[This post appeared in Crikey, 15th July, 2008] It has only been a few decades since interest rates were pretty much regulated and there were a raft of controls on banks. That ended with the Wallis Inquiry of the late 1990s. And since then, political-economic equilibrium on banking control has held because of the twin gifts of loose monetary policy and competition against the major banks. Those gifts have now been returned.
Yet, in the wake of the US government making its implicit guarantee of Fannie Mae and Feddie Mac explicit, there are numerous calls for Australia to leave the market to itself (e.g., in today’s AFR editorial). I believe this is the wrong call economically because there is ample evidence that the market does not provide a sufficient level of liquidity on its own. But it is also a poor political strategy as well.
Consider this: over the next year we have tighter monetary policy at the same time as the real competition in home lending has dried up. We have already been seeing the result of this: interest rates rising faster than the RBA targets and credit rationing of small business lending. And all awhile that major banks keep telling everyone that things are just fine.
That will last until the first profit statements from those banks appear. I predict they will be a bumper year for Australian majors. And then the politics will shift and we will see a raft (yes, a raft as per The Hollowmen) of measures to claw that back. Most of these will just tie banks’ hands and not truely deal with structural competitive issues.
This is a solid reason, apart from hedging the economic risks, that banks, the Treasury and the RBA need to seriously consider structural options. Christopher Joye and I have been suggesting a structural solution to this for sometime. Along with the Australian Securitisation Forum, we see a role in Australia for a government-sponsored enterprise like Fannie and Freddie (well, at least what they were before privatisation, political capture, and slack over-sight). Put those in place as a backstop for the bad times and banks and other financial institutions can make the case for continued de-regulation and a light hand in the good times. The alternative is a heavy hand at all times. Banks playing the political game here have to consider just what they are risking.
[Update: Daniel Gross on the economic risks. Bottom line: relatively small and a good public bargain.]