A "sound financial system" is a big reason Australia had one of its "mildest" recessions in the post-War period while the US and several European countries had one of their "most serious", Reserve Bank of Australia governor Glenn Stevens said in April.
One is a cooling housing market. After rising for 16 consecutive months, capital city house prices were virtually unchanged in April, according to the RP Data-Rismark Hedonic Home Value Index. Weak demand for home loans – the number approved in April was the lowest since March 2001 – suggests other capital cities might soon follow Brisbane, Perth and Darwin, where prices are already falling.
If this happens, bank profits are sure to follow. Why? Because the share of home loans in banks' total lending stands at 58 per cent, according the RBA. Falling house prices spell fewer buyers, borrowing less and paying banks less interest.
If they fall enough, house prices can drag down an entire economy. This is what happened in the US in 2006 when falling prices led to a jump in the number of Americans unable to pay their mortgages and, a year later, a sharp rise in unemployment. The newly jobless swelled the ranks of defaulters until the losses tipped thousands of US banks and mortgage firms into bankruptcy and the global financial system into crisis.niversity of Western Sydney economist Steve Keen can see something similar happening in Australia. He says households are so indebted – the ratio of mortgage debt to gross domestic product has quintupled to 85.7 per cent over the past two decades – they can borrow no more."Our current level of economic performance is dependent on an increasing level of debt to GDP," Keen says. "As soon as you have a stabilising, which we are seeing now, then you are in trouble."
The head of the RBA's financial stability department, Dr Luci Ellis, counters that the recent US experience is historically anomalous. "Financial crises are normally sparked by other sources," she told a conference in May. "These [sources] include commercial property, property development, leverage buyouts, sovereign debt and so on."Which is why the developing sovereign debt crisis in Europe provides a second reason to worry about local banks. While the big banks have little exposure to European governments in difficulty, the RBA's Stevens concedes the most important effects in Australia will come through "the impact on world and Asian growth, on resource prices and on the cost and availability of global capital"."A collapse in China – or even a global slowdown – will have an impact on the economy, Australian income growth, and that would certainly feed into house prices," Australian School of Business researcher Glenn Otto says. "The impact of unemployment is also crucially important for house prices; an economic shock pushing up unemployment would have even more consequences for house prices."While few economists are as pessimistic, most agree the big banks are now too big for any government to let fail. "They are all too systematically important to fail," real estate funds manager Rismark's managing director, Christopher Joye, says. "That is one reason why taxpayers offered the major banks deposit and liability guarantees during the GFC."
Fortunately, they did not have to draw on those guarantees. But what if they do in the future? Is the government's balance sheet big enough to cover the big banks' deposits and liabilities?"The Armageddon outcome would be the complete implosion of the banking system if taxpayers were not there to backstop institutions in the case of a crisis, which could cause extreme credit rationing and precipitous price falls," Joye says.According to a former chief economist of the International Monetary Fund, Simon Johnson, Australia's big banks pose a bigger risk to the economy than the biggest US banks do. Johnson thinks no single bank should own assets (mainly housing, small business and corporate loans but also derivatives and other investments) worth more than 4 per cent of a country's economic output.
Yet NAB owns assets equal to 54 per cent of Australia's GDP, followed closely by CBA 51 per cent) and Westpac (49 per cent).Even the bank with the fewest assets, ANZ (42 per cent) is almost three times the size, in relative terms, of the biggest US bank, Bank of America (which owns assets worth 15.6 per cent of US GDP)."One of the lessons of the global financial upheaval was that sometimes simple is best – and mutuals are very sound, with straightforward balance sheets, conservative funding, high-quality assets and high capital," she says. "Global collapses and bail-outs were about very big, very complex, aggressive and 'creative' institutions."For this reason, Rismark's Joye is more concerned about the overseas expansion of ANZ and NAB than he is about a collapse in house prices."The major banks' peers in the UK and Europe had far greater direct exposures to the US sub-prime crisis through their overseas expansion strategies," he says."My single greatest concern with the major banks right now is their offshore expansion plans, which directly undermine their greatest source of strength during the GFC."Like Joye, Keen is also cool on a size cap, believing banks would successfully lobby it away during stretches of economic and political stability. He favours a cap on the size of home loans instead – equal to 10 times the rental income from a property – and other measures to reduce demand for credit in the first place.Of course, the failure of a big bank is still an unlikely, if no longer a preposterous, idea. According to John Laker, chairman of the Australian Prudential Regulation Authority (APRA), the main bank regulator, the big banks would survive a Chinese and global economic downturn severe enough to raise unemployment to 11 per cent and lower house prices by 25 per cent.However, as Laker admits, a future downturn will "not play out as specified" in APRA's so-called "stress-test". "It is just one of a myriad of future possible outcomes," he said in early June.Among clear lesson of the global financial crisis is that the unlikeliest outcomes become possible in a crisis. After all, the best computer models said US house prices would fall by 20 per cent only once every 10,000 years.
