Joe Hockey (North Sydney, Liberal Party, Manager of Opposition Business in the House) Share this | Hansard source

I do not intend to make this a particularly political speech, but I think it is important to get on the record what has occurred and what may occur in the future. The only point I make is that I remain genuinely disappointed that the Prime Minister has not addressed this parliament on what is the greatest financial crisis of our generation and maybe even beyond. I am at that point because I think someone needs to explain to the Australian people how this all happened. It needs to be explained. How did this all happen?

The starting point is that we have seen the failure of a significant financial product, the subprime mortgage. In the United States, with significant real estate growth in property prices and in supply, we saw that, as prices of real estate were going up, increasingly lax lending practices were being introduced. As that occurred, we found that when inflation was going up, in part as a direct result of rising oil prices and rising food prices, the people who could least afford to repay a mortgage had to choose between their mortgage or putting fuel into their cars and food on the table. As we saw a gradual increase in the default rate in the subprime market around March-April 2007, we saw the first collapse of subprime mortgage lenders in the United States. When the first one went, others followed and, as the market started to collapse, it was pretty obvious by around September 2007 that there was a growing systemic crisis in financial markets.

There is an indicator of the real impact on financial markets, known as the TED spread, which is a measure of credit risk for interbank lending. It is the difference between the three-month LIBOR—LIBOR being the London interbank offered rate, the rate at which banks lend to each other—and the US Treasury bill rate. I would appreciate the opportunity to table a chart, which I will show to the parliamentary secretary at the table in a moment. The TED spread—that is, the gap between the US Treasuries and the rate at which banks were prepared to lend money to each other—grew dramatically in about September 2007, at one point reaching three per cent. This was the moment—in September 2007—when confidence in the financial system collapsed, when the blood flows of the body of financial services suddenly froze up, when banks said to each other, ‘We do not trust you.’ The reason that is so significant is that if banks do not trust each other then banks are not going to trust corporates and they are not going to trust individuals.

The real impact of this crisis is on the poorest people in the community, who are the greatest credit risk. That is where it starts. In part, there was encouragement from the US congress and the President of the United States years ago to lend money to people who were least able to afford the repayments. When that occurred, suddenly the financial system was being used to deliver social policy—that is, housing for poorer people—rather than allowing the financial markets to properly price risk. That is what financial markets do: they supply credit and they price risk. When a government regulatory distortion occurs, it distorts the pricing of risk, it distorts the availability of credit and the net impact is that financial markets seize up.

I read an article by George Soros, ‘The crisis and what to do about it’, which appeared in the 4 December edition of the New York Review of Books. It is a powerful article. Mr Soros recognises:

The crisis was generated by the financial system itself.

The difference between this recessionary outlook and previous recessionary outlooks is that on this occasion it is the banks that have been collapsing. It is the banks that have been in financial distress. In the eighties in Australia we had corporates in financial distress, driven in part by the activities of people like Christopher Skase, Alan Bond and a range of others. This time it is not the satellites that have been falling out of the sky but the mother ships, the mother ships being the banks that keep the blood flowing. When we saw the dramatic collapse of the subprime lenders and then the mortgage insurers—AIG in particular—and when we saw Fannie Mae and Freddie Mac go into significant states of financial distress, we saw the mother ships start to come down, and of course it was going to spread right across the world community. It was going to spread right across the world community as two things occurred. The first was that there was a rapid repricing of credit risk. Despite central banks around the world—apart from Australia, which I will come back to—dramatically dropping the cost of funds, there was still the fact that the markets had to price in risk and, in pricing in risk, there was a massive increase in the TED spread. That in turn had a huge impact on the cost of credit for corporates. Governments had to step in, particularly the government of the United States, which I think was too slow to step in—and the Europeans are still too slow, even though the British moved quickly. As that all occurred, it became clear that bank guarantees were becoming sovereign guarantees and the value of a bank guarantee was equivalent to that of the country from which the bank came or in which it was based.

That comes back to a point which I was going to talk a little bit about earlier—that the financial crisis becomes an economic crisis, which in turn becomes a political crisis, because banks that are based in countries with poor credit risk are going to in turn suffer the same fate as a financial institution or a corporate with poor credit risk. As Mr Soros says:

A deep recession is now inevitable and the possibility of a depression cannot be ruled out. When I predicted earlier this year that we were facing the worst financial crisis since the 1930s, I did not anticipate that conditions would deteriorate so badly.

…            …            …

Usually markets correct their own mistakes.

How true that is, but the challenge is that financial markets are unable to correct their own mistakes when the markets themselves become distorted. I think one of the most important statements that George Soros makes is:

In view of the tremendous losses suffered by the general public, there is a real danger that excessive deregulation will be succeeded by punitive reregulation.

That is a key point. When I was Minister for Financial Services and Regulation a few years ago, we had to get the right amount of regulation—not too much regulation but enough to keep the markets honest and transparent—whilst at the same time having a free and open market that allowed the markets themselves to properly price risk.

There are going to be stabilisers in the system. One of the stabilisers in our system is the fact that we have a very liquid currency, a currency that is very well traded, but a currency that also in recent times has been hammered. If you look at the changes in trade weighted exchange rates between 31 July and 23 October this year, the Australian dollar has fallen by 30.8 per cent, compared with falls in the currencies of Brazil by 25.6 per cent, Korea by 24.2 per cent and the United Kingdom by 2.5 per cent. The yen has gone up by 15.8 per cent and the US dollar by 12.3 per cent. In part that is because there has been a movement from other global currencies towards the yen and the US dollar as a flight to safety. Also, the Australian dollar has become a surrogate currency for the other currencies of the region which are not widely traded or floated. Therefore, the Australian dollar has been punished. There are upsides and downsides to that, of course. One of the challenges with a falling currency is that there is a risk that our imports, being more highly priced, are going to feed into the inflationary challenge. As that occurs, inflation might prove more of a challenge than we expect.

However, the fact of the matter is that Australia is in a better position than most other countries. It is in a better position for two key reasons. Firstly, our financial services regulation is amongst the best in the world—if not the best. It is regulation that we thought very carefully about, beginning with the Wallis review initiated by Peter Costello and further delivered in individual reforms, including my Financial Services Reform Act, which in effect ensured that Australia could not go down the path of the US in delivering credit to people who could not afford to repay it. In doing so, we tried to regulate—or regulate out of existence—low-doc and no-doc loans and we tried to have a greater level of regulation on the provision of credit. In that case I got too much resistance from the states, which wanted to retain control of credit. It was a challenge at the time but we got the balance right.

We got the balance right with the creation of APRA and ASIC and the separation of the three regulators into individual regulators—the central bank, the prudential regulator and the corporate regulator. The relationships are different in the United States and the United Kingdom, but what you get out of having three separate regulators, which we initiated in government, is that that they can focus on the challenges that directly affect them. And so, when HIH collapsed, APRA and ASIC were able to focus on meeting the challenge of what could have been a systemic collapse of the insurance market in Australia, and the RBA continued to focus on its challenge. Rather than having, as is the case in the United States, the prudential regulator and the central bank effectively as one or, as is the case in the United Kingdom, the corporate regulator as a standalone almost private sector operation with the Bank of England focusing on central bank activity, we got the formula right. It is the first great initiative that Australia is reaping the benefit of.

The second initiative is the fact that the budget was in surplus, that the Australian government has no debt and that we have a diverse economy. We have some lag indicators of benefit to the Australian economy. Those lag indicators are continuing benefits of the commodity boom but there is still a significant amount of deleveraging that needs to occur in relation to commodities, and so the assessment that the commodities boom would continue—which was made by the government earlier this year—was just dead wrong. Notwithstanding the fact that China has had a massive injection of fiscal stimulus, the fact is that, if China does not grow at nine per cent per annum, it will not create the 15 to 20 million jobs a year that are needed in that economy. There are economies around the world which are going to suffer dramatically if they do not continue to create the jobs that keep their people employed and, most importantly in developing countries, keep their people fed.

I said on the Sunday program that I am bearish. I cannot hide that fact. I live in hope that we will see this through. I really do. I think we have to have a message of hope but also, if people are going to level with the Australian people, we need to recognise that this is going to be a very challenging time and why. In the first place, if it is bad for individuals to have too much debt and it is bad for corporations to have too much debt, it is going to be bad for countries to have too much debt. Any country that is debt laden and which will potentially default on its repayments is going to suffer the serious pain associated with the global financial crisis. I fear that the United States, the United Kingdom and Europe will not have the appetite to bail out defaulting countries in the way they have in the past.

Secondly, it needs to be recognised that the recession in Europe is even deeper than that in the United States. In part that is a direct result of the fact that Western Europe funded the massive expansion and growth of Eastern Europe over the last few years. The expectation that in some parts of the world there will be economies that will be able to fully withstand the impact of this economic crisis is just dead wrong. As countries in South America and even in Asia and in Europe start to default on their loans, the question is: who is going to give them the money? Will countries like Australia, the United Kingdom, Europe and the United States have the appetite when there is rising unemployment? In the United States’ case three-quarters of a million houses were foreclosed on in the last quarter. People were living in their cars.

You say to yourself, ‘Now is the time more than ever when we need to have money in the kitty not just to help ourselves but importantly to help others because that potentially leads to the political challenges of tomorrow.’ I am sorry I am running out of time on this, but someone at some point needs to call it as it is, to go beyond the spin of tomorrow’s headlines and to say, quite frankly, that these are potentially the most challenging times our people have ever faced. Whilst it started as a financial crisis, it is now an economic crisis. The inevitability is that it will lead to some political crises in our region or around the globe and now is the time when we need to prepare. I seek leave to incorporate the chart in Hansard.

Leave granted.

The chart read as follows—

See this speech in context