Saturday, November 27, 2010

Relax. Nervously. Reserve Bank Governor Stevens

Full transcript, Joye's highlights below

The man who sets our interest rates has good news for summer. We can relax. Rates are not going up again ahead of Christmas and probably not until well into the new year.

The usually plain message, delivered three times during his three-hour grilling by the parliament's economics committee appears designed to reassure shoppers, borrowers and retailers put on edge by the outsized mortgage rate increases imposed by the big four banks on top of his Melbourne Cup day lift in the cash rate of 25 points.

Mr Stevens came close to defending the banks in his testimony, saying if he had to choose between "banks with good profits and banks with no profits" he would "choose the former every time," and that his board expected the banks to top-up their margins when it took the decision.

Asked why it expected wider margins he said the members "just read the newspapers".

The extra imposts wouldn't hurt because the Reserve would be more gentle in its own decisions to compensate...

"When we were raising rates in 2007 and 2008, we raised by less than we otherwise would have. We cut by more subsequently and we have raised by less since, because of the recognition of these shifts in margins," he said.

"The question is whether all those people with a mortgage are paying seriously higher rates than they should be from an economic management point of view. What I am saying is that I do not think they are, because we pretty much offset the change in the margins."

The Governor also poured cold water on moves to increase competition in banking ahead of an announcement by the Treasurer expected next month.

"In many areas it is probably the case that more competition is always better for consumers, but in banking more competition is good to a point - but beyond a point more competition pushes down lending standards and banks end up lending money to people who really should not get it," he said.

Bank margins had fattened in the last two years but were still much better than "10 or 15 years ago".

"We are arguing about a small backtrack a little way back up that curve," he told the committee. The profits of the big four banks were "good," but "many Australian corporates would be looking to earn those kinds of rates of return, not just banks."

Asked about the outlook for rates Governor Stevens said "at the moment most commentators do not anticipate and market pricing do not anticipate any further near-term change by us for quite some time."

"I think that is probably a reasonable position for them to have based on the information we have," he added.

There would probably be some more rate rises "next year and maybe a little bit more after that" but it was "unlikely there will be anything from us imminently - I think that is probably a reasonable expectation of
people just now."

The Aussie dollar slumped one cent on the Governor's words to 97.16 US as futures traders wound back their bets on future rate rises, cutting the implied probability of a hike before May from 74 to 42 per cent.

Governor Stevens said while he did not want to get into "political debate" Australia's government debt worried him not at all.

"I have never felt in recent years that the size of the public debt that we have outstanding is a material problem," he said.

Published in today's SMH and Age

Reserve Bank Governor's November Testimony

Christopher Joye writes:

Well, Governor Glenn Stevens gave a remarkably interesting account of himself in Parliament today. Decoding the central banking speak, this transcript is nothing short of amazing..


Mr CIOBO—The flip side of that coin is of course that that increase in expenditure also leads to a tightening of monetary policy. In the economic context in which both your opening statement and other comments from the Reserve Bank have been made, is it reasonable therefore to assume that somewhere around that $10 billion or $15 billion increase in expenditure would see a similar tightening of monetary policy along the lines of what Mr Richardson said?

Mr Stevens—If there is a $15 billion increase in projected government spending in a single year, beyond what is already built into the forecasts—if that is proposed and enacted—then obviously that has a material impact on demand versus supply in the economy and will have a significant bearing on decisions that we would make. Let me be clear: this is an increase of a per cent of GDP compared with a baseline. It is not the increase that is already in the baseline, because that has already been factored in.

Mr CIOBO—I note that Paul Bloxham—who, as you know, spent the last 12 years of his working life inside the RBA’s economic analysis group and a few months ago left to take the chief economist position at HSBC—wrote this week in the Financial Review: “… by choosing not to tighten fiscal policy sooner, the government has implicitly chosen higher interest rates than might otherwise have been the case.”

Mr Stevens—It would have been lower had the stimulus measures not occurred. We would have had to lower the cash rate further. I think that has to be true. I think it is a different thing to say, though, that that would necessarily be a better mix of policies. One could debate that, I think, because there was scope to do discretionary fiscal stimulus. The whole point of having budget surpluses, really, over a run of years is that when a rainy day comes you can do something if you feel you should. We had that scope. Many countries do not, but we did. It has to be true that, if that had not occurred, interest rates, I think, would have fallen further, and then of course eventually they would have had further to come back up to normal in due course than they did have. Would that have been a better world? That is a very interesting question that we can debate if you want to, because there are plenty of things that can get you into trouble with really low rates, particularly if they persist for a while. I think your analysis is correct. The interesting question is whether a world of no fiscal easing and more monetary easing would actually have been the ideal mix. It is an interesting question.


Mr Stevens—…As to the regulatory changes, it is an important question to what extent these changes may have flexibility. It is very hard for me to tell. Many people that we encounter from a business background are quite concerned.

Mr Stevens—People I have spoken to are concerned that it will be harder to get productivity gains and harder to contain costs in the future and that the flexibility of the system is not as great as it was. Whether those concerns are fair and valid, whether they turn out to be validated by experience, time will tell. I cannot know yet. I can only record that many people from a business background that I have heard talk about these things do have these concerns. It will be important that the new system is administered and implemented in a careful and flexible way.


Mr Stevens—On ‘moral hazard’, there is a moral hazard everywhere in the world because governments and central banks did extraordinary things. Some of the things we did were unprecedented for us but by the standards of what some other countries did were pretty mild. So there is a huge moral hazard because governments and central banks did these things. They had to be done, because the system faced a catastrophe in the absence of these measures. But them having been done, and even though we are withdrawing them, the issue we will face—and this is what you were getting at, I guess—next time there is some pressure is whether there will be another guarantee. My very firm view is that we ought to try to get to a position where at that time, whenever that day comes—hopefully not soon—our government will be in a position to say, ‘No, we are not going to give a guarantee and the system can cope with that.’ I think we are much closer to being able to say that than most countries, but we still have some work to do to get a permanent set of arrangements, particularly for deposits, which can stand the test of time. That is on our agenda at the moment and for the early part of next year. I expect that at future meetings we will probably come back to that. It is a very important question.

This is why, to hark back to the questions Ms Owens asked about the global regulatory work that is being done, people are very conscious of this, very conscious of the need to try to lessen the moral hazards surrounding some of these very big global banks by making them safer, less likely to fail and easier to resolve if they do fail and so on. It is very much, though, still a work in progress. That is the best I can tell you at this point.


Ms O’DWYER—Governor, would you consider that these guarantees are contingent liabilities—that they increase the risk profile of the Commonwealth prior to its position pre the crisis?

Mr Stevens—We are getting into areas where it is very difficult to talk about this publicly, so I will be a little bit guarded. But, from a strictly accounting point of view, they have taken on a contingent liability that they did not have before. What is the probability that you would actually have to make good on the entire deposit base of the banking system? It is extremely low. So, if you were trying to measure this obligation, it would be the size of that times some probability of having to make good on that, and that is very low number. I think you would also, to be honest, have to in the back of your mind pose the question: in the previous world, without this guarantee, would a government stand by to let the system collapse and do nothing? I cannot think that they would. There was always some unspoken, unquantified support. But it is a very interesting question: should that be made explicit and priced or shouldn’t it? That is one of the issues that I think would probably have to have a discussion about, but today is probably not quite the moment.


Ms O’DWYER—That leads pretty nicely into my next question, which is: can you tell us whether there is a risk in the fact that Australia has four ‘too big to fail’ banks that effectively benefit from implicit taxpayer guarantees.

Mr Stevens—We have four large institutions, but the number in a crisis is not necessarily limited to four because in crisis conditions, if people are panicked enough, even a smaller entity can end up being quite disruptive if it is in distress. The other side of that, of course, is that those institutions are supervised very intensively by the supervisor, who is quite prepared on occasion—and has done so—to require banks to do this or that additional thing over the minimum, if they think that is appropriate from an individual risk or even a systemic risk point of view. But this is the nature of banks. It is a tricky area because banking just is not like any other business. A bank failure, even for a not-so-big bank, is not like the failure of any other business, where someone else comes in, buys the assets, employs the people and everything keeps going. It is not that simple in banking, which is why we have regulation that is much more intrusive on a bank than it is on your average industrial company. It is for that reason. It is why there is this very difficult, delicate balance with the problem of moral hazard. To make moral hazard go away entirely is probably impossible. It is a tricky area.


Ms O’DWYER—I want to refer to the new statement on the conduct of monetary policy that was signed in September 2010. As I understand it, the RBA added the following new text, which has not appeared in previous statements since the first one was signed by the former Treasurer. That statement is: “The Reserve Bank’s mandate to uphold financial stability does not equate to a guarantee of solvency for financial institutions, and the Bank does not see its balance sheet as being available to support insolvent institutions.”

As you of course know, the RBA has a responsibility to serve as a lender of last resort to deposit-taking institutions that are adversely affected by these liquidity shocks, as it did during the global financial crisis. If a bank can no longer fund itself because of an external shock and the RBA is the only counterpart in the world willing to lend to it, how can this not represent the RBA using its balance sheet to support insolvent institutions?

Mr Stevens—The distinction, though, is between illiquid and insolvent, so, in the classic central banking setting, if an institution is illiquid but it does have assets it can pledge as collateral the central bank, on the assumption that it has some reasonable look at the quality of those assets, can lend against them at an appropriate rate of interest. This is Bagehot’s classic— in a liquidity crunch, lend freely at a high rate to sound banks. We would do that. Nothing in this statement on the conduct of monetary policy changes that fact. The Reserve Bank will always play the role of provider of liquidity against collateral at an appropriate interest rate. The statement about not seeing the balance sheet as being available to support an insolvent institution is making a different point. It is saying that we do not regard it as proper, and no central bank would, for a bank which is actually insolvent to be bailed out by the taxpayer through us. If it is going to be bailed out by the taxpayer, the government should make that decision and should fund it itself. We would probably have some role in facilitating that in the event it occurred, but the government would have the credit risk, not the central bank. I think that would be, in central banking circles around the world, the way all central banks would think about it. So our role is in liquidity and we will always be prepared to do the right thing there by the system and by participants in the system in a crisis, and we have done that and we basically doubled our balance sheet in 2008-09, for a brief period, for that very purpose. As to the financial rescue of an institution which is not solvent, there may or may not be a public policy case to do that but that is a government call. We would obviously give them our views if they asked, but that would be their call, I think quite properly.

From David Llewellyn-Smith:

Having read the hansard what is obvious is just how much the RBA is rebuilding itself from the ruins of the crashed debt pilots of yesteryear.

Let's take a look.

Gone is the Pitchford Thesis and the free and easy love of private sector debt: Glenn Stevens
Private debt, on the otherhand, is considerably higher than in some countries. It is probably in the pack for English-speaking countries with which we would compare ourselves, but some of those have had a prettybad time lately, so we would not necessarily want to stand out too much more on that score. Thatis why I think that the more modest growth of housing credit that we see now is probablysufficient for the economy’s needs, but we do not want to see that ratio of debt to income keepgoing up the way it was. So that is a thing to watch.

Gone is faith in asset-based wealth: Glenn Stevens
We have looked at households in other countries getting into serious trouble. I think we have all thought, ‘We ought to be a bit carefulabout rate of borrowing and maybe we should be saving more of our current income as opposedto allowing an assumed rise in asset values to, in effect, do our saving for us.’ I think that is atendency that was there a few years back in many countries. My guess is that there has been akind of sea change in people’s attitudes that we would expect to persist for a while.

Gone is faith in private bank prudence: Glenn Stevens
Pretty much every supervisor in the world is telling their banks to rely less onwholesale funding because it is risky. The rating agencies say it. My suspicion would be that, if the financial institutions could have got away with continuing the old pattern, they would have because they found it attractive and profitable, but they did not have that choice. They certainly took decisions to try to raise more deposit funding but it was a decision on which I am not sure they had a great deal of choice in taking.

Gone is the efficient market hypothesis: Glenn Stevens
In many areas it is probably the case thatmore competition is always better for consumers, but in banking more competition is good to apoint but beyond a point more competition is not good, because the bankers can be led to dothings that ultimately cause a lot of subsequent damage. I think we have to understand that. Thatis not to say that the current amount of competition we see in any particular market is necessarilyenough, but there is a point beyond which extreme competition in lending money leads to problems.

There is inquiry about how to manage guarantees: Glenn Stevens
I think you would also, to be honest, have to in the back of your mind pose the question: in the previous world, without this guarantee, would a government stand by to let the system collapse and do nothing? I cannot think that they would. There was always some unspoken, unquantified support. But it is a very interesting question: should that be made explicit and priced or shouldn’t it? That is one of the issues that I think would probably have to have a discussion about, but today is probably not quite the moment.

There is realism about the banks and moral hazard: Glenn Stevens
My very firm view is that we ought to try to get to a position where at that time, whenever that day comes—hopefully not soon—our government will be in a position to say, ‘No, we are not going to give a guarantee and the system can cope with that.’ I think we are much closer to being ableto say that than most countries, but we still have some work to do to get a permanent set of arrangements, particularly for deposits, which can stand the test of time.

Gone is the comfort with wholesale funding: Glenn Stevens
They [the banks] have sought to do that to increase the share of their book funded fromdomestic deposits and to lessen the share funded through wholesale sources. It is pretty obviouswhy that happens and I think it is prudent of them to do it. What we have seen in the past severalyears is that those wholesale funding sources, which for some years up to the middle of 2007 were very available, very inexpensive and, apparently, quite reliable and quite stable, changeddramatically after the problems began in 2007 and especially after the Lehman failure in September 2008.

Gone is the reticence to 'lean against the wind early in the cycle': Glenn Stevens
I cannot think of very many cases in history where we looked back and thought, ‘Yep, we tightened too soon.’ I can think of several times where we looked back and thought we should have tightened a bit earlier. I think that if we are doing it right the decisions will be finely balanced most of the time—that is where we should be—and we will probably move a little bit earlier than the moment when it is clear that you have to. That is if we are doing it well. There is some risk that you do things you do not need to do—I agree with that. We have to balance that risk, obviously, against the risk of getting behind the game. Historically, for many central banks, including us, that has tended to be the mistake that we made.

Gone is an easy comfort with trend line growth: Glenn Stevens
So we will see, I think, continued uncertainty about how all this will play out. My guess, as Isay, is that we will see repeat episodes of anxiety every so often for a few years. What thatmeans is that, for us, we balance the possibility that things could go pear-shaped in Europe—they may or may not; we will not know for sure for quite some time.

There is some skepticism about commodities and vision beyond: Phil Lowe
If you look forward, we cannot expect the terms of trade to keep rising and we will inevitably go back to a period where growth in our living standards is going to be determined by productivity growth, or, to put it another way, expansion of the supply side. We are not the experts on how to do that. There are obviously areas, in transport, in education, in health, where things can be done to improve the ability of the economy to produce goods and services efficiently. It is not our core area of competency but it isan area that needs to be looked at very carefully.

Compared with the profligacy of former governors, this is impressive stuff.

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