Wayne Swan (Lilley, Australian Labor Party, Treasurer) Share this | Link to this | Hansard source

The world has witnessed substantial financial market turbulence since it began in August last year, making its presence felt across markets, across nations and across continents.

It is of course most evident in the United States, but it affects all of us to a greater or lesser degree, including the hardworking families of Australia.

As global financial market turbulence has become more prolonged, Australians have become more concerned about the dimensions and possible consequences of this uncertainty.

Later this week the House will rise, and when we next meet it will be to consider the first budget of the Rudd government.

Accordingly I seek the indulgence of this House at this time to review the character, magnitude and status of recent global financial turbulence.

I will inform the House how the Commonwealth government and the relevant regulatory authorities and agencies within my portfolio are assessing the risks and monitoring these developments.

And I will offer this assessment in the wider context of where the Australian economy has come from, where it is now and where we hope to go.

When these developments began to unfold eight months ago, the central concern was around the size of the write-downs that major global banks would have to accept from the rapidly rising default rates in US subprime mortgages.

Within a very short time, however, it became an issue of uncertainty about the credit risks embedded in packages of mortgages bundled together by financial institutions and sold into global financial markets.

Sources of funding dried up and the market in subprime mortgages virtually closed.

Shortly thereafter the entire residential mortgage backed securities market ceased to function with the depth and liquidity that had made these securities among the most widely held financial assets over the last decade.

With financial institutions here and elsewhere unable to raise as much funds through securitisation, and with uncertainty as to the extent of exposures to losses on these assets, they began to hold on to the cash they had.

Banks here and elsewhere became more reluctant to lend to each other, except in the very short term.

Central banks in all major advanced economies, including our own, responded by offering to lend cash to banks on a much larger scale than usual, accepting as security a wider range of financial assets.

Towards the end of last year it appeared the crisis was beginning to ease as the US Federal Reserve responded by cutting the cash rate and supporting the liquidity of financial institutions.

However, as financial institutions sought to finalise positions prior to Christmas, spreads began to widen once more.

As we entered the new year, renewed concerns in financial markets were coupled with increasingly convincing signs that economic activity in the US was sharply slowing.

Equity prices across the world declined, as did the US dollar, and banks once again became reluctant to part with cash.

The US Federal Reserve responded with a large cut in the cash rate in January and more recently has taken action to provide further liquidity to the market.

The prolonged uncertainty took its toll as exposed financial institutions, those with illiquid assets and short-term liabilities, came under increasing pressure.

In Australia we experienced a fresh episode of funding dislocation this year, which we have seen in a wider premium of wholesale market rates over the cash rate.

In the US market, concern moved on from household mortgages to the risks of dealing with investment banks which might have difficulty accessing liquidity.

Just this week the US’s fifth largest investment bank was absorbed into a larger competitor after it encountered mounting liquidity problems.

I do not want to downplay the severity of the global financial developments.

Nor do I wish to say that they have no impact on us.

On the contrary, there is no doubt Australia’s financial system has been affected by the global financial circumstances.

The residential mortgage backed securities market is no longer functioning in an effective way.

This is true more generally for most asset backed paper markets, here and elsewhere.

Where Australian financial institutions had been very successful in bundling streams of mortgage income to sell as securities offshore, they now have been obliged to seek other sources of funding.

In recent weeks there has been renewed stress in global short-term bank funding markets.

This is in addition to the continued difficulties in term and securitisation markets, which have functioned under considerable strains for some months.

Funding costs have continued to increase.

Though markedly narrower than it was a week ago, the spread between the Australian 90-day bank bill rate and the cash rate is still around 60 basis points—somewhat wider than the usual spread.

Australian banks have continued to issue in offshore markets, though at higher spreads than were previously the case.

This has led to higher costs of borrowing for businesses and higher mortgage rates for households.

The Australian Prudential Regulatory Authority is closely monitoring the impact of developments in our banking sector.

Its focus is on ensuring that all institutions have adequate plans in place if the market turbulence continues.

Despite increased issuance in domestic and international bond markets in the early months of this year by major Australian banks, further instances of market turbulence cannot be ruled out.

Problem loans are still very low by historical and international standards, however, and Australia’s corporate debt-to-equity ratio remains at historically low levels.

The turmoil in global financial markets has not unduly restricted the total supply of finance to our economy, with strong growth in bank lending more than offsetting the reductions in corporate bond issuance, and in lending to households by mortgage originators.

As the House will be well aware, the Commonwealth government and its regulatory agencies are charged by this parliament with the responsibility to protect the stability of the financial system on which this economy depends.

My department, the agencies within my portfolio and the government have been following the global market developments with an eagle eye.

We are in close and continuous contact with financial markets here and offshore.

I have been in almost daily discussion on this topic: with our central bank, with the regulatory authorities and with the leadership of the financial community.

I have consulted with my counterparts in Europe and North America.

Only last Thursday the secretary of my department met with his colleagues in the Australian Council of Financial Regulators to discuss all of these developments.

While we are alert to the impacts on our economy, I would point out to the House that the circumstances of our financial institutions are different from those in the United States.

While the 12 consecutive rate rises since 2002 have undoubtedly taken a toll on household budgets, we are not experiencing the same levels of mortgage defaults that are now occurring in the United States.

While it is important that we recognise the severity, duration and possible consequences of the global financial turbulence, we should also recognise that Australia’s circumstances are more favourable than those elsewhere.

We are not in the least bit complacent about the circumstances of the Australian economy, but we do recognise that we have strengths on which we need to build.

The very clear differences between Australia’s circumstances and those of some other economies bring me to my second theme.

This is the issue of what economic policy strategy is appropriate in Australia’s current circumstances.

One of those circumstances is the financial turbulence which I have already described.

But that is by no means the only circumstance which I am taking into account in shaping policy in the run-up to the budget over the next couple of months.

I want to now offer the House my assessment of some other important aspects of our economy.

Our economy’s strength in recent times has been supported by large rises in the prices of our commodity exports.

Australian output growth through the last year was just under four per cent.

But while we have high prices for our commodities, over the last few years our export performance still has been weak.

It is a surprising but undeniable fact that Australian exports have been growing only slowly over most of this decade, at least in terms of volumes.

Our export volumes have grown at an average annual rate of just 1.9 per cent in the seven years since 2000, compared to an average annual rate of 6.9 per cent over the preceding seven years.

This slowdown in export volumes growth has occurred despite strong world growth over this period and against a backdrop of a once-in-a-generation terms of trade boom.

It is clear this performance is more a reflection of supply side constraints, rather than a lack of demand for our exports.

The slowdown in export growth also goes hand in hand with the slowdown in productivity growth.

Driven by strong global demand for our metals, minerals and energy exports, our terms of trade have risen to 50-year highs.

While the resource-rich states of Western Australia and Queensland have experienced the largest direct benefits from the terms of trade, the impact has been felt across the whole of our economy.

The rising terms of trade have provided a significant external stimulus to the economy—adding something like 1½ percentage points each year to the growth of Australia’s gross domestic income over the last four years.

Demand created by this strong growth in income has outpaced increases in the economy’s supply capacity. This has contributed to inflationary pressures.

While there is considerable uncertainty around the medium-term outlook for non-rural commodity prices, recently settled contracts and market expectations for iron ore and coal suggest further support for the terms of trade in the period ahead.

While further gains in our terms of trade could be expected to continue to support domestic activity, they also present further challenges for an economy already pushing up against its capacity.

It is sometimes said, including in this place, that an upswing in mining output from Western Australia and Queensland must be at the expense of Victoria and New South Wales.

This was quite evident in conversation with my state colleagues last week. However, they do not necessarily see it that way.

While Queensland and Western Australia are expecting remarkable increases in the production and transport of iron ore and coal in particular, New South Wales and Victoria are not despondent about the outlook.

Some talk loosely about a two-track economy, but New South Wales’s final demand increased by over 4.5 per cent last year, and overseas exports from New South Wales increased by over four per cent.

Exports increased more in New South Wales over that same period than in Victoria or Queensland or Western Australia and, of course, were well above the national average.

Over the same period Victorian final demand increased over five per cent.

Unemployment in New South Wales is 4.2 per cent and in Victoria 4.1 per cent, in both cases the lowest outcomes in 30 years of data.

These are not numbers which suggest considerable gloom in either state.

With the right policies, growth in the resource-rich states of Western Australia and Queensland does not have to be incompatible with growth in New South Wales and Victoria.

A good deal of the increased income from mining will be distributed locally as higher employment and, consequently, higher local spending.

But some of it will be distributed through the rest of the country as higher government revenue or as returns to shareholders.

It is our task to think through all of these challenges, as we are doing in the run-up to the budget, and get the balance of policy right.

Given the challenges we confront, the Rudd government has twin objectives in economic policy, which it is pursuing with equal vigour.

One is primarily about the next year or two, and the other is primarily about the next decade.

It would be quite wrong to suggest to the House that our first May budget will accomplish both objectives immediately.

On the contrary, we are now planning the architecture of at least three budgets, each closely related to its predecessor and each taking us a bit further down the road towards our twin objectives.

The first objective is of course the gradual moderation of inflation from the rate of four per cent or so, which the Reserve Bank expects to see in the year to March, to within the target band.

And we will be doing what we can through budget policy and through other measures to make the Reserve Bank’s job less difficult.

That is why we have a five-point plan to fight inflation which includes a surplus target of at least 1.5 per cent of GDP in 2008-09.

The second objective is to modernise our economy.

This includes the removal of constraints in our physical infrastructure of roads, bridges, ports, water and energy.

It includes a big improvement in Australian education, from preschool to our centres of higher education, to compete with the best in the world.

It includes more and better training in skills to improve the quality and size of our workforce.

And it also includes taxation and childcare reforms to lift labour force participation to reward hardworking families for all of their efforts.

These are big jobs, but we are clear about what we want to do and we will deliver on all of our election commitments to Australians.

We have already laid foundations with the establishment of Infrastructure Australia, the provision of an additional 450,000 high-quality training places, the decision to better resource technical training in schools and the plans we have in hand with our counterparts in COAG, of which I will have more to say on another occasion.

The government seeks an effective balance between our two objectives.

We cannot rebuild the nation’s economic infrastructure in one budget. Building world-class education systems, modernising our infrastructure and tackling skills shortages will take some time.

And our new policies will need to be carefully implemented so that we do not further complicate demand pressures in the economy.

But we also recognise that tackling inflation in the longer run is largely an issue of the capacity and the flexibility of the Australian economy.

The underlying trend increase in inflation has been apparent now for some time and it represents a failure of past government to foresee and to prepare for the inevitable consequences of the long expansion that we have enjoyed.

To control inflation we need a more responsive and flexible economy, and we will not get it without addressing our infrastructure constraints now and into the future, without world-class education at every level, without upgrading the skills and the quality of our workforce.

So in that sense our two objectives are mutually reinforcing.

Once a lower rate of inflation is achieved we will have more room to remedy the structural shortcomings which have contributed to its acceleration over recent years.

The deteriorating global outlook does present a significant risk to the Australian economy.

Businesses and households are already feeling the effects of higher interest rates which, in part, reflect global financial turmoil.

The outlook for the global economy and uncertainty in global financial markets is beyond our control, but we are vigilant.

And we remain confident that Australia’s financial institutions and our regulatory agencies are coping reasonably well with a global challenge of considerable severity.

Developments in global financial markets, combined with significant inflationary pressures in the domestic economy, reinforce our determination to build long-term productivity and growth in our economy.

We are putting all of our efforts into modernising our economy so it is strong enough and flexible enough to meet future challenges—to create the right environment for business to flourish and to deliver for the working families of our nation.

Anthony Byrne (Holt, Australian Labor Party, Parliamentary Secretary to the Prime Minister) Share this | Link to this | Hansard source

I move:

That so much of the standing orders be suspended as would prevent the member for Wentworth speaking for a period not exceeding 17½ minutes.

Question agreed to.

Malcolm Turnbull (Wentworth, Liberal Party, Shadow Treasurer) Share this | Link to this | Hansard source

I welcome the statement by the Treasurer on the crisis in international credit markets. The Treasurer has summarised the history of the development of the crisis, and I will not go over the same ground again other than to make some observations about the different nature of this credit crisis relative to previous episodes consequent upon periods of imprudent lending. Over the last 20 years, we have seen the development of enormous markets for securitising debt of all kinds. Residential mortgages are very much the focus of attention at the moment, but the securitisation markets cover all debt classes. This has enabled a substantial increase in competition in all debt markets, and Australian home buyers have especially benefited from this. Since the early 1990s, the range of lenders has continued to expand as balance sheets could be effectively outsourced to the public markets via securitisation.

What we have seen, as the Treasurer observed, is a global shutdown of those securitisation markets. Since the beginning of this year, for example, and according to Assistant Governor of the Reserve Bank Guy Debelle, speaking on 5 March, there has only been one successful securitisation of Australian residential mortgage backed securities. This credit crunch has seen some second-tier mortgage lenders pulling out of the business, including Macquarie Bank, and others dramatically curtailing their lending. The consequence is that, whereas six months ago the top five banks had around two-thirds of the Australian mortgage market, perhaps a little less, now they are believed to have over 90 per cent of that market. The major banks have continued lending but in doing so have been obliged, as the Treasurer noted, to access the wholesale debt markets directly. The availability of credit does not yet appear to be unduly constrained in Australia but, as the assistant governor observed recently, the major banks have been picking up the slack from the closed public markets. Corporates that financed themselves directly from the public markets are now borrowing from the banks directly—a process of reintermediation—and that is coming with an increased cost of credit. A number of banks’ CEOs have talked about credit rationing. What that means, of course, is that credit terms will be tighter and the cost of credit will be higher. This is one of the factors that feeds into the considerations by the Reserve Bank on interest rate adjustments in particular and inflation in general.

The closure of these securitisation markets has been particularly unfair to the Australian market. Our residential mortgage market is of a considerably higher credit quality than that in the United States. In that sense, in Australia we are all being tarred with the same brush. Residential mortgage backed securities are out of fashion, to say the least, and there does not seem to be a lot of discrimination in the markets at the moment; there has been such a collapse in confidence. It is worth noting that the Reserve Bank’s Financial Stability Review of March 2007 said:

The closest equivalent to sub-prime loans in Australia are non-conforming housing loans, which are provided by a few specialist non-deposit taking lenders and account for an estimated 1 per cent of all outstanding mortgages, well below the 15 per cent sub-prime share in the United States.

The reality is that the American residential mortgage market is very different from ours. It has a very large, relative to Australia, share of subprime loans. If they can be described as imprudent lending—and I think few people would disagree with that characterisation with the benefit of hindsight—then we can say that Australia’s credit culture has been a more responsible and conservative one. I was speaking only today with Paul Fegan, who is the Chief Executive of the St George Bank, our fifth biggest bank, and he noted that out of 500,000 Australian mortgages St George has issued it has got foreclosure proceedings in respect of 74. Each one of those would be a matter of great disappointment—tragedy, perhaps—to the particular borrowers, but it gives you an idea of the strength of our overall residential mortgage book. Nonetheless, the securitisation markets are as shut for Australian mortgages as they are in the United States. It is important also to remember that residential mortgages in the United States are, for all practical purposes, nonrecourse to the borrower. A homebuyer can literally give the keys back to the bank without further recourse to him for the balance of the loan.

The former Federal Reserve Chairman Alan Greenspan said yesterday in an article in the Financial Times that the credit crisis ‘is likely to be judged as the most wrenching since the end of the Second World War’. If that is so—and let us hope it is not—it will be because of the way in which the contagion from this imprudent lending on residential mortgages, subprime mortgages, infected the whole system. This can be compared with an earlier credit crisis in the United States, in the late 1980s, when a large number of what we would call building societies, I suppose—Savings and Loans—collapsed again because of poor lending practices. In that episode, the impaired assets—the dud loans—of the S&Ls remained on their balance sheets for the most part. The United States government was able to take over the S&Ls via an entity called the Resolution Trust Corporation, so a conventional process of workout was undertaken—assets were sold, losses were realised and the market was able to function.

In this case, the economic interest—the ownership, if you like—in the subprime mortgages had been so widely sliced and diced in different forms of securitisation that the impacts of the dramatic fall in value of those assets are widespread and very difficult to predict and identify. The difficulty in identifying where the losses lie, on a mark to market basis, has dramatically undermined confidence in financial institutions. Once confidence dries up, so does credit. Confidence is critical. So we have seen central banks around the world pumping unprecedented levels of liquidity into the financial system. As the Treasurer said, we cannot be complacent here in Australia, notwithstanding our stronger financial system and our stronger credit culture. It is vital that our regulators are more attentive than ever to the health of our financial system. That is why I welcomed the statement by the Treasurer yesterday in a response to a question of mine that the Labor Party’s proposal to cut $130 million of funding from ASIC will be rescinded, at least for the next two years.

The Treasurer has taken the opportunity to recapitulate his economic policy. I will seek briefly in response to that to identify where I differ from him. Firstly, I recognise—as do we all—the importance of ensuring that inflation remains within moderate levels, by which I mean between two and three per cent on average over the cycle. That is the inflation target objective. It is in the latest objectives of monetary policy that have been agreed to by the current Treasurer and the Reserve Bank, and the target has been set out in that form since 1996, when it was put in place by Mr Costello. Despite the very considerable positive shock to our economy from the improvement in our terms of trade we have, over recent years—and in particular over the 47 quarters of the Howard government—been able to contain inflation within the target band. That is so whether you are measuring inflation as the headline CPI or as the RBA’s preferred measure of underlying inflation, the trimmed mean. It is salutary to recall why we have been able to do this and it is important to be proud of that achievement and not to deny it. It was only last week that the Reserve Bank Governor, Glenn Stevens, answered the question: how have we been able to do this? He said:

Having said all that, it is important to keep some perspective about the situation in which we find ourselves. We have been living through one of the largest transformations in the structure of the global economy, as far as Australia is concerned, for a century. The rise in the terms of trade over the past five years is the biggest such event since the Korean War boom in the early 1950s ... In essence, we are seeing a very large change in relative prices in the world economy, and a relative price change that is more important to Australia, in particular, than to almost any other country. These sorts of events will always produce stresses and strains, including significant divergences in performance across industries and regions (though these are often exaggerated in popular discussion). Because the event is, overall, very expansionary, it was always likely to be associated with some risk of higher inflation.

In other words, the Reserve Bank Governor is speaking with the moderation, the objectivity and the perspective that has been so lacking in the rhetoric of the Treasurer. Therein lies my disagreement with the Treasurer. He has spoken about our economy not only in a way that is misleading in terms of our economic history but in a manner that is calculated to undermine confidence. Treasurers and central bank governors have one big thing in common: they should speak about the economy in a way that creates confidence and ensures that people have faith in our markets and in investing. Let me go on with Governor Glenn Stevens. He continued:

But given the magnitude of the shock, when all is said and done, the economy has coped pretty well so far. Yes, inflation has risen. This is a problem, and requires a suitable response from monetary policy. But compare the outcomes on this occasion with those in the commodity price booms of the early 1950s or the mid 1970s. In the early 1950s, CPI inflation reached 25 per cent, then fell back to zero within a few years, associated with quite a pronounced recession. In the mid 1970s, inflation reached about 18 per cent, and took a very long time to come down to acceptable levels. This time, we are grappling with a peak CPI inflation rate that looks like it will be around 4 per cent in CPI terms, and trying to assess how soon it can reasonably return to 2 -3 per cent. This is a far cry from the problems of yesteryear.

How different is that language? Scrupulously accurate, endorsed as comprehensively correct yesterday by the Treasurer—and yet it is night and day; that language is at complete odds with the exaggerated rhetoric of the Treasurer. The governor is seeking to inspire confidence by being accurate and measured in what he says; the Treasurer, to make a political point, is undermining confidence. The governor goes on:

The reason we are doing better this time around is not hard to fathom, either.

Well, it is pretty hard for the Treasurer to fathom—but, anyway, it is not hard for the governor or for anyone on this side to fathom.

As work in the Treasury has argued persuasively, a flexible exchange rate, a reformed and flexible industrial environment, better private-sector management and much stronger fiscal and monetary policy frameworks have made a lot of difference. The fruits of those decades of effort of reform are an economy that, for all its strains, is doing well under the circumstances.

I could not describe the economy better myself. The Governor of the Reserve Bank has spoken accurately and comprehensively about inflation and in moderate language which inspires confidence.

Why is confidence so important? As Alan Greenspan said on 12 February 1998 in his congressional testimony:

The state of confidence so necessary to the functioning of any economy has been torn asunder.

He was speaking about the circumstances of the time.

Vicious cycles of ever rising ... fears have become contagious.

              …              …              …

Once the web of confidence, which supports the financial system, is breached, it is difficult to restore quickly.

Indeed, as Martin Feldstein, the President of the National Bureau of Economic Research in the United States said only last month: ‘Confidence is everything.’ And that is why, historically, prime ministers, treasurers and central bank governors have consistently used moderate language when speaking about the economy—for confidence can turn quickly; it can ‘turn on a dime’, as the Americans say, and as recent consumer and business confidence surveys show. We have now seen three surveys of confidence, with business confidence falling dramatically in the National Australia Bank’s survey for January 2008 and record falls in consumer sentiment in the Westpac-Melbourne Institute survey showing confidence at its lowest level since 1993. So, in 106 days under the Rudd government, business and consumer confidence have tumbled. That is a fact.

The Treasurer no doubt would say: ‘It’s not my fault. Look at all the turmoil around the world.’ Well, there is plenty of turmoil around the world. But there is something that was not there before November last year—and there was plenty of turmoil at the end of last year, and not just in electoral politics in Australia; this crisis really got underway in August of last year. The big difference is that we now have a Treasurer who speaks about the economy in a way that is calculated to undermine confidence.

He is not prepared to acknowledge that our economy is one that has been described by the Economist as the ‘wonder down under’. Our economy is one that has unemployment at a 35-year low and a participation rate at a record high. Our economy enjoyed average growth over the 11½ years of the previous government—so reviled by the Treasurer—of 3.6 per cent a year, higher than most other developed economies, including the United States and Europe. Our economy was 50 per cent larger in real terms when the coalition left government compared to when it came into government. Real wages grew 21½ per cent over those 11½ years, where they had fallen 1.8 per cent under the Hawke and Keating governments. This is a government that has no net debt and has run consistent strong surpluses. The government was praised in September last year by the IMF for its ‘exemplary macroeconomic management’. That is the track record.

I do not expect the Treasurer to become a spokesman for the previous government. I do not expect him to sing our praises. But what he does not seem to understand—and it is not that he does not know enough about the economy; I think it is that he does not have a feeling for it—is that confidence underpins everything. And when you trash your own economic history, when you say, ‘The inflation genie is out of the bottle,’ that is inevitably interpreted as, ‘Inflation is out of control.’ That is interpreted as meaning that the Reserve Bank is not doing its job and that the government was not doing its job—that the system is not working. And yet, manifestly, the system is working. We want our financial system to work. We want the securitisation markets to reopen. We want Australian homebuyers to have access to more lenders to get the benefits of competition. And central to all of that is confidence, and confidence is evaporating. (Time expired)