>Interbank lending rates have been very high, but again, it's not so
>much about price but availability. The interbank market has
>essentially frozen. If you're going to debunk the MSM, you should
>hold yourself to higher standards.
Paul Keating joins Lateline
http://www.abc.net.au/lateline/content/2008/s2379522.htm
Australian Broadcasting Corporation
Broadcast: 01/10/2008
Reporter: Leigh Sales
The former Prime Minister and Treasurer, Paul Keating talks with Leigh Sales about the recent global economic developments.
LEIGH SALES, PRESENTER: Australian authorities are grappling with two key questions at the moment; how deep will the US economic downturn cut, and how well is Australia poised to with stand the pain? This nation's last period of severe economic hardship was the recession of the early 1990s. The Hawke and then Keating Labor governments were in power then, and those two men know better than anyone the pressures now facing Kevin Rudd and Wayne Swan.
Joining me in the studio tonight is the former Prime Minister Paul Keating, and of course before that, the Treasurer. Thanks very much for coming in.
PAUL KEATING, FORMER PRIME MINISTER: Good, Leigh.
LEIGH SALES: How does what we're seeing today compare to what you experienced as treasurer in 1987 and then as prime minister in the early 1990?
PAUL KEATING: This is a much different event. Then we had two common things; an exuberance of bank lending, which was about to blow inflation rate out of the water again. So that was common, except inflation is not really a risk this time. What we're seeing at the moment is a disintegration of the international financial system. That's not what we had in 1990. We had a world recession in 1990. It was a business recession. That means business investment fell. A normal cyclical business recession. What we have here is the advanced disintegration of the international financial system.
LEIGH SALES: So are there lessons, then, that can be drawn from Australia's last recession and applied now?
PAUL KEATING: Well I think if we hadn't had had the recession in 1990 we wouldn't have banks as strong as this today. You know, they'd be all be cot cases like the Americans ones. I mean, we pulled them into line, set up the balance sheets. I mean, I had the ANZ and Westpac in the sort of humidicrib for three or four years, and got their balance sheets back together again. And I think that lesson has been learned by the current generation of Australian bank executives. But that lesson was not learned in the United States.
LEIGH SALES: We heard in that package before, the controversy today about whether or not the banks should pass on the full Reserve Bank interest rate cuts that are expected. What is your view on that?
PAUL KEATING: The Treasurer is right about this and the Prime Minister. Look, Malcolm Turnbull, frankly, should know better than this sort of populism. The London interbank rate today is 250 basis points, at Libor, 250; it's normally 25 or 30. Or 40. It's 250.
Banks won't lend to one another. In other words, normally you see the Libor rate is the rate just above the cash rate of the Central Bank and it's the bank, one bank lend to another to fund its affairs each day. Now bank A won't lend to bank B unless it pays a margin of 2.5 per cent, 250 basis points. So essentially banks are not lending, they are sitting on cash and they won't lend to other banks. Cash is what makes the money goes around. Now, our banks have to get out there and borrow our current account deficit at 6 per cent of GDP, that's $60 billion a year. That's about $5 billion a month.
So whether or not they are well off here is important, but it's not the whole picture. The whole picture is they have to get out there because we don't have enough savings, and borrow the current account deficit, and they're borrowing in these polluted markets where you have to pay 2.5 per cent just to be spoken to. So of course the Treasurer was right in saying they're not in such a strong position as they were, say, two months ago when borrowing cost at that point were lower.
LEIGH SALES: But I am wondering how easy it is to sell that message to the public when what the public sees is bank executives on large salaries, banks posting record profits.
PAUL KEATING: I know. Look, banks are fundamentally utilities. Why are they utilities? I will tell you why. Their tier-one capital is too thin and their risks are mostly too big. They make returns greater than most industrial companies for that very reason. Their capital is too for the risk they take. Why do they take the risk they take? Because they know they can come running back to mama, that the central bank. And central banks give them discounted facilities and liquidity when they need it.
So in the end they are, their writ runs as far as it can, but they are not like any other industrial company. This is why it is obscene for these executives to pay themselves $6 to $10 or $15 million a year. Within the end they're managing essentially, look, if you track the growth of Australian banks and you run a graph up of nominal GDP and overlay the Commonwealth, the ANZ, Westpac, it will be the same. You know, fundamentally all they are doing is tracking growth. Yes OK they will pinch a bit of market share from one another and yes, they've got to cut costs occasionally and keep their ratios right, but frankly, you know, would you need to pay someone $15 million or $16 million a year for that? Of course you wouldn't.
LEIGH SALES: Alright, let's look a bit more broadly. In July 2003 you delivered a speech in New Zealand and you spoke there about there being three economic long waves over the last century, one from 1904 to 1929, a second from 1947 to 1974 and a third which began in 1982 and you predicted in that speech that this wave should run until about 2007, 2008, which is now being born out. But how does this wave end for Australia? Well or poorly?
PAUL KEATING: Well, there's a new wave beginning. You see, in the 20th century, the first half dominated by the United States, the second half was dominated by Japan. And the first half of the 21st century will be dominated by China. The new long wave has already begun, it begun about 2000, in my opinion. Now, but what we have, we've got transitions, and in the last long wave which went for 25 years, 1982 to 2007, what happens is that in a period of long growth two relatively modest business cycle recessions, but a period of long growth, low inflation and low interest rates, you end up with complacency and coupled with financial innovation, money gets put to points in the economy, every crack and crevice in the economy gets pasted with some money.
And we saw the risk premium come right down. So what we used to call junk bonds, used to have an enormous premium over gilt treasury bonds. We saw that premium come down. When you see that risk premium come down to virtually nothing, you know we're in trouble, you know. And this is what happened in the United States. You know, Greenspan had rates at 1 and 2 per cent, less than the inflation rate. So the big investment banks geared themselves up and all the housing lenders went out and lent this money. People then got out of their fixed-rate mortgages and refinanced at much lower rates and spent the money.
The biggest problem we're facing the world today is that in the United States asset values are way too high and leverage debt is way too high. And as people are walking away from the assets, the losses are impacting on the balance sheets of Banks and the banks have to be recapitalised. So what we're facing in the world is not a liquidity crisis, it's a solvency crisis. That's why the interbank rate is 2.5 per cent. Do you understand the point? A bank won't lend to another bank because they're not sure the other bank is solvent. It's not a matter of money in the system that week. It's not liquidity, it's solvency.
LEIGH SALES: But if we look at the big picture, what I want to know is, is Australia still on the old wave that's ending or are we riding the new wave?
PAUL KEATING: Oh, no. We're in a much better position. We've got superannuation here at $1 trillion. Now this country's 20 million people. The United States is 260 million people, 13 times the population. Pro-rating that, the Americans would have if they had our super scheme, they would have $13 trillion of savings. That's the size of the American property market. So we have something they don't have.
But what we need to do is to make those savings more useful, we have to do what I think is financial engineering, that, is you see, if your mortgage or my mortgage is a safe mortgage, let's say it's a triple A mortgage, it's half equity or it's half debt or better, there's no reason why the super funds can't hold those bonds. No reason at all. Instead of that, they're holding equity, so they're falling. They were holding property in the real estate investment trusts, they've all gone down on average about 70 per cent. But if they were holding Leigh Sales' mortgage and you're paying them 8 per cent, wouldn't a super fund be better earning eight from you than going minus five out of the stock market? Of course they would.
LEIGH SALES: Let me ask you some very sort of blunt questions and have you respond simply and briefly to them. Do you agree with people that Australia is well poised to deal with this crisis because we're buffered by China?
PAUL KEATING: Yes, we've got the terms of trade kicker. We have a strong, prudentially well supervised banking system with good capital asset ratios. We've got super which is the big asset. So the answer to that is, yes and we have a flexible economy and flexible exchange rate.
LEIGH SALES: Are you in favour of this US bailout plan?
PAUL KEATING: Yes. But the problem is, you see, the debt out there I think at the moment, the gap between American housing debt and American housing values is probably $5 trillion or $6 trillion. So three-quarters of $1 trillion is not going to do the job. What we're in here is a long change, long change. Essentially, what's happening is that the governments are being asked to recapitalise the banking industry. And we can do that. But it requires a bit of thought and brain power and some courage.
LEIGH SALES: Even though economic cycles always turn and Australia has had a long period of prosperity and so we're in line for it, how much of a risk is it for Labor that if Australia does go into a recession, that Labor will be held to blame for that and you could be then looking at...
PAUL KEATING: We all get blamed for recessions. I mean, there's no doubt about that. But it's the Government's job to do what is conscientious and right, right? Now, the key thing now for our banking sector is to keep them lending. If you get to a point in your economy where the banks don't lend, the whole financial system of the modern age stops. Now, they won't lend if they can't get, if they can't fund themselves appropriately.
LEIGH SALES: That's all true, but I wonder if this sort of nuance is something that people out in voter land understand, or if they just look at it, "Oh, we've got a Labor government, oh, we've got another recession going on. We had a recession last time we had a Labor Government."
PAUL KEATING: You know, anyone educated in this system, and you mentioned Malcolm Turnbull earlier tonight. Malcolm knows that the interbank rate's 2.5 per cent. He knows full well how banks are going to be battling.
LEIGH SALES: But lots of people probably don't understand it.
PAUL KEATING: Now, if people want to believe in fairy tales, that's fine. But it's very costly. So a Government's job is to steer their way through. Australia is in a good position but, you see, we don't have enough savings. The last Coalition Government refused to increase superannuation from 9 to 15 per cent. Had they done so, our banks would not be out there in these polluted markets bidding for as much savings as they have to to fund the current account deficit, right? A current account deficit exists because the call on it by investment on our savings is higher than the level of our savings. So what do you do? You either cut investment or lift savings.
Howard and Costello refused to lift savings. So the banks are still out there knocking on the door in New York, and they'll do it this well, they've got to find $1 billion a week fundamentally, in these markets. A billion a week.
LEIGH SALES: Mr Keating, too much to talk about, too little time. Thank you very much for joining us.
PAUL KEATING: Thank you. Bye.
rtsp://media1.abc.net.au/reallibrary/lateline/200810/20081001-late-keating_16_9_bband.rm