11 Jul 2018
The worst financial crisis since the Great Depression, variously described as the Great Recession, the Lehman Shock or the GFC, had its signature moment a decade ago this weekend.
That was when Lehman Brothers, the American bank which actually was a loose-knit agglomeration of nearly a thousand disparate businesses, was allowed by regulators to fail.
"The most afraid I’ve ever been was not when I was shot in the leg… but when the financial system teetered after the wreck of Lehman”. – Mike Smith, former ANZ CEO
They allowed it to fail because they couldn’t find a buyer after Lehman experienced the equivalent of a bank run – a liquidity crisis rather than a solvency one. It had enough assets, just not enough cash.
Whether Lehman should have been saved or some other measure adopted is an ongoing debate. Allowing it to fail though without a doubt precipitated the greatest financial system panic in living memory. Capital markets froze, myriad financial companies failed and governments were forced to desperate measures. The repercussions are still being felt.
ANZ’s former chief executive Mike Smith has mused more than once he would begin his memoirs with the line “the most afraid I’ve ever been was not when I was shot in the leg trying to escape a blockade in Argentina but when the financial system teetered after the wreck of Lehman”.
Yet the Australian financial system endured as well as any in the world. While some institutions had to be taken over, none failed outright. Taxpayers actually made more than half a billion dollars guaranteeing the banking system. The economy didn’t even suffer a recession.
There’s been no shortage of accounts of the crisis in recent weeks, the most interesting drawing on interviews with prominent figures of the time from the Reserve Bank of Australia, the Australian Prudential Regulation Authority and the Federal Treasury.
These accounts are fascinating, some of the detail revealed for the first time. But what has been missing to date has been acknowledgement of the human dimension of Australia’s exceptionalism.
In short Australia succeeded because it had a relatively recent history of failure. It meant there was a degree of humility all round and a willingness to admit unprecedented times called for unprecedented actions.
In the aftermath of the crisis I wrote a series for The Australian Financial Review on how Australia dodged the crisis.
"I think one of the main reasons things went so right in Australia for the major banks is that they went so wrong in the 1980s and early 1990s," Bob Joss, the American executive brought in to save Westpac after its near death in 1992, told me.
"All the majors, perhaps Westpac the most since it suffered the biggest credit losses, had to start with the basics and strengthen their credit cultures and processes after realising how poorly they had performed in this dimension during the 1980s boom.”
“In this regard, the Australian banks were ahead of the curve compared to other major banks around the world, and were early adopters of better risk management systems and practices."
There were similar scars at the regulators.
"We had our clarion call with (the failure of general insurer) HIH," then APRA chairman John Laker told me. “It was almost like 'don't mention the HIH war' for a few years. It's in APRA's record but [the lesson of HIH] proved its worth in the financial crisis."
The other human element which stood Australia apart was regulators and supervisors talked. As then RBA governor Glenn Stevens said: they knew one another’s phone numbers. Indeed Laker came from the RBA.
Unlike the UK, where regulators from the prudential and competition sides had conflicting mandates, or the US where gaping holes existed because of multiple regulators with unclear mandates, Australia’s regulators at the time acted in concert.
Indeed, the then relatively new Council of Financial Regulators, comprising the RBA, APRA, Treasury and the Australian Securities and Investments Commission, was central to the response.
The key actions taken – the RBA providing almost unlimited liquidity to the system, a huge fiscal stimulus package from the government, an unprecedented deposit protection scheme and the guarantee of bank liabilities by the government – were understood across the regulatory universe and coordinated.
Moreover, the RBA and APRA had not been idle in the run up to the crisis. The RBA had been lifting interest rates in response to inflation, APRA had been tightening capital rules and stress testing banks and – perhaps more critically – the mortgage insurance industry while increasing its supervisory activities. The RBA had named and shamed a housing ‘bubble’ in 2003-4.
Whether ‘Fortress Australia’, as it was known, was the result of good luck or good judgement, those memories of crises and the coordination were fundamental features. Prudent policy bought its own luck too: Australian banks, as a rule, didn’t need to chase yield (and hence buy the toxic mortgage-backed products behind the US crisis) because interest rates here were much higher and the system was profitable.
Of course, China’s enormous stimulus package, which translated to an enormous boost to Australia’s terms of trade via higher bulk commodity purchasing, helped a lot.
The slightly unnerving element of the current anniversary coverage of the crisis - and indeed what is playing out in public debate - is those less tangible elements of Australia’s experience are being overlooked.
There’s an element of truth in the arguments that some hubris has built up after the crisis. It’s almost the flipside of what happened before: previous crises placed Australia in good stead; this time avoiding the GFC has created complacency.
It seems almost forgotten though there is a tension between competition and stability. Policy makers quite rightly made stability a priority as the world crumbled. That was the right call at the time and while the crisis is still playing out a decade later, it needs to be born in mind.
Competition is the great servant of consumers but there’s always destruction when it comes to creative destruction.
Perhaps most concerning though is signs of tension between regulators, particularly as the Royal Commission into Financial Services brings a spotlight onto particular actions.
Whether the ‘twin peaks’ model of regulation brought in after the Wallis Financial System Inquiry needs modernising or not, at the heart of Fortress Australia was communication and coordination, not turf wars. All policy makers and government worked together.
If another crisis eventuates – and it will – it is to be hoped the RBA, APRA, ASIC and Treasury, as COFR, can confidently deliver what they did 10 years ago: a detailed, five-page Memorandum of Understanding on Financial Distress Management laying out the protocols for dealing with the crisis, including Treasury's core role in giving advice to the government.
Andrew Cornell is Managing Editor at bluenotes. His analysis of Australia in the financial crisis won the 2010 Walkley Award for criticism, analysis and commentary.
The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.
11 Jul 2018
12 May 2015