The ingrown toenail of Australian politics

This is a story that was on ABC recently but is so good I had to put it up here too. I especially love the Paragraph Highlighted in Orange.

By Tim Dunlop Updated Mon 20 Jan 2014, 1:26pm AEDT

Neither major political party any longer represents the electorate as a whole, writes Tim Dunlop. They have instead become self-perpetuating mechanisms for the advancement of their own kind. What we are seeing in Australia at the moment is a collapse in the relevance and standing of our political class. By "political class" I mean those organisations and institutions involved in the day-to-day work of running and informing the country, most especially, the major political parties and the mainstream media.

How did this come about? It begins with the parties themselves, as they are ultimately the institutions on whom we rely to not only carry the weight of sensible political discussion but to stand up to the various rent seekers (from mining companies to retail magnates) who think the country should be run for their benefit. Both Labor and the Coalition are failing to do either.

The opinion polls that once (allegedly) showed our desire to change government and install the Coalition have already swung back the other way. The problem is that neither major party any longer represents the electorate as a whole. They have instead become self-perpetuating mechanisms for the advancement of their own kind.

In the absence of a broad membership, Labor and the Coalition have become inwardly rather than outwardly focussed, the captive of special interests. Their reason for being is no longer to serve but to continue to exist.

Both parties are riven by internal disputes that have less to do with policy differences (that is, visions for how to make the country better) than with factional power. The most obvious example is the insane infighting that culminated in the Rudd/Gillard disputes of the last few years. Nothing has done more to undermine the credibility of the Labor party than these so-called "leadership" battles.

The Coalition has benefitted from Labor infighting in that they are the only major alternative for which people can vote, but that doesn't mean that people are happy with them either. In fact, major factional battles exist within the Coalition too, and they are driven by the same malaise: a disconnect from the electorate at large and an inability to articulate a vision of the national good outside their own obsessions.

Even an ideologue like News Ltd journalist and former Liberal staffer Chris Kenny is honest enough to admit the fact. Back in 2009, as Tony Abbott ousted Malcolm Turnbull as party leader, Kenny wrote:

The federal parliamentary Liberal Party has become, in a practical sense, divided into two separate and disparate parties, one in the Senate and one in the house. The Senate party is deeply conservative, reluctant to take action on climate change and supports Tony Abbott as leader. The Liberal Party of the House of Representatives is moderate, supports an emissions trading scheme and prefers Malcolm Turnbull as leader. In the recent leadership change and policy U-turn over the emissions trading scheme, the Senate party imposed its will on the house party. ...the conservative minority pushed for a leadership spill but still fell well short of the required numbers. Confronted by this defeat, the conservative wing, from its power base in the Senate, unleashed a shock-and-awe campaign of frontbench resignations, forcing the Liberals into a policy and leadership crisis, from which Abbott won by a solitary vote.

He concluded that, "The Senate-house divide, unchecked, could lead to a fatal disconnect between conservative politicians and the people they seek to represent." That's exactly what is happening and it is what I call the ingrown-toenail syndrome of Australian politics: a seemingly endless bout of political self-obsession.

The net effect of it is the rise of a harsh partisanship of which the Abbott government is the most successful proponent. Public policy is no longer seen as a long-term process of trying to enact reforms that are to the benefit of the nation as a whole, but as a winner-takes-all game where the incumbent gets to reshape the country according to its own prejudices. Or rather, the prejudices of the dominant faction within the governing party. Under such circumstances, the emergence of Cory Bernardi is not an aberration but a logical development. When parties stop reflecting the mainstream of voters, marginal ideologues emerge, and Bernardi represents a particular faction within the Coalition trying to assert itself so that it gets to play its part in the game of "reshape the country".

The electorate's dissatisfaction with all this is palpable. The opinion polls that once (allegedly) showed our desire to change government and install the Coalition have already swung back the other way. And polls are far from the only indication of our dissatisfaction. At the last federal election, more of us voted for someone other than the major parties than ever before. As Antony Green summarises:

Support for minor parties and independents reached record levels for both the House and Representatives and the Senate at the 2013 election. Support for non-major party candidates reached 21.1 per cent in the House of Representatives, representing more than one in five of all votes. In the Senate, support for non-major party candidates reached 32.2 per cent, just under one in three of all votes. ...In the House the 21.1 per cent non-major party support broke the 20.4 per cent record at One Nation's first election in 1998. The level of support for independents and minor parties has now been above 14 per cent at every election since 1996. Non-major support in the Senate has always been several percentage points higher than in the House. The new record of 32.2 per cent surpasses 26.2 per cent in 2010 and 25.0 per cent at One Nation's first election in 1998. Minor party and independent support in the Senate has now been above 19 per cent at every election since 1996.

These are incredible figures and they show how we are desperately scratching around, trying to find an alternative. At the moment, the system is throwing up "solutions" as diverse as Palmer United and Cathy McGowan, but small parties and independents alone cannot properly address voter concerns. Indeed, under such circumstances, the very act of voting deepens our sense of powerlessness rather than allaying it. We simply don't feel we are getting a parliament with our best interests at heart.

Compounding the problems is the collapse of coherent public discussion. The mainstream media, in print and on television (television being where the vast majority of us still get our political information) simply can't cope. They either oversimplify everything to the point of caricature, or they become - as is the case of the Murdoch newspapers - openly and comically partisan. This partisanship is in part the result of the financial problems within the media industry, an attempt to consolidate what small market share they have by pandering to the converted. It is probably inevitable. But I don't think it is our chief concern.

The problem is more fundamental. The media isn't failing because their business model is broken (though it is). They are failing because their news model is broken. They, too, have lost touch with their audience, in exactly the same way that the political parties have. Audiences are bored and turned off by the way politics is covered and the editors and journalists in charge of things have little idea about how to respond. So just as people have sought alternative candidates come election time, they are also seeking alternative sources of news and information as they try to get their head around the changing political environment. The emergence of social and other online forms of new media is most welcome: can you even imagine how much worse things would be if we were still limited to the handful of media outlets we were stuck with before the invention of the internet? Nonetheless, new media is still in its infancy. And just as a few independent MPs cannot fix a parliamentary system struggling for relevance, a few new news sites and social media pages cannot replace a coherent, focussed and properly functioning fourth estate.

Where does all this leave us? The bottom line is that we are passing through a period of transition, and the trick at this stage is to step back from the day-to-day trivia and see the big picture. That's a lot easier said than done, but the ferment obvious in our national politics - from our voting patterns to the way we are now consuming media - suggests an engaged electorate actively thinking about how to make things better. It is from such engagement that reinvention will emerge.

Proper Discourse

Occupy Wall Street is a protest movement that began September 17, 2011 in Zuccotti Park, located in New York City's Wall Street financial district, initiated by the Canadian activist group Adbusters. The protests are against social and economic inequality, high unemployment, greed, as well as corruption and the undue influence of corporations on government—particularly from the financial services sector. The protesters' slogan We are the 99% refers to the growing income and wealth inequality in the U.S. between the wealthiest 1% and the rest of the population.


Prior to the global financial crisis, Australia had a diverse and highly competitive financial system. The four major banks went head-to-head with the likes of St. George, BankWest, Bendigo Bank, Aussie, Adelaide Bank, RAMS, Wizard, and Challenger.

Today every single one of these entities has disappeared as a genuinely independent concern, wholly or partly acquired by the majors (with competition concerns waived by the ACCC), or merged with one another.

Prior to the crisis, Australia's banks were not explicitly government-backed. And taxpayers had never guaranteed bank deposits before (or conceived of providing such guarantees for free as they currently do), nor had they ever guaranteed the banks' institutional debts.

The taxpayer-owned central bank, the Reserve Bank of Australia (RBA), had also never lent to the banks on the much longer-dated and more flexible terms that it offered as the financial markets meltdown started to gather momentum, and continues to offer to this day.

The reason taxpayers had not got into the business of bailing-out private banks was because of a well-founded fear of "moral hazard". That's the concern that once you start insuring away a private company's risk of failure, you remove the critical disciplining influence of free markets. And executives will, over time, start behaving less responsibly, and expose taxpayers to even greater risk of loss.

Banks have nevertheless always been different to private companies because they perform a vital social function: they take our short-term savings and transform them into long-term loans. They run this constant "mismatch" between the term of the funding they receive from depositors (eg, mums and dads) and the length of the loans they give to businesses and households.

As a result, banks have always risked insolvency if their funders rapidly withdraw their money. In the 1890s, before the RBA existed, most of Australia's private banks failed. That's why we now have a public "central bank" that lends directly to the private banks. And it's the reason we have a banking regulator, APRA, to ensure that the banks hold enough "capital" to cover liquidity shocks.

We were compelled to write this op-ed because we're convinced that the policymaking surrounding Australia's banking system has been predicated on a flawed and risky paradigm: the frequently-referenced — by APRA and the RBA — trade-off between "competition" and "financial stability", which ends-up favouring a more concentrated industry.

Today Australia's prosperity relies on four colossal banks — or "oligopolists" — worth around $50 billion each. They control 80-90% of all financial transactions executed across the country. Importantly, the introduction of government guarantees for the first time during the GFC bequeathed them with a unique comparative advantage.

In contrast to their smaller rivals, the four majors are now regarded by credit rating agencies and investors alike as "too-big-to-fail". The majors get the benefit of credit ratings that have been explicitly lifted "two notches" higher than they would otherwise be because Standard & Poor's thinks they alone can depend on "extraordinary government support" in a crisis.

This helps them raise money much more cheaply than their smaller peers, which in turn means it is almost impossible to compete effectively against them. Size thus begets more size.

Some recent advertising campaigns have claimed that "the banks are at war for your home loan". Both the new head of the ACCC, Rod Sims, and we disagree. A few weeks ago Sims concluded,

    Normally four players in a market should lead to a lot of competitive activity. In the banking sector it seems to need more because even though there are four of them there is a lack of full and effective competition.

While they rank amongst the 30 largest banks in the world, Australian policymakers have worked surprisingly hard to have the four majors excluded from the extra capital charges that global regulators are sensibly insisting the biggest, and most "systematically important", banks hold.

For a number of years we've suggested this is misguided and symptomatic of a worrying oligarchy between Australian banks and their policymakers. Last month the IMF agreed with us, arguing that Australia's major banks should, in fact, be forced to hold extra capital as systematically important institutions. More capital means less leverage and less taxpayer risk. So why exempt the majors, particularly when they have designs on higher-risk growth strategies overseas?

An additional capital buffer for systematically important banks would also be an intelligent disincentive to becoming too-big-to-fail. And it recognises a point we've made for some time: in many ways the catastrophic risks posed by smaller and simpler banks, like Bendigo & Adelaide, Bank of Queensland, and Members Equity, are a fraction of those threatened by the majors.

In all properly-functioning financial markets there is an inexorable trade-off between risk and return. The higher the risks you take, the higher the returns you generate. But in Australia this maxim has been turned on its head: in Australia, the supposedly lowest risks banks with the highest credit ratings — the majors — are somehow able to yield the highest shareholder returns. In contrast, the smallest banks, with the lowest credit ratings, produce much lower returns on equity. This complete reversal of the inverse relation between risk and return is the purest possible illustration that taxpayer subsidies are being used for the benefit of the banking oligarchy to the detriment of meritocratic democracy.

During the GFC, most of the smaller banks did not use the taxpayer guarantees of wholesale debts because the premium paid for the guarantee was, ironically, based on the banks' credit ratings. This made it cheapest for the major banks to use the government’s insurance, which they did in vast volumes. It was peculiar that Treasury decided to price its insurance using the same rating agencies that had missed so many of the moral hazards that triggered the crisis in the first place.

A more subtle example of how the system encourages extreme size are the terms on which the banks borrow from the RBA. When doing so, banks have to pledge an asset as collateral to get RBA funding. Included in the list of "eligible" assets the RBA will accept as collateral is any senior debt issued by an Australian bank. But historically that debt had to have a credit rating — yes, there it is again — of A- or higher, which excluded the debts issued by smaller regional banks and building societies. Since the major banks were amongst the few that qualified for the RBA's funding, this helped further support investor demand for their bonds, and thus lowered their cost. While this month the RBA cut the minimum rating to BBB+, this still excludes several smaller banks and building societies.

A final example of the unanticipated consequences flowing from recent policy decisions is the advent of so-called "covered bonds".

In the past, the first-ranking creditor to any Australian bank has been depositors. It was illegal to issue a debt security that subordinated depositors, which precluded covered bonds. When a bank raises money from an institutional investor, it normally issues an "unsecured" loan. This means that if the bank goes belly-up, the investor must queue up behind mum and dad depositors when getting paid out.

In contrast, a "covered bond" allows banks to issue loans to investors that are secured by specific bank assets. The investors thus have a claim on these assets that ranks ahead of everybody else, including mums and dads. Securing their covered bonds with billions of dollars of home loans has allowed the four AA- rated major banks to win rare AAA ratings for their funding.

The problem for the smaller banks is that they do not have the major banks' credit ratings, which, as noted earlier, are lifted higher because the majors are regarded as too-big-to-fail. And since the smaller banks have far lower credit ratings, they would have to pledge many more assets to secure a AAA-rating for their covered bonds. The bottom-line is that this makes it, in the words of one bank CFO, "non-economic" for them to do so, much like it was non-economic for them to use the government guarantees during the crisis.

In the last four months the major banks have raised about $17.5 billion of new funding via their AAA-rated covered bonds. None of their competitors has followed suit.

Setting aside the fact that allowing the majors to issue covered bonds has provided them with another fund-raising advantage over their rivals, there has been a second, perhaps more damaging, consequence: it has significantly increased their competitors' cost of funding.

CBA and Westpac's sale of around $7 billion worth of covered bonds to Australian investors has created a new ultra-safe, domestic asset-class. By doing so, it has made every other bond, including the unsecured, more lowly-rated bonds offered by smaller banks and building societies, more expensive.

The former head of capital markets at Standard and Poor's, Phil Bayley, concludes, "The bad news coming out of CBA's covered bond issue is that all other debt issues in the market will be more expensive … One of the hardest hit asset-classes will be securitised home loans, which has been a key source of funding for smaller lenders."

That, frankly, is a short-strokes summary of the policy problems we are focussed on. While resolving them will require leadership, we believe that there are tractable solutions. Here are three:

1) Change the policy paradigm: It is often said in financial markets that neither APRA nor the RBA care much about banking competition, and would prefer it if there was only one bank to regulate. Policymakers have been captive to the idea that there is an unavoidable trade-off between improving competition and reducing financial system risks. They are wrong.

As a matter of pure logic, a financial system reliant on four $50 billion banks that are regarded as implicitly government-guaranteed (much like Fannie Mae and Freddie Mac were in the US) is surely less secure, and more prone to moral hazard, than one based on, say, ten, $20 billion banks, each small enough to fail without causing widespread damage. Think of ten pillars as opposed to four.

We learnt from the US experience with Fannie and Freddie that there is a threshold beyond which size becomes a massive "contingent liability" for taxpayers. Like the major banks, Fannie and Freddie could raise money more cheaply than their competition because investors believed they were government-backed. And they were right. Both institutions are now owned by US taxpayers.

The learning from this is that we need to remove the regulatory incentives that actively encourage size of the too-big-to-fail variety. And we should consider, at the very least, explicit breaks on banks becoming too big, and then using this size advantage to horizontally consolidate other industries, such as funds management, financial planning and insurance.

One policy option is a progressive financial taxation regime, such as that being proposed in Europe, which attempts to price the too-big-to-fail subsidy: ie, the bigger you get, the higher the price you pay. Today the system is stacked in the opposite direction: as a bank’s size increases, all its costs decline.

2)  Guarantee the assets, not the institutions: Australia's financial system already suffers from moral hazard writ large. Taxpayers are guaranteeing billions of dollars of bank deposits for free, and the majors have artificial fund-raising advantages through their credit ratings and new devices like covered bonds.

There is, however, one solution, which we’ve advocated in the past. All these financial subsidies come back to the fact that there is a catastrophic risk that only governments can insure. That's why the government guarantees bank deposits and bank debts. That's why the government's central bank — the RBA — explicitly refers to itself as the "lender of last resort" to private banks during crises.

Moral hazard emerges when this taxpayer insurance is not properly priced. So let's allow the taxpayer to earn a fair return and iron-out the dysfunctions at the same time. The simplest and most conceptually elegant way to do this would be to offer a permanent government-guarantee of bank-issued, asset-backed securities. This would allow any bank, irrespective of size, to issue asset-backed bonds that had the highest possible credit rating.

So long as the underlying asset quality met the required criteria, this would in turn mean that minnows like ME Bank and Bendigo & Adelaide could raise funding at the same price as CBA or Westpac. It would immediately level the competitive playing field, and remove many of the majors' regulatory advantages. And, as the current Chairman of ASIC, Greg Medcraft, leading economist Dr Nicholas Gruen, and we have argued before, there is a compelling precedent: Canada. The Canadian government offers exactly this type of insurance to its lenders. So why can't we?

3)  Back the government's banking regulator, not the rating agencies: the cost of the RBA's lender of last resort facilities, and the price of government guarantees (determined by Treasury), has been based on a bank's credit rating. This confers immediate fund-raising benefits on the majors. Yet Australia's banking regulator, APRA, is responsible for setting the banks' capital requirements, and overseeing their risk management, with powers to intervene directly with a bank if it thinks something is wrong.

Since the government licences the banks, controls their risk management, and can directly remedy any issues it identifies, the government should be willing to rely on itself when determining the price of taxpayer support. We believe that the cost of government insurance should be the active and intrusive regulation of APRA, and generally priced the same, irrespective of an institution's size. If APRA is doing its job properly, ME Bank should pose no more risk to taxpayers than CBA (and vice versa).

Australia can build both a more stable and competitive financial system. All it requires is real leadership. That is the challenge politicians and policymakers now face.