Posts Tagged ‘Covered Bonds’
Crony Capitalism

In banking perceptions can create their own reality. A panic can cause a run that will make any bank insolvent without the assistance of others. That’s the downside of lending long and borrowing short. So it’s interesting that the following Money Morning post is getting another airing, courtesy of Naked Capitalism.

Key passages include:

NAB and Westpac’s Secret Bailout Revealed

I’m talking about the near collapse of the Australian banking system in 2008. I’m talking about the likelihood of two Australian banks collapsing in 2008 if they hadn’t secured a secret loan from the US Federal Reserve.

The fact that National Australia Bank [ASX: NAB] had to borrow USD$4.5 billion from the US Federal Reserve during 2008 and 2009.

And Westpac Banking Corp [ASX: WBC] needed USD$1.09 billion in January of 2008 and 2009.

It wasn’t Westpac’s US office that needed the dosh, it was Westpac in Australia that needed it. It shows you that without the direct financial support of the US Federal Reserve Westpac and NAB would have been toast.

Westpac and NAB needed the loans because they were on the verge of going belly up. It’s that simple. If they hadn’t gotten secret loans from the US Fed they would undoubtedly have needed secret loans from the RBA.

Fortunately for the RBA, the Fed opened the door and this allowed Aussie central bankers and bankers to claim that the Aussie banks hadn’t received a bailout.

And it must now make the Reserve Bank of Australia (RBA) feel foolish, considering in September 2008, just before NAB sought the Fed’s help, the RBA wrote:

“The Australian financial system has coped better with the recent turmoil than many other financial systems. The banking system is soundly capitalised, it has only limited exposure to sub-prime related assets, and it continues to record strong profitability and has low levels or problem loans. The large Australian banks all have high credit ratings and they have been able to continue to tap both domestic and offshore capital markets on a regular basis.”

Tapping “offshore capital markets” obviously included the US Fed.

So we wonder, how much did the Reserve Bank of Australia know about this? While it was talking up the strength of the Australian banking system did it know that two of the four Australian banking pillars were desperately seeking loans from the US Fed?

Or, like you, was the RBA in the dark? And what about the Australian Prudential Regulation Authority (APRA)? We’ve been told they’ve done all manner of stress tests and the banks passed with flying colours.

Read the whole thing.

One of the commentators to the post points out that:

The banks were presented with the cheapest source of funds that they would see in their lifetimes and some took advantage.

If so they were not the only ones to do so:

The Real Housewives of Wall Street

Why is the Federal Reserve forking over $220 million in bailout money to the wives of two Morgan Stanley bigwigs?

Don’t you just love the whiff of crony capitalism in the morning? It sure beats the odour of the Occupy Wall Street camps. Although there is something honest about a good old fashioned cesspit.

Australia recently failed our test of its power to resist crony capitalism and allowed covered bonds. Covered bonds give their owner the right to collateral that covers the bond. Collateral that previously would have been used to reimburse depositors if the bank got into trouble. At the same time it moved to allow covered bonds, the government made permanent its “temporary” guaranty of deposits. In other words, the taxpayer will have to make up the money going to the covered bondholders.

Bank bailouts tend to mean bailing out of bondholders as the depositors are already covered. Australia’s wonderful government has locked taxpayers into effectively bailing out bondholders without their even knowing it. Nice.

Now we get this:

NAB eyes covered bonds issue

THE National Australia Bank is expected to become the first major bank to issue a covered bond once the government’s new changes come into place.

The Australian government is also happily subsidising its own subprime mortgage market:

Purchase Of RMBS – Program Update

To date, the AOFM has invested $12.7 billion in 45 RMBS issues. These investments have assisted 19 lenders in raising over $29 billion in funding. The RMBS issuance supported by the Program has financed mortgages over more than 150,000 residential properties across Australia.

On 5 April 2011 the Treasurer issued a Direction for the AOFM to invest up to an additional $4 billion in Australian RMBS, together with remaining capacity from the current program of about $3.5 billion.

Gosh, it looks like taxpayers could be on the hook for losses amounting to billions from RMBS and from covered bonds. Best hope Australia does not follow the US example of a large fall in house prices. We are certainly munching on our own mad meat.

Uncovering covered bonds

The proposed government changes to the financial services are terrible policy. They will increase the weight of money going into housing compared to what would otherwise be the case. This effect may not manifest itself immediately, but it will when a bubble next gets going. Investment banks will get fees structuring products, some lucky people will exit the market at the right time (turning points are not predictable, so the best timing will result from luck). Most will find themselves in a similar spot to Americans, but without the option of sending in the keys. They will enter bankruptcy or spend much of the rest of their life with a crushing debt load. Nice.

Politically it could delay the Australian downturn. There is a lot of money in superannuation and it could replace Chinese demand for our housing. Because the super investments will be going into unproductive assets, the economy will not generate sufficient wealth for the retired people to live the life they are expecting, as per America. No matter what nominal balances may suggest in the interim. Super should go toward digging holes, growing or processing things. It would be nice if we could make something as well. We will not be a wealthy country on the back of flipping houses to each other, no matter how high a proportion of each flip is captured by the financial sector.

Of course on the political side, if they can’t inflate housing enough to counteract the effects of the Chinese purchase slow down, they are gone. It’s a bit like Bush kicking the can down the road. But at some point the debt burden gets too big. I’d rather our government learnt the lessons from around the world, rather than repeating them. Thus far we avoided covered bonds, no longer. When things get messy, they will be very messy. And they will get messy. Can’t predict exactly when, and how horrible it is partly depends on what we do between now and then. This is the opposite of what we should do. It is standing at the bottom of a hole and deciding to dig madly rather than climb.

The government solutions are destined to fail because they bring the wrong conceptual framework to the problem. They are too influenced by Keynesian economics. They discount the fact that we have endured a credit expansion induced bubble in multiple asset classes. The excess debt created has to be cleared, as does the mal-investment associated with the boom:

When there is a credit-inflated boom that results in your working at a job in which you produce goods that no one wants, needs, or can obtain financing to buy, and which your employer consequently cannot sell, it naturally follows that neither you nor your co-workers are going to be employed in the near future”. Source Vox Day cited in Why Keynesians and Krugman are Wrong

The Australian experience may yet come to reflect that of America:

(US 2005) Full employment was accompanied not only by an unsustainable external deficit, but also unsustainable asset prices, private debt levels and levels of consumption (and savings) relative to income as well as higher public debt levels. When the public’s willingness to increase its debt load waned as real estate prices fell, consumption, economic activity and employment fell along with it. We are now experiencing balance sheet recession and existing debt levels appear to be a barrier to increased private and public sector debt-financed demand.

Most troubling, but not surprising, the trade deficit is growing again and is unsustainable at about 3.7% of GDP. The external imbalance is not a temporary phenomenon. The simple and sad fact is that an unsustainable trade deficit implies that full employment levels of GDP are also unsustainable”. Source: Richard Alford cited in Why US stimulus can’t fix unemployment

Analysis demonstrating the beneficial effects of government stimulus’s are flawed. The models can’t fail but to attribute growth in GDP to them:

“If government spends a dollar; this will always be shown as contributing to GDP in the period it is spent. And, it would be shown this way even if the whole dollar were spent on imports and did not, in fact, contribute to GDP… If the government spends taxpayers’ money to build, say, a school library, at a reasonable cost, this will be shown dollar for dollar as contributing to GDP. If the same library were built at an inflated cost, this would be shown dollar for dollar as contributing to GDP. If the same library were then immediately demolished at government expense even more would be added to GDP. And this is not the end of the matter. If government takes resources away from the private sector to build a school library, this will be recorded, and probably written up, as the economy being saved from a decline in private sector activity by government spending” Source: Peter Smith cited in Keynesians are so wrong

Thanks to Chinese demand for Australian commodities Australia had the chance of a gentle landing. Almost everything economically significant that I can think of that the Government has done will make the economic downturn worse. Thank you Mr Rudd, Ms Gillard and the media sycophants who played a part in their election.

Vested interests co-opt Australia

Australian financial vested interests move to gorge themselves on taxpayer bailouts once the credit expansion contracts. They make the money we take the risks. They get the bonuses we get the bills. Elect idiots and they will make us pay. On covered bonds we previously stated:

Covered bonds are the canary in the coal mine for Australia. If a bank issuing covered bonds became insolvent the holders of the covered bonds will receive money from the sale of assets covered by the bonds before depositors get their money.  Currently the government insures most depositors. Basically covered bonds help stop investors taking a loss and increases the chance the taxpayer will pick up the tab.

In Australia there are still strong institutions working for the public good:

The RBA Prudential Regulation Authority have warned that covered bonds could threaten both depositors and existing debt investors. Source: The Australian

But the financial vested interests are making their move:

Borrowers may face higher interest rates unless Australia’s prohibition on covered bonds is lifted, allowing banks to compete more easily for funding when a global debt refinancing wave hits in 2012, analysts say. Source: The Sydney Morning Herald


The ABA (Australian Bankers Association) supports the development of a covered bond market in Australia and supports more reforms to boost securitisation markets. Source: NineMSN

The RBA is enormously influential in Australia. Normally one would not bet against it. But the lure of lucre and the appeal of jobs in investment banks will seduce many. It will be interesting to see what happens. The financial sector has not captured government in Australia to anything like the extent it has in the USA.

Well at least as far as the Australian Labor-Green government is concerned the question is answered:

Allow Australian banks, credit unions and building societies to issue covered bonds

The Government will amend the Banking Act 1959 to allow Australian banks, credit unions and building societies to issue covered bonds, to secure the long-term safety and sustainability of our financial system so it can continue to provide reasonably priced credit to Australian households and small businesses. Source: Treasury

And to make sure that when it does blow up the taxpayer is liable to the maximum possible extent:

Confirm the Financial Claims Scheme as a permanent feature of our financial system. Source: Treasury


The Gillard Government will invest a further $4 billion in high-quality, AAA-rated RMBS. Source: Treasury

The Gillard Government, not the Government! – That’s how it appears on the Treasury website. It looks like the labor spin doctors have well and truly penetrated the Treasury, as if we were in any doubt. Either that or it’s a Freudian slip on the part of some Treasury official. The decision is manifestly against the best interests of the nation. Even the Treasury econocrats can’t miss that. But he who pays the piper calls the tune

This takes government exposure to non-bank players since the onset of the global financial crisis up to $20 billion. Hat tip Business Spectator. $20 billion may not seem like much, but there are only around 20 million Australians. It’s around $1,000 for every Australian or nearly $2,000 for every working Australian. That’s equal to about two weeks of total average Australian earnings. Way to go government. We will thank you for it when our property bubble eventually pops.

If that’s not enough exposure for you, there is another $150 billion in large deposits and wholesale guarantees as well. That’s around $7,500 per Australian or $15,000 per working Australian. Approximately 15 weeks of total average Australian earnings.

Apparently this represents 6.6% the value of the scheme. I’m not even going to try and calculate what that adds up to. But it’s a lot of risk to have taken on board since the financial crisis. Particularly as most people do not even realize they are exposed to it.

If your exposure through your government is not enough, they have changed the rules to increase your exposure through your superannuation fund:

Financial institutions have expressed interest in using this bullet structure to raise funds. A recent Commonwealth Bank issuance included a $210 million bullet tranche. The success of that deal further demonstrates the viability of the bullet RMBS concept, with more bullet issuances expected over the coming months.

Bullet issuances can be structured to be eligible for inclusion in certain bond market indices, such as the UBS Composite Bond Index. Many institutional investors, who invest on behalf of Australian superannuation funds, are required to replicate or invest in the securities contained in these indices. This additional structural demand and diversification of investors has the potential to make RMBS more reliable and cost effective. Source: Treasury

Are we really gong to live a comfortable retirement selling houses to each other? How’s that working out in America? At least it is possible to create a reasonable sounding argument for selling our houses to the Chinese. Sure it priced us out of decent property, but at least it would be foreigners left making the losses when prices eventually collapsed.

If someone has to be hurt, I’d rather it was not my fellow citizens. But if citizens must suffer, it should be those responsible, and those who knowingly took the risk. Although it could be argued that Australians took the risk of electing the Labor government. It’s their incompetence that will cost us dear. So many voters are not blame free. But as with the US, we are effectively selling our unborn children into debt bondage. It’s either that or trashing our reputation for paying what we owe.

Also the Treasury has not thought through the web address when posting the extracts, unless they never intend to issue another banking report:

Bright boys in Treasury, our national finances are in good hands. Sigh. For when the extracts disappear the full report is available from here. Note the usual Orwellian name “Competitive and Sustainable Banking System”.  That’s as opposed to “How to Shaft the Taxpayer when all our Dodgy Loans Come Home to Roost”. As they inevitably will when our credit induced expansion reverses itself.

Poor old Glenn Stevens, a good man in a tough spot. He may have to follow the Chinese example and raise reserves. That will be politically popular. I can just imagine the vested interests taking that quietly. And we now know how powerful they are. His successor, who knows? He might be cognitively captured. I’d say the same about Swan, but I am not sure he has much by way of cognition to be captured.

Not that the Opposition are looking much better. Initial media reporting suggests Hockey has not grasped the problem with covered bonds. As for Malcolm Turnbull, the former Chair and Managing Director of Goldman Sachs Australia, he will look out for us. People never have a tendency to believe in the merits of whatever they do.

I’m optimistic on Abbott, his opposition to carbon trading cost the financiers dearly. He saw the truth then, he may do so again.  As for the “independents”, who knows? There is always a chance they can be made to see sense, particularly as the Reserve Bank is probably still against allowing banks to issue covered bonds.

If ever there was a tea party moment for all Australians, this is it. The rebellion against Turnbull’s ETS shows that the grass roots of a political party can get active and make a difference. But this needs to extend beyond that into the midst of those not normally involved in politics. I don’t think things are obviously bad enough in Australia to energize the masses of decent law abiding citizens. Those focused on making a living and looking after their family, friends and neighbors.

We will have our tea party moment, just as Ireland will have its Guinness one. That’s if the Irish have not had one, or two or three or…. already.  Imagine fighting so hard for for so many centuries for independence from England, only to give it up to the EU a couple of generations later. Is that what their forebears died for? Remember it’s better to laugh rather than cry.