we have the strongest rate of
population growth since 1971; I think that in December 2008 the rate of population growth was
1.9 per cent. House prices in Australia fell by 2.6 per cent in 2008, in contrast to the predictions
from the likes of Steve Keen and Gerard Minack of between 20 and 40 per cent price falls. I can
tell you that in the first five months of this year Australian residential property prices increased
by four per cent. The June quarter numbers, which come out later this week, will show continued
growth. Importantly, house prices are increasing modestly—that is, at a relatively slow rate—
across all areas, so this claim that there is a first home buyer bubble is completely and utterly
incorrect. The top 20 per cent most expensive suburbs in Australia are also registering price
increases.
In the banks’ defence, we have seen a huge increase in the conservatism of their lending
practices, so the maximum loan-to-value ratio—LVR—available to residential borrowers today
is the lowest it has been since the late 1980s. In many ways it is actually harder to get a home
loan today than it has ever been before. The conservatism of our banking practices, inspired by
the guidance of APRA and the RBA, has in turn perpetuated these extremely low default rates.
According to the RBA’s financial system review in March 2009—or whenever it was released—
the 90-day default rate on bank balance sheet loans in Australia, which are the vast bulk of all
loans, was only 0.58 per cent. That is about 15 per cent of equivalent US mortgage default rates
and about 25 per cent of UK default rates. Residential property has actually served as a
remarkably stable source of wealth for Australian households.
I make one final point, Barnaby, in response to your point about unemployment. In the 1991
recession, unemployment rose from 5.6 per cent in January 1990 to 10.8 per cent by December
1992. Over that time, Australian house prices actually increased by two per cent per annum. So
house prices did not fall precipitously the last time unemployment rose to nearly 11 per cent. On
the other hand, commercial property—as it has during this crisis—experienced substantial falls
according to the available indices. So the banks, in their defence, are allocating capital to those
areas that they perceive to be the ones that offer them the highest risk-adjusted returns, and
residential mortgages are actually an incredibly safe investment. As the RBA has repeatedly
noted, there have never been any losses that crystallised in these securities—obviously on a
loan-by-loan basis there have been losses. So, again, I personally am not concerned about the
impact of high rates of unemployment on the house prices.
Senator JOYCE—That is a great statement. I do have concerns, and I think that it is going to
be an interesting one to watch, because at this time the valuations of houses are at the end of an
immense spike in real estate valuations, which they were not back when we had the other
headline unemployment rates. We were not at the back of a real estate boom.
E 18 Senate Tuesday, 28 July 2009
ECONOMICS
Mr Joye—I would just say that people are prone to make all sorts of unsubstantiated
assertions in relation to residential property. As the Reserve Bank noted in, I think, Tony
Richards’s latest speech, the rate of house price growth in Australia since the end of the last
boom—that is, the end of 2003—has been lower than both nominal GDP growth and nominal
household disposable income growth. Alan Greenspan, in his memoirs, and the RBA itself—Ric
Battellino, Tony and others—have repeatedly said that the residential mortgage market in
Australia actually leads the US and the UK by circa three years. We actually had a correction last
year. That 2.6 per cent fall was actually the largest in 26 years. I think your words of caution are
justified; we should be cautious. There is certainly reason to watch this space very carefully, but
I do not think that any of the sensationalist predictions that you sometimes see bandied around in
newspaper headlines will come to pass.
CHAIR—Thank you, Mr Joye. I am afraid we have to stop there, although we would very
much like to continue with your very interesting comments. Thank you for appearing.
………………………………………………………………………………………………………………………………………………………………….Senator JOYCE—Dr Edey and Mr Schwartz, exactly how much is the Australian guarantee
currently underwriting?
Mr Schwartz—The figures are in the submissions—the most recent figures available. I
believe the figures that were published in the budget papers had the Financial Claims Scheme
deposit guarantee covering around $650 billion, and the Guarantee Scheme for Large Deposits
and Wholesale Funding is currently at around $130 billion.
Senator JOYCE—$650 billion and $130 billion is about $780 billion all up. When I worked
in banking and we issued a guarantee, which we did all the time, there was always a belief that
we could actually honour it if it was called on, but there is no way in the world we could honour
$780 billion.
Dr Edey—I think that the circumstances in which an amount of that scale would be called
upon to be honoured is so remote as to be completely unrealistic. It is not just me saying that; the
markets and rating agencies are all keeping a close eye on this stuff. Neither of those has raised
concerns about it. Other countries are doing the same thing. These are theoretical contingent
liabilities of the government. The set of circumstances in which the amounts that we are talking
about here would be called on are just so remote as to be unrealistic.
Senator JOYCE—This leads me to the next question. I can understand that, although I do
query as to why we issue a guarantee for something we could not possibly honour, and I
question whether there should have been more of a realistic approach to what was issued—that it
should be limited to what you could possibly call on. So my question is: what could we honour?
Dr Edey—What you are really asking is whether I can put a figure on the maximum amount
of debt that the government could have on issue.
Senator JOYCE—Could we honour half of it?
Dr Edey—You will appreciate that I cannot put a figure on that. Theoretically, a scenario that
you are talking about is that the government has to pay out a lot of money and it has to issue a lot
of bonds into the market to fund that. What is the government’s funding capacity in a scenario
Tuesday, 28 July 2009 Senate E 27
ECONOMICS
like that? I cannot put a number on that, but you have countries around the world that have
already got debts out there on issue of the order of 50, 100 or more than 100 per cent of GDP.
You are talking about potentially huge numbers. The amount of prospective debt that our
government would be incurring is nowhere near that order of magnitude, so there is huge
capacity for our government to borrow more if it needed. All of that is very theoretical.
Senator JOYCE—Because we have issued the guarantee, has anybody in the Reserve Bank
got a number, a rough idea or anything before them of exactly how much of the guarantee we
could actually honour if it were called on us? Is it 10 per cent of the guarantee we could honour?
Dr Edey—I do not think it would be responsible for me to try and put a number on that. Sorry.
Senator JOYCE—Has anybody in the Reserve Bank actually done the calculation? I would
only want you to take it on notice. I just want to know if anybody has done the mathematics to
say what portion of the guarantee could actually be honoured if it were called on.
Dr Edey—I do not think that that would be a sensible thing for us to try to calculate.
Senator JOYCE—Has it been calculated, or has anybody even attempted to calculate it?
Dr Edey—I just said that I do not think it would be sensible to try to calculate a number like
that.
Senator JOYCE—That would make me assume that it has not been calculated. So really we
have a guarantee that no-one has actually done the modelling behind to see if there is any
efficacy to it.
Dr Edey—I have made the general point that our government has a very large capacity to
borrow, and we think the circumstances in which significant amounts of the guarantee would be
called on are very remote.
Senator JOYCE—I will turn the question around. Seeing that it has relied on the premise that
the government has a very large capacity to borrow, how much can the government borrow to?
Dr Edey—Again, I do not think that I can put a sensible figure on that. You would be aware
of the figures as anyone, but all I can do is point you to amounts that other governments have
been able to borrow. They are very large; they are large multiples of what our government has
currently borrowed or is planning to borrow.
Senator JOYCE—Has anybody in the Reserve Bank done any assessment of what the actual
level is that the government could borrow to?
Dr Edey—We are aware of what the international patterns are so it is pretty clear what the
orders of magnitude are that countries are able to borrow in markets. We know what those
figures look like. I can talk about those some more if you want me to, but I do not think it would
make a lot of sense to try to pin it down to a single number.
E 28 Senate Tuesday, 28 July 2009
ECONOMICS
Senator JOYCE—Do you have a confident belief that other governments have the capacity
to pay back the magnitude that they borrow to?
Dr Edey—Yes, I believe so. I am not prepared to declare that any government around the
world is insolvent or unable to pay back its debts.
Senator JOYCE—Has anybody in the Reserve Bank done even a fraction for the proportion
of GDP that we would be able to borrow to or had any advice as to the fraction of GDP that we
would be able to borrow to?
Dr Edey—Again I could talk to you about the proportions of GDP that other countries have
borrowed and seem to have no difficulty servicing.
Senator JOYCE—That would be all well and good if I were having an interview with them,
but I am actually interested in where we are in Australia—obviously, our position is unique and
different to other nations—otherwise there is no purpose to you being there. With the implicit
understanding of the Australian economy, where do you think we can get to in our borrowing?
Dr Edey—I raise other countries simply because well managed economies have a capacity to
borrow; well-managed governments have a capacity to borrow. We do not believe that our
capacity to borrow in relation to GDP is any less than that of any other well-managed country.
The sorts of numbers that other countries either have borrowed or are likely to borrow over the
next few years are of the order of 50 to 100 per cent of GDP, and that is a large multiple of what
is projected for Australia.
Senator JOYCE—Can you give me an example of what in your purview is a well-managed
economy overseas?
Dr Edey—Yes; the United States.
Senator JOYCE—What is the extent of the United States’ borrowing now?
Dr Edey—I think it is about 60 per cent of GDP. I would have to check that figure, but I know
it is higher than 50 per cent of GDP and it is projected to rise pretty quickly over the next few
years.
Senator JOYCE—Obviously that interlinks very closely with us. Your assessment is that they
have the capacity to repay that?
Dr Edey—My assessment is that they have the capacity to repay that and that markets do not
have a concern or any doubt about that being the case.
Senator JOYCE—How much of our book is currently underwritten residential housing
within our banking system?
Dr Edey—You are asking how much of bank lending is for housing?
Senator JOYCE—Yes.
Tuesday, 28 July 2009 Senate E 29
ECONOMICS
Dr Edey—I think that would be about 60 per cent.
Senator JOYCE—We have already had evidence that we believe that is very secure, yet we
have also seen obviously in the United States economy that that is not the case. I understand
there is a difference in the terms and the capacity in America to walk away from a loan, which
we do not have here with the bankruptcy laws. Have you done any statistical analysis or any
modelling on what will be the effects of a higher unemployment rate and a lower capacity to
meet repayments for housing loans that were sourced at the peak of a real estate boom? Very low
equity was placed in those houses when those loans were sought.
Dr Edey—There was a large-scale exercise done on that a couple of years ago in conjunction
with the IMF’s financial sector assessment program and there is another exercise being
conducted at the moment to look again at the same questions.
Senator JOYCE—When will that be complete?
Dr Edey—That is work that involves APRA. I cannot give you exact timing on that. You may
want to ask the APRA spokesman about that later.
Senator JOYCE—Have you seen in the marketplace any lateral capacity for the value that
has been attributed to these residential assets to be realised? Is there capacity to easily access the
value that is written in the security papers should the need arise or has that capacity to cover the
loan with the sale of the house been diminishing?
Dr Edey—I do not see any problem on that front. House prices have been reasonably stable
recently, so the situation here is very different to what it is in the United States, where you have
had a period of quite extensive ongoing falls in house prices. That has not been the case here,
and loan-to-valuation ratios in general have been reasonably conservative, so I do not think there
is any problem there at all.
Senator JOYCE—What is the connection between increase in unemployment and default
rates in residential housing markets?
Dr Edey—You would expect in a time of rising unemployment that people would find it more
difficult to service their loans and so you would expect to see some rise in default rates. It is
already the case that the unemployment rate is up by about two percentage points from its
trough, so you would expect to already have seen some of that sort of effect coming through to
the extent that it is coming through. But in reality the increases in default rates that we have seen
so far have been very modest.
CHAIR—Senator Joyce, I think we are going to have to wrap up there.
Senator JOYCE—I have one last question. How much money are we making from the
guarantee?
Mr Schwartz—This information is also published on the government guarantee website. I
think the cumulative total to date is around $480 million.
E 30 Senate Tuesday, 28 July 2009
ECONOMICS
Senator JOYCE—Thank you very much.
CHAIR—We thank the witnesses from the Reserve Bank for appearing. We have gone
through our morning tea break, but for the convenience of various officers and people in the
room we will have a five-minute break. We will resume in five minutes.
Proceedings suspended from 11.01 am to 11.14 am
………………………………………………………………………………………………………………………………………………………………….
Senator JOYCE—Going to the whole structure of this, if I was to decide tomorrow that I
wanted to set myself up as underwriting banks, and I am a man of modest means, could I do it?
Could I issue a guarantee and collect a fee for it?
Tuesday, 28 July 2009 Senate E 41
ECONOMICS
Mr Chapman—So you would go off to a bank and say, ‘You pay me a premium and I will do
it’?
Senator JOYCE—Yes. Could I do that?
Mr Chapman—Depending on how you structured it, we would have to authorise you as an
insurer, but in principle, yes—
Senator JOYCE—That is exactly the point. In authorising me as an insurer, what are you
looking for?
Mr Chapman—Substance in terms of capital; risk management and controls; proper
valuation of liabilities; the fitness and propriety issues; the governance and expertise issues. So it
is a fairly intensive process. But, after you have convinced us that we should give you an
insurance licence, you have then got to convince an individual bank that you are the person they
want to deal with.
Senator JOYCE—Would my capacity to actually meet those underwritings that I give, as and
when they fall due, be one of the things you would analyse?
Mr Chapman—Yes, that is what the insurance process is all about. We have a structured
process through the insurance requirements, where people need to work out what their claims are
going to be on average and they need to then add capital factors on top of that. The theory goes,
and we have seen no evidence to show that we are fundamental wrong with our policy and
capital settings, that an insurance company has a 99.5 per cent probability of meeting all claims
as and when they become due. Obviously, there are a lot of probability estimates that go into
that. We work through that regularly with our regulated flock to ensure that they are making
those assumptions on a reasonable basis and they are changing them and stressing them as
necessary.
Senator JOYCE—The problem I seem to have is that the government is underwriting $780
billion, which I know from other discussions with Treasury we would not have a hope of
repaying if it were called upon, not on top of the $315 billion of federal debt and the other $230
billion of subprefecture debt. Their words, and going to the most optimistic, were 80 per cent of
our GDP, which is $900 billion. We would not even get within being able to honour half of this
guarantee, if it were called upon. The problem I have is that we have managed to collect $480
million, or half a billion, for a guarantee that we could not possibly honour.
Mr Chapman—That is definitely not an APRA question. It is a policy question for the
government.
Senator JOYCE—Is there something intrinsically wrong about collecting a fee for something
you could not possibly honour?
Mr Chapman—That is not an APRA question, I am sorry, Senator.
Senator JOYCE—Would you be interested to know what sort of statistical analysis or
modelling they have done? How would you envisage this bank guarantee being paid? We have
E 42 Senate Tuesday, 28 July 2009
ECONOMICS
got four major banks, so if one went you would have a big lumpy hole in your guarantee straight
away. Is that how it would work, or would you just pay out some of the bank’s money?
Mr Chapman—They are questions to ask Treasury, I am afraid, Senator, not us.
Senator JOYCE—They just did not seem to want to answer it. The answer we got from them
is that they have not done any modelling. Does that concern you at all?
Mr Chapman—That is not an APRA question, I am afraid, Senator.
Senator JOYCE—Would you run through again what sort of licensing arrangement you
would wish to see in place before you allowed someone else to issue this guarantee?
Mr Chapman—If an entity applied to us for a licence and they said, ‘We want to be in the
business of guaranteeing debt, be it a bank or any other corporate entity,’ and that was clearly
structured as insurance—which is not always the case because you can provide guarantees which
are not an insurance policy, they can just be a straight guarantee; but if they were looking at an
insurance structure to do that—we would be looking at the entity itself, its history, its
background, because one of the biggest risks we always see is people straying into areas which
are outside their normal ones. We would be looking at their internal capacity to analyse data and
the way in which they were looking at their future payments and future cash flows. We would be
looking at how they were going to raise capital and what degree of capital they had there,
because capital is not there to pay claims, in an insurance sense; capital is there to ensure that
there is a buffer against adverse experiences. So there are a lot of individual processes that go to
make up to the process. We would also be looking, of course, at the nature of the businesses they
were proposing to undertake. If they were taking a highly concentrated approach to a particular
business line we would usually be requiring them to hold additional capital or to have other
mitigants in the process.
Senator JOYCE—How do the government manage to offer a product which they have
collected half a billion dollars for and not do any of that?
Mr Chapman—That is not a question for APRA.
Senator JOYCE—It seems like a handy sort of business to be in—to be offering products
that you cannot actually cover, to collect the money up front without doing any actual analysis of
what you are doing and to have no statistical backing or modelling behind what you are doing.
But let us move on to another area: let us look at the risk side. I have been told just now by the
Reserve Bank that the premise of this is that it is matched against other well-run economies such
as the United States of America. Do you see the United States of America currently as a well-run
economy?
Mr Chapman—I am sorry to keep repeating myself here, but I do not think that question by
itself is a question for APRA. We are happy to talk about some of the regulatory differences
between us and the US, but I do not think that a status of the economy report is an APRA
question. I think Dr Edey is much better qualified than either I am or we are to answer that
specifically.
Tuesday, 28 July 2009 Senate E 43
ECONOMICS
Senator JOYCE—When you are doing your analysis of banking and your prudential
oversight, do you do any risk matrices or modelling of the banks to see exactly what their
exposures are? Do you just create a contingent liability which sits on the books regardless of
whether it has been paid out or is likely to be paid out? Do you do any forward analysis of a risk
position for the debts that are currently held by the bank?
Mr Johnson—I can answer that one. We undertake quite a lot of what I think you are
referring to: stress testing at the banks—
Senator JOYCE—Yes.
Mr Johnson—asset books, lending and the like for potential developments. We have been
doing that for a number of years and we are continuing to do so. I think you mentioned the
residential mortgage market earlier. APRA in 2003 did quite a comprehensive stress test of the
full range of ADIs for a 30 per cent fall in housing prices and a commensurate rise in default
rates to see what the impact would have been on the capital ratios. A small number of ADIs
would have got to a position that we were uncomfortable with. We worked with them to develop
a minimum capital level that was able to withstand that sort of stress test. We did, as Malcolm
Edey said, stress tests with the IMF in the FSAP a couple of years ago. As part of the new Basel
II arrangements, we also require banks to undertake regular stress testing and, for some of the
smaller ADIs, to be able to have some basic capabilities there.
Senator JOYCE—Do you think it would be pertinent for a person offering a product,
whether it is the Reserve Bank or anybody else, for there to be an analysis of exactly what is the
total amount of debt that that entity, whether it is a government or a bank, should be able to
issue?
Mr Chapman—I do not think that is a question for APRA. If someone is regulated by us, we
put a lot of process into ensuring that the people regulated by us have as low a probability of loss
to depositors or policy holders as could possibly be achieved. But, even in that environment, we
cannot and should not make a promise that there will be no failures.
Senator JOYCE—I will put it this way. If one of the major four, next time you went down
and had a squiz in their securities department, said, ‘Whilst you were away, we offered $780
billion worth of guarantees,’ would that be of concern to you?
Mr Chapman—Yes.
Senator JOYCE—What would then be your process of discussion with that bank?
Mr Chapman—We would probably quite shortly be having a major discussion with the
chairman and the board.
Senator JOYCE—What would you do to try and see if that $780 billion could get
underwritten? What would you be advising them?
Mr Chapman—Hypothetically—because we have not got it—and in a general sense, where
we think any of our institutions, in any sector, are taking a risk which they have not properly
E 44 Senate Tuesday, 28 July 2009
ECONOMICS
considered or mitigated, the process we will be doing with that institution would be to make sure
it did take steps to do that.
This has come up, though not at that quantum, a number of times in the insurance sector and
the mitigation taken in those circumstances is, for example, more reinsurance or a spread of risk
so you are not only with one reinsurer. We would say, ‘If you’ve done this and you really meant
to do it, what controls do you have in place to make sure that the residual risk is lowered?’ The
gross risk might still be $780 billion but if the residual risk is much lower then by itself it is not
much of a problem. If we found one of our institutions had gone into this in a big way, we would
be extremely unhappy because we work cooperatively with the industry and we would expect
them to talk to us about undertaking such a large risk.
Senator JOYCE—In essence, you would expect a very stringent exit plan to be delivered to
you, so you had some confidence that the entity was under control. You would say, ‘What is your
process for offsetting this and spreading this risk around and’—more pertinently—’what is your
process for getting out of this position’?
Mr Chapman—Yes, that is fundamentally how we look at all the businesses that our
regulated entities undertake.
Senator JOYCE—If someone presented you with just two bullet points that basically said
that when things get better they will pay the money back, would that give you confidence that
you knew what they were on about?
Mr Chapman—If one of our regulated institutions did that, the answer would be no.
Senator JOYCE—Thank you very much.
CHAIR—Thank you very much for appearing.
………………………………………………………………………………………………………
CHAIR—Thank you very much, Senator. Senator Joyce.
Senator JOYCE—Chair, how long have I got?
CHAIR—We could give you until one o’clock.
Senator JOYCE—I want to go back to the discussion about the interplay between the
Australian Office of Financial Management and the spreads. How is the AOFM currently
coming into the market that you are dealing with?
Ms Anderson—They have been purchasing residential mortgage backed securities that have
been issued by non-bank financial intermediaries, because those institutions cannot issue those
securities to the institutional market whereas two years ago they could.
Senator JOYCE—So the Australian Office of Financial Management is basically running out
buying product that is underwritten by residential houses.
Ms Anderson—Correct.
Senator JOYCE—The AOFM are doing that, obviously, with borrowed money.
Mr Gilbert—To the extent that the budget is in deficit now, yes.
Senator JOYCE—I am interested in why we are borrowing money to purchase something
that you guys could be purchasing.
Ms Anderson—Why are we?
E 58 Senate Tuesday, 28 July 2009
ECONOMICS
Senator JOYCE—Yes.
Ms Anderson—I guess it is a policy decision on the part of the government, and I would think
it is couched in the competitive forces that they wish to maintain, to have these nonbanks
providing funding to housing and ensuring that they could gain access to funding.
Mr Gilbert—Also, Senator, some banks are in the program as well.
Senator JOYCE—Is this actually forcing your members out of the marketplace?
Ms Anderson—It is just a distortion that we as investors that invest on behalf of
superannuation funds have purchased residential mortgage backed securities that are marked or
priced in our portfolio at spreads that are somewhat wider than the securities that are getting
issued to the AOFM.
Senator JOYCE—Because they are just getting them at spreads of 50—
Ms Anderson—They are issuing about 125. In my portfolio I cannot sell them because the
market is very illiquid, but when my investors come and ask me for their money back, because it
is a unit trust structure, I have to ensure that I have valued my assets at a fair market price. The
thing with a lot of these securities is that it is an over-the-counter market, it is not traded on an
exchange, so there is a very limited number of natural buyers and hence there is a very high
liquidity premium. So the valuation in my portfolio is somewhat lower.
Senator JOYCE—We have had a lot of debenture issuing lending that has been affected by
this government guarantee. You were also saying that we were ending up with a two-tier market,
where there were the four major banks and users and it was really a non-commercial form of
lending. It is a port of last resort. How do you see that in your day-to-day operations? Are you
seeing that sort of middle tier just being completely squeezed out of the marketplace?
Ms Anderson—I would not say they are completely swept out. That was definitely true;
fourth quarter last year it was completely closed. It was very frightening, as a capital market
participant. I think it is very fair to say that conditions have improved somewhat, but there are
still segments of the market—and the ones that I can identify that have not reopened are the
commercial mortgage backed securities, the mortgage funds and certain industry classes—that
banks have lent to but that over time will need to source capital market funding because the
banks will become overexposed to certain industries or certain issuers.
Senator JOYCE—When you talk about the banks, are you including the Bank of Queensland
and Bendigo Bank or are you talking about a primary position that the four banks are in that noone
else is in?
Ms Anderson—Generally, the major banks obviously lend the most in our market. It would
include the regionals, but the regionals typically do not have capacity to lend to the very large
borrowers. They perform a role in the intermediate sized institutions.
Tuesday, 28 July 2009 Senate E 59
ECONOMICS
Senator JOYCE—You say that the current policy is bringing about a centralisation of the
banking market down to the four pillars and that that really this is exacerbating the flow towards
four banks running the show.
Ms Anderson—I definitely believe that it is amplifying it. We can see that market share.
Again, we come back to the competitive point.
Senator JOYCE—With the removal of this guarantee obviously there would be huge
problems because we would have disparities around the world. The next issue would be: how do
you get rid of it without there being a flow of funds to where it is? Are these people who have
been forced out of the market in a period of hiatus or are they actually out of the market for
good? Is there capacity for the re-entry to the market of competitive forces to keep the major
banks honest? Could this bring about a structural change which is really not reversible?
Ms Anderson—I think we will see a structural change for sure, but I think it will not be a
momentous one. For example, the regional banks will thrive. As time passes by, I believe that
conditions will normalise. Their biggest challenge at this time will be the pricing of the
guarantee in the wholesale space. They will naturally find it difficult because they will have to
pay a higher fee because of their lower credit quality but they are competing against the major
bank lenders at a lower price.
Senator JOYCE—How many people do you represent who actually pay the guarantee?
Mr Gilbert—IFSA? Our members do not actually get the guarantee. We have 100 members,
and none of them get a guarantee.
Senator JOYCE—Would they wish to avail themselves of the guarantee if it were there for
them?
Mr Gilbert—A look-through similar to the retail guarantee? Yes. But a look-through and
having to pay for the guarantee? No, because that would be competitive disaster for them.
Senator JOYCE—That is, they do not want the guarantee forced on them; they want it as an
option—if they want to buy it they can but they do not have to?
Mr Gilbert—And they could then advertise it as that.
Senator JOYCE—Do you find it peculiar that the government have collected just shy of half
a billion dollars—$480 million—issuing a guarantee which, if it were actually realised, they
would not have the capacity to pay?
Mr Gilbert—It is a large amount of money. It is a matter of how much in the future you could
tax Australians to pay that if there were a debt accumulated.
Senator JOYCE—What I have said from the outset is that the extent of the guarantee is
beyond the capacity of the Australian economy to pay for it. There is $780 billion in it. We have
no hope of paying that. But that is not really the issue. There is probably no likelihood—we
E 60 Senate Tuesday, 28 July 2009
ECONOMICS
hope—that we would ever have to pay it, but what concerns me is that the government in their
righteousness have charged people for something that they know they could not possibly honour.
Mr Gilbert—I would prefer not to answer that directly. But I would say that the international
rating houses, like Standard and Poor’s et cetera, would no doubt take that into consideration as
they give us our credit rating. So in a way there is a mechanism to try to ameliorate that or
equilibrate that and compare our arrangements to what is happening overseas.
Senator JOYCE—What is the total value of your membership’s book, roughly?
Mr Gilbert—It is $1.2 trillion.
Senator JOYCE—What portion of the market is that?
Mr Gilbert—Before the GFC, that would have been more than the banking sector.
Senator JOYCE—So it is not just a corner issue, a slice of the market or a peculiar corner of
the market of which there is a lot of noise but no real effect; it is a substantial competitive
pressure in the market which is being affected by this current guarantee?
Mr Gilbert—Yes. The two genres of funds directly affected are the CMTs and the mortgage
trusts, and that is about eight per cent of our market. Then you bring in fixed interest spreads—
but that is more a general problem—which is another 20 per cent. So it is about 28 per cent when
you look at money market type funds. In terms of direct effect it is eight per cent.
Senator JOYCE—My final question is this: if I were to wave a magic wand and you were the
boss of the show and you could do whatever you wanted, what exactly would you be doing
within the next year to try to recalibrate the show, bring it back into balance, and give your
members a better chance?
Mr Gilbert—Clearly, there are two issues: firstly, wind back the guarantee sensibly and in
consultation with industry; and, secondly, if there is a concern from the parliament about the fact
that we have 250,000 people with frozen funds, what do we do through the Office of Financial
Management and perhaps industry in order to defreeze them? Where is the antifreeze coming
from? I guess that is the analogy.
Senator JOYCE—And where do you think we would get it from?
Mr Gilbert—At the end of the day, we have put forward the proposal for the ABIP bank,
which I think the Senate has rejected as a proposal. This was never part of that package, but we
think there would be an opportunity there to securitise some of these mortgages. The other way
is for the government to actually put some of their deposits in these funds and show the people
of Australia that they are very confident about the future of these funds and people should be
reinvesting in them.
CHAIR—That concludes this section. Thank you very much for appearing. It has been very
interesting evidence.
Tuesday, 28 July 2009 Senate E 61
ECONOMICS
Proceedings suspended from 12.53 pm to 1.16 pm
………………………………………………………………………………………………………
CHAIR—Thank you. We might reverse the order. Would you like to begin, Senator Joyce?
Senator JOYCE—Thank you very much, Chair. First of all, Mr Porges, at Aussie are you
owned by, controlled by or tied into any of the major four banks?
Tuesday, 28 July 2009 Senate E 63
ECONOMICS
Mr Porges—About six months ago we sold one-third of the business to the Commonwealth
Bank. Two-thirds of it is still owned by John Symond. There is no management control
whatsoever by the Commonwealth Bank. They have two out of the six seats on the board, but
that is it.
Senator JOYCE—Where do you get your money from?
Mr Porges—As I say, at the moment we do not get a lot from anywhere. We have three
potential sources of wholesale funding. At the moment the majority of it is probably with
Macquarie Bank, ANZ and the Commonwealth Bank.
Senator JOYCE—You obviously understand about people underwriting. Why is the
underwriting worth anything to the banks? I am trying to be tricky. The underwriting only has a
value because people believe in the strength of the Australian capacity to pay for it—that would
be fair enough, wouldn’t it? Otherwise it is nothing more than a piece of paper.
Mr Porges—Yes, I am not going to disagree with that.
Senator JOYCE—How much debt do you think Australia can rack up before the value of
taking another guarantee to underwrite something is kind of pointless?
Mr Porges—I am not going to make a call on government debt, but I think the challenge you
have, slightly, is that it is all relative. The proportion of government debt to GDP in Australia is
less than in a lot of other countries. If I am valuing insurance, I am always going to value
relative insurance, so I would be happier with the Australian insurance than I would, for
example, in a country that has a 100 per cent debt to GDP ratio.
Senator JOYCE—The problem we obviously have with this current guarantee is that, if it
were ever realised, it would be about $780 billion, which we do not have a snowflake’s chance
of ever being able to pay.
Mr Porges—But—no, continue.
Senator JOYCE—The point is: surely it could be mitigated down to a form where you get a
relevant amount that the government could actually cover and give greater capacity in winding it
down to a more reasonable level to allow people like Aussie back into the market.
Mr Porges—There are two issues there. One is that, although you could not cover all of the
guarantee at the moment, that would assume that every amount of money that was lent out by the
banks ceased to exist and there were no assets there. I cannot envisage what could possibly
create that apart from some sort of holocaust, and then no-one would be calling in any money
anyway. I think it is a more relevant point that you really want to start thinking about how some
of the guarantees that the government gives need to have assets behind them, whereas if you are
just guaranteeing a bank generally then you are not really sure what they are going to do with
those funds. Those funds may be paid as dividends, some may go in the mortgage market and
some may go to hedge funds—who knows?—whereas if you can actually start using the
guarantee to guarantee physical assets, as in the RMBS solution, then you really want to start
E 64 Senate Tuesday, 28 July 2009
ECONOMICS
looking at only having mortgages over, let us say, 90 per cent, so you have a bit of a buffer there
as well.
Senator JOYCE—Yes.
Mr Porges—But I agree completely that guarantees just over a general area are very difficult
to manage when they are of the sort of size they are now.
Senator JOYCE—I suppose the point we are getting through this inquiry is that it is
ridiculous—as you have said, you would need a holocaust before you would have a realisation of
it—but the problem on the other side of the coin is that the government is managing to charge
you for it. So it is charging you for something that it cannot actually deliver, yet that charge has
brought in about half a billion dollars to the government, so it is happy. Obviously the banks
have just handed the cost on, so they are ambivalent, but in the same process they have managed
to get a form of market manipulation which centralises control back to the four pillars and forces
you out of the market. Really, the value of the guarantee for them is the effect of restricting
competition for you.
Mr Porges—To a degree, but at the same time I think you have to put a slightly larger hat on
and talk from the Australian perspective. If the guarantee were not there, the country would have
been in all sorts of trouble, so the guarantee had to come in. I am happy to accept that. The other
side, though, is that it would be worth mentioning the meaning of insurance. If I knew that 100
per cent of what I insured would have to be paid, I would charge you 100 per cent insurance, so
you would not insure. So, by definition, when you are making insurance you are making an
assumption that only a portion of those claims will ever have to be paid out. You therefore make
an informed judgment on what portion and therefore how much you charge for that insurance.
Senator JOYCE—This is an interesting discussion. The good thing about insurance, though,
is that you have a multiplicity of participants—literally thousands and thousands. Not every
house burns down, so you are covered, and that makes implicit sense. But what we have here is a
guarantee where you are excluded from the capacity to be covered. What you are left with is a
guarantee for four major banks. Banks do not go half broke—they go totally broke—so therefore
you have an extremely lumpy call on that guarantee, for which there has been no factoring into
how they have assessed it.
Mr Porges—But banks do not go broke without assets, remember. The bank may well go
broke—and let us say that, in the worst case, it did—but there would still be all those mortgages
that it had given out and all the loans to corporates. They would still be in place. It is just a case
of how long it takes you to work those loans out. You still would not be exposed to losing all
those funds.
Senator JOYCE—But what we are doing now is working towards a realistic analysis of
exposure and exactly how it is going to work which, from our queries to the Reserve Bank, has
never been done. This thing was basically plucked out of the air, the government said, ‘This is a
great idea,’ and there is really not very much homework that sits behind it.
Mr Porges—But it had to happen that way. Once Ireland guaranteed, the UK guaranteed and
everyone followed suit, if Australia had not guaranteed then it would have been a matter of 15
Tuesday, 28 July 2009 Senate E 65
ECONOMICS
minutes before the country had funds running out of it so quickly that it would not have been a
solution we could have come to then.
Senator JOYCE—But surely we have now had the time to look at it more closely and start
saying, ‘Let’s wind back this guarantee to something that’s more reasonable and start doing the
homework.’ If we have issued a product, which a guarantee is, and in the process collected a fee
for it, which means that there is the belief that we can honour the commitment, we had better
start doing some homework to show that we can actually honour the commitment, because if we
cannot honour the commitment then we have just fraudulently accepted a fee. If the extent of
debt of the government is, as we have heard the Treasurer say, $315 billion, and then there is the
subprefecture debt of the states, at another $230 billion, then there is already half a trillion and
upwards in debt that already has to be handled by the government. We have already heard
Treasury say, in earlier inquiries, that 80 per cent of GDP is definitely the limit, and obviously
they would have been saying something to placate the government, so my fear is that they would
have gone to the top end. Our GDP is $1.2 trillion, so that is a $900 billion debt and then lights
are out. A $780 billion underwriting is just impossible, impractical and illogical. Without the
homework underneath it, it is nothing more than a gesture.
Mr Porges—I think that is correct, but I think that is what everyone is assuming; you have to
back out of that guarantee at some stage and ease off the government guarantee there.
Senator JOYCE—So when do we start easing out of this guarantee, or when should we? If I
wave a magic wand and make you the boss, how do we back out of it and ease off?
Mr Porges—Without G20 approval, you will not do it. There has to be a coordinated
international response to removing the guarantees, and that will only happen once you have
actually got to an understanding that the GFC is pretty close to over or at least once the
corporates have all cleansed their balance sheets. Once that happens, you will have to have a
coordinated global response unless you believe that Australia and the Australian banks are so
much stronger than any other country that you will not have a flow of funds.
Senator JOYCE—In light of other things that are floating around at the moment, could
Australia lead the way and get out of it first? Do you reckon the rest of the G20 would follow?
Mr Porges—Australia could lead the way in discussions, but if Australia just made an
announcement then there would be a rash of money running out of the country.
Senator JOYCE—It seems that on other things, such as the ETS, we believe we can lead the
way, but you are saying that on this one we cannot because the reality is that the rest of the world
would fall over laughing and take our money on the way.
Mr Porges—In my opinion, yes.
Senator JOYCE—So what would be appropriate? Will we move out of this guarantee in
steps or do you believe that at some date we will just move out of it overnight?
Mr Porges—I think you have to move out of it in steps but, again, what I think is not all that
relevant. It is going to be what the economic leaders of the G20 countries think.
E 66 Senate Tuesday, 28 July 2009
ECONOMICS
Senator JOYCE—So who is going to coordinate that and where is that leadership coming
from?
Mr Porges—That is something Australia could coordinate. We have a supremely respected
Reserve Bank, and they could do that.
Senator JOYCE—In what horizon do we have the capacity, a process or a mechanism, to get
this ball rolling?
Mr Porges—I am not a politician but I would suggest that you would want to do it sooner
rather than later, because it is going to take a long time for it to actually be coordinated.
Senator JOYCE—In that sort of arbitrage, will it be the case that any person left with a
guarantee will be in an extremely strong position and can absorb money, or will it really be that
any person left with a guarantee whose economy underpinning it is extremely strong will be in
an extremely strong position?
Mr Porges—That is the key: anyone whose economy is in a strong position.
Senator JOYCE—Going to whose economy is in a strong position, how strong is the
American economy at this point in time?
Mr Porges—That is an interesting question. There is an argument to be made that the
American economy is not in an extremely strong position. But, going to the Australian example,
they have 250-odd million people who they can tax and, if they want to be in a strong position, it
would not politically be a very palatable solution but they could actually raise enough capital out
of consumers.
Senator JOYCE—How much debt do you think there is? There must be some ballpark
figures, so that people have a rough idea of how much debt the US can put around their necks
before it pulls them under the water.
Mr Porges—I have absolutely no idea, sorry.
Senator JOYCE—What about the English economy? Is it in a strong position?
Mr Porges—Having just returned from there, no, I do not think the English economy is in a
strong position at all. Equally, I think that, as they have a much smaller number of consumers
and a not rapidly recovering economy, apart from that which is exposed to finance, they are not
in as strong a position as the US.
Senator JOYCE—What about the Eastern European economies? Are they in a strong
position?
Mr Porges—I cannot see why they would be.
Senator JOYCE—What about the Russian economy? Is it in a strong position?
Tuesday, 28 July 2009 Senate E 67
ECONOMICS
Mr Porges—No.
Senator JOYCE—Do any of the African countries?
Mr Porges—Keep going and you will get to China. They have a strong economy.
Senator JOYCE—So the Chinese economy is in a strong position. Who else, apart from
China, is in a strong position?
Mr Porges—I am not sure that is something that I am qualified to discuss.
Senator JOYCE—Who, to the best of your knowledge, would have a comparative position
moving towards China?
Mr Porges—China is overwhelmingly the strongest economy in the world.
Senator JOYCE—So, once we have moved away from there, it is either insignificant—that
is, a strong economy but insignificant in the way the world plays the game—or degrees of
weakness, basically.
Mr Porges—Yes, but that said, it does not take a strong economy. For example, if Ireland
decided not to remove the guarantee and everyone else did, funds would flow to Ireland from all
around the world.
Senator JOYCE—Funds would flow to Ireland now, with full knowledge of what the Irish
economy is like?
Mr Porges—If their economy was acceptably strong.
Senator JOYCE—But it is not.
Mr Porges—It is not all that crash hot, but it is probably no worse than the Eastern European
one.
Senator JOYCE—That is no different than if Iceland starting underwriting. People could not
care; it is irrelevant. They are broke. Is there any role for the IMF to play in moving people out
of this position?
Mr Porges—I am sure the IMF are thinking about it.
Senator JOYCE—When do you see Aussie being in a position to move back into the market
as a competitive force, as that is obviously the main sort of queue that we want. We are seeing
the distraction of money policy in our nation because monetary policy by the Reserve Bank is
becoming more and more irrelevant to the banks. The banks will do as they wish once they have
control of the marketplace. When do you see your capacity to come back to the market as a
strong competitor for business happening?
E 68 Senate Tuesday, 28 July 2009
ECONOMICS
Mr Porges—We need either the return of the RMBS market or for wholesale funds to be
equivalent to retail funds. Everyone has this perception that wholesale is always cheaper than
retail. When you are a bank, retail is your cheapest source of funds. On transaction accounts and
things you pay pretty close to zero interest on them. But, if you go and raise wholesale money in
the public markets, you are paying four, five or six per cent or whatever interest rate you are
paying at the time, whereas a large of portion of retail funding is pretty close to free.
Senator JOYCE—And while this guarantee remains as it is that capacity is not there.
Mr Porges—No.
Senator JOYCE—Thank you very much for that.
………………………………………………………………………………………………………
Senator JOYCE—Could I ask one question before you go. In the new development areas, the
western suburbs of Sydney and the western suburbs of Brisbane, what do you think, as a sort of
gut feeling, was the loan-to-valuation ratio in those?
Mr Porges—Previously or now?
Senator JOYCE—Previously.
Mr Porges—Previously I think it was around 95 per cent and up. Now, 90 per cent is
relatively easy and 95 per cent is getting difficult. It was quite high previously.
Senator JOYCE—And this was people basically building a house—I suppose they would be
looking at around half a million dollars and up; that was nothing unusual. That would have been
sort of the mean?
Mr Porges—Roughly. I think our average loan size at the moment is $325,000 or something
and our average LVR in the new product is about 80 per cent.
Senator JOYCE—And generally it is premised on two salary and wage earners?
Mr Porges—It is hard to say a general premise. A bank will look at the situation each time—
how reliable the salary is, whether it is likely that one of the salary earners will decide to stay
home with children, or have children, or how long they have been employed. All those things
come into account, even more so now than they used to. With the restriction of credit, even if
you apparently can service it, it is not that easy to get a loan nowadays.
Senator JOYCE—So the restriction of credit has brought down that loan-to-security ratio
somewhat?
Mr Porges—Significantly, yes.
Senator JOYCE—In the past you could borrow up to 90 to 95 per cent of your house—
Mr Porges—Some people were borrowing 100 per cent.
Senator JOYCE—And now you would be borrowing, what, around 80 per cent?
E 72 Senate Tuesday, 28 July 2009
ECONOMICS
Mr Porges—Yes, 80 per cent to 90 per cent. And there is nothing necessarily wrong with
borrowing 105 per cent—if you have the ability to pay it back. If you have the ability to pay 200
per cent of your mortgage payments, then the bank is taking a view on 100 of that 105 is covered
by an asset and five per cent is really just a lend against cash flow.
Senator JOYCE—But that was not unusual. There was certainly a fair bit of that out in the
marketplace.
Mr Porges—Yes. Not in our product, thankfully, but there was some out there.
Senator JOYCE—Would a new suburb be more likely to have a congregation of these highloan
security ratios as opposed to an established suburb?
Mr Porges—Probably. The average mortgage in Australia actually gets paid out in only about
eight years. In an established suburb and if someone has been there for a while, they will have
paid their mortgage down. You need to be looking at the average across the entire suburb. If the
entire suburb is brand new and people are just coming in and have not had time to pay that
mortgage down, you do not have that seasoning effect, as they call it.
Senator JOYCE—That loan security ratio is purely on the house and not on the chattels
inside the house?
Mr Porges—Just on the house
Senator JOYCE—The car in the garage is something entirely different and the stereo in the
corner and all that sort of rubbish?
Mr Porges—The plasma screen and the surf skis that you find through the Hunter Valley, yes.
Senator JOYCE—Would the McMansions be the prime source of high debt and low equity?
And of course the big houses need lots of things in them. You would have to say there is a lot of
debt parked inside the houses as well as the bricks and mortar.
Mr Porges—Maybe. You actually find it is not necessarily the McMansion that is—
Senator PRATT—My weatherboard house has a lot of debt attached to it, I can vouch for
that.
Mr Porges—Yes, it is not necessarily the McMansions. Quite often McMansions are built by
people who have struggled and struggled for 20 and 30 years to really earn some capital and they
want to build their lifelong dream. They do not usually build the McMansion as a first home. It
is the first home owners who actually have a much higher portion of debt.
Senator JOYCE—No doubt you would have had to model unemployment into all this. What
is the stringency between an increase in unemployment and an increase in arrears?
Mr Porges—If unemployment gets above about eight per cent, we start to worry. It is hard to
model it as accurately as you would think because there is constant changing of the LVR and
Tuesday, 28 July 2009 Senate E 73
ECONOMICS
thinking whether we start from rates being at 15 per cent before unemployment went up or at
five per cent before unemployment went up. Our gut feel is that 7½ to eight per cent is the sort
of unemployment before we would start to see stress which is less than you see internationally.
Again, back to that point, Australians have huge pride in keeping their home and managing to
pay it off, so they sacrifice a lot of things before you see that pick up. If you want to look for
early warning signs, look in credit cards and look in the personal loans rather than looking in
mortgages.
Senator JOYCE—Has there been any increase in stress in credit cards and personal loans?
Mr Porges—A little is starting to kick in.
Senator JOYCE—I have done a little time in banking and if we did not have about two or
three per cent arrears, they would say you were not trying hard enough. What is a reasonable
amount of arrears on your book? Is it 90 days plus?
Mr Porges—On our mortgage book?
Senator JOYCE—Yes.
Mr Porges—We would not see a lot more than that. We run a very conservative mortgage
book because we are not a huge balance sheet business. We do not have access to things like the
government guarantee, so we are extremely cognisant of taking any losses.
Senator JOYCE—Right. Thank you very much for that.
CHAIR—In a general way, we are seeing a recovery, are we not? We are moving slowly out
of this GFC. Prices of properties are increasing, at least in parts of Australia.
Mr Porges—Australians are incredibly enthusiastic people. We believe there are green shoots.
Senator Joyce might appreciate this more: the green shoots I do not think are necessarily the
green shoots you see in a paddock after it has been burnt; the green shoots may well be just the
first leaves you see out of one of the eucalyptuses that have just been burnt. It will be many years
before we have the sort of economy we had three or four years ago. It will not be an immediate
recovery, although we love to dream it might be.
CHAIR—I am not suggesting it would be immediate, by any means. It is interesting, as I read
somewhere yesterday, that real estate prices are increasing around the country.
Mr Porges—They have stopped falling. There was this uncertainty across the entire country
and real estate prices came into it. You did not know what was going to happen. Now I think we
have seen a little bit of a bounce, which reflects that people are thinking, ‘The GFC is not over
but the lift cannot fall any further, so now we are happy and starting to resume our normal life.’
Once that level of uncertainty is taken out, you get a natural blip but then you just have
stagnation for a while.
CHAIR—Which raises another question in terms of bank guarantees and the general issue of
the length of time it will take to recover from what we have just been through around the world.
E 74 Senate Tuesday, 28 July 2009
ECONOMICS
How long would you suggest governments such as the Australian government will need to put in
place measures to provide support to the economy in general?
Mr Porges—That is a very broad question and depends how you define ‘the economy in
general’. We think you have to support the RMBS market only until the securitisation market or
something picks, and I think that is only a couple of years. Some of the longer term changes—
and we have seen some structural changes in the economy—have probably got many years to
work their way through. I think financial markets, being very, very robust animals and being
very early predictors of global recovery, will probably start to open up again in the next year to
two years. I actually think the guarantee is going to work its way out naturally, but it is going to
work out earlier than the economy recovers.
CHAIR—Thank you very much for those observations.
Committee adjourned at 1.56 pm